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Nutter Bank Report, September 2017

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1. Federal Banking Agencies Propose Simplifications to Regulatory Capital Rules

2. Congress Extends Protections for State Licensed Medical Marijuana Businesses

3. New Guidance on Current Expected Credit Loss Issued by Banking Agencies

4. States Consider Legislation to Establish FinTech Sandboxes

5. Other Developments: Qualified Thrift Lender Test and Securities Settlement Cycle

1. Federal Banking Agencies Propose Simplifications to Regulatory Capital Rules

The federal banking agencies have proposed amendments to their regulatory capital rules intended to simplify the capital treatment for mortgage servicing assets (MSAs), certain deferred tax assets, investments in the capital of unconsolidated financial institutions, and capital issued by a consolidated subsidiary of a banking organization and held by third parties (minority interest). Most aspects of the proposed amendments released on September 27 would apply only to banking organizations that are not subject to the “advanced approaches” capital rules (generally, institutions with less than $250 billion in total consolidated assets and less than $10 billion in total foreign exposure). The proposal also includes revisions to the capital treatment of certain acquisition, development, or construction (ADC) exposures to address concerns about the current definition of high volatility commercial real estate (HVCRE) exposure under the capital rules’ standardized approach. Under the standardized approach, the proposed revisions to the treatment of ADC exposures would not apply to existing exposures that are outstanding or committed prior to the effective date of any final rule. Comments on the proposed rule will be due within 60 days after it is published in the Federal Register, which is expected shortly. Click here for a copy of the proposed rule and here for a copy of the agencies’ summary of the proposed rule for community banks.

     Nutter Notes: The proposed amendments to the regulatory capital rules would replace the complex definition of HVCRE exposures under the capital rules’ standardized approach with a more straightforward definition for higher-risk ADC loans called high volatility acquisition, development, or construction (HVADC) loans. HVADC loans would include credit facilities that primarily finance or refinance ADC activities—a potentially broader range of exposures than the HVCRE definition. An HVADC exposure would receive a 130% risk weight. The proposed amendments would also simplify the threshold deduction treatment for MSAs, temporary difference deferred tax assets not realizable through carryback, and investments in the capital of unconsolidated financial institutions. The existing capital rules limit the inclusion of each of these threshold deduction items to 10% of common equity tier 1 capital, with a combined 15% limitation. The proposed amendments would raise the limit for MSAs and temporary difference deferred tax assets, individually, to 25% of common equity tier 1 capital and would not include a combined limit. In addition, the proposed amendments would remove the distinction between significant and non-significant investments in the capital of unconsolidated financial institutions and establish a combined limit on these investments of 25% of common equity tier 1 capital.

2. Congress Extends Protections for State Licensed Medical Marijuana Businesses 

On September 8, President Donald Trump signed into law a federal budget measure approved by Congress that extends certain appropriations for federal agencies for 3 months and, in doing so, also extended the so-called Rohrabacher-Blumenauer Amendment, which protects state licensed medical marijuana businesses from federal prosecution. The Rohrabacher-Blumenauer Amendment prohibits the Department of Justice (DOJ) from expending federal funds to prevent states from implementing their own laws legalizing medical marijuana. On August 16, 2016, the United States Court of Appeals for the Ninth Circuit ruled that the Rohrabacher-Blumenauer Amendment would prohibit the DOJ from prosecuting for federal drug crimes an individual who was engaged only in activity permitted by state medical marijuana laws and who was in full compliance with such state laws. That appeals court ruling was applied for the first time in a federal drug trial on August 8, 2017 by a U.S. district court in California to block the prosecution of two medical marijuana growers for federal drug crimes. In that case, the district court found that the medical marijuana growers had demonstrated that they were in full compliance with California medical marijuana law, and ruled that the federal prosecution against them could not continue unless and until the Rohrabacher-Blumenauer Amendment expires or is repealed. Click here for a copy of the U.S. district court’s decision. The Rohrabacher-Blumenauer Amendment is currently due to expire on December 8.

     Nutter Notes: U.S. Attorney General Jeff Sessions has reportedly lobbied Congress to repeal the Rohrabacher-Blumenauer Amendment, which has been included in each DOJ appropriations bill and budget extension since 2014. The Attorney General has made other efforts that appear to be aimed at freeing federal prosecutors to target state licensed marijuana-related businesses for federal drug charges. While the Ninth Circuit appeals court interpretation of the Rohrabacher-Blumenauer Amendment protecting state licensed marijuana-related businesses is binding on the federal trial courts in that circuit (Alaska, Arizona, California, and Hawaii), federal courts in other jurisdictions, including Massachusetts, are free to ignore the ruling or follow it at their own discretion unless the federal appeals court in those jurisdictions rules on the issue. While Massachusetts is among the states that have legalized medical marijuana, and is in the process of developing a regulatory regime for legalized recreational use of marijuana, it remains a federal crime to manufacture, possess, or distribute marijuana, and funds derived from such activities are considered illicit funds for anti-money laundering purposes. In 2013 and 2014, DOJ guidance to federal prosecutors on federal marijuana enforcement priorities (commonly known as the Cole Memos) and 2014 guidance from the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) clarified how a bank can provide services to a marijuana-related business consistent with the bank’s Bank Secrecy Act obligations. FinCEN’s guidance includes specific due diligence procedures for banks to follow. However, banks that provide financial services to a marijuana-related business, directly or indirectly, face a number of legal, regulatory, and reputational risks even if they follow FinCEN’s due diligence procedures and otherwise comply with the Cole Memos.

3. New Guidance on Current Expected Credit Loss Issued by Banking Agencies

The federal banking agencies have updated their guidance entitled Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses to provide more information about the application of the current expected credit losses (CECL) methodology for estimating credit loss allowances and related supervisory expectations and regulatory reporting guidance. The updated guidance published on September 6 addresses a variety of issues, including whether qualitative factors are still relevant under CECL, the data needed to implement CECL, purchased credit-deteriorated assets, the evaluation of the public business entity criteria, and the mechanics of adopting the standard for Call Report purposes and collateral-dependent loans. For example, the updated guidance clarifies that a bank should not rely solely on past events to estimate expected credit losses, so banks should continue to incorporate both qualitative and quantitative factors when estimating allowances for credit losses under CECL. The new CECL methodology will take effect in 2020 or 2021, depending on an institution’s characteristics, such as whether the institution is an SEC filer and has a calendar year fiscal year. Click here for the updated guidance.

     Nutter Notes: The Massachusetts Division of Banks issued an industry letter on September 21 to inform Massachusetts banks that the Conference of State Bank Supervisors (CSBS) has developed a tool to help banks prepare for the changes associated with the CECL methodology. The tool—a CECL readiness checklist—provides a framework that banks may use to plan for the accounting changes. In its industry letter, the Division stated that there is no regulatory expectation that Massachusetts banks must use the CECL readiness checklist, and that the suggested dates in the tool are suggestions only and are not regulatory expectations or deadlines. The Division also cautioned banks that the tool does not replace or revise any agency guidance related to CECL, and should not replace any advice a bank may receive from auditors or accountants. Click here for the CSBS’s CECL readiness checklist and the CSBS’s associated examiner guide that banks may find useful to understand and anticipate examiners’ expectations.

4. States Consider Legislation to Establish FinTech Sandboxes

Arizona is considering legislation that would allow financial technology (fintech) companies to develop new financial products and services without complying with certain regulatory requirements. Arizona Attorney General Mark Brnovich proposed legislation on September 6 that would create a program under which a fintech company could temporarily test innovative financial products, services, business models, or delivery mechanisms on a limited basis without being required to first obtain a bank charter or similar license as a regulated financial institution. Under the proposed legislation, a fintech company could apply for approval to test a new product or service by offering it to a limited number of consumers in Arizona for up to 12 months. Other states, including Illinois, are reportedly consider similar legislation. Click here for a copy of the proposed Arizona fintech sandbox legislation.

     Nutter Notes: The OCC announced in December 2016 that it would consider applications for special purpose national bank charters for fintech companies. The OCC simultaneously issued a white paper, titled Exploring Special Purpose National Bank Charters for Fintech Companies, that discusses the issues and conditions that the OCC will consider in granting fintech charters. In April 2017, the CSBS filed a complaint against the OCC in the U.S. District Court for the District of Columbia seeking to prevent the OCC from issuing special purpose national bank charters to fintech companies. The CSBS argued in its complaint that the OCC’s fintech charter proposal exceeds the limited chartering authority granted to the agency by Congress under the National Bank Act and other federal banking laws. New York’s Department of Financial Services (DFS) in May 2017 filed its own lawsuit against the OCC to block its fintech charter proposal, also claiming that the OCC’s decision to grant special purpose national bank charters to financial technology companies exceeds its chartering authority. Meanwhile, the CFPB on September 14 issued a no-action letter to a fintech company that uses alternative data in making credit and pricing decisions. As a condition of the no-action letter, the company must regularly report lending and compliance information to the CFPB to mitigate risk to consumers.

5. Other Developments: Qualified Thrift Lender Test and Securities Settlement Cycle

  • Federal Reserve Provides Guidance on QTL Test and New QTL Exam Procedures

The Federal Reserve on September 7 issued guidance on compliance with the Qualified Thrift Lender (QTL) test under section 10(m) of the Home Owners’ Loan Act (HOLA) to state savings banks and insured cooperative banks that are members of the Federal Reserve System and that have made an election under HOLA for their parent holding companies to be treated as savings and loan holding companies.

     Nutter Notes: The guidance provides an overview of the Federal Reserve’s QTL requirements and the consequences of failing the QTL test for electing banks that are members of the Federal Reserve System and their parent holding companies. It also outlines procedures examiners should consider when assessing an institution’s QTL compliance program. Click here for a copy of the guidance.

  • FDIC and OCC Propose to Shorten Securities Settlement Cycle to T+2

The FDIC and OCC have jointly proposed to amend their securities settlement rules to shorten the standard settlement cycle from 3 business days to 2 for securities purchased or sold by national banks, federal savings associations and FDIC-supervised institutions. The agencies may consider, as an alternative, implementing the 2-business-day settlement requirement by cross-reference to the standard settlement cycle provided under SEC rules. Comments on the proposed amendments are due by October 11, 2017.

     Nutter Notes: The agencies’ proposal to move to a 2-day settlement cycle is part of a larger, industry-wide shift that includes a securities industry initiative and rule changes being implemented by other financial regulators and securities self-regulatory organizations. Click here for a copy of the proposed amendments to the FDIC’s and OCC’s rules.

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, after interviewing our clients and our peers in the profession, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. Visit the U.S. rankings at The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Heather F. Merton. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich
Tel: (617) 439-2989

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

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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