It is possible that the loan can be grandfathered, provided that it did not violate Regulation O at the time it was made. If you are concerned about whether the loan originally complied with Regulation O, you should confirm that it was not made on preferential terms and did not exceed the applicable Regulation O lending limits. If the loan can be grandfathered (which we believe may be the case) and did not violate Regulation O when it was made, there should be no issues under Regulation O.  Please note, however, that we do not provide legal advice, and you may wish to consult further with your bank counsel.

Can the loan be grandfathered?

If the candidate was not an “insider” of the bank at the time the loan was made — i.e., that he or she was not an executive officer, director, principal shareholder, or a related interest — then it may be possible to grandfather the loan, meaning that it will not be treated as violating Regulation O. The OCC’s position is that “the requirements of Regulation O apply at the time a loan or extension of credit is made.” Thus, if the loans credit were made to the individual before he or she becomes an “insider,” the loans are grandfathered, provided they were made in good faith and not in contemplation of the individual’s becoming an insider. If those loans exceed the amount permitted by Regulation O for an insider, “they will be considered nonconforming rather than a violation of Regulation O.” Interpretive Letter 1096 (March 20, 2008). Of course, you should not make new loans or renew any grandfathered loans that would violate Regulation O.

The OCC’s letter cited above involved a borrower who was not an insider at the time the loan was made. A more complicated question arises if the borrower was an insider at the time the loan was made and later takes on an “executive officer” position. In that case, the loan may have complied with Regulation O’s general lending limit for insiders, but it likely exceeded the much more stringent lending limit for “executive officers,” which is $100,000 at most institutions. In that situation, we believe that the OCC’s reasoning still would apply, and the loan could be considered grandfathered. However, to be safe, you may wish to exclude the chairman from any major policymaking functions “by resolution of the board of directors or by the bylaws of the bank or company, from participation (other than in the capacity of a director) in major policymaking functions of the bank or company, [provided] the officer does not actually participate therein.” 12 CFR 215.2(e)(1).  

While we do not know the status of the candidate when the loan was made, we should note another grandfathering situation. If the candidate was an “advisory director” when the loan was made, the candidate would not have been considered to be an insider at that time, and the loan can be grandfathered for the reasons described in the OCC’s letter. An advisory director is not subject to Regulation O if he or she:

“(i) Is not elected by the shareholders of the company or bank;

“(ii) Is not authorized to vote on matters before the board of directors; and

“(iii) Provides solely general policy advice to the board of directors.” 12 CFR 215.2(d).

In any event, even if the loan can be considered to be grandfathered, you may want to check off the next two questions to confirm that the loan did not violate Regulation O when it was made. If the answer to both questions is “no,” then it will likely be found to comply with Regulation O.

Was the loan to the candidate made on preferential terms?

Regulation O requires any extension of credit to an insider to be made “on substantially the same terms (including interest rates and collateral) as, and following credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions by the bank with other persons,” provided that the loan “does not involve more than the normal risk of repayment or present other unfavorable features.” 12 CFR 215.4(a)(1). If the terms of the loan and your underwriting procedures were substantially the same as they are for any other customer, and there are no abnormal risks or unfavorable features, then move on to the next question. Or, if the loan was made as part of an employee benefit or compensation plan that is widely available to all bank employees, without giving preference to the chairman candidate, then move on to the next question. 12 CFR 215.4(a)(2).

Does the loan exceed the lending limits under Regulation O?

Under Regulation O, a general lending limit applies to all bank insiders, and a more stringent lending limit applies only to “executive officers.” If the chairman candidate was an insider when the loan was made, the general Regulation O lending limit applied: 15% of the bank’s unimpaired capital and unimpaired surplus, with an even higher limit applying to loans fully secured by “readily marketable collateral.” 12 CFR 215.4(c)12 CFR 215.2(i). Because that lending limit is so generous, it is unlikely that this loan exceeded it. Also note that advance board approval may have been required, with the borrower abstaining from any direct or indirect participation in the voting — prior approval is required for any extensions of credit over $500,000 (or 5% of your institution’s unimpaired capital and unimpaired surplus, if that is a lower amount). 12 CFR 215.4(b).

However, if the chairman candidate was an “executive officer” at the time the loan was made, the loan would have exceeded the applicable lending limit: $100,000 (or 2.5% of the bank’s unimpaired capital and unimpaired surplus, if that is a lower amount). 12 CFR 215.5(c)(4). An “executive officer” is defined as any person who has authority to participate in the bank’s major policymaking functions, such as “the chairman of the board, the president, every vice president, the cashier, the secretary, and the treasurer . . . .” 12 CFR 215.2(e).

There are several exceptions from the $100,000 lending limit for executive officers. It does not apply if the executive officer is properly excluded “by resolution of the board of directors or by the bylaws of the bank or company, from participation (other than in the capacity of a director) in major policymaking functions of the bank or company, and the officer does not actually participate therein.” 12 CFR 215.2(e)(1). And even if the borrower is an executive officer, the $100,000 limit does not apply to loans to finance the education of an executive officer’s children, loans to finance or refinance the purchase, construction, maintenance, or improvement of an executive officer’s residence, or loans secured by a perfected security interest in certain types of collateral (such as Treasury bills). 12 CFR 215.5(c)(1) – (3).