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Nutter Bank Report, December 2010

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12.29.2010 | Legal Update

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1. Treasury Accepting Applications for Capital under Small Business Lending Program
2. Federal Reserve Proposes Cap on Interchange Fees
3. Federal Banking Agencies Issue Real Estate Appraisal Guidelines
4. Proposed Rules to Establish a Risk-Based Capital Floor and Revise Market Risk Standards
5. Other Developments: CRA and Dodd-Frank Consumer Protections

1. Treasury Accepting Applications for Capital under Small Business Lending Program

The U.S. Treasury Department has issued the terms, application materials and an application guide for its Small Business Lending Fund (SBLF) program, which will provide Tier 1 capital to qualified community banks with assets of less than $10 billion. According to the summary of terms released on December 22, Treasury will provide participating banks with capital by purchasing Tier 1-qualifying preferred stock or equivalents from each bank or holding company. Treasury is still developing terms and guidance for mutual institutions and Subchapter S corporations. Insured depository institutions (not controlled by a holding company) with total assets of less than $10 billion and holding companies with total consolidated assets of less than $10 billion are eligible to apply for a capital investment from the SBLF. An institution currently on the FDIC problem bank list (or any similar list) or that has been removed from that list in the previous 90 days is not eligible. Generally, this will include any bank with a composite CAMELS rating of 4 or 5. Institutions that have total assets of $1 billion or less may apply for SBLF funding that equals up to 5% of risk-weighted assets. Institutions that have assets of more than $1 billion but less than $10 billion may apply for SBLF funding that equals up to 3% of risk-weighted assets. Treasury may require an applicant to raise separate matching funds from private, nongovernmental sources as a condition to receiving an SBLF investment. Such matched funding will need to be received either prior to or concurrent with Treasury’s SBLF funding. Generally, capital raised after September 27, 2010 may be included. Applications for institutions eligible to apply under the available terms should be submitted by March 31, 2011.

    Nutter Notes:  The SBLF was established by the Small Business Jobs Act signed into law earlier this year. The SBLF is designed to stimulate loans for small businesses by providing capital to community banks under terms that include incentives for participating institutions to increase small business lending. An SBLF investment may also be used to refinance preferred stock issued to the Treasury through the Capital Purchase Program (CPP) or the Community Development Capital Initiative (CDCI) under certain conditions. In general, the dividend rate on an SBLF capital investment will be reduced as the amount of the institution’s qualifying small business loans increases. The initial dividend rate will be, at most, 5%. If an institution’s small business lending increases by 10% or more over a baseline established prior to the investment, then the rate will fall to as low as 1%. If qualified lending does not increase in the first two years, however, the rate will increase to 7%. After 4½ years, the rate will increase to 9% if the bank has not already repaid the SBLF funding. The average of qualified small business lending reported by an applicant for the four quarters ending on June 30, 2010 will be the baseline against which subsequent lending is measured. Qualified small business lending will consist of commercial and industrial loans, owner-occupied nonfarm, nonresidential real estate loans, loans to finance agricultural production and other loans to farmers, and loans secured by farmland. However, any loan or group of loans to the same borrower (and its affiliates) with an original principal or commitment amount greater than $10 million or to a borrower with more than $50 million in revenue will not be considered a small business loan. The federal banking agencies have also issued underwriting standards for small business loans originated under the SBLF.

2. Federal Reserve Proposes Cap on Interchange Fees

The Federal Reserve has proposed a rule to implement the debit card interchange fee and routing provisions of the Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act by capping interchange fees. The Federal Reserve released its proposed new Regulation II, Debit-Card Interchange Fees and Routing, on December 16. The new Regulation II would establish standards for determining whether a debit card interchange fee received by a card issuer is reasonable and proportional to the cost incurred by the issuer for the transaction. The Federal Reserve offered two alternative standards for consideration: an issuer-specific standard with a safe harbor and a cap and, in the alternative, a cap applicable to all covered card issuers. The standards would apply to card issuers that, together with their affiliates, have assets of $10 billion or more. Under the first alternative, the interchange fee standard would apply based on each covered issuer’s costs, with a safe harbor initially set at 7 cents per transaction and a cap initially set at 12 cents per transaction. The other alternative would be a stand-alone cap initially set at 12 cents per transaction. The proposed rule would also prohibit circumvention or evasion of the interchange fee limitations (under both alternatives) by preventing the issuer from receiving net compensation from a network for debit card transactions other than interchange transaction fees. The maximum allowable interchange fee received by covered issuers for debit card transactions under either of the proposed standards would be more than 70% lower than the 2009 average for interchange fees when the new rule takes effect, according to the Federal Reserve. Comments on the proposal are due by February 22, 2011.

      Nutter Notes: The Dodd-Frank Act amended the Electronic Funds Transfer Act to require that, effective on July 21, 2011, the amount of any interchange transaction fee that an issuer receives or charges with respect to an electronic debit transaction must be reasonable and proportional to the cost incurred by the issuer with respect to the transaction. The Dodd-Frank Act authorizes the Federal Reserve to prescribe regulations regarding any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction and requires the Federal Reserve to establish standards for assessing whether an interchange transaction fee is reasonable and proportional to the cost incurred by the issuer. Another element of the proposed rule would prohibit network exclusivity arrangements and routing restrictions. The proposal offers two alternatives to the rules prohibiting network exclusivity, as well. One alternative would require at least two unaffiliated networks per debit card, and the other would require at least two unaffiliated networks for each type of transaction authorization method (such as signature or PIN). Under both alternatives, the card issuers and networks would be prohibited from inhibiting a merchant’s ability to direct the routing of an electronic debit transaction over any network that may process such transactions.

3. Federal Banking Agencies Issue Real Estate Appraisal Guidelines

The federal banking agencies have issued new real estate appraisal guidelines to update and replace existing supervisory guidance to reflect changes in appraisal and evaluation practices. The Interagency Appraisal and Evaluation Guidelines (Guidelines) released on December 2 apply to all real estate lending functions and real estate-related financial transactions originated or purchased by a depository institution for its own portfolio or for assets held for sale. The Guidelines build on and replace certain existing supervisory issuances that address valuing real property, including the 1994 Interagency Appraisal and Evaluation Guidelines, the 2001 Statement on Appraisal Standards, the 2003 Interagency Statement on Independent Appraisal and Evaluation Functions, and the 2006 Revisions to Uniform Standards of Professional Appraisal Practice. The following real estate appraisal guidance documents continue to be in effect: the 2005 Interagency FAQs on Residential Tract Development Lending and the 2005 Frequently Asked Questions on the Appraisal Regulations and the Interagency Statement on Independent Appraisal and Evaluation. The Guidelines contain four appendices that clarify current regulatory requirements and supervisory guidance. Appendix A addresses real estate-related financial transactions that are exempt from the banking agencies’ appraisal regulations. Appendix B addresses an institution’s use of analytical methods or technological tools. Appendix C clarifies the minimum appraisal standards required by certain appraisal regulations for analyzing and reporting appropriate deductions and discounts in appraisals. Appendix D provides a glossary of terms. The Guidelines became effective on December 10.

      Nutter Notes:  The federal banking agencies’ appraisal regulations implementing Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) set forth, among other requirements, minimum standards for the performance of real estate appraisals in connection with “federally related transactions,” which are defined as those real estate related financial transactions that one of the agencies engages in, contracts for, or regulates and that require the services of an appraiser. The regulations also specify the requirements for evaluations of real estate collateral in certain transactions that do not require an appraisal. The 1994 Interagency Appraisal and Evaluation Guidelines and subsequent supervisory issuances clarified and expanded the FIRREA appraisal regulations. Changes from earlier guidance in the new Guidelines include more detailed expectations for appraisal independence, such as the types of communications that would not be construed as coercion or undue influence on appraisers and persons performing evaluations, as well as examples of actions that would compromise independence. The Guidelines also address standards for appraiser qualifications, selection of valuation methods and tools, additional explanation of minimum appraisal standards and when the use of evaluations rather than appraisals for low-risk transactions are appropriate.
4. Proposed Rules to Establish a Risk-Based Capital Floor and Revise Market Risk Standards

The Federal Reserve, FDIC and OCC have jointly proposed two rules that would amend the current Basel II capital adequacy framework to be consistent with certain provisions of the Dodd-Frank Act and revise the market risk capital rule to reflect changes to the Basel II market risk framework. The first proposed rule released on December 15 would amend the advanced approaches capital adequacy framework known as Basel II to be consistent with certain provisions of Section 171 of the Dodd-Frank Act (commonly known as the Collins Amendment). The Collins Amendment provides that the capital requirements generally applicable to insured banks must serve as a floor for other capital requirements the federal banking agencies establish. Under the proposed rule, a banking organization subject to the advanced approaches standards would be required to meet, on an on-going basis, the higher of the generally applicable risk-based capital standards and the advanced approaches minimum risk-based capital standards. Currently, the advanced approaches of Basel II allow for reductions in risk-based capital requirements below those generally applicable to insured banks, which is inconsistent with the Collins Amendment. (The OTS is expected to propose an amendment to its capital regulations that would parallel the proposed rule issued by the other three banking agencies.) Other provisions of the Collins Amendment are expected to be addressed in subsequent proposals. Comments on the proposed rule are due 60 days after it is published in the Federal Register, which is expected soon.

    Nutter Notes:  The second proposed capital rule released on December 15 would revise the market risk capital rules for banking organizations with significant trading activity. The current market risk capital rule supplements both the agencies’ general risk-based capital rules and the advanced capital adequacy guidelines (advanced approaches rules) (collectively, the credit risk capital rules) by requiring any bank subject to the market risk capital rule to adjust its risk-based capital ratios to reflect market risk in its trading activities. The rule applies to any bank with worldwide, consolidated trading activity equal to 10% or more of total assets, or $1 billion or more. The primary federal supervisor of a bank may apply the market risk capital rule to a bank if the supervisor deems it necessary or appropriate for safe and sound banking practices. (The OTS currently does not apply a market risk capital rule to savings associations, but is expected to propose a market risk capital rule for savings associations that would parallel the rules of the other federal banking agencies.) The proposed revisions to the current market risk capital rule are meant to enhance the rule’s sensitivity to risks that may not be adequately captured by the current rule and to enhance modeling requirements in a manner that is consistent with advances in risk management since the initial implementation of the current rule. The proposed revisions would also modify the definition of a covered position in a manner meant to capture positions for which treatment under the rule is appropriate and to increase transparency through enhanced disclosures. Comments on the proposed rule will be due 90 days after it is published in the Federal Register, which is expected soon.

5. Other Developments: CRA and Dodd-Frank Consumer Protections

• CRA Changes to Encourage HUD Neighborhood Stabilization Program Activities

The federal banking agencies announced final amendments to their Community Reinvestment Act (CRA) regulations on December 15 to support stabilization of communities affected by high foreclosure levels. The amendments encourage depository institutions to support eligible development activities in areas designated under the Neighborhood Stabilization Program (NSP) administered by the U.S. Department of Housing and Urban Development (HUD).

       Nutter Notes:  Under the NSP, HUD has provided funds to state and local governments and nonprofit organizations for the purchase and redevelopment of abandoned and foreclosed properties. The amendments provide for CRA credit to depository institutions that make loans and investments, and provide services to support NSP activities in areas with HUD-approved plans. The final amendments will become effective on January 19, 2011.

• Federal Reserve Proposes Rules Implementing Dodd-Frank Consumer Protections

The Federal Reserve proposed two rules on December 13 that would expand the coverage of consumer protection regulations to credit transactions and leases of higher dollar amounts. The proposed rules would amend Regulation Z (Truth in Lending) and Regulation M (Consumer Leasing) to implement a provision of the Dodd-Frank Act.

    Nutter Notes:  Effective July 21, 2011, the Dodd-Frank Act requires that the relevant consumer protections of the Truth in Lending Act (TILA) and the Consumer Leasing Act (CLA) apply to consumer credit transactions and consumer leases up to $50,000, compared with $25,000 currently. Comments on the proposed rules are due by February 1, 2011.

Nutter Bank Report

Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. The 2009 Chambers and Partners review says that a “real strength of this practice is its strong partners and . . . excellent team work.” Clients praised Nutter banking lawyers as “practical, efficient and smart.” Visit the U.S. rankings at ChambersandPartners.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Lisa M. Jentzen. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich
kehrlich@nutter.com
Tel: (617) 439-2989

Michael K. Krebs
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Tel: (617) 439-2288

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This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.  

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