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Nutter Bank Report, December 2011

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1. OCC Issues Guidance on Risks Associated with Residential Foreclosures
2. Federal Reserve: Asset Exchanges Raise Safety and Soundness Concerns
3. Stricter Supervisory Standards Proposed for Systemically Important Institutions
4. CFPB Releases Prototype Consumer Credit Card Agreement
5. Other Developments: Market Risk Capital Rules and SLHC Reporting

1. OCC Issues Guidance on Risks Associated with Residential Foreclosures
The OCC recently issued guidance to national banks and federal savings associations on obligations and risks related to foreclosed residential property. The December 14 guidance, entitled Guidance on Potential Issues with Foreclosed Residential Properties (OCC Bulletin No. 2011-49), summarizes certain legal, safety and soundness, and community impact considerations related to residential foreclosures. The guidance addresses the conduct of a bank or savings association in cases where the institution is the owner of a foreclosed property, is the servicer or property manager, or is the securitization trustee. The OCC’s guidance also emphasizes the importance of understanding requirements imposed by Fannie Mae, Freddie Mac and the U.S. Department of Housing and Urban Development (HUD) on servicers. An institution should have robust policies and procedures in place to address risks associated with foreclosed (or soon to be foreclosed) properties, according to the OCC’s guidance. The guidance states that institutions should identify all risks arising from acquiring title to properties through foreclosure, or from acting as a servicer, property manager, or securitization trustee, and ensure that policies and procedures for monitoring and controlling those risks have been implemented. The OCC said in its guidance that while the standards focus primarily on residential foreclosed properties, many of the same principles apply to commercial properties.

      Nutter Notes:  Earlier this year, the OCC directed national banks to conduct self-assessments of foreclosure management practices to ensure that such practices conform to OCC expectations. However, that directive did not specifically focus on risk management activities. The OCC guidance issued this month addresses certain specific foreclosure risks that management and the board of directors should consider when implementing risk management policies and procedures. Those specific risks include assuming the primary responsibilities of an owner, such as maintenance, security, property taxes, acting as landlord, and maintaining appropriate insurance. The guidance recommends that foreclosing institutions communicate with localities, including homeowner associations, to learn about any specific requirements applicable to foreclosed residential properties, such as property upkeep, maintenance, and security requirements, and local foreclosure registration requirements. In terms of risks and obligations related to acting as servicer or manager of a foreclosed property, the guidance notes that Fannie Mae and Freddie Mac each have detailed servicing guides setting forth servicer obligations and responsibilities for foreclosed properties or vacant properties in the process of foreclosure. In the case of private securitizations, the guidance recommends that institutions consider the obligations detailed in the applicable pooling and servicing agreement or its equivalent. The guidance also recommends that an institution acting as a securitization trustee consider risks such as potential reputation and litigation risks if a servicer undertakes foreclosure actions in the trustee’s name as the secured party.

2. Federal Reserve: Asset Exchanges Raise Safety and Soundness Concerns
In recent supervisory guidance, the Federal Reserve staff expressed concerns that so-called “asset exchange” transactions used by financial institutions to dispose of or reduce nonperforming assets and other real estate owned (OREO) may present significant risks and could compromise safety and soundness. The December 21 guidance, entitled Disposal of Problem Assets through Exchanges (Supervision and Regulation Letter No. 11-15), highlights certain risks specific to asset exchange transactions that are designed to reduce problem assets in the short term. According to the guidance, asset exchanges involve third parties or marketing agents who offer to purchase problem assets from an institution and replace them with performing assets. The guidance warns that a lack of appropriate due diligence may result in heightened risks over the longer term and that incorrect or other inappropriate assumptions used in determining the fair value of purchased assets may result in loss recognition shortly after closing an asset exchange. The supervisory guidance applies to all state member banks, bank holding companies and their nonbank subsidiaries, and savings and loan holding companies that engage in asset exchange transactions. The guidance outlines certain risks specific to asset exchange transactions, relevant risk management considerations for institutions, and the supervisory considerations examiners will use when reviewing such transactions.

      Nutter Notes:  The guidance recommends that management assess relevant risk exposure before entering into asset exchange transactions. Specifically, management should determine an asset exchange’s long-term effect on the institution’s balance sheet and loss exposure, according to the guidance. The guidance also recommends that management determine how these risks align with the institution’s overall risk management strategy. The guidance indicates that examiners typically will not include a specific review of these transactions in routine examination and inspection activities, particularly where there is no evidence that a bank has engaged in such transactions. However, examiners will be looking for indications of possible asset exchange transactions as part of their routine monitoring between examinations. Institutions can expect examiners to discuss asset exchanges with management as part of the supervision process if examiners become aware that the institution is considering these types of transactions. According to the guidance, supervisory monitoring activities will focus on financial statement changes commonly associated with asset exchanges, internal risk management reports, and other documents received on a routine basis. Any review of asset exchanges by examiners will consider whether appropriate risk management measures have been considered and whether management has used appropriate valuations in accordance with GAAP.

3. Stricter Supervisory Standards Proposed for Systemically Important Institutions
The Federal Reserve has proposed a number of regulations intended to strengthen regulation and supervision of large bank holding companies and systemically important non-bank financial institutions. The proposed regulations released on December 20 would implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The new rules would address capital, liquidity, credit exposure, stress testing, risk management, and early remediation requirements, among other things. The proposed regulations would generally apply to all U.S. bank holding companies with consolidated assets of $50 billion or more and any non-bank financial institution that may be designated by the Financial Stability Oversight Council as a systemically important financial institution. Savings and loan holding companies (“SLHCs”) would be subject to certain stress test requirements under the proposal, but otherwise would not be subject to the proposed regulations. The Federal Reserve announced that it plans to issue a separate proposal to address the applicability of the enhanced standards to SLHCs and to address similar issues for foreign banking organizations. Financial institutions subject to the proposed regulations would need to comply with certain of the enhanced standards within one year after they are finalized. The requirements on stress testing for bank holding companies would take effect shortly after the regulations are finalized. Comments on the proposal are due by March 31, 2012.

      Nutter Notes:  Included among the proposed regulations are enhanced risk-based capital and leverage requirements for large bank holding companies and systemically important non-bank financial institutions that would be implemented in two phases. First, covered financial institutions would be subject to the Federal Reserve’s capital plan rule, which was issued in November 2011. That rule requires covered institutions to develop annual capital plans, conduct stress tests, and maintain adequate capital, including a tier one common risk-based capital ratio greater than 5%, under both expected and stressed conditions. Second, the Federal Reserve would implement a risk-based capital surcharge based on the framework and methodology developed by the Basel Committee on Banking Supervision. Stress testing would be conducted annually under the proposal using three different economic and financial market scenarios. A summary of the results, including company-specific information, would be made public. Certain liquidity requirements would also be implemented in multiple phases under the proposal, including standards that would require companies to conduct internal liquidity stress tests and set internal quantitative limits to manage liquidity risk. The proposed regulations would also limit credit exposure of a covered financial institution to a single counterparty as a percentage of the institution’s regulatory capital, and credit exposure between the largest financial institutions would be subject to a narrower limit.

4. CFPB Releases Prototype Consumer Credit Card Agreement
The Consumer Financial Protection Bureau (“CFPB”) has developed a model form of consumer credit card agreement as part of its Know Before You Owe project that the agency said is shorter, clearer and more consistent. The model agreement was released on December 7 for public comment, and the CFPB said that it would also begin a pilot test of the prototype through a federal credit union. The industry average for a credit card agreement is about 5,000 words, according to the CFPB. The CFPB’s model agreement is about 1,100 words. According to the CFPB, the model credit card agreement also has an easy-to-read layout and is written in plain language. The model agreement is organized into three sections: costs, changes, and additional information. The model credit card agreement would also establish standard definitions for certain terms like “authorized charges,” “card,” “balance transfer,” and “default.” The model agreement identifies defined terms by underlining them, but the definitions would be provided either in a separate document or on a website that is accessible by consumers. The model form of credit card agreement is available on the CFPB’s website. 

    Nutter Notes:  In addition to introducing the model form of consumer credit card agreement, the CFPB announced that it will host an online database of existing credit card agreements where the public can compare existing agreements with the CFPB’s prototype. The Credit Card Accountability Responsibility and Disclosure Act of 2009 required credit card issuers to provide copies of their credit card agreements to the Federal Reserve so it could maintain a database for consumers. The Dodd-Frank Act transferred responsibility for that database to the CFPB. The Dodd-Frank Act granted authority to the CFPB to prescribe rules to ensure that the features of any consumer financial product or service, both initially and over the term of the product or service, are fully, accurately, and effectively disclosed to consumers in a manner that permits consumers to understand the costs, benefits, and risks associated with the product or service. In connection with its mandate under the Dodd-Frank Act, the CFPB initiated the Know Before You Owe project to improve the transparency of information about consumer financial products, including residential mortgage loans and student loans. The CFPB has not addressed whether use of the final form of consumer credit card agreement by credit card issuers would be voluntary or subject to future CFPB rulemaking.

5. Other Developments: Market Risk Capital Rules and SLHC Reporting

  • Federal Banking Agencies Request Comment on Market Risk Capital Rules

The federal bank regulatory agencies released a notice of proposed rulemaking on December 7 that would amend an earlier market risk capital proposal announced in December 2010 to modify the agencies’ market risk capital rules for banking organizations with significant trading activities. The amended proposal would include alternative standards of creditworthiness in place of credit ratings to determine the capital requirements for certain debt and securitization positions.

      Nutter Notes:  The proposed creditworthiness standards include the use of country risk classifications published by the Organization for Economic Cooperation and Development for sovereign positions, company-specific financial information and stock market volatility for corporate debt positions, and a supervisory formula for securitization positions. Comments on the proposal are due by February 3, 2012.

  • Federal Reserve Announces Phase-In Period for SLHC Reports

The Federal Reserve on December 23 issued a final notice for a two-year phase-in period for most SLHCs to file Federal Reserve regulatory reports, and an exemption for some SLHCs from initially filing Federal Reserve regulatory reports. Earlier this year, the Federal Reserve requested comment on proposals to require SLHCs to submit the same reports as bank holding companies, beginning with the March 31, 2012 reporting period.

    Nutter Notes:  Under the final notice, a limited number of SLHCs will be exempt from most regulatory reporting using the Federal Reserve’s existing regulatory reports. Exempt SLHCs would continue to submit Schedule HC, which is currently a part of the Thrift Financial Report, and the OTS H-(b)11 Annual/Current Report. However, exempt SLHCs will file annual reports on the Federal Reserve’s form FR Y-6 (or FR Y-7 for foreign banking organizations).

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

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

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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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