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Nutter Bank Report, June 2010

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1.  Conference Committee Approves Regulatory Reform Bill
2.  Final Guidance Issued on Incentive Compensation Arrangements
3.  Borrower’s Bid to Enjoin Home Foreclosure Is Denied
4.  Transaction Account Guarantee Program Is Extended
5.  Other Developments: Right to Unionize and Supervisory Conversions

Full Reports

1.  Conference Committee Approves Regulatory Reform Bill

The Dodd-Frank Wall Street Reform and Consumer Protection Act, proposed financial regulatory reform legislation of a size and scale not seen since the early 1930s, was reported out of a congressional conference committee on June 25 and will likely soon be voted on by both the full House and Senate.  The legislation would re-structure the financial services regulatory system as well as impose new restrictions on particular financial products and services.  Although the legislative purpose is, in general, to prevent another systemic crisis by reining in excessive risk-taking by large banks and other institutions that are systemically significant, smaller institutions including community banks will suffer collateral damage on several fronts.  A detailed summary of the 2,319-page bill will be included in an upcoming special edition of the Nutter Bank Report.  Among other provisions, the bill would:

  • Establish the Financial Stability Oversight Council to identify and manage risk throughout the financial system.  The Council would be chaired by the Treasury Secretary and include the Federal Reserve Board, SEC, CFTC, OCC, FDIC, FHFA, NCUA and the new Consumer Financial Protection Bureau, among other members.
  • Establish the Consumer Financial Protection Bureau within the Federal Reserve, led by an independent director appointed by the President and confirmed by the Senate.  The CFPB would have a dedicated budget paid by the Federal Reserve System but would autonomously write consumer protection rules governing all financial institutions offering consumer financial products or services.
  • Abolish the Office of Thrift Supervision and create a new thrift regulatory division within the Office of the Comptroller of the Currency.  The OCC would be permitted to issue new federal thrift charters, and the OCC would regulate, supervise and examine federal thrifts.  The OTS’s treatment of a mutual holding company’s waived dividends would be grandfathered.
  • Require the federal banking agencies to write regulations generally prohibiting proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and limiting relationships with hedge funds and private equity funds.
  • Require large, complex financial companies to periodically submit plans for their rapid and orderly winding up in the event they fail.  Higher capital requirements and restrictions on growth and activities would be imposed if these companies fail to submit acceptable and timely plans.
  • Eliminate trust preferred securities as a permissible component of Tier 1 capital while grandfathering existing trust preferred securities, except that bank holding companies with less than $500 million in assets and which otherwise qualify as small bank holding companies under the Federal Reserve’s policy statement on small bank holding companies would be exempt.
  • Require mortgage lenders including banks to ensure a borrower’s ability to repay, prohibit certain pre-payment penalties, impose new disclosure requirements in connection with adjustable rate mortgage loans, lower the interest rate and points and fees thresholds that define high-cost mortgage loans and impose penalties for non-compliance.
  • Bar the OCC from determining that state laws are inapplicable to federally chartered banks and savings associations unless the laws “prevent or significantly interfere” with the ability of those federally chartered institutions to exercise powers granted under federal law.
  • Require the Federal Reserve to issue rules to ensure that interchange fees charged to merchants in connection with debit card transactions are reasonable and proportional to the cost of processing those transactions.
  • Permit interest to be paid on commercial demand deposit accounts.
  • Permanently increase deposit insurance coverage for banks, savings associations and credit unions to $250,000, retroactive to January 1, 2008.

2.  Final Guidance Issued on Incentive Compensation Arrangements

The federal banking agencies on June 21 issued final guidance on incentive compensation arrangements.  The guidance states that it is based on three fundamental principles: (1) incentive compensation arrangements at banking organizations should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risk; (2) the arrangements should be compatible with effective controls and risk management; and (3) the arrangements should be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.  Incentive compensation arrangements at banks and bank holding companies should not provide incentives for employees to take risks that could jeopardize the safety and soundness of the organization.  The guidance seeks to address the safety and soundness risks of incentive compensation practices by focusing on the basic problems they can pose from a risk-management perspective.  Incentive compensation arrangements – if improperly structured – can give employees incentives to take imprudent risks, according to the guidance.

Nutter Notes:  The Federal Reserve, in cooperation with the other banking agencies, has completed an initial analysis of incentive compensation practices at large, complex banking organizations as part of a so-called horizontal review, a coordinated examination of practices across multiple companies.  Last month, the Federal Reserve delivered assessments to the companies that included analysis of current compensation practices and areas requiring prompt attention.  The large organizations that were examined are now submitting plans to the Federal Reserve outlining steps and timelines for addressing outstanding issues to ensure that incentive compensation plans do not encourage excessive risk-taking.  During the next stage, the banking agencies will be conducting additional cross-company, horizontal reviews of incentive compensation practices at large, complex banking organizations for employees in certain business lines, such as mortgage originators.  The agencies will also be following up on specific areas that were found to be deficient in the initial analysis including inadequate identification of employees who can expose banking organizations to material risk, failure to fully identify the risks involved and, in connection with deferred payouts, taking a “one-size-fits-all” approach and failing to tailor deferral arrangements according to the type or duration of risk.

3.  Borrower’s Bid to Enjoin Home Foreclosure Is Denied

A Massachusetts trial court has denied a borrower’s request to stop a foreclosure proceeding despite the borrower’s claim that the loan was “unfair” under the Massachusetts consumer protection law, Chapter 93A of the General Laws.  In its May 13 decision denying the borrower’s request for an injunction, the court examined a stated income (no documentation) loan and determined that the borrower was not likely to prevail on a claim that the loan featured a combination of four characteristics that qualify as “unfair” under Chapter 93A.  The four-part test was proposed by the Massachusetts Attorney General and endorsed by the Massachusetts Supreme Judicial Court in a 2008 case in which a lender was enjoined from foreclosing on a loan that featured those four characteristics of unfairness.  The borrowers in the present case signed a Uniform Residential Loan Application and other documents stating their annual household income, but later claimed that the annual income stated in their application was more than double the actual amount of their annual income.  The court found that there was no evidence that the lender knew or should have known that the borrower’s representations about their income were false.  The borrowers also claimed that they were told that their loan was a fixed rate loan, despite numerous documents disclosing that it was an adjustable rate loan.  The court held that the borrowers were bound by the loan documents they signed regardless of whether they read or understood its terms, and that they otherwise failed to show that the loan was unfair.

Nutter Notes:  The four criteria used by the court to determine whether a residential mortgage loan qualifies as unfair under chapter 93A are: (1) is the loan is an adjustable rate mortgage loan with an introductory rate period of 3 years or less; (2) does the loan feature an introductory rate for the initial period that is at least 300 basis points below the fully indexed rate; (3) is the loan to a borrower for whom the debt-to-income ratio would have exceeded 50% had the lender measured the borrower’s debt by the monthly payments that would be due at the fully indexed rate rather than under the introductory rate; and (4) is the loan-to-value ratio 100% or more, or does the loan include a substantial prepayment penalty (greater than the conventional prepayment penalty as defined in the Massachusetts Predatory Home Loan Practices Act, Chapter 183C of the General Laws) or a prepayment penalty that extends beyond the introductory rate period?  In the 2008 case, the Massachusetts Attorney General had shown that those four characteristics made it reasonably likely that the borrower would not be able to make the necessary loan payments, leading to default and then foreclosure.

4.  Transaction Account Guarantee Program Is Extended

The FDIC on June 22 issued a final rule extending the Transaction Account Guarantee Program through December 31, 2010, for banks currently participating in the program, with the possibility of an additional extension of up to 12 months without additional formal rulemaking, on a determination by the FDIC’s Board of Directors that continuing economic difficulties warrant a further extension.  The final rule modifies the assessment base for calculating the assessment for a bank’s continued participation in the TAG program to the average daily balances in the TAG related accounts, but makes no changes to the assessment rate itself.  The final rule requires banks that are participating in the TAG program and that offer NOW accounts covered by the program to reduce the interest rate on such accounts to a rate no higher than 0.25 percent from a prior cap of 0.50 percent and to commit to maintain that rate for the duration of the TAG extension in order for those NOW accounts to remain eligible for the FDIC’s continued guarantee.

Nutter Notes: In October 2008, the FDIC adopted the Temporary Liquidity Guarantee Program following a determination of systemic risk by the Secretary of the Treasury.  The TLGP was part of an ongoing and coordinated effort by the FDIC, the U.S. Department of the Treasury, and the Federal Reserve to address unprecedented disruptions in the financial markets and preserve confidence in the American economy.  The TLGP comprises two distinct components: the Debt Guarantee Program, pursuant to which the FDIC guarantees certain senior unsecured debt issued by entities participating in the TLGP, and the TAG program, pursuant to which the FDIC guarantees all funds held at participating banks (beyond the standard maximum deposit insurance limit) in qualifying noninterest-bearing transaction accounts.  As part of its rulemaking process, the FDIC in November 2008 expanded the TAG program to cover, among other accounts, NOW accounts with interest rates no higher than 0.50 percent if the bank offering the account committed to maintain the interest rate at a level no higher than 0.50 percent through December 31, 2009.  Under the Dodd-Frank bill (see Report #1 above), the TAG program would be extended for two years and would become mandatory for all insured banks.

5.  Other Developments: Right to Unionize and Supervisory Conversions

  • Government Contractors Required to Inform Employees of Right to Unionize

A final rule issued by U.S. Department of Labor on May 20 that requires federal government contractors to post a notice advising employees of their rights under the National Labor Relations Act to form and join labor unions may apply to all insured banks, not just banks that offer US savings bonds or have Treasury Tax & Loan accounts with federal agencies.  The rule defines a government contract to include any agreement for insurance services.  The American Bankers Association reported on June 16 that, while neither the final rule nor the executive order it implements references deposit insurance, Department of Labor officials said in a recent webinar that FDIC insurance is a covered government contract.

Nutter Notes:  The ABA said that an audio recording of the webinar is available until July 2 by dialing 800-333-1825.  The rule became effective on June 21 and requires the notice to be posted where the institution displays its other federal labor posters.  Any institution that posts notices to employees electronically about their jobs must also provide a link to the required notice on the Department of Labor’s Office of Labor-Management Standards’ website.  Copies of the form of notice are available at the Department’s website:

  • OTS Approves Supervisory Conversion in Maine

The OTS has approved a voluntary supervisory conversion involving Savings Bank of Maine in Gardiner, Maine.  As of December 31, 2009, the bank was undercapitalized and the bank and its mutual holding company parent were subject to a Prompt Corrective Action Directive and a Cease and Desist Order requiring them to become at least adequately capitalized by June 30, 2010 and to have and maintain core and risk-based capital ratios, respectively, of at least 10.76 percent and at least 13.78 percent by September 30, 2010, according to OTS Order No. 2010-23.

Nutter Notes:  In a voluntary supervisory conversion, a mutual institution is converted to stock form and the stock issued to investors, without participation by depositors.  The investor in this case is a Maryland corporation formed in March 2010 for the purpose of acquiring the bank.  The acquiring corporation engaged in a private placement of its common stock to fund the acquisition of the bank, according to the OTS Order.  On completion of the private placement, no one investor would own more than 9.9 percent of the stock of the acquiring corporation, the OTS Order said.

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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