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Nutter Bank Report, June 2012

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1. Massachusetts Legislature Considers Competing Foreclosure Reform Bills
2. Federal Banking Agencies Propose Regulatory Capital Rules to Implement Basel III
3. Court Rules that Balloon Payment May Not Be Ignored in Determining Ability to Repay
4. Federal Reserve and OCC Issue Guidelines for Independent Foreclosure Review
5. Other Developments: Mortgage Servicer Practices and OCC Lending Limits

1. Massachusetts Legislature Considers Competing Foreclosure Reform Bills

The Massachusetts legislature continued its consideration this month of House and Senate versions of foreclosure reform bills that would modify the foreclosure process and require a creditor to make a good faith effort to avoid foreclosure before proceeding with a foreclosure sale on certain types of home mortgage loans. Both the House and Senate versions of the bill (H. 4096 and S. 2298) would amend Chapter 244, Section 35A of the General Laws of Massachusetts to require that documentation of assignment(s) of the mortgage be recorded before the foreclosing mortgagee may send a foreclosure notice. Both versions of the bill would also add a new Section 35B to Chapter 244, which would establish criteria that a creditor must meet to show that the creditor has taken reasonable steps and made a good faith effort to avoid foreclosure on certain types of home mortgage loans. Those criteria would include an assessment of the borrower’s current income, total debts and obligations, the net present value of receiving payments pursuant to a modified mortgage loan as compared to the anticipated net recovery following foreclosure, and the interests of the creditor. The good faith effort to avoid foreclosure requirements would apply to home mortgage loans with features such as a teaser rate, interest-only payments (other than an open-end home equity line of credit), negative amortization, limited or no documentation of the borrower’s income or assets, certain prepayment penalties or loans meeting certain loan-to-value criteria. Significant differences remain between the House and Senate versions of the bill and the legislature concludes its formal sessions on July 31. 

    Nutter Notes: Differences between the House and Senate versions of the foreclosure reform bill include a provision in the Senate version that would establish a new foreclosure mediation program and an exemption in the House bill from the good faith effort to avoid foreclosure requirements for loans originated under MassHousing and Massachusetts Housing Partnership programs. The foreclosure mediation program under the Senate version would be administered by the Massachusetts Office of Public Collaboration at the University of Massachusetts at Boston. The Senate bill would require a creditor to deliver notice of the borrower’s right to participate in the Massachusetts foreclosure mediation program along with a notice of the right to cure the default. The notice would include a foreclosure mediation request form that the borrower would use to initiate mediation by submitting it to the creditor within 30 days after receipt of the notice. Under the Senate bill, if a borrower elects to initiate foreclosure mediation, the creditor would be prohibited from accelerating the note or otherwise initiating foreclosure proceedings until the mediator has certified that the creditor participated in the foreclosure mediation, engaged in mediation in good faith, and made all reasonable efforts to find an alternative to foreclosure. Mediation costs would be borne by the parties to the mediation, but a borrower’s portion of the fee would not exceed 15% of the total cost of the mediation, and borrowers that cannot afford to pay for mediation would still be allowed to participate in the program.

2. Federal Banking Agencies Propose Regulatory Capital Rules to Implement Basel III

The federal banking agencies have released proposed rules that would revise and replace the agencies’ current capital rules to implement the minimum regulatory capital ratios and capital adequacy requirements under the Basel III capital accords. The proposed rules issued on June 12 would apply to all banks, savings associations and top-tier bank holding companies with more than $500 million in assets, and all savings and loan holding companies regardless of asset size. Among other changes, the proposed rules would implement a new regulatory capital component called the common equity tier 1 capital ratio, require institutions to maintain a capital conservation buffer, and raise the minimum tier 1 capital ratio from 4% to 6% of risk-weighted assets (the minimum total risk-based capital ratio would remain unchanged at 8%). The new common equity tier 1 capital minimum ratio would be 4.5% of risk-weighted assets. Common equity tier 1 capital would be predominantly made up of retained earnings and common stock instruments, net of treasury stock, and net of a series of regulatory capital deductions and adjustments. Common equity tier 1 capital may also include limited amounts of common stock issued by consolidated subsidiaries to third parties under the proposal. The new common equity tier 1 capital conservation buffer would be a specific amount of common equity tier 1 capital in excess of the minimum risk based capital ratio. Under the proposal, the changes would be implemented in phases, with the full transition to the new capital requirements taking effect on January 1, 2015. Comments on the proposed capital rules are due by September 7, 2012.

    Nutter Notes: The minimum common equity tier 1 capital conservation buffer would be 2.5%. If an institution’s common equity tier 1 capital conservation buffer falls below the minimum amount, the institution would become subject to limitations on capital distributions (including dividend payments, discretionary payments on tier 1 instruments, and share buybacks) and certain discretionary bonus payments. The proposal would require each institution to publicly disclose, at least quarterly, the amount of its buffer and whether it is subject to any limitations on capital distributions and discretionary bonus payments as a result of falling below the minimum buffer amount. The proposed rules would also implement a new method (the “Standardized Approach”) for calculating risk-weighted assets (the denominator in each of the risk-based capital ratios) and update the prompt corrective action rules. The Standardized Approach would increase risk sensitivity by revising the methods for risk-weighting residential mortgage exposures (risk-weighting an exposure based on certain loan characteristics and its loan-to-value ratio), certain commercial real estate credit facilities (assigning a higher risk weight), exposures that are more than 90 days past due or on nonaccrual (assigning a higher risk weight), and exposures to foreign entities (by basing the risk weight on the country’s risk classification). The prompt corrective action rules would be updated to reflect the proposed changes to the definition of capital and the minimum regulatory capital ratios and by incorporating the common equity tier 1 capital measure.

3. Court Rules that Balloon Payment May Not Be Ignored in Determining Ability to Repay

In a recent ruling, the U.S. District Court for the District of Massachusetts held that a home mortgage loan that was subject to Chapter 183C of the General Laws of Massachusetts, the Massachusetts Predatory Home Loan Practices Act, violated Chapter 183C’s requirement that the lender reasonably believe that one or more of the borrowers will be able to make the scheduled payments because the loan included a balloon payment feature. The court’s March 6 ruling came in a case involving a 6-month bail-out or bridge loan that, the lender claimed, was meant to enable the borrowers to restore their credit and obtain a conventional loan to refinance the bridge loan. Chapter 183C requires a lender, in connection with a high-cost home mortgage loan, to make a reasonable determination that one or more of the borrowers will be able to make the scheduled payments to repay the loan based upon a consideration of the borrower’s income, obligations, employment status, and other financial resources other than the borrower’s equity in the home. The lender argued that the balloon payment should not be included in the calculation of monthly payments because the loan was a temporary bridge loan that was meant to be refinanced by tapping the equity in the home to obtain a conventional mortgage. In doing so, according to the court, the lender impermissibly considered the borrowers’ equity in the home when making its determination of the borrowers’ ability to repay in violation of Chapter 183C. The balloon payment feature itself also constituted a separate violation of Chapter 183C, which prohibits a scheduled payment that is more than twice as large as the average of earlier scheduled payments.

    Nutter Notes: The court also ruled on a provision of Chapter 183C that prohibits a lender from paying a contractor from the proceeds of a high cost home mortgage loan unless such payment is made by an instrument payable to the borrower or jointly to the contractor and the borrower, or such payment is made at the borrower’s election through an escrow agent under an agreement signed by the borrower, the lender and the contractor. In this case, some of the loan proceeds were withheld at closing to pay for home repairs. The lender presented a home repair escrow letter to the borrowers at closing. The escrow letter provided for the use of loan proceeds to pay for repairs made by a contractor selected by the borrowers and the lender. After the closing, a contractor was selected, the repairs were made, and the contractor was paid from the escrowed funds. However, only the borrower signed the escrow letter. The court held that such an escrow letter must be signed by the borrower, the lender and the contractor to comply with the requirements of Chapter 183C. The court also ruled that the counseling requirements of Chapter 183C apply to all borrowers, and that no exception to the counseling requirements may be made for sophisticated borrowers.

4. Federal Reserve and OCC Issue Guidelines for Independent Foreclosure Review

The Federal Reserve and the OCC have released guidance that will be used in determining the compensation or other remedy that a borrower may receive for financial injury identified during the agencies’ Independent Foreclosure Review. According to the agencies, the financial remediation guidelines issued on June 21 will help ensure that similarly situated borrowers who suffer financial injury as a result of errors in foreclosure actions on their homes are treated similarly. The Independent Foreclosure Review was initiated as part of a consent order between the agencies and 14 mortgage servicers arising from deficient mortgage servicing and foreclosure practices affecting loans secured by primary residences during the period from January 1, 2009 to December 31, 2010. Although the financial remediation guidelines apply to qualifying loans serviced by one of the 14 mortgage servicers subject to the Independent Foreclosure Review, the guidelines represent a significant precedent for the types of financial remediation that examiners may expect for comparable errors in foreclosure actions by other lenders and servicers. Under the guidelines, remediation for injuries may include lump-sum payments, suspension or rescission of a foreclosure, a loan modification or other loss mitigation assistance, correction of credit reports, or correction of deficiency amounts and records. Lump sum payments can range anywhere from $500 to $125,000 plus the value of any equity the borrowers may have had in the home.

    Nutter Notes: The financial remediation guidelines describe various categories of foreclosure errors, list the remedy for the error and list the dollar amount, if any, payable to the borrower. Examples of some of the actions that might have resulted in financial injury to a borrower that are covered by the guidelines include foreclosing on a borrower in violation of the Servicemembers Civil Relief Act (SCRA), foreclosing on a borrower who was not in default on the mortgage, and failing to convert a qualified borrower to a permanent modification after successful completion of a written modified payment plan that was supposed to lead to permanent modification. The financial remediation guidelines also cover foreclosing on a borrower prior to expiration of certain types of modified payment plans while the borrower was performing all requirements of the plan, denying a borrower’s loan modification application that should have been approved, failing to offer loan modification options as required by an applicable program, and not providing a borrower with proper notification during the foreclosure process. The categories included in the guidelines are not exhaustive and do not cover all possible situations or remediation options for borrowers who may be entitled to compensation or other remediation for financial injury. The Federal Reserve and the OCC also issued answers to frequently asked questions to illustrate how remediation will work.

5. Other Developments: Mortgage Servicer Practices and OCC Lending Limits 

  • Guidance on Mortgage Servicer Practices That May Pose Risks To Servicemembers

The Consumer Financial Protection Bureau (CFPB) and the federal banking agencies issued joint guidance on June 21 to warn of mortgage servicer practices that may pose risks to homeowners who are serving in the military. The guidance applies to servicemembers who have received Permanent Change of Station (PCS) orders, which occur when a servicemember is ordered by the military to relocate to a new installation.

    Nutter Notes: The interagency guidance describes the agencies’ concerns about the particular loan servicing practices that have the potential to mislead or otherwise cause harm to homeowners with PCS orders, including asking servicemembers to waive their legal rights under the SCRA and failing to provide such servicemembers with accurate, clear, and readily understandable information about available assistance options for which they may qualify. 

  • OCC Amends Lending Limit to Cover Credit Exposures from Derivatives

The OCC released an interim final rule on June 20 that amends its lending limit rule to include certain credit exposures arising from derivative transactions and securities financing transactions. The interim final rule implements Section 610 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act), which revised the statutory definition of loans and extensions of credit for purposes of the limits on loans to one borrower to include derivatives and securities financing credit exposures.

    Nutter Notes: The interim final rule adopted by the OCC applies to both national banks and savings associations. State banks are subject to separate restrictions under Section 611 of the Dodd-Frank Act. National banks and savings associations have through January 1, 2013 to comply with the rule’s requirements for derivative transactions and securities financing transactions. The interim final rule becomes effective July 21, 2012, and comments are due by August 6, 2012.

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

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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