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Nutter Bank Report, April 2011

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1. Federal Reserve Puts Forward Minimum Underwriting Standards for Mortgage Loans
2. FDIC and Federal Reserve Proposals Would Allow Interest on Demand Deposit Accounts
3. New FASB Rules on Troubled Debt Restructuring Could Increase Loan Loss Reserves
4. FDIC Recommends Responses to Excessive Customer Use of Overdraft Protection
5. Other Developments: FHA Audited Financials Requirement and Savings and Loan Holding Companies

1. Federal Reserve Puts Forward Minimum Underwriting Standards for Mortgage Loans

The Federal Reserve has issued proposed amendments to Regulation Z, which implements the Truth in Lending Act (TILA), that would require lenders to make a reasonable and good faith determination that a consumer will have a reasonable ability to repay the loan before making a mortgage loan and would establish minimum mortgage underwriting standards. The proposal released on April 19 would implement statutory changes to TILA made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) that expand the scope of the ability-to-repay requirement to cover any consumer credit transaction secured by a residence (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan). A lender would be required to consider and verify specified underwriting factors in making the ability-to-repay determination unless the lender satisfies one of three optional methods to comply with the general ability-to-repay standards. The first option would allow a lender to refinance a “non-standard mortgage” (a loan with features considered to be risky) into a “standard mortgage” (a loan that has limits on fees and that does not contain certain features such as negative amortization, interest-only payments or a balloon payment) with a lower monthly payment. Under the second option, a lender may make a loan that meets the criteria to be a “qualified mortgage.” The proposal describes two alternative approaches the Federal Reserve is considering to define what constitutes a qualified mortgage. The third option would allow lenders operating predominantly in rural or underserved areas to make a “balloon-payment qualified mortgage,” which would be similar to a qualified mortgage except for the balloon payment feature. Comments may be submitted to the Federal Reserve until July 22, 2011, at which time the Consumer Financial Protection Bureau (CFPB) will take over rulemaking authority for TILA.

      Nutter Notes:  The first of the two alternative definitions of a “qualified mortgage” being considered by the Federal Reserve would operate as a legal safe harbor, meaning that a loan that meets the definition of a qualified mortgage is deemed to comply with the ability-to-repay requirement. The first alternative would define a qualified mortgage as a mortgage loan that does not contain negative amortization, interest-only payments or a balloon payment. The term of a qualified mortgage could not exceed 30 years and total points and fees could not exceed 3% of the total loan amount. Finally, a lender would be required to consider and verify the income or assets relied upon in making the ability-to-repay determination, and the underwriting decision would have to be based on the maximum interest rate applicable in the first five years and use a payment schedule that fully amortizes the loan, taking into account any mortgage-related obligations. The second alternative would provide a rebuttable presumption that a loan complies with the ability-to-repay requirement and would define a qualified mortgage to include the criteria listed under the first alternative and additional underwriting factors from the general ability-to-repay standards. The additional underwriting factors under the second alternative would include considering and verifying the consumer’s employment status, the monthly payment for any simultaneous mortgage, the consumer’s current debt obligations, the monthly debt-to-income ratio or residual income, and the consumer’s credit history. Since the CFPB will assume rulemaking authority for TILA during the comment period, the CFPB will be responsible for the final rule.

2. FDIC and Federal Reserve Proposals Would Allow Interest on Demand Deposit Accounts

The FDIC and the Federal Reserve have separately issued proposed rules to allow the payment of interest on demand deposit accounts. The proposals would implement Section 627 of the Dodd-Frank Act, which will repeal the statutory prohibition against the payment of interest on demand deposits effective as of July 21, 2011. The FDIC proposal announced on April 21 would rescind 12 C.F.R. Part 329, the regulation which implements that prohibition with respect to state-chartered nonmember banks, effective on the same date as the statutory repeal. Part 329 includes a regulatory definition of the term “interest” that the FDIC proposes to transfer to 12 CFR Part 330 because it may be useful in interpreting the temporary, unlimited deposit insurance coverage for noninterest-bearing transaction accounts under Section 343 of the Dodd-Frank Act. The FDIC is also considering whether to retain an interpretive rule in Part 329 that defines what constitutes a “premium”—certain payments that are not deemed to constitute interest—for purposes of determining whether an account qualifies as a noninterest-bearing transaction account. Any demand deposit account for which a bank begins paying interest after the statutory repeal will no longer qualify for the temporary, unlimited deposit insurance coverage program for noninterest-bearing transaction accounts. Comments on the FDIC’s proposed rule are due by May 16, 2011.

      Nutter Notes:  The Federal Reserve on April 6 issued a proposed rule to repeal its Regulation Q, which prohibits the payment of interest on demand deposits by institutions that are member banks of the Federal Reserve System. The proposed rule would implement the provision of Section 627 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that repeals Section 19(i) of the Federal Reserve Act in its entirety effective July 21, 2011. The repeal of that section of the Federal Reserve Act eliminates the statutory authority under which the Board established Regulation Q. The proposed rule would also repeal the Federal Reserve’s published interpretations of Regulation Q and would remove references to Regulation Q found in the Federal Reserve’s other regulations, interpretations, and commentary. Unlike the FDIC proposal, the Federal Reserve is not proposing to retain Regulation Q’s definition of “interest,” which could create some uncertainty for member banks in determining which accounts are considered interest-bearing or noninterest-bearing for purposes of other laws or regulations. The Federal Reserve is also soliciting comments on whether the repeal of Regulation Q would have implications for balance sheets and income of depository institutions, short-term funding markets such as overnight federal funds market, the demand for interest-bearing demand deposits, and competitive burden on smaller depository institutions. Comments on the Federal Reserve’s proposal are due by May 16, 2011.

3. New FASB Rules on Troubled Debt Restructuring Could Increase Loan Loss Reserves

The Financial Accounting Standards Board (FASB) has amended the accounting standards used to determine when a loan modification should be considered a troubled debt restructuring (TDR) and therefore recorded as an impairment loss. Accounting Standards Update No. 2011-02 issued on April 5 amends FASB’s Accounting Standards Codification Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. Under the new rule, a creditor, including a banking organization, must separately conclude that a loan modification constitutes a “concession” and that the debtor is experiencing “financial difficulties” when evaluating whether a loan modification constitutes a TDR. If a creditor determines that it has granted a concession to a debtor, the creditor must make a separate assessment about whether the debtor is experiencing financial difficulties to determine whether the restructuring constitutes a TDR. The amendments to Topic 310 clarify the guidance on a creditor’s evaluation of whether it has granted a concession and what constitutes financial difficulty. Public companies are required to apply the new TDR rule to financial statements covering the first interim or annual period ending on or after June 15, 2011. Nonpublic companies are required to apply the new rule to financial statements covering annual periods ending on or after December 15, 2012.

      Nutter Notes:  The application of the new TDR rules could increase the loans a bank must treat as TDRs, and therefore increase loan loss reserves. Accounting experts have reported that the new rules lower the threshold for when a bank would classify a loan modification as a TDR, which could mean more modifications will be classified as TDRs. For example, if a debtor does not otherwise have access to funds at a market rate for a loan with similar risk characteristics as the modified loan, the modification would be considered to be at a below-market rate, which may indicate that the creditor has granted a concession. In addition, a temporary or permanent increase in the interest rate as a result of a modification does not prevent the modification from being considered a concession because the new interest rate could still be below the market interest rate for a new loan with similar risk characteristics. Under the new rules, a debtor may be experiencing financial difficulties even if the debtor is not currently in default of payments due under the loan. In addition, the new rules clarify that a creditor may not use the “effective interest rate test” (under Topic 470, the debtor’s guidance on restructuring of payables) when evaluating whether a restructuring constitutes a TDR.

4. FDIC Recommends Responses to Excessive Customer Use of Overdraft Protection

The FDIC has published on its website answers to Frequently Asked Questions (FAQs) about the FDIC’s Overdraft Payment Supervisory Guidance issued in November 2010 (FIL-81-2010) (ODP Guidance). The FAQs were published on April 1 following the FDIC’s March 29 teleconference held to discuss the ODP Guidance. The FAQs clarify how an automated overdraft payment program differs from “ad hoc” overdraft payment practices, when customer use of an overdraft payment program is considered excessive or chronic, and what an institution must do to undertake meaningful and effective follow-up with the customer. The FAQs suggests considerations for determining an appropriate daily limit on overdraft fees and an appropriate de minimis overdraft amount, and provides guidance on establishing a reasonable and proportional overdraft fee. The FAQs also address whether an institution is required to provide new alternatives to automated overdraft payment programs or terminate or suspend a customer’s access to an automated overdraft payment program for chronic or excessive use. The ODP Guidance will be incorporated into the FDIC’s examination process. According to the FAQs, the FDIC expects institutions to have compliance and risk management action plans, policies and procedures that respond to the ODP guidance in place by July 1, 2011.

    Nutter Notes:  The ODP Guidance addresses risks posed by automated overdraft payment programs, and its recommendations about customer follow-up do not apply to ad hoc overdraft payments. The ODP Guidance recommends that FDIC-supervised institutions monitor automated overdraft payment programs for excessive or chronic customer use and, if a customer overdraws his or her account on more than six occasions where a fee is charged in a rolling 12-month period, undertake meaningful and effective follow-up action. According to the FAQs, an “occasion” occurs each time an overdraft transaction generates a fee. As a result, it is possible that more than one “occasion” can occur per day. If more than one overdraft fee is charged as a result of multiple transactions, each fee would constitute a separate occasion even if the fees are aggregated. Overdraft items paid where no fee is charged would not be included. “Meaningful and effective” follow-up, according to the FAQs, means that the institution has made reasonable efforts to provide the customer with information on alternatives to overdraft payment programs and a clear means for the customer to opt for those alternatives. The FAQs provide examples of how institutions may engage in such follow-up using either “enhanced periodic statements” (which would include a message that describes how the customer could contact the institution to discuss alternative options) or targeted outreach (which would involve contacting a customer whenever there is a cycle of repeated, excessive use).

5. Other Developments: FHA Audited Financials Requirement and Savings and Loan Holding Companies

  • FHA Waives Audited Financial Statements Requirement for Small Banks

The FHA announced on April 18 that supervised lenders with less than $500 million in assets will not be required to submit audited financial statements for FHA lender approval or renewal. The FHA’s waiver of the requirement will expire on April 7, 2012.

    Nutter Notes:  The FHA said that the waiver only applies to the submission of audited financial statements and does not apply to the requirement that supervised lenders submit an independent auditor’s opinion of internal control and compliance with HUD programs.

  • Federal Reserve Outlines Supervisory Guidance for Thrift Holding Companies

The Federal Reserve issued a notice on April 15 that outlines how it intends to apply certain parts of its current consolidated supervisory program for bank holding companies to savings and loan holding companies (SLHCs). The proposal indicates that the Federal Reserve plans to assess SLHC capital using supervisory methods similar to those currently used by the OTS until consolidated capital standards are finalized in the Basel III rulemaking process.

    Nutter Notes: The Federal Reserve’s consolidated supervision program applies primarily to large and regional holding companies. The Dodd-Frank Act transfers supervisory functions related to SLHCs and their non-depository subsidiaries from the OTS to the Federal Reserve on July 21, 2011. Comments on the proposal are due by May 23.

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 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
Tel: (617) 439-2989

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