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Nutter Bank Report, February 2009

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02.27.2009 | Legal Update

Headlines

1.  Capital Assistance Program for Large Institutions: Term Sheet Issued
2.  Administration’s Mortgage Foreclosure Mitigation Plan Detailed
3.  Commercial Loan Workouts: New Tax Incentives
4.  Massachusetts Data Security Rules Take Effect January 1, 2010
5.  Other Developments: Extension of TLGP and Call for Foreclosure Moratorium

Full Reports

1.  Capital Assistance Program for Large Institutions: Term Sheet Issued

The Treasury Department has released a term sheet for publicly traded institutions and application guidelines under the Capital Assistance Program (CAP).  First announced on February 10 by the Treasury as a component of the Administration’s comprehensive Financial Stability Plan, the CAP will give qualifying financial institutions access to equity capital through the sale of convertible preferred stock to the Treasury, similar in some ways to Treasury’s Capital Purchase Program (CPP).  The CAP generally will be available to U.S. bank holding companies, including financial holding companies, insured depository institutions and savings and loan holding companies.  To qualify for a CAP investment, each eligible institution will be required to undergo a special forward-looking capital assessment (commonly called the “stress test”) to determine whether an additional capital buffer is needed for the institution to absorb losses and continue lending even in a more adverse economic environment.  If the stress test indicates the need for additional capital, the institution will have six months to apply for and receive a CAP capital investment.  Eligible institutions with assets in excess of $100 billion on a consolidated basis are required to participate in the stress test, and may apply for CAP funds immediately.  Smaller institutions may voluntarily participate in the CAP.  Additional information, including submission instructions, can be found at each federal banking agency’s web site.  All CAP applications must be submitted to the appropriate federal banking agency no later than 5:00 p.m. (EST) on May 25, 2009.

Nutter Notes:  According to the CAP term sheet for public companies released on February 25, Treasury will purchase mandatorily convertible preferred stock valued at a 10% discount to the price of the institution’s common stock prevailing prior to February 9, which will carry a 9% dividend yield.  With supervisory approval, eligible institutions may redeem existing CPP preferred stock with the proceeds received from CAP convertible preferred stock.  Each eligible institution may issue an amount of convertible preferred stock equal to between 1% and 2% of its risk-weighted assets plus an additional amount to the extent the proceeds are used to redeem preferred shares sold under the CPP and, if applicable, the TARP Targeted Investment Program.  The preferred stock will be convertible into common stock at the issuer’s option, subject to the approval of the applicable federal banking agency.  Under certain circumstances, the preferred stock will be convertible into common stock at Treasury’s option.  After seven years, the convertible preferred stock will automatically convert into common if not redeemed or converted before that date.  Recipients of CAP funds will be subject to restrictions on common stock dividends and repurchases and executive compensation requirements under the Emergency Economic Stabilization Act of 2008, as amended (EESA).  Each institution must submit with its CAP application a plan for how it intends to use the capital to preserve and strengthen its lending capacity.  The plans will be made public when the CAP investment is closed.  Recipients of capital investments under the CAP or any other new initiative under the Financial Stability Plan will also be required to participate in the mortgage foreclosure mitigation program described in Report #2 below.

2.  Administration’s Mortgage Foreclosure Mitigation Plan Detailed

President Obama on February 18 unveiled a comprehensive program to reduce foreclosures.  The Homeowner Affordability and Stability Plan (the Plan) announced on February 18 includes an ambitious plan to modify residential mortgage loans held by Fannie Mae, Freddie Mac, and the private sector.  The central feature of the Plan is a program to reduce monthly mortgage payments for at-risk homeowners by modifying the terms of their current mortgage loans.  Eligible borrowers will include anyone with high combined mortgage debt compared to income or with a combined principal loan balance higher than the current market value of the mortgaged property.  Only mortgage loans for owner-occupied homes will qualify, and no home mortgages larger than the Freddie/Fannie conforming limits will be eligible.  Eligibility for the Plan will sunset after three years.  Delinquency will not be a requirement for eligibility—so borrowers at risk of imminent default despite being current on their mortgage payments will be eligible.  Recipients of capital investments under any new initiative under the Financial Stability Plan, such as the CAP, described in Report #1 above, will be required to participate in the mortgage foreclosure mitigation program.  As outlined, the Plan will provide incentives for servicers and mortgage holders to voluntarily implement mortgage foreclosure mitigation measures.

Nutter Notes:  Servicers will be offered a fee of $1,000 for each eligible modification and $1,000 “pay for success” fees–awarded monthly for three years as long as the borrower stays current on the loan.  The Plan will also include payments of $1,500 to mortgage holders and $500 for servicers for loan modifications made while a borrower at risk of imminent default is still current on payments.  A home price decline insurance fund of up to $10 billion will be created by Treasury and the FDIC for mortgages modified under the Plan.  The fund will provide mortgage holders with an insurance payment on each modified loan based on declines in the home price index.  The payments could be set aside as reserves in case future losses from default and foreclosure are higher than expected due to home price declines.  To participate, a lender would have to first reduce the interest rate or principal amount of the mortgage loan so that the borrower’s monthly mortgage payment is no greater than 38% of his or her income.  The federal government would match further reductions in interest payments dollar-for-dollar with the lender, down to a 31% debt-to-income ratio for the borrower.  If the lender implements a principal reduction, the government would subsidize a partial share of the costs, up to the amount the lender would have received for an interest rate reduction.  Lenders would have to keep the modified payments in place for five years, after which interest rates could increase gradually to the conforming loan rate at the time of the modification.

3.  Commercial Loan Workouts: New Tax Incentives

The American Recovery and Reinvestment Act of 2009 (ARRA) provides tax relief to borrowers that re-structure debt in a manner that results in the discharge of some or all of their indebtedness.  Section 1231 of the ARRA allows a taxpayer that “reacquires” its indebtedness to elect to defer recognition of income from the discharge of indebtedness that would otherwise be recognized in the year of the transaction.  The deferral is over a five-year period if the debt is reacquired in 2009, or over a four-year period if the debt is reacquired in 2010.  This provision only applies to debt that is reacquired in 2009 or 2010.  For purposes of the ARRA, a debt has been “reacquired” by a taxpayer if the taxpayer or a related party to the taxpayer actually buys the instrument itself or if the instrument is exchanged for another debt instrument, including a deemed exchange resulting from a material modification of the original debt instrument.  A “related party” would include a person’s spouse, ancestors and descendants and their spouses, but not siblings, as well as any entities which the taxpayer controls.  The term “material modification” would include any change which reduces principal or adjusts the yield of the instrument more than an insignificant amount.

Nutter Notes:  To illustrate the effect of the deferral election, a taxpayer that has indebtedness of $4 million negotiates with its lender to pay $3 million in satisfaction of the debt in 2009.  Prior to the enactment of the ARRA, the taxpayer would have recognized $1 million in discharge of indebtedness income in the year that the debt was settled.  That taxpayer may now elect to defer recognition of that $1 million for five years and would thereafter recognize $200,000 of discharge income in the each of the subsequent five years beginning in 2014.  The opportunity to avoid an immediate tax payment requirement may increase a borrower’s willingness and ability to consider restructuring a greater portion of existing debt rather than other work-out alternatives, particularly where the borrower may believe that, given time, its business will once again prosper.  For more details about this provision of the ARRA, or other information relating to the restructuring of troubled loans, please contact your attorney at Nutter or one of the attorneys in Nutter’s Workout, Restructuring and Bankruptcy Practice Group.  See www.nutter.com.

4.  Massachusetts Data Security Rules Take Effect January 1, 2010

The compliance deadline for new Massachusetts information security standards has been extended by the Office of Consumer Affairs and Business Regulation (OCABR).  OCABR filed an amendment to its regulations on February 12 that requires any person or business that owns, licenses, stores, or maintains a Massachusetts resident’s personal information to come into compliance by January 1, 2010.  The regulations, “Standards for the Protection of Personal Information of Residents of the Commonwealth,” which had been scheduled to become effective on May 1, 2009, require all businesses that maintain personal information about Massachusetts residents to develop and implement a security program that is consistent with standards set forth in General Laws Chapter 93H, which was approved last year.  The amendment also modified a provision requiring businesses to take reasonable steps to verify that any third-party service provider with access to protected personal information has the capacity to protect such information as required by the regulations.  Before the rule was amended, it would have expressly required each business to contractually require its vendor’s compliance with the data security standards and obtain a certificate of compliance before allowing the vendor to access protected information.  The revised rule eliminates the contract and certificate requirements, but says that a business must take “all reasonable steps” to ensure that its vendors apply security measures at least as protective as those required by the regulations.

Nutter Notes:  The new regulations apply to, among other businesses, all financial institutions including banks – despite the fact that banks are already subject to similar federal requirements.  The law and regulations define “personal information” to mean a Massachusetts resident’s first name, or first initial, and last name, combined with his or her Social Security number, driver’s license number, or any financial account, debit account number, or credit card number—regardless of whether they are accompanied by the individual’s security code, personal identification number or password.  All written information security programs must address certain minimum requirements set forth in the regulation, including identifying where paper, electronic or other records that contain personal information are stored, identifying and assessing reasonably foreseeable risks to the security of such personal information, and limiting the amount of personal information collected, and the time such information is retained, to a level reasonably necessary for the business.  Minimum security requirements for computer systems include encryption of all personal information transmitted across public networks or transmitted wirelessly, and encryption of all personal information stored on laptops or other portable devices.

5.  Other Developments: Extension of TLGP and Call for Foreclosure Moratorium

  • FDIC Extends the TLGP

The FDIC announced on February 10 that it will extend the Temporary Liquidity Guarantee Program for an additional four months.  The TLGP will be extended to October 31, 2009, for an additional premium, to provide liquidity to banks as part of the administration’s overall strategy to improve economic conditions.

Nutter Notes:  The FDIC announced the extension of the TLGP in a joint release with the OCC, OTS and the Federal Reserve that outlined other emergency economic initiatives, such as a new public-private investment fund to remove toxic assets from the balance sheets of financial institutions and the expansion of the existing Term Asset-Backed Securities Lending Facility to include securities backed by consumer loans and small business loans.

  • OTS Calls for Moratorium on Home Mortgage Foreclosures

The OTS urged savings associations to temporarily suspend foreclosures on owner-occupied homes while the OTS and other federal agencies work out the details of the home loan modification program component of the Financial Stability Plan.  The February 11 announcement said that the program would be “finalized in the next few weeks.”

Nutter Notes:  In his February 12 CEO memorandum appealing for the temporary suspension of foreclosures, OTS Director John Reich suggested that OTS-regulated thrifts should consider avoiding the costs of foreclosures in cases where loan modifications may be feasible under the new plan.

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 in the 2007 Chambers and Partners U.S. rankings. The “well known and well-versed” Nutter team “excels” at corporate and regulatory banking advice, according to the 2007 Chambers Guide. Visit the 2007 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 Rena Marie Strand and 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
mkrebs@nutter.com
Tel: (617) 439-2288

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