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Nutter Bank Report, January 2010

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1.  Division of Banks Opinion Permits HAMP Loan Modifications
2.  FDIC Considers Rules Linking Insurance Costs to Compensation Risks
3.  Call Report Changes Announced by Federal Banking Agencies
4.  Advisory Describes Expectations for Managing Interest Rate Risk
5.  Other Developments: OTS Denies By-Law Change and Shelf Charter Used

Full Reports

1.  Division of Banks Opinion Permits HAMP Loan Modification

The Massachusetts Division of Banks has issued an opinion concluding that home loan modifications under the federal Home Affordable Mortgage Program (HAMP) do not violate a Massachusetts law allowing loan modifications benefitting the borrower despite the fact that the interest rate on a HAMP program loan can adjust upwards after five years to a rate ultimately higher than the pre-modification rate. In Opinion 09-028, dated January 13, 2010, Massachusetts Deputy Commissioner of Banks and General Counsel Joseph A. Leonard, Jr. reviewed the purposes of the Massachusetts law and the HAMP program and concluded that, because the interest rate on the modified loan in the five-year period following modification is fixed at a lower rate than the interest rate before the modification, the modification is permissible under Massachusetts General Laws Chapter 183, Section 63A. That Massachusetts statute authorizes a lender, including a bank, subject to certain conditions to revise the interest rate on an owner-occupied, one-to four family mortgage loan on a Massachusetts home provided that “the interest rate. . . after any such revision, shall not be in excess of the interest rate on the existing note and mortgage so revised.”

Nutter Notes:  The HAMP program offers incentives to lenders (including secondary market purchasers of mortgage loans), servicers and homeowners to modify residential mortgage loans to provide sustainable mortgage payments for borrowers. The program provides, in pertinent part, that the interest rate on certain modified mortgage loans with an adjustable rate must be fixed for the first five years after modification to a lower rate, and then the rate may increase one percentage point per year until it reaches the Freddie Mac Primary Mortgage Market rate for 30-year fixed rate conforming mortgage loans. The Division’s opinion letter determined that the General Court’s intent in enacting Section 63A was to increase loan modifications to assist homeowners in avoiding foreclosure, and that a reduced, fixed interest rate for the first five years after modification benefitted the borrower and would not be a circumvention of the Massachusetts statute simply because of the possibility that the modified rate could at some point in the future adjust upwards to exceed the interest rate in effect prior to the modification.

2.  FDIC Considers Rules Linking Insurance Costs to Compensation Risks

The FDIC is considering changes to its risk-based deposit insurance assessment system to account for risks posed by certain employee compensation programs. The FDIC issued an advance notice of proposed rulemaking on January 14 to seek comments about whether and how to incorporate employee compensation criteria into the risk-based assessment system. The FDIC said that some types of compensation programs can increase losses to the Deposit Insurance Fund (DIF) because they provide incentives for bank employees to engage in excessive risk taking which can ultimately increase a bank’s risk of failure. The FDIC examined Material Loss Reviews conducted in 2009 that addressed the factors contributing to losses resulting from 49 bank failures and found that employee compensation practices were a contributing factor in 35% of those cases. The FDIC is requesting comments to identify criteria for adjustments to the risk-based assessment system in order to correctly price and assess the risks presented by certain compensation programs to adequately compensate the DIF for the risks inherent such programs. Comments must be submitted to the FDIC on or before February 18.

Nutter Notes: The employee compensation criteria would focus on whether an employee compensation program is likely to align employee performance with the long-term interests of the bank and its stakeholders, including the FDIC. The notice suggests certain features of compensation programs that may help to discourage excessive risk-taking and meet the FDIC’s goals. For employees (including senior management) of stock institutions whose business activities can present greater risk to the bank and who also receive a portion of their compensation according to formulas based on the achievement of performance goals, the FDIC suggests that, in lieu of cash or immediately exercisable stock options, a significant portion of such employees’ compensation should be comprised of restricted, non-discounted company stock awards that vest at intervals over a period of years. The FDIC also suggests that the stock initially be awarded at the closing price in effect on the day of the award. Significant awards of stock should become vested over a multi-year period and should be subject to a claw-back designed to account for the outcome of risks assumed in earlier periods. Finally, the FDIC suggests that compensation programs should be administered by a committee of independent directors, with input from independent compensation professionals. The FDIC is considering whether banks that are able to attest that their compensation programs include those features present a lower risk to the DIF and, as a result, should face a lower risk-based assessment rate than those banks that cannot make that kind of an attestation.

3.  Call Report Changes Announced by Federal Banking Agencies

The Federal Financial Institutions Examination Council (FFIEC) has approved revisions to the reporting requirements for the Consolidated Report of Condition and Income (Call Report) for 2010. The revisions announced on January 22, which take effect on March 31, 2010 unless otherwise indicated, include the following:

  • New memorandum items in Schedule RI, Income Statement, to identify the components of other-than-temporary impairment losses on debt securities;
  • Clarification of the instructions for reporting unused commitments in Schedule RC-L, Derivatives and Off-Balance Sheet Items;
  • Breakdowns of existing items in Schedule RC-L for unused credit card lines and other unused commitments, and a related breakdown of the existing item for other loans in Schedule RC-C, part I, Loans and Leases;
  • New items in Schedule RC-C, part I, and Schedule RC-L pertaining to reverse mortgages that would be collected annually beginning December 31, 2010;
  •  A breakdown of the existing item for time deposits of $100,000 or more and revisions of existing items for brokered deposits in Schedule RC-E, Deposit Liabilities, as a result of the temporary increase in deposit insurance coverage;
  • A change from annual to quarterly reporting for small business and small farm lending data in Schedule RC-C, part II, Loans to Small Businesses and Small Farms, and for the number of certain deposit accounts in Schedule RC-O, Other Data for Deposit Insurance and FICO Assessments;
  • New items in Schedule RC-M, Memoranda, for assets acquired from failed institutions that are covered by FDIC loss-sharing agreements; and
  • The elimination of the item for internal allocations of income and expense from Schedule RI-D, Income from Foreign Offices (which is completed only by certain banks on the FFIEC 031 report form).

Nutter Notes:  For the March 31, 2010 report date, banks may provide reasonable estimates for any new or revised Call Report item initially required to be reported as of that date for which the requested information is not readily available. This policy on the use of reasonable estimates will also apply to the reporting of the new reverse mortgage items that will be first implemented effective December 31, 2010. Drafts of the report forms for March 2010 (which also show the new December-only items for reverse mortgages) and draft instructions for the new and revised Call Report items are available on the FFIEC’s Web site (

4.  Advisory Describes Expectations for Managing Interest Rate Risk

The federal banking agencies have jointly issued an advisory to remind depository institutions of supervisory expectations for sound practices in managing interest rate risk. The January 6 Advisory on Interest Rate Risk Management reiterates the importance of effective corporate governance, policies and procedures, risk measuring and monitoring systems, stress testing, and internal controls related to the interest rate risk exposures of depository institutions. It also clarifies elements of existing guidance and describes interest rate risk-management techniques used by effective risk managers. The advisory states that the agencies expect each depository institution to manage its interest rate risk exposure using processes and systems commensurate with its complexity, business model, risk profile, and scope of operations. The advisory also reminds depository institutions that an effective interest rate risk-management system would not only involve the identification and measurement of interest rate risk, but also appropriate actions to control the risk. According to the agencies’ statement, if an institution determines that its core earnings and capital are insufficient to support its level of interest rate risk, it should take steps to mitigate its exposure, increase its capital, or both.

Nutter Notes:  According to the advisory, senior management is responsible for ensuring that strategies, policies, and procedures for managing interest rate risk that are approved by the board of directors are appropriately executed within designated lines of authority and responsibility. The agencies recommend that such policies and procedures ensure that the interest rate risk implications of significant new strategies, products and businesses are integrated into the interest rate risk management process. Such policies and procedures also should document and provide for controls over permissible hedging strategies and hedging instruments. The agencies advise depository institutions to ensure that the assessment of interest rate risk is appropriately incorporated in firm-wide risk management efforts so that the interrelationships between interest rate risk and other risks are understood. An accompanying supervision and regulation letter issued by the Federal Reserve notes that although the advisory is targeted at depository institutions, the advice provided is also directly pertinent to bank holding companies. The supervision and regulation letter reminds bank holding companies that they should manage and control aggregate risk exposures, including interest rate risk, on a consolidated basis, while recognizing legal distinctions and possible obstacles to cash movements among subsidiaries.

5.  Other Developments: OTS Denies By-Law Change and Shelf Charter Used

  • OTS Disapproves By-Law Change Permanently Barring Bad Boy

The OTS has denied an application by a federal savings bank to amend its by-laws to permanently bar a person who has been subject to a cease and desist order based on certain types of wrongful conduct from serving as a director or nominating anyone to be a director, and to require directors to be residents of the state where the savings bank is located.

Nutter Notes:  In the January 14 Director’s Order, the OTS concluded, among other things, that the proposed restriction on director nominations would diminish the property rights of stockholders and members of a federal savings bank. The OTS also noted that a permanent ban on service as a director was too harsh in that it would preclude the possibility of rehabilitation of a person who had been subject to a cease and desist order.

  • OCC Approves First Use of a Shelf Charter to Acquire a Failed Bank

The OCC announced on January 22 that it approved the first use of a “shelf charter” for the acquisition of a failed bank by an investor group. The investor group was granted preliminary approval for a shelf charter on October 23, 2009. Final approval is subject to various conditions to ensure the safe and sound operation of the new bank.

Nutter Notes:  A shelf charter remains inactive, or “on the shelf,” until such time as the investor group is in a position to acquire a troubled institution. The OCC said that by granting preliminary approvals of this kind, it expands the pool of potential buyers available to buy troubled institutions, and in particular the pool of new equity capital available to bid on troubled institutions through the FDIC’s bid process.

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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