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Nutter Bank Report, December 2009

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1.  Risk-Based Pricing Rules Issued
2.  Joint Rule Applies Recent Changes in GAAP to Regulatory Capital Standards
3.  Additional Guidance on Interest Rate Restrictions
4.  New SEC Rules Require More Compensation and Corporate Governance Disclosures
5.  Other Developments: CRE Loan Workouts and Mortgage Loan Modifications

Full Reports

1.  Risk-Based Pricing Rules Issued

The Federal Reserve and the Federal Trade Commission on December 22 jointly issued final rules to implement the risk-based pricing provisions in the Fair and Accurate Credit Transactions Act of 2003. The rules, which will become effective on January 1, 2011, generally require a creditor to provide a risk-based pricing notice to a consumer when the creditor uses a consumer report to grant or extend credit to the consumer on terms that are materially less favorable than the most favorable terms available to a “substantial proportion” of consumers from or through that creditor. The term “risk-based pricing” refers to the practice of adjusting the price and other terms of credit offered to a consumer to reflect the risk of nonpayment by that consumer. Information from a consumer report is generally used in evaluating the risk.  Creditors that engage in risk-based pricing generally offer more favorable terms to consumers with good credit histories and less favorable terms to consumers with poor credit histories. The final rules provide two alternative means by which creditors can determine when they are offering credit on terms that are materially less favorable. The rules also include certain exceptions to the general rule, including exceptions for creditors that provide a consumer with a disclosure of the consumer’s credit score in conjunction with additional information that provides the consumer with the context to understand the relevance of the credit score.

Nutter Notes:  Under the Fair and Accurate Credit Transactions Act of 2003, a person must generally provide a risk-based pricing notice to a consumer when the person uses a consumer report in connection with an application, grant, extension, or other provision of credit and, based in whole or in part on the consumer report, grants, extends, or provides credit to the consumer on terms that are materially less favorable than the most favorable terms available to a “substantial proportion” of consumers from or through that person. The risk-based pricing notice requirement is designed primarily to improve the accuracy of consumer reports by alerting consumers to the existence of negative information on their consumer reports so that consumers can, if they choose, check their consumer reports for accuracy and correct any inaccurate information. It is intended to complement the existing adverse action notice provisions of the Fair Credit Reporting Act. The agencies recognize that no single test or approach is likely to be feasible for all of the various types of creditors to which the rules apply or for the many different credit products for which risk-based pricing is used. As a result, the final rules provide alternative approaches that creditors may use to comply with the statute’s requirements. The final rules clarify that the risk-based pricing notice requirements apply only in connection with credit that is primarily for personal, family, or household purposes, but not in connection with business credit.

2.  Joint Rule Applies Recent Changes in GAAP to Regulatory Capital Standards

The federal bank regulatory agencies have issued a joint rule in connection with the adoption by the Financial Accounting Standards Board of Statements of Financial Accounting Standards No. 166 and No. 167, which make substantive changes to the rules governing how banking organizations account for securitized assets currently excluded from their balance sheets. The final rule announced on December 16 amends the general risk-based and advanced risk-based capital adequacy frameworks by eliminating the exclusion of certain consolidated asset-backed commercial paper programs from risk-weighted assets. The final rule includes a transition mechanism that allows banking organizations the option to delay implementation for two quarters, followed by an optional two-quarter partial implementation of the final rule.  The transition mechanism is optional because it requires a banking organization that chooses the option to prepare and maintain two sets of financial records for special purpose entities affected by the new accounting standards for the duration of the delay and partial implementation periods (to account separately for financial reporting under U.S. generally accepted accounting principles and for regulatory capital reporting). The delay and subsequent phase-in periods of the optional implementation mechanism apply only to risk-based capital requirements, not to the leverage ratio requirement. The final rule is effective 60 days after it is published in the Federal Register, which is expected shortly.

Nutter Notes:  FAS 166 and FAS 167, among other things, establish new accounting standards for a transfer of assets to a special purpose entity, known as a variable interest entity (VIE) under GAAP, and for consolidating VIEs. Under FAS 167, banking organizations may be required to consolidate assets, liabilities, and equity in certain VIEs that were not consolidated under the previous GAAP standards.  Organizations affected by the new accounting standards generally will be subject to higher minimum regulatory capital requirements. The federal banking agencies’ risk-based capital and leverage rules generally require banking organizations to include assets held by newly consolidated VIEs in their leverage and risk-based capital ratios. As a result, both the leverage and risk-based capital ratios of banking organizations that must consolidate VIEs (that they did not previously consolidate) would be likely to fall by varying amounts due to FAS 167, all other factors remaining constant.  The final rule also provides for an optional two-quarter delay, followed by an optional two-quarter partial implementation, of the application of the agencies’ regulatory limit on the inclusion of the allowance for loan and lease losses (ALLL) in tier 2 capital for the portion of the ALLL associated with the assets a banking organization consolidates as a result of FAS 167. Finally, the rule permits the agencies to require banking organizations to treat entities that are not consolidated under accounting standards as if they were consolidated for risk-based capital purposes, commensurate with the risk relationship of the banking organization to the entities.

3.  Additional Guidance on Interest Rate Restrictions

The FDIC has issued additional guidance on whether a bank that is not well capitalized may pay deposit rates that exceed the national rate caps posted by the FDIC. Financial Institution Letter 69-2009 released on December 4 describes the procedures and criteria the FDIC will use to determine whether a bank subject to interest rate restrictions under FDIC regulations is operating in a high-rate area, and may therefore use the prevailing rates in its market area rather than the average national rate to determine conformance with the interest rate restrictions. A bank subject to the interest rate restrictions under Section 337.6 of the FDIC’s regulations may request a determination that it is operating in a high-rate area by sending a letter to its FDIC regional office, specifying the bank’s market area(s). The FDIC will base its decision on average rates for the geographic area in which the bank is operating, using state(s), metropolitan statistical area(s), and local area data. If the standardized rate data for the bank’s market area exceed the national average for a minimum of three of the four deposit products reviewed by at least 10 percent, the FDIC will generally determine that the bank is operating in a high-rate area. The non-jumbo deposit products considered are money market deposit accounts and 12-month, 24-month and 36-month CDs. Banks that submit determination requests by December 31, 2009 will receive a response by January 30, 2010.  If the FDIC determines that a bank is not operating in a high-rate area, it will instruct the bank to begin using the national rate caps by March 1, 2010. Any bank that is not well capitalized and submits a determination request after December 31, 2009 must use the national rate caps until it has received notice that it is operating in a high-rate area.

Nutter Notes:  The FDIC approved an amendment to Section 337.6 of its regulations in May to change the way the FDIC administers the statutory restrictions on deposit interest rates paid by banks that are less than well capitalized. Effective January 1, 2010, a bank that is subject to the interest rate restrictions under Section 337.6 is required to use the “national rate” to determine conformance with the restrictions unless the bank is operating in a high-rate area. The amendment redefines the national rate as “a simple average of rates paid by insured depository institutions and branches for which data are available” and deems the national rate to be the prevailing rate for all market areas. A bank that is subject to the restrictions and that believes it is operating in an area where the rates paid on deposits are higher than the “national rate” can use the local market to determine conformance with the interest rate restrictions only if it seeks and receives a determination from the FDIC that the bank is operating in a high-rate area. If such a determination is granted, the bank’s deposit rates must not exceed by more than 75 basis points the prevailing rate cap for the bank’s market area. The FDIC’s determination is effective for the calendar year in which it is granted, but will be rescinded by written notice if, during the calendar year, the bank’s market area no longer meets the requirements for being a high-rate area. Banks operating in high-rate areas must apply for determinations annually.

4.  New SEC Rules Require More Compensation and Corporate Governance Disclosures

The Securities and Exchange Commission has approved amendments to its rules that will require public companies to disclose additional information about risk, compensation and corporate governance matters. According to the SEC, the new disclosure requirements announced on December 16 are intended to enhance the information provided to shareholders so that they are better able to evaluate the leadership of public companies. In particular, the amendments will require new disclosures about compensation policies and practices as they relate to a company’s risk management, the board’s role in stock and option awards to company executives and directors, potential conflicts of interests of compensation consultants, and legal actions involving a company's executive officers, directors and nominees. The amendments will also require disclosures in proxy and information statements about the background and qualifications of directors and board nominees, the consideration of diversity in the process by which candidates for director are considered for nomination, board leadership structure and the board's role in risk oversight. Smaller reporting companies will not be required to provide the new disclosures. The new disclosure requirements will become effective on February 28, 2010.

Nutter Notes:  The amendments will require public companies to provide a narrative disclosure about their compensation policies and practices for all employees if those policies or practices create risks that may have a material adverse effect on the company, in addition to the existing disclosure required for public companies (other than smaller reporting companies) regarding compensation for the most highly compensated executive officers. For each director and board nominee, each public company will have to disclose the particular experience, qualifications, attributes or skills that led the company’s board to conclude that the person should serve as a director, any directorships at public companies and registered investment companies that each director and board nominee held at any time during the past five years, and an expanded list of legal proceedings, including SEC securities fraud enforcement actions against the director or nominee, going back ten years, instead of five years as is currently required. Amendments to Form 8-K will require companies to disclose the results of a shareholder vote within four business days after the end of the meeting at which the vote was held, replacing the requirement to disclose voting results in annual or quarterly reports, which are sometimes filed months after the relevant meeting.

5.  Other Developments: CRE Loan Workouts and Mortgage Loan Modifications

  • Audio Conference Addresses Commercial Real Estate Loan Workouts

The FDIC has posted on its web site a transcript of a December 3 interagency audio conference on prudent commercial real estate loan workouts in which the federal banking agencies addressed some of the frequently asked questions that they have received on the interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts.

Nutter Notes:  Among other topics, the agencies discussed restructuring a loan by splitting it into a multiple-note structure (so-called A and B notes) in a situation where the borrower is able to meet a certain level of debt service, but cannot meet the entire debt service requirements of the original loan.

  • Fed Provides Guidance for Adverse Action on Mortgage Loan Modifications

The Federal Reserve issued guidance in a December 4 consumer affairs letter on whether an adverse action notice under Regulation B (Equal Credit Opportunity) is required when an institution declines to modify a residential mortgage loan under the U.S. Treasury Department’s Making Home Affordable Modification Program.

Nutter Notes:  In the letter, the Federal Reserve advises that Regulation B requires a four-part analysis to determine whether an adverse action notice is required. The analysis must consider whether there is an extension of credit, whether there is an application, whether there is an adverse action on an application, and whether the borrower is delinquent or in default on the loan.

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 Rena Marie Strand and Lisa M. Jentzen. 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

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