Regulatory Support for Banks Accepting Stock Warrants

Support for Banks Accepting Stock Warrants

Regulatory guidance supports national banks accepting stock warrants from clients under specific conditions, primarily governed by 12 C.F.R. § 7.1006.

Here’s a breakdown of the key aspects:

1. Legality of Accepting Warrants

• National banks can accept stock warrants as partial or full compensation in loan agreements, commonly known as an “equity kicker.”

• The warrants can be taken in lieu of, or in addition to, interest, but the bank cannot exercise them to avoid direct stock ownership concerns under Section 24(Seventh) of the National Bank Act.

2. Key Considerations for Acceptance

• Banks must not condition the borrower’s repayment ability on the performance of the warrants or underlying equity.

• Warrants must be incidental to banking activities, such as lending, and not a means of speculative investment

• A bank’s loss exposure must be limited, ensuring it does not hold open-ended liability for the issuing company

3. Handling and Disposition of Warrants

• If a bank wishes to dispose of the warrants, it can do so by:

• Selling the warrants directly.

• Exercising the warrants only if they are immediately sold (i.e., the bank never retains the shares).

• Ensuring the sale process aligns with securities law and banking regulations

4. Precedents and Interpretations

• The OCC has consistently upheld the right of banks to accept warrants under these conditions but strictly prohibits long-term ownership.

• Banks that take warrants must ensure they can withdraw their investment if the issuing company engages in activities not permissible for bank investments.

Conclusion

Banks can accept stock warrants, provided they do not speculate, exercise control, or expose themselves to undue risk. Instead, warrants serve as a tool for risk-adjusted return enhancements within structured financial arrangements.