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Nutter Bank Report, October 2009

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1.  FDIC Proposes to Collect Prepaid Assessments
2.  House Committee Approves Amended Consumer Protection Agency Bill
3.  Fed Proposes Guidance on Incentive Compensation
4.  President Announces Capital Investment Plan to Support Small Business Lending
5.  Other Developments: Truth in Lending and Purchases of Legacy Securities

Full Reports

1.  FDIC Proposes to Collect Prepaid Assessments

The FDIC has issued a proposed rule that would require insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. Under the proposal announced on September 29, prepaid assessments for each of these periods would be collected as a lump sum on December 30, 2009, along with each institution’s regular quarterly risk-based deposit insurance assessment for the third quarter of 2009. The FDIC also adopted an Amended Restoration Plan to allow the Deposit Insurance Fund to return to its statutorily mandated minimum reserve ratio of 1.15% within eight (rather than seven) years and adopted a uniform 3-basis point increase in risk-based assessment rates effective January 1, 2011. For the fourth quarter of 2009 and for all of 2010, the prepaid assessment rate would be calculated using an institution’s total base assessment rate for the third quarter of 2009, modified to assume that the assessment rate in effect for the institution on September 30, 2009 had been in effect for the entire third quarter of 2009. The prepaid assessment rates for 2011 and 2012 would be equal to the modified third quarter 2009 total base assessment rate plus 3 basis points. Each institution’s prepaid assessment base would be calculated using its third quarter 2009 assessment base, adjusted quarterly assuming a 5% annual growth rate through the end of 2012. The entire amount of the prepaid assessment would be accounted for as a prepaid expense as of December 30, 2009 against which the regular quarterly assessments would be charged until the prepaid expense is exhausted. Once exhausted, the institution would record an accrued expense payable each quarter for the assessment payment, which would be paid in arrears at the end of the following quarter. If the asset is not exhausted by December 30, 2014, the FDIC would return the remaining amount to the institution. The public comment period for the proposed rule closed on October 28.

Nutter Notes:  Under the proposed rule, the FDIC would have discretion to exempt an institution from the prepaid assessments if the FDIC determines that the prepayment would adversely affect the safety and soundness of the institution. The FDIC would consult with the institution’s primary federal regulator, if it is not the FDIC, in making such a determination, but the FDIC would retain the ultimate authority to grant an exemption. The FDIC would notify any affected institution of its exemption by December 24, 2009. In addition, an institution could apply to the FDIC for an exemption from all or part of the prepayment requirement if the prepayment would significantly impair the institution’s liquidity, or would otherwise create significant hardship. The FDIC would consider exemption requests on a case-by-case basis. Written applications for exemptions from the prepayment obligation would be submitted to the Director of the Division of Supervision and Consumer Protection on or before December 1, 2009, by fax or electronic mail. In order for an application to be accepted and considered by the FDIC, the application would need to include an explanation of the need for the exemption along with supporting documentation, such as current financial statements and cash flow projections, a description of management’s plans to correct the circumstances that caused the inability to pay the assessment, and any other relevant information that the FDIC deems appropriate. The FDIC would notify an applicant by December 24, 2009 of the FDIC’s determination as to whether the institution is eligible for exemption from the prepaid assessment. Determinations of eligibility for exemption made by the FDIC would be final and not subject to further agency review.

2.  House Committee Approves Amended Consumer Protection Agency Bill

The House Financial Services Committee has concluded its consideration of amendments to H.R. 3126, the bill that would create a new Consumer Financial Protection Agency (CFPA), and has approved an amended draft of the bill. The committee approved H.R. 3126 on October 22, although Chairman Frank has indicated the legislation may be incorporated into a larger regulatory reform bill that is still under consideration by the committee before being reported to the full House of Representatives. The current version of H.R. 3126 would establish the CFPA and grant it rulemaking, examination and enforcement authority over financial institutions, including banks and thrifts, that provide consumers with financial products and services. The rulemaking authority of the Federal Reserve and other federal banking agencies under existing consumer protection laws would be transferred to the CFPA, and it would have broad rulemaking authority to address unfair, deceptive and abusive acts and practices identified by the agency. The CFPA would be funded by an annual transfer from the Federal Reserve equal to 10% of the Federal Reserve’s total system expenses, assessments on non-bank institutions (as set by CFPA regulation) and assessments on banks, thrifts and credit unions. Funding and spending on banks would be segregated from funding and spending on non-banks. As proposed, banks and thrifts would not pay more for consumer compliance supervision than they did before the creation of the CFPA.

Nutter Notes:  The House Financial Services Committee approved H.R. 3126 with a number of amendments to the bill as originally proposed, including one that eliminated provisions that would have required banks to offer so-called “plain vanilla” products with standard terms determined by the government. Also eliminated from the bill was a requirement that communications with consumers be “reasonable.” The committee also approved an amendment that would leave primary responsibility for consumer compliance examinations of depository institutions with total assets of $10 billion or less with their primary federal banking regulator rather than CFPA examiners. Finally, an amendment to the preemption provisions in the original bill was approved. The bill would now permit a federal regulator to preempt a state consumer financial protection law by rule only after a written finding that the state law “prevents or significantly interferes” with a federally regulated bank’s or thrift’s exercise of its federally granted powers. The regulator would be required to consult with the CFPA to determine that consumers would still be protected under federal law if the state law were preempted.

3.  Fed Proposes Guidance on Incentive Compensation

The Federal Reserve has issued proposed guidance on incentive compensation policies that would be applicable to all bank holding companies and state member banks to ensure that incentive compensation policies do not encourage excessive risk-taking. The proposed guidance released on October 22 is based on three key principles. First, incentive compensation arrangements at a banking organization should provide employees incentives that do not encourage excessive risk-taking beyond the organization’s ability to effectively identify and manage risk. Second, incentive compensation arrangements should be compatible with effective controls and risk management. Finally, incentive compensation arrangements should be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. The term “incentive compensation” as used in the proposal refers to that portion of an employee’s current or potential compensation that is tied to achievement of one or more specific metrics (e.g., a  level of sales, revenue, or income). Incentive compensation does not include compensation that is awarded solely for, and the payment of which is tied to, continued employment (e.g., salary). The Federal Reserve’s proposal would require all affected banking organizations to evaluate their incentive compensation arrangements for executive and non-executive employees who, either individually or as part of a group, have the ability to expose the organization to material amounts of risk and the risk management, control, and corporate governance processes related to those arrangements. Affected banking organizations would have to immediately address deficiencies in those arrangements or processes that are inconsistent with safety and soundness. Comments on the proposed guidance must be submitted on or before November 27.

Nutter Notes:  In addition to the proposed guidance on incentive compensation, the Federal Reserve announced that it will implement two related supervisory initiatives. The first initiative, applicable only to 28 large, complex banking organizations, will involve a special review of each organization’s compensation policies and practices to determine whether the policies are consistent with principles for risk-appropriate incentive compensation set forth in the proposal. Under the second initiative, banking supervisors will review incentive compensation practices at regional, community, and other banking organizations not classified as large and complex as part of the evaluation of risk management, internal controls, and corporate governance during the regular, risk-focused examination process. The Federal Reserve will assess the potential for incentive compensation arrangements to encourage excessive risk-taking, the actions an organization has taken or proposes to take to correct deficiencies, and the adequacy of the organization's compensation-related risk management, control, and corporate governance processes. The reviews will be tailored to reflect the scope and complexity of the organization’s activities, as well as the prevalence and scope of its incentive compensation arrangements. Supervisory findings for all types of organizations will be included in the relevant report of examination or inspection and incorporated, as appropriate, into the organization’s rating component(s) and subcomponent(s) relating to risk management, internal controls, and corporate governance as well as the organization’s overall supervisory rating.

4.  President Announces Capital Investment Plan to Support Small Business Lending

President Obama has announced new proposals under the Financial Stability Plan to encourage small business lending by providing capital support to community banks, which tend to make more small business loans in proportion to all business lending than larger banks. The proposals announced on October 21 include a program that would provide low-cost capital to banks with less than $1 billion in assets. To be eligible for the capital, qualifying banks would be required to submit a plan explaining how the capital will allow them to increase lending to small businesses. In addition, participants would be required to submit quarterly reports detailing their small business lending activities.  Community banking organizations, subject to approval by their federal banking regulators, would be eligible to receive new capital in an amount of up to 2% of risk-weighted assets. The initial dividend rate for the investment would be 3%, compared to the 5% dividend available under the original Capital Purchase Program (CPP). The dividend rate under the new program would increase to 9% after five years to encourage timely repayment. Existing CPP participants would be given the opportunity to replace existing CPP capital with the lower-cost investments under the new program. The U.S. Treasury Department has not yet finalized the terms of the new capital program, and the administration announced that Treasury will work with community banks and the small business community to do so in the near future.

Nutter Notes:  It is not clear from the administration’s summary whether the program will be part of the Troubled Assets Relief Program (TARP) as the CPP is. If the new capital program to encourage small business lending is part of the TARP, as appears likely, then participants would be subject to Treasury’s rules, regulations and guidance with respect to executive compensation, transparency, accountability and monitoring applicable to all TARP participants. In addition to providing capital for community banks for small business lending, the President also announced a program that would provide additional capital for certified Community Development Financial Institutions (CDFIs) and called for legislation that would increase the size of certain loans supported by the Small Business Administration (SBA). Under the CDFI program, banks and thrifts that document that over 60% of their small business lending and other economic development activities target low-income or underserved populations would qualify for capital investment at a 2% dividend rate for up to 8 years. The dividend rate would increase to 9% thereafter to encourage repayment. CDFIs would be eligible to receive new capital in an amount of up to 2% of risk-weighted assets. The legislation the President proposed would increase the maximum loan size for the SBA’s 7(a) loan program from $2 million to $5 million, would increase the maximum loan size for the SBA’s 504 loan program from $2 million ($4 million for manufacturers) to $5 million ($5.5 million for manufacturers), and would increase the maximum loan size for the SBA’s microloan program from $35,000 to $50,000.

5.  Other Developments: Truth in Lending and Purchases of Legacy Securities

  • Federal Reserve Interpretation of FHA Note

The Federal Reserve issued an official interpretation on September 29 advising the Department of Housing and Urban Development that the form of promissory note commonly used on residential mortgage loans insured by the Federal Housing Administration (FHA) will not be deemed to violate restrictions in Regulation Z applicable to certain types of prepayment penalties.

Nutter Notes:  Changes effective October 1 to the Federal Reserve’s Regulation Z, which implements the Truth in Lending Act, prohibit prepayment penalties for mortgage loans that qualify as “Higher Priced Mortgage Loans.” The form of note commonly used on FHA loans permit what would have been deemed an impermissible prepayment penalty under the new “Higher Priced Mortgage Loan” rule.

  • Public-Private Investment Funds Poised to Begin Purchasing Legacy Securities

The Treasury announced the initial closings of several Public-Private Investment Funds (PPIFs) established under the Legacy Securities Public-Private Investment Program (PPIP). Each PPIF closed with at least $500 million of committed equity capital from private investors bringing total committed equity and debt capital to $12.27 billion. Each PPIF receives matching equity and debt financing from Treasury using TARP funds.

Nutter Notes:  PPIP is part of the broader Financial Stability Plan designed, in part, to support market functioning in the commercial and non-agency residential mortgage-backed securities markets. The PPIFs will purchase legacy assets from banks and other financial institutions to help re-deploy capital and extend new credit to households and businesses.

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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