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Supervision News Flash

March 2019

Regulation U: A Few Reminders

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Not all regulations come into play for a bank with the same frequency. This may be due to limited exposure or the infrequency of conducting transactions subject to certain regulations.  One such case is Regulation U, which provides requirements related to margin stock lending. We periodically get questions about this regulation, so we wanted to take a moment to revisit the regulation as a reminder in case your bank has, or may have, a loan subject to Regulation U.  Regulation U establishes maximum loan-to-value (LTV) requirements for loans secured by margin stock, requires bankers to complete the applicable form, the FR U-1 (U-1), and requires maintaining the U-1 form in the loan file.

Margin stock includes any equity security registered on a national securities exchange, such as the New York Stock Exchange or the American Stock Exchange, any over-the-counter (OTC) security trading in the Nasdaq Stock Market's National Market, any debt security convertible into a margin stock and most mutual funds.

If the collateral you are taking to secure a loan meets the definition of margin stock, lenders must determine whether the loan is a purpose loan or a non-purpose loan. The regulation is applicable regardless whether a lender directly engaged in the original transaction or acquired the loan indirectly after origination, such as purchasing the loan or a participation. Purpose loans are those made for the express purpose to fund the borrowers purchase or holding of margin stock.  For a loan secured by margin stock where the purpose was not to purchase or to carry the margin stock, the loan would be a non-purpose loan. 

Requirements under Regulation U vary between purpose and non-purpose loans when the loan amount is greater than $100,000. Purpose loans are limited to a 50 percent LTV ratio at origination and require all sections of the U-1 form to be completed. Non-purpose loans do not have any LTV requirements and would only require completing the purpose statement on the U-1 form. In either situation, both the lender and borrower should sign the U-1 form, keep the form with the loan file and retain it for three years after the loan is paid-off.

The regulation was designed to limit the inherent risk of loans that have the purpose of using leverage to purchase stocks. These purpose loans have increased credit risk arising from the volatility in the value of the collateral repayment source. When non-purpose loans use margin stock to secure the loan, losses could be incurred if the expected repayment source is the collateral. Therefore, it is important for lenders to be mindful of the expected repayment source and structure the loan appropriately.

More details on the requirements for loans secured by margin stock are included in Regulation U and the Federal Reserve’s Compliance Guide for bank lenders. The regulation also covers the requirements for nonbank lenders. If you have questions about how to apply Regulation U to a specific scenario or general questions, feel free to reach out to your portfolio analyst or Central Point of Contact here at the Richmond Fed.

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