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A bank appealed the OCC's decision to deny its proposed community development (CD) investment. The bank proposed to use a parcel of other real estate owned (OREO) and to make a no interest/no fee construction loan to its wholly-owned operating subsidiary. The operating subsidiary would complete the construction of a municipal office building on the parcel. The parcel was acquired as a result of the bankruptcy of the developer who had already developed a shopping center and parking garage on an adjacent lot. The bank acquired the entire project as OREO and separated it into two parcels. The second parcel included the municipal office building. A government entity agreed to purchase the office building upon its completion guarantee and a payment and performance bond in favor of the operating subsidiary. The project would provide the bank with a cash recovery of $4.5 million, which would partially offset a $7.7 million write-off the bank took on the original loan.
The OCC ruled that the proposal, as structured through its operating subsidiary, did not meet the requirements of 12 USC 24 (eleventh) and 12 CFR 24, and could be completed under part 34. The regulatory accounting for additions to OREO would normally be treated as additions to a bank's nonperforming assets instead of as "other assets." The bank's appeal states that the structure of the project was in large part dictated by the municipal government and its need to act within city guidelines and regulations. Bank management is puzzled that the OCC's denial letter suggests that such a project must be carried out through a Community Development Corporation (CDC). They read part 24 as providing national banks the option of undertaking CD investments either through a CDC or directly through the bank. Further, bank management believes that it is within the OCC's discretion to determine that the additional investment need not be classified as OREO. Although the accounting for the initial investment would retain its OREO status, the appeal requested that the additional investment be recorded as "other assets."
Bank management views its proposal as exactly the type of public purpose project envisioned by part 24. It benefits a depressed area that includes census tracts with some of the lowest median incomes in the United States. It creates jobs in this community, which has the highest unemployment rate in the city. It benefits minority and small businesses, and provides needed services by ensuring that the project will remain as an anchor in the community. It represents the largest commitment of CD financing and resources in the area. And it will serve as a catalyst for encouraging other business and residential development. If the safe and sound improvement of OREO can be used as a catalyst for economic development in a severely depressed area, bank management believes banks should be permitted to rely on the CD authority and accounting, rather than that of OREO, especially if the project does not involve speculative development of real estate.
Section 24 (eleventh) of the National Bank Act authorizes national banks to "make investments, subject to specified limits, designed primarily to promote the public welfare, including the welfare of low-and moderate-income communities or families (such as providing housing, services or jobs)". The statue authorizes banks to make the investments directly or by purchasing interests in an entity primarily engaged in making such investments. A bank may not make an investment that would expose it to unlimited liability. Part 24 of Title 12 of the Code of Federal Regulations implements section 24 (eleventh) and provides guidance as to what is a permissible public welfare investment. Specifically, the OCC has stated that it will consider a CDC or CD - project investment to be primarily designed to promote the public welfare if all of the following three criteria are met.
(1) The investment must primarily benefit low- and moderate- income (LMI) persons and families (such as by providing housing, services, or jobs) or small businesses, including minority owned businesses.
The project primarily benefits LMI persons, families, and small businesses. It will help stabilize a low-income community in the city. It will provide customers for small businesses and jobs for LMI persons. It will enhance the economic vitality of the community. The project will attract new businesses to the adjacent shopping mall because of the patronage of the employees of the municipal office tower. Patronage from the employees will help stabilize the shopping center and parking garage and preserve the viability of the businesses already located there. The bank submitted studies and economic plans for the community that envisions the project as the centerpiece for future development in the community.
However, current OCC policy requires that a bank's investment primarily benefit LMI persons, families, and small businesses by providing them with new and long-term benefits (such as housing, services, or jobs).
The bank's proposal was not clear how the investment in the municipal office tower would primarily benefit LMI persons or small businesses by providing long-term employment and business opportunities. During the appeal process, the bank clarified that even though its investment was in the municipal office building, the bank wanted consideration for the entire project, including the shopping center and garage. The bank also provided additional information that the entire project would provide long-term employment opportunities for low-and moderate-income persons and business opportunities for small businesses.
(2) The investment must address community development needs not met by the private market in one or more communities served by the bank, including, for example, the needs of low-and moderate-income areas, underserved rural communities, or government-designated redevelopment areas within a town, city, county or state.
The bank indicates that the proposed investment will be in an LMI area that has been underserved by the private market. The proposal indicates that the community has been an economically distressed area for many years. Much of the recent development in the community has been undertaken with government subsidy and substantial involvement of the nonprofit sector. Further, the project was initially undertaken by a profit-motivated entity that proved unsuccessful. The OCC concludes that the bank's additional investment in the municipal office tower, as part of the entire project, reflects its efforts to dispose of the OREO property.
(3) There must be non-bank community involvement in the CDC and CD project, indicating that the affected primary beneficiaries and representative of local or state government have endorsed and demonstrated support for the CDC or CD project activities.
Because the bank is developing OREO through a non-CD entity, the bank demonstrates an acceptable approach for ensuring non-bank community involvement through its operating subsidiary. Community support for the project includes partnerships with a local economic development organization and the president of the community government and the involvement of the city as the purchaser of the project. Because the project involves an operating subsidiary, the OCC considered alternative community involvement criteria.
As a policy matter, the OCC currently permits banks to undertake real estate development, directly, under the OREO regulation (part 34) and under the CD Investments regulation (part 24). In this case, because 90 percent of the project was being managed by the bank's operating subsidiary, it was more feasible for the OCC to permit the bank to complete the construction of the project through its operating subsidiary and to establish alternative community involvement criteria rather than requiring the bank to move the OREO property to its existing CDC.
Regarding the accounting for the transaction, classification as OREO is not a relevant issue under generally accepted accounting principles (GAAP). GAAP allows OREO to be included as part of "other assets" but requires a separate footnote disclosure if it is material. This disclosure would quantify the balance of foreclosed asset investments (inclusive of the additional project investment). The disclosure would include further narrative discussion of the nature of this particular investment, setting forth a discussion of the purpose of the additional investment and the existence of the contract to purchase from the city.
For regulatory reporting, schedule RC-M of the call report instructions states that all real estate other than bank premises be classified as OREO. Further, the instructions to schedule RC-F exclude from "other assets" real estate that is acquired in any manner for debts previously contracted. However, the call report instructions did not consider improvements to OREO such as those associated with the project. Accordingly, if the project qualifies as a permissible CD project, the bank may account for it as a CD "other asset." Specifically, the bank would classify it as an "asset held for short-term disposition."
The Ombudsman's Office decided to grant the bank's appeal. The ombudsman concluded that the bank's amended proposal to complete the project is a permitted public welfare investment consistent with the statute, regulation, and OCC policies. The bank may develop the project directly through its operating subsidiary rather than through a CD entity, such as its established CDC. Finally, the bank may carry its additional investment in the project under "other assets" instead of treating it as nonperforming assets. Consistent with GAAP a material amount of OREO should be disclosed as such on schedule RC-F of the call report.