05-2

05-2

January 13, 2005

Re: Lending Limits and Ineligible Personal Property

Dear Mr. ________:

This responds to your letter of December 10, 2004 in which you requested our legal opinion regarding the eligibility of specific personal property as security for a proposed credit commitment.

You have requested that we express our opinion regarding two separate credit proposals. The collateral of the first credit proposal relates to Anheuser-Bush franchise and distribution rights in Butte County, and the collateral for the second relates to lumber and associated accounts receivable. I will discuss the second question first.

The Commissioner has declared several classes of personal property to be ineligible. When determining whether collateral is eligible, the Commissioner weighs the practical considerations of how easily removed or transferred the property is and how readily identifiable it is. DFI has declared assigned accounts receivable, whether or not taken on a notification basis, and inventory to be ineligible collateral; therefore, the loan collateralized by the lumber and accounts receivable does not meet the requirements of Section 1223.

I will now address the first question regarding Anheuser-Bush franchise and distribution rights. First, there are two aspects of Section 1223: (1) whether the collateral has been declared ineligible and (2) if it is eligible, it must have a market value at least 15% greater than the amount of the obligation. Among the collateral types considered ineligible are assigned contracts covering services which are to be, or have been, performed. You have not provided us with enough information to distinguish franchise and distribution contracts from other service contracts so that we may make a determination with respect to their eligibility. We need to consider the rights and obligations of the parties to the franchise agreement, as well as the bank’s rights and duties after foreclosure, to be able to make an appropriate determination. Please present us with the legal arguments and points of authority that support your contention that these rights are eligible collateral. In addition, please forward to us a copy of the franchise and distribution agreement and a copy of all pertinent loan documents so that we may provide you with our opinion regarding Section 1223 eligibility.

With respect to the second aspect, even if we determine that the contracts are eligible to be collateral, we need to consider whether the Section 1223 test is met. To qualify as eligible collateral it must exceed the amount of the credit by at least 15 percent, based upon a valid appraisal, and the bank’s lien position must be protected against the claim of third parties. If the bank can support its valuation of and lien position against the collateral, these requirements could be met. The actual rights that the bank may foreclose against are of particular importance. It is critical that the appraisal be of the specific rights that the bank will own after foreclosure. If the collateral is not easily removed or transferred and is readily identifiable, the crux of the question then relates to the bank’s contractual relationship with Anheuser-Bush, should foreclosure ever be required. Questions such as the following must be addressed: Will the bank step into the same position as its borrower? Or, will it be in some less favorable position? If the franchise and loan documents will place ownership of the franchise and distribution rights in the hands of the bank after foreclosure, such that the bank is free to sell those rights in the open market, and the valuation requirement as stated above is met, then the collateral may meet the requirements of Section 1223.

You have stated that you consider this credit secured unless DFI instructs you otherwise. Please be aware that you risk violating the Financial Code if you fail to provide evidence that the collateral should be considered eligible under Section 1223.

Very truly yours,

PAUL T. CRAYTON

Staff Counsel

PC:acp

December 10, 2004

Mr. Scott Cameron

Department of Financial Institutions

1810 13th Street

Sacramento, CA. 95814

Subject: Lending Limits and Ineligible Personal Property

Dear Mr. Cameron,

The purpose of this letter is to formally request the Department of Financial Institutions’ (DFI) legal opinion regarding the eligibility of specific personal property as security for a proposed credit commitment. The bank has proposed a credit commitment to a local, financially sound, beer wholesaler in our market area. The credit proceeds will be utilized to purchase Anheuser-Bush franchise and distribution rights in neighboring Butte County. The franchise and distribution rights retain significant and highly marketable economic value, and will represent a large portion of the bank’s security. The market value of the franchise rights is fully supported with quantitative analysis.

Our question is whether we should apply the bank’s lending limits to this proposed credit extension on a secured or unsecured basis? Financial Code Section 1223 states that the commissioner may declare any particular kinds or classes of personal property ineligible as security. Legal opinion letters posted on the DFI’s website do not specifically exclude this asset class; however, prudence dictates our request for your opinion regarding application of Section 1223.

In addition, while evaluating the above matter, a lumber wholesaler’s operating line has also come into question. The line of credit (LOC) is primarily secured with lumber and accounts receivable. Management considers this credit fully secured for lending limit purposes and closely monitors the performance of the LOC via the following loan covenants:

· Monthly Borrowing Base Certificates

· Quarterly Financial Statements

· Annual CPA Audited Financial Statements

· Independent Annual Inventory and A/R Audits including Client Confirmation

Although this credit relationship has been reviewed at the previous two Safety and Soundness Examinations, we request regulatory confirmation. We shall consider this credit secured unless your department instructs the bank otherwise.

Your prompt response on these matters is greatly appreciated.

Respectfully,

Patrick J. Moly

Senior Vice President

and Chief Credit Officer