of the last sentence of the first paragraph on page 4 of its statement the Board inadvertently omitted the words "the bank's files." Should this proposed legisla tion be enacted it would be the duty of our examiners in cases where there were certifications by bank officers to ascertain that the bank's files or the knowledge of its officers of the financial condition of each maker is in fact reasonably adequate. In a case where this could not be done to the satisfaction of the bank examiner the obligations in question would be included in the line of credit of the dealer, and the loan set up as excessive.

To sum up, under exception 2 of existing law national banks may purchase from a dealer unlimited amounts of negotiable installment consumer paper endorsed by the dealer without any requirement that such paper be secured. Under exception 13 a bank will be able to do so with respect to such paper only if it has the required certification on file, and with such certification it I will also be able to do so with respect to nonnegotiable paper, usually conditional sales contracts which, as indicated above, in many instances provide protection to a lender superior to that provided by the element of negotiability.

Loans on real estate security.-The Board of Governors expresses doubt with respect to the advisability of section 4(d) of H.R. 6092, which would permit national banks to make working-capital loans and to take mortgages on the borrower's real estate without such loans being considered as real estate loans. In this connection it should be pointed out that in a letter dated March 25, 1959, with respect to an identical proposal made by the Treasury Department, the Board advised the Bureau of the Budget as follows:

"Sections 1, 3, and 4 of the Treasury draft were included among the proposals submitted by the Comptroller to the Senate Banking and Currency Committee in 1956 for inclusion in the then proposed Financial Institutions Act of 1957. The Board in its report of October 19, 1956, to the Senate committee stated that, since these proopsals appeared to be peculiarly within the scope of operations of the Comptroller's Office or to have no material significance insofar as the functions and responsibiilties of the Federal Reserve System were concerned, the Board had no comment to offer.

The Board now states that section 4(d) constitutes "a major departure from a basic principle of banking." We do not believe that this proposal represents any departure from basic principles of banking. This proposal merely recognizes that the loans referred to are in fact commercial loans which are not predicated upon the value of real estate.

In the table which we have furnished to the committee concerning State laws regarding the percentage of appraised value which State banks may lend against real estate security, there are listed 17 States which contain no such statutory limitations. It is this facet of the present Federal law that most frequently prevents national banks from taking mortgage security on manufacturing or industrial plants. In addition, the State of Michigan has a statute, adopted in 1958, which states that:

"Loans made to industrial or commercial business where the bank looks for repayment out of the operations of the borrower's business, relying primarily on the borrower's general credit standing and forecast of operations, with or without security, but wishes to take a mortgage on the borrower's real estate as a precaution against contingencies, shall not be considered as real estate loans within the meaning of this section but shall be classed as ordinary commercial loans."

The State of New Jersey has a statute which provides that:

"A loan secured by a mortgage upon real property or upon a lease of the fee of real property shall not be deemed a mortgage loan for the purposes of this article if such loan shall be warranted by—

"(1) the financial condition of one or more persons directly or indirectly obligated for the repayment of such loan, or

"(2) the financial condition of one or more persons directly or indirectly obligated for the repayment of such loan and other security given to the bank for the payment of such loan, or

"(3) other security given to the bank for the payment of such loan." The State of Ohio has a statute which provides that:

"Loans made to established industrial or commercial businesses which are in whole or in part secured by real estate are not subject to this section with respect to the percentage which the loan shall bear to the appraised value of the real estate. The provisions of any such loan shall require the reduction of the

principal amount of the loan within 3 years after the making of such loan to an amount within the limits, in terms of such percentage of such appraised value at the time of making such loan."

We have no doubt that a perusal of the statutes of other States would disclose similar provisions permitting loans of this type to be treated as commercial rather than real estate loans.

This office does not agree that enactment of section 4(d) "could lead to a tendency" to consider all business loans supported by real estate security as loans based on the general credit of the borrowers. Under its terms it would be confinied to loans made to manufacturing and industrial businesses where the bank looks to repayment out of the operations of the borrower's business, relying primarily on the borrower's general credit standing and forecast of operations. This merely recognizes the fact that loans of this type are in fact not real estate loans, since they are not based upon the value of the real estate.

In the event a bank had to foreclose upon the property it would be faced with the problem of trying to find another manufacturer to operate the plant, and if it could not do so the plant would have only salvage value.

A mortgage on a manufacturing or industrial plant does, of course, furnish additional safeguards to a lending bank. It has both tangible and intangible values. Enactment of this statute permitting national banks to take mortgages on industrial plants in connection with working capital loans would, we believe, enable banks to make loans to small manufacturers that they might otherwise not be willing to make.

Restrictions on payments of dividends.-The Board suggests that the change which enactment of section 22(a) would make in section 5204 of the Revised Statutes (12 U.S.C. 56) would produce inequitable results in some situations, and it cites examples in support of its conclusion.

The Board's comments misconstrue the purpose and substance of the change which would be made. The Board states that presumably the purpose of the proposed new sentence is to give greater freedom, with respect to dividends, to a national bank that has built up its surplus account until that account exceeds the amount of its capital stock. The fact is that the change in language in section 5204 is not designed to, and does not make any substantive change in existing law, but is designed to clarify and make intelligible the language of Revised Statutes, section 5204. We have consistently interpreted the words "net profits then on hand" as used in section 5204 to include all capital funds exclusive of (1) the actual capital account, (2) that portion of the surplus account which is equal to the common capital account, and (3) reserve for contingency accounts. In other words, we have taken the position that that portion of the capital structure accounts which constitute net profits legally available for payment of dividends consists of (1) the portion of the surplus account which is in excess of the amount of the common capital account, and (2) its undivided profits account. With respect to reserves we have taken the position that a board of directors is free to transfer all or any portion of a reserve for contingencies account to the undivided profits account, but that such a transfer should not be made on an unsound basis.

Thus it will be seen that the proposed change would state explicitly the exact position that the Comptroller has maintained for many years as the correct interpretation of existing law. This is fully set forth in paragraph 6305 of the "Digest of Opinions of the Office of the Comptroller of the Currency Relating to Operations and Powers of National Banks," which is furnished to every national bank for its guidance. A copy of this paragraph is enclosed for your convenience.

(Par. 6305, referred to above, appears at the close of this letter.)

Under these circumstances it is readily apparent tht the examples cited in opposition to the change could be cited equally in opposition to the existing law. This law has remained substantially unchanged since its original enactment in 1864, but problems of this nature have not arisen. The truth is that there is no practical inequity problem involved as bankers never lose sight of the need to maintain flexibility in undivided profits and reserves so as to assure continued ability to pay justifiable dividends. During the many years the Comptroller has interpreted the present provisions of R.S. 5204, in this manner, to our knowledge no national bank, nor any State bank member of the Federal Reserve System, has experienced any difficulty in paying a dividend that could be warranted in the light of its condition and undivided profits available for such purpose. The adverse examples cited by the Board of Governors of the Federal Reserve Sys

tem simply have not occurred over many years in the past. We are positive that national banks will not find the proposed amendment detrimental to the interests of their shareholders.

The suggestion of the Board that if section 22(b) of H.R. 6093 is adopted, the limitations of R.S. 5204, will be unnecessary we do not believe should be adopted. The purpose of section 22 (b) is to prevent a national bank from paying excessive dividends in any 1 year. It would prohibit the payment of dividends exceeding net profits over a 3-year period, whereas the determination of whether dividends may be paid under R.S. 5204 depends upon the current situation of the bank. Section 22(b) does not take cognizance of statutory bad debts as does R.S. 5204. We believe it to be essential that before payment of dividends there should be prior elimination of bad debts from net profits and reserves on hand. We would not recommend the elimination of R.S. 5204.

For the reasons stated we believe that the reservations expressed by the Board are not warranted, and that the suggestions made by the Board of Governors of the Federal Reserve System should not be adopted by the committee. We urge the enactment of H.R. 6092 and H.R. 6093 modified as suggested in our testimony and that of the Federal Deposit Insurance Corporation.

Very truly yours,

L. A. JENNINGS,

Acting Comptroller of the Currency.

C. DIVIDENDS

6305. Legality of declaration and payment of dividends

The principal problem for national bank directors to consider in determining the legality of a proposed dividend is the question what constitutes "undivided profits then on hand" or "net profits of the association" as used in R.S. 5204 and R.S. 5199 (12 U.S.C. 56, 60). R.S. 5204 reads, in part, as follows:

"If losses have at any time been sustained by any such association, equal to or exceeding its undivided profits then on hand, no dividends shall be made; and no dividend shall ever be made by any association, while it continues its banking operations, to an amount greater than its net profits then on hand, deducting therefrom its losses and bad debts."

A bank's "undivided [or "net"] profits then on hand" include all capital funds exclusive of (1) the actual capital account, (2) that portion of the surplus account which is equal to the common capital account, and (3) reserve for contingency accounts. In other words, the following capital-structure accounts constitute a bank's profits which are legally available for payment of dividends: 1. That portion, if any, of the surplus account which is in excess of the amount of the common capital account.

2. The undivided-profits account.

A bank's "Reserve for Bad Debts," or its unallocated charge-off account against loans, may be used only to absorb "statutory bad loans" (see Paragraph 6330) and loan losses, thereby freeing a correspondingly larger portion of the undivided profits, as constituted by the two accounts enumerated above, for the payment of dividends after deducting therefrom any remaining statutory bad debts and losses. However, the "Reserve for Bad Debts" and unallocated charge-off accounts against loans are not "undivided profits then on hand" in the sense that they constitute funds out of which dividends may be paid.

An unallocated charge-off account against bonds occupies the same position as a similar account against loans. It is available for use only in absorbing statutory bad bonds or bond losses, and does not constitute "undivided profits then on hand" out of which dividend payments may be made.

Reserves for Contingencies may be used to absorb statutory bad debts or losses in the assets against which they have been earmarked, or, if not earmarked, statutory bad debts and losses of any character; but they do not constitute "undivided profits then on hand" out of which dividend payments may be made. A board of directors is free to transfer all or any portion of a Reserve for Contingencies account to the undivided-profits account, but such a transfer should not be made on an unsound basis for the purpose of legalizing the payment of a dividend that otherwise would be illegal.

Depreciation reserves against Banking House or Furniture and Fixtures, and reserves or unallocated charge-offs for the amortization of bond premiums, are not involved in computing a bank's "undivided profits then on hand" for dividend-legality purposes. Neither is an unallocated charge-off against Other

Real Estate, except to the extent that it absorbs losses in the other-real-estate account.

The following examples may clarify the foregoing discussion :

1. Capital

Net profits on hand

Less reserve for bad debts

6,000

15, 000

In this case, payment of dividends in any amount would be unlawful, as net loan losses exceed the Net Profits on Hand.

In this case, payment of dividends in any amount would be unlawful, as net losses and statutory bad debts fully absorb the Net Profits on Hand.

In this case, the bank could legally declare a dividend not in excess of $10,000 (that is, Net Profits on Hand less net losses), assuming one-tenth of net profits for the preceding half year had been transferred to Surplus prior to the above computations; see Paragraph 6310A.

In this case, the bank could legally declare a dividend of $45,000, representing the remaining Net Profits on Hand after deducting the $105,000 of statutory bad loans and loan losses not provided for by the Reserve for Bad Debts and Unallocated Charge-Off.

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In addition to the foregoing, it should be borne in mind that no dividends may be declared or paid on common stock until cumulative dividends on any outstanding preferred stock have been paid in full (section 302 of the Act of March 9, 1933; 12 U.S.C. 51b), and that no dividends may be paid if the bank is in default on the payment of any assessment due to the Federal Deposit Insurance Corporation (section 18 (b) of the F.D.I. Act; 12 U.S.C. 1828 (b)).

STATEMENT OF THE CHAMBER OF COMMERCE OF THE UNITED STATES TO A SUBCOMMITTEE OF THE HOUSE BANKING AND CURRENCY COMMITTEE ON H.R. 6092 AND H.R. 6093

The Chamber of Commerce of the United States urges enactment of H.R. 6092 which would amend the lending and borrowing limitations currently applied to national banks and would authorize the appointment of two additional Deputy Comptrollers of the Currency. The National Chamber also supports H.R. 6093, which would amend the national banking laws to clarify or eliminate obsolete and ambiguous provisions.

The National Chamber supported provisions in the Financial Institutions Act of 1957 which would have amended the regulations on lending limits of national banks. These provisions, now embodied in H.R. 6092, are designed to remove restrictions of present law which have come to handicap national banks in aiding the special financial problems in several business fields of broad economic importance-frozen food, dairy cattle and real estate development. The liberalization and modernization of present laws pertaining to real estate loans by national banks as proposed by H.R. 6092 is of particular urgent necessity. The laws are antiquated in the light of modern industrial development practices. Massive shopping centers and new plants require firm commitments from responsible lenders to take permanent loans with the resulting problems of providing working capital loans under term-loan agreements. Furthermore, the present restrictions on the total amount of construction loans a bank may legally make is unrealistic in view of other safeguards and present-day construction costs.

The change proposed in H.R. 6092 will allow national banks to compete with State banks in the financing and construction of industrial and commercial facilities and preserve the dual system of banking.

The National Chamber also approves the following liberalized provisions in national bank operations as contained in H.R. 6092, that would—

1. Increase from 10 percent to 25 percent of capital and surplus the amount of obligations which may be acquired from a single borrower if