that plaintiff lacked standing, an argument the Court accepted with respect to AAI but rejected as to AIA. American Insurance Association v. Selby, 624 F. Supp. 267 (D.D.C. 1985). The pending cross-motions for summary judgment then followed.
Plaintiff attacks the Comptroller's decision on three grounds. First, it argues that the activity at issue here is not included among the express powers enumerated by section 24 (Seventh) of the National Bank Act, and does not fall within the reach of the "incidental powers" clause of the Act as that clause has been construed by the courts. Accordingly, plaintiff contends, municipal bond insurance is an activity that exceeds the authority of a national bank. Second, plaintiff argues that Citibank's standby credit is at bottom a promise to answer for the payment of the debt of another, if the person liable in the first instance fails to make payment, and as such is an impermissible guarantee under the National Bank Act. Finally, plaintiff claims that Citibank's proposal raises a substantial question as to whether or not the bank's holding company, Citicorp, is in violation of the BHCA by virtue of the subsidiary's insurance activity. Plaintiff contends that the Comptroller should have conditioned its concurrence on the Federal Reserve Board's resolution of that question and that, in view of the Comptroller's failure to do so, this Court should enjoin Citibank's insurance activity in order to preserve the Board's jurisdiction over the matter. The Court addresses each of these contentions in turn.
A. The Business of Banking
Plaintiff correctly notes that Citibank's subsidiary, like Citibank itself, may exercise only those powers either expressly conferred by the National Bank Act,
or those "incidental powers . . . necessary to carry on the business of banking." 12 U.S.C. § 24 (Seventh). Plaintiff argues that the Act itself contains no provision authorizing banks to engage in general insurance underwriting activities, much less municipal bond insurance, thus the subsidiary's activity is permissible only if it fits within the "incidental powers" clause. That clause has been defined as encompassing those activities "directly related to" and "convenient or useful" to the performance of customary and expressly authorized banking services. M&M Leasing Corp. v. Seattle First National Bank, 563 F.2d 1377, 1382 (9th Cir. 1977), cert. denied, 436 U.S. 956, 57 L. Ed. 2d 1121, 98 S. Ct. 3069 (1978); Arnold Tours, Inc. v. Camp, 472 F.2d 427, 431-32 (1st Cir. 1972). The only expressly authorized banking services that municipal bond insurance could conceivably be related to, plaintiff contends, are the power to "loan money on personal security" and to purchase municipal debt securities for the bank's own account. 12 U.S.C. § 24 (Seventh). According to plaintiff, however, the subsidiary's activity is neither directly related nor convenient to a bank's lending function, but is instead a radical departure from that customary activity which places Citibank squarely in the business of insuring rather than lending. Plaintiff argues that as a lender, a bank grants a borrower, such as a municipality, the temporary use of its funds in exchange for a payment of interest. In so doing, of course, the bank assumes a risk of nonpayment. To safeguard against this risk, the bank not only assesses the creditworthiness of the borrower, but because such assessments are not infallible, the bank also fixes its interest rates at levels calculated to permit a reasonable profit even if some defaults occur. Nonetheless, the bank's principal compensation is the payment of interest, which reflects the market price for the use of its funds, not a risk premium. Here, plaintiff insists, the fee Citibank's subsidiary will receive for its insurance is unmistakably a risk premium. Under the proposal, the subsidiary is not a lender since it advances no funds to the municipality; instead, it is in the position of a borrower obliged to repay the true lenders -- the municipal bondholders -- in the event of a default. The mere fact that the subsidiary undertakes a credit analysis is, in plaintiff's view, irrelevant. Such an undertaking is customary in property and casualty insurance, and in no way alters the fact that the subsidiary's compensation is an insurance premium, calculated on the basis of the bank's underwriting judgment concerning the likelihood of default.
Plaintiff's argument proceeds from a narrow and artificially rigid view of both the business of banking and the statute that governs that business, a view that the Comptroller, and this Court, reject. Whether or not the five enumerated powers set out in the National Bank Act are an exhaustive list or, as some commentators have argued, merely illustrative, see, e.g., Symons, The "Business of Banking" in Historical Perspective, 57 Geo. Wash. L. Rev. 67 (1983), the Court cannot accept plaintiff's cramped and simplistically literal interpretation of the banking industry's lending power. At bottom, "the business of banking reduces to the provision of financial support for the transactions of others." Letter from James E. Smith, Comptroller of the Currency, [1973-78 Transfer Binder] Fed. Bank. L. Rep. (CCH) P96,301 at 81,417. Banks can and do provide such support by means other than direct loans of their own funds. As then Judge Cardozo explained over fifty years ago, the business of banking involves the substitution of the "[bank's] own credit, which has general acceptance in the business community, for the individual's credit, which has only limited acceptability . . . . It is the end for which a bank exists." Block v. Pennsylvania Exchange Bank, 253 N.Y. 227, 170 N.E. 900, 901 (N.Y. 1930). Indeed, the extension of credit on both a secured and unsecured basis is such a long-standing practice under the National Bank Act, see e.g., The Third National Bank v. Blake, 73 N.Y. 260, 263 (Ct. App. 1878); National Bank v. Case, 99 U.S. 628, 633, 25 L. Ed. 448 (1878), that credit is today viewed as one of "the principal banking 'products.'" United States v. Philadelphia National Bank, 374 U.S. 321, 326 n.5, 83 S. Ct. 1715, 10 L. Ed. 2d 915 (1963). Banks provide this "product" in a variety of forms not specifically enumerated in the Act: they offer irrevocable lines of credit, standby and mercantile letters of credit, and check guaranty and credit card programs. See e.g., 12 C.F.R. §§ 7.7017, 7.7016, 7.378, 32.3 (1985).
The question then is not, as plaintiff couches it, whether the National Bank Act expressly authorizes banks to engage in the municipal bond insurance business, or whether that business is directly related and useful to what plaintiff narrowly conceives as the lending function -- i.e. the direct advance of funds to a borrower. Rather, the question is whether the Comptroller correctly found that the issuance of standby credits in the form of municipal bond insurance is a basic credit transaction permissible under the Act. Applying its particular financial expertise, the Comptroller determined that, notwithstanding their name, the standby credits at issue here are the functional equivalent of standby letters of credit, and are thus a permissible extension of credit in the form of an advance commitment to honor a customer's obligations in the event the customer defaults. As that determination is neither erroneous nor arbitrary and capricious, the Court will not disturb it.
While plaintiff and amici expend considerable effort demonstrating that national banks are not permitted, with certain exceptions, to sell or underwrite insurance, there can be no serious quarrel with the Comptroller's assertion that it is entitled to look beyond the label given a certain activity to determine whether or not it is permissible. "The validity of the commitments undertaken in a particular [financial] instrument . . . cannot rationally be ascertained or tested by mere examination of the label that the instrument bears." H. Harfield, Bank Credit and Acceptances (5th ed. 1974) (hereinafter "Harfield") at 164-65. Indeed, in M&M Leasing Corp. v. Seattle First National Bank, 563 F.2d 1377 (9th Cir. 1977), the Ninth Circuit determined that national banks were permitted to lease motor vehicles and other personal property because the leases at issue were "functionally interchangeable" with secured loans. Id. at 1383. The court stressed that this "functional interchangeability" was the "touchstone" of its decision, and noted that "whether third parties in other contexts should treat leases that are equivalent to loans as nonetheless distinct and separate . . . should not influence our opinion in this case." Id. Here, the Comptroller determined that the subsidiary's standby credits are "functionally equivalent" to standby letters of credit, which are a well-recognized form of credit. Generally, a credit is:
an original undertaking by one party (the issuer) to substitute his financial strength for that of another (the account party), with that undertaking to be triggered by the presentation of a draft or demand for payment and, often, other documents. The credit arises in a number of situations, but generally the account party seeks the strength of the issuer's financial integrity or reputation so that a third party (the beneficiary of the credit) will give value to the account party. The beneficiary extends credit by selling goods or services to the account party on credit, by taking the account party's negotiable paper, or by lending the account party money.
J. F. Dolan, The Law of Letters of Credit: Commercial and Standby Credits (1984) (hereinafter "Dolan") at para. 2.02. That is the essence of the transaction at issue here. The subsidiary, or issuer, will substitute its financial strength for that of the municipality, the account party, by promising to honor the municipality's obligations to bondholders in the event of a default. Because of this undertaking by the subsidiary, third parties will give value to the municipality by purchasing its bonds. The subsidiary's undertaking will be triggered by presentation of a demand for payment by the third party bondholders, either in the form of a notice of default or by simply presenting the bond itself after the date payment is due.
In its letter of concurrence, the Comptroller found that the subsidiary's standby credits satisfied all the criteria set out in the regulation governing letters of credit, save for the requirement that they be labeled "letters of credit."
It noted that the standby credits "are for a definite term, are limited in amount, obligate the operating subsidiary to pay upon presentation of a document . . ., and result in an unqualified obligation of its customer to reimburse the operating subsidiary for payments made to the beneficiary . . . ." Patriarca letter at 2; AR at 98. The Comptroller acknowledged that the standby credits were not denominated letters of credit, but observed that exceptions to this requirement have been made in the past and that, in any event, the substance of a transaction, rather than its label, should control.
The Comptroller further buttressed its conclusion that the subsidiary's municipal bond insurance activity is in fact a credit activity by noting that the subsidiary will issue standby credits on the basis of the municipality's creditworthiness, rather than on an actuarial judgment concerning the likelihood of default. While plaintiff argues that such credit assessments are common to casualty and property insurance as well, this argument misses the point. "Banking" and "insurance" are not mutually exclusive businesses; "from a functional point of view there is a considerable overlap between the [two]." Harfield at 184. Whether or not this overlap is, as some maintain, the result of the insurance industry's encroachment on the business of banking,
the essential fact here is that in issuing the standby credits, the operating subsidiary will assume that a default will occur and will therefore undertake a financial assessment of the municipal issuer, not an actuarial judgment. That insurers also engage in credit assessments in no way alters the fact that such an analysis lies at the heart of a bank's lending activities. Such an investigation into the issuer's creditworthiness is "a typical financial-judgment process similar to the ones the bank makes in any commercial-loan setting." Dolan at para. 12.03[b]. Indeed, the distinction between a credit and an actuarial assessment is precisely that which separates a letter of credit from a surety.
If the banker, in the exercise of his informed credit judgment, decides that his customer will be capable of making a money payment at a particular time and in a particular amount, then the banker is justified in undertaking to make that payment on behalf of the customer, and it is of almost no moment whether the commitment is in the form of a present advance of funds, an undertaking by way of an unconditional commitment to lend to the customer, or by way of a commitment to third parties to make the payment on behalf of the customer at the time and in the amounts specified. If, on the other hand, the banker assumes the role of a surety and makes a commitment on the assumption that his customer's mercantile capacity is such that the banker's commitment will not be called upon, that is neither sound nor appropriate banking practice.