As we’ve previously discussed, the Georgia Department of Banking and Finance had proposed to modify the way in which loans to related entities are treated, among other changes.  No material changes to the proposed rules have been made, and the new final rules are effective on September 7, 2009.  The new final rules are available from the DBF’s website.

The new rules, effectively consolidating many related party loans, may cause the consolidated relationships to become in technical violation of Georgia’s loans to one borrower rule upon renewal.  However, the DBF, in recognition of the current economic environment, has allowed for a transitional phase for loans that were previously made and separately remain in compliance with the DBF’s prior rule on an unconsolidated basis.  Those loans should be reworked to comply with the new regulations if feasible, but will otherwise be treated as grandfathered under the prior rules.  So long as such loans are modified or renewed by the bank without any additional extension of credit, the loans will not be cited for a violation of the Georgia legal lending limit.

The DBF has NOT provided any relief from loan to one borrower issuers in the context of declining legal lending limits due to reduced capital.  Under the Georgia regulations, where the bank’s statutory capital base is reduced for any reason, existing debt which was in conforming with the legal limitations at the time it originated are not construed to be non-conforming with new legal limitations resulting from the reduced statutory capital base.  However, extensions, renewals and rollovers are generally considered to be a new loan, and must conform to the new, lower lending limitations.

In the current economic environment this places banks in an untenable situation because borrowers are unable to pay off the loans due to a lack of liquidity and no other financial institutions are willing to take over the credits.  There are few options left for a bank in such a situation; e.g., enter into some sort of forbearance agreement with the borrower.  The result of that, however, is that after 90 days the loan will need to be downgraded to substandard, regardless of whether the borrower is able to keep interest payments current.  We have had extensive discussions with the Georgia DBF on this issue, focused on the OCC rules, which permit extensions or renewals in this situation.  However, the Georgia DBF has stated that it will not modify its position at this time.

The Georgia DBF has offered the following explanation of the modification to the legal lending limit and the permitted actions for grandfathered loans.

The primary purpose for the rule change is to clarify and modify the way in which loans to related entities are treated. As you know, the previous rule allowed loans to related entities to exceed the legal lending limit in aggregate if separate sources and uses of funds could be demonstrated. The related entities may have demonstrated separate sources and uses of funds prior to and at the time of loan origination, but in the current environment, many of these entities are now commingling funds in order to meet their obligations or looking to a common repayment source such as a guarantor, which will place the borrower(s) in violation when it comes time for renewal.

The new rule does not change the State lending limits, but it does change the way the Department looks at related entities. In short, the new rule is meant to mirror that of national banks in regards to defining related entities. Now, the focus will not be primarily on sources and uses of funds, but instead on common ownership (common enterprise). In simplistic terms, if the entities are related, then the debts are aggregated. This should eliminate the egregious practice of “stacking” loans that has been problematic at a handful of our banks.

Going forward, the Department will allow for a transitional phase for those related loans and borrowers that are in excess of revised Rule 80-1-5, but were in compliance with the former “sources and uses” rule. Basically, the Department will now take the position that if loans to related entities were previously in compliance with the former “sources and uses” rule and such loans are modified or renewed by the bank without any additional extension of credit, such loans will not be cited for a violation of the Georgia legal lending limit. Loans that originated under the previous rules will be grandfathered in accordance with the terms of the loan. New loans originating after the date of the adoption of the rules would be expected to comply with the new requirements.

Please note that this transitional period has no effect on how the Department treats classifications, restrictions that have been put in place under enforcement actions, or the problem that banks are facing with shrinking legal lending limits due to declines in capital.

It is also important to note that this transitional period is based on the Department’s recognition of the current challenging environment; therefore, there is no fixed time period. However, when a loan can be re-worked to bring it into compliance, it should be brought into compliance.