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Nutter Bank Report, October 2010

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10.29.2010 | Legal Update

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1. FDIC Capital Restoration Plan Provides Near-Term Assessment Relief
2. Federal Reserve Issues Dodd-Frank Appraiser Independence Rule
3. CSBS White Paper Calls for Community Bank Stress Tests
4. Basel Committee Recommends Corporate Governance Principles
5. Other Developments: Volcker Rule and Call Report Changes

1. FDIC Capital Restoration Plan Provides Near-Term Assessment Relief

In connection with its new capital restoration plan for the Deposit Insurance Fund (DIF), the FDIC will forego a uniform 3 basis point increase in initial assessment rates that was scheduled to take effect on January 1, 2011. The FDIC on October 19 approved a long-range plan to manage the DIF, which includes the new Restoration Plan, to ensure that the DIF reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The FDIC said that it decided to keep the current assessment rate schedule in effect because an updated FDIC analysis predicts somewhat lower DIF losses from 2010 through 2014. The FDIC now projects that the DIF reserve ratio will reach 1.15% by the fourth quarter of 2018 without the 3 basis point increase in initial assessment rates. The FDIC also issued a proposed rule that would set the DIF reserve ratio at 2% as a long-term, minimum goal, adopt a lower assessment rate schedule when the reserve ratio reaches 1.15% so that the average assessment rate over time should be about 8.5 basis points and, in lieu of dividends, adopt lower rate schedules when the reserve ratio reaches 2% and 2.5% so that average assessment rates will decline by about 25% and 50%, respectively. Comments on the proposed rule are due by November 26, 2010.

      Nutter Notes:  The proposed rule is based on an FDIC historical analysis of DIF losses which shows that, to maintain a positive fund balance and steady, predictable assessment rates, the DIF reserve ratio should be at least 2% before a period of large fund losses, and average assessment rates over time should be approximately 8.5 basis points. The Dodd-Frank Act raised the minimum designated reserve ratio of the DIF to 1.35% from the former minimum of 1.15%, and removed the upper limit on the reserve ratio which was formerly capped at 1.5%. The Dodd-Frank Act also requires the FDIC to take “such steps as may be necessary” to increase the DIF reserve ratio to 1.35% of estimated insured deposits by September 30, 2020, rather than 1.15% by the end of 2016, as formerly required. In addition, the Dodd-Frank Act eliminated the requirement that the FDIC pay dividends from the DIF when the reserve ratio is between 1.35% and 1.5% and granted the FDIC discretion in determining whether to suspend or limit the declaration or payment of dividends. In setting assessments, the Dodd-Frank Act requires the FDIC to “offset the effect of [requiring that the reserve ratio reach 1.35% by September 30, 2020] on insured depository institutions with total consolidated assets of less than $10,000,000,000.” Accordingly, the FDIC said it intends to propose another rule next year to address the method that will be used to assess insured depository institutions with total consolidated assets of $10,000,000,000 or more to reach the required reserve ratio of 1.35%.

2. Federal Reserve Issues Dodd-Frank Appraiser Independence Rule

The Federal Reserve has published an interim final rule amending Regulation Z to establish new requirements for appraisal independence for any consumer credit transaction that is secured by the consumer’s principal dwelling, as required by the Dodd-Frank Act. The interim final rule released on October 18 prohibits coercion, bribery and other similar actions in connection with a real estate appraisal. The interim final rule also prohibits appraisers and appraisal management companies from having financial interests in the property or credit transaction, and prohibits a creditor from extending credit if it knows, before closing, of a violation of the prohibition on coercion or conflict of interest. The interim final rule requires that parties involved in the transaction report appraiser misconduct to state appraiser licensing authorities. It also requires that a creditor pay only reasonable and customary compensation to a “fee appraiser”—an appraiser who is not employed by the creditor or the appraisal management company hired by the creditor. The interim final rule becomes effective on December 27, 2010, but compliance is optional until April 1, 2011 to allow time for any necessary operational changes. The interim final rule also causes the Home Valuation Code of Conduct to have no further force or effect. Comments on the interim final rule are due by December 27, 2010.     

      Nutter Notes: A creditor is presumed to have paid reasonable and customary compensation to a fee appraiser if the fee is reasonably related to recent rates paid for appraisal services in the geographic market and the creditor has taken into account certain factors, such as the type of property and the scope of work, and has not engaged in any anti-competitive actions, such as price fixing or restricting others from entering the market. Additionally, a creditor is presumed to have paid a reasonable and customary fee if the creditor relies on rates established by independent third parties. The interim final rule applies to any person who performs valuation services or valuation management functions and to any valuation of a consumer’s principal dwelling, not just to licensed or certified appraisers. Institutions with both an appraisal function and loan production function are not by definition conflicted, but must establish firewalls and other safeguards between these two functions in order to qualify for a safe harbor from the conflict of interest provisions. The interim final rule provides guidance for both small institutions (defined as having assets of $250 million or less) and larger institutions regarding the specific criteria for establishing firewalls and other safeguards. A creditor may make a loan based on a valuation known to be either coerced or conflicted if the creditor uses reasonable due diligence to determine that the valuation does not materially misstate the value of the property.

3. CSBS White Paper Calls for Community Bank Stress Tests

The Conference of State Bank Supervisors (CSBS) is recommending that community banks use stress testing to evaluate the potential impact of key risk factors. The recommendation announced on October 20 is described in a white paper entitled The Case for Stress Testing at Community Banks; Enhancing the Risk Management Framework to Ensure Economic Viability. The white paper calls for stress testing to be an industry-driven initiative and not a regulatory exercise. The CSBS said that conducting stress tests would help bank managers to better understand their institution’s risk profile and vulnerabilities, and should be accompanied by standards and best practices to define risk parameters, appropriate applications, and limitations. The white paper suggests that stress tests be integrated into the risk management framework of a bank and that banks should work to develop the standards and best practices with reasonable parameters and limitations. The CSBS said that it believes technology and the existing availability of data should not make stress testing an excessive burden or cost to community banks. According to the CSBS, simple stress tests can be conducted based on public data for banks with well defined risks and core deposit funding, but banks with more concentrated or high-risk asset structures would require more specialized stress testing to incorporate loan and other relevant data.

    Nutter Notes: The CSBS said that it developed the white paper to spark dialogue among industry participants, policymakers and regulators on the benefits that may be achieved from conducting stress tests at community banks. The white paper recommends that stress testing should not be conducted by bank regulators, but that state and federal regulators should review the assumptions used by management to ensure that a bank is taking a realistic view of its potential risks. It also recommends that regulators evaluate the results of stress tests and review bank management’s plans for mitigating risks identified by stress testing. The CSBS suggested that a bank’s management should be evaluated on its risk mitigation efforts. However, CSBS said that a bank should not be subject to regulatory criticism as a result of identifying vulnerabilities through stress testing because it would create incentives for banks to conduct less effective stress tests. The white paper points out that the Dodd-Frank Act contains several provisions that require stress testing for systemically significant bank holding companies and other financial institutions. While the Dodd-Frank Act does not require community banks to undergo stress tests, the white paper suggests that regulators will become accustomed to seeing stress testing as part of the risk management framework and an important part of the supervisory process. The CSBS said that “bank management will find it difficult to demonstrate sufficient risk management processes without incorporating an element of stress testing.”

4. Basel Committee Recommends Corporate Governance Principles

The Basel Committee on Banking Supervision (Basel Committee) has published a final version of its Principles for Enhancing Corporate Governance, which provides guidance to banks in light of the corporate governance failures that occurred during the financial crisis beginning in mid-2007. This guidance released this month revised guidelines adopted by the Basel Committee in 2006. The Basel Committee created 14 corporate governance principles that cover the responsibilities and qualifications of the board, the board’s responsibility for defining appropriate governance practices, internal controls for risk identification and management, board oversight and risk-analysis of compensation, and transparency of governance. The guidance also explains the function of bank supervisory agencies in relation to bank corporate governance. The guidance recommends that a supervisor’s functions include conducting comprehensive evaluations of the existence and implementation of corporate governance policies and practices, monitoring internal and external reports, and requiring remedial action to address problems in corporate governance policies and practices. The Basel Committee emphasized that its guidance should be implemented in a manner that is consistent with applicable national laws and is not intended to create a new regulatory framework that overlays existing national statutes.

      Nutter Notes:  The guidance recommends that banks customize the principles to fit “the size, complexity, structure . . . and risk profile of the bank.” In addition to these principles, the Basel Committee also said that fostering a corporate culture that supports and provides appropriate standards and incentives for professional and responsible behavior creates a key building block to good corporate governance. According to the Basel Committee, the guidance is intended to help banks improve their corporate governance framework and prevent the types of failures that contributed to the most recent financial crisis. The failures cited by the Basel Committee include poor board oversight of senior management, insufficient risk management and improper, ineffective or cumbersome operational structures. Risk management is one of the more significant themes that runs throughout the corporate governance principles. The guidance suggests that every bank reconsider how it identifies and manages risk in light of board risk management practices and internal controls, the risk tolerance of the bank, communication practices and employee compensation.

5. Other Developments: Volcker Rule and Call Report Changes

  • FSOC Seeks Comment on Rules to Implement “Volcker Rule”

The Financial Stability Oversight Council (FSOC) is seeking public comment in advance of rules that will be proposed to implement Section 619 of the Dodd-Frank Act, which prohibits depository institutions from engaging in proprietary securities trading and from maintaining certain relationships with hedge funds and private equity funds (the Volcker Rule). Comments are due by November 5, 2010.

       Nutter Notes:  The Dodd-Frank Act requires the FSOC to conduct a study and make recommendations by January 22, 2011 to inform federal agency rulemaking on the Volcker Rule. The Federal Reserve, the FDIC, the OCC, the SEC and the CFTC are required to consider the findings of the FSOC study in developing regulations to implement the Volcker Rule.

  • Federal Banking Agencies Propose Changes to Call Report

The federal banking agencies on October 25 issued a request for comments on several proposed revisions to the Call Report that would take effect on March 31, 2011. The proposed reporting changes include a new breakdown by loan category of loans that are troubled debt restructurings, and the elimination of an exclusion from reporting restructured troubled consumer loans. Comments are due by November 29, 2010, and will be shared among all the agencies.

      Nutter NotesAccording to the agencies, the proposed Call Report changes are intended to provide data to meet safety-and-soundness needs and for other public purposes, and would assist the agencies in gaining a better understanding of banks’ credit and liquidity risk exposures, primarily through enhanced data on lending and other activities.

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
mkrebs@nutter.com
Tel: (617) 439-2288

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