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Nutter Bank Report, October 2012

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1. OCC Issues Guidance to Community Banks on Loan Portfolio Stress Testing
2. Federal Court Decides HOLA Preempts a Massachusetts Mortgage Law
3. CFPB Publishes Debt Collection Examination Guidance
4. OCC Revises Short-Term Investment Fund Rules
5. Other Developments: Credit Card Rules and Large Bank Stress Tests

1. OCC Issues Guidance to Community Banks on Loan Portfolio Stress Testing

The OCC has issued guidance to national banks and federal savings associations with assets of $10 billion or less on using stress testing to assess risk in their loan portfolios. The October 18 guidance contained in OCC Bulletin 2012-33 clarifies the OCC’s stress testing expectations for community banks and provides an example of a simple stress test framework for banks to consider. The OCC said that some form of stress testing or sensitivity analysis of loan portfolios on at least an annual basis is a key part of sound risk management for community banks. According to the guidance, the OCC expects all banks, regardless of size, to have the capacity to analyze the potential impact of adverse outcomes on their financial condition in order to establish and support their risk appetite and tolerances, set concentration limits, adjust strategies, and appropriately plan for and maintain adequate capital levels. According to the guidance, stress tests do not need to involve sophisticated analysis or third-party consultative support. The OCC said that effective methods can range from a single spreadsheet analysis to a more sophisticated model, depending on portfolio risk and the complexity of the bank. The OCC also announced that it is making a new portfolio level stress test tool for income producing commercial real estate (CRE) loans available to national banks and federal savings associations through its BankNet website. The spreadsheet-based tool is designed to provide bankers a simple method to perform portfolio stress testing on income producing CRE loans, particularly in institutions with significant CRE loan concentrations, according to the OCC.

    Nutter Notes: The OCC guidance includes appendices with additional information on a variety of stress testing methods that community banks may employ. According to the guidance, any effective stress testing method has common elements that a community bank should consider, such as asking plausible “what if” questions about key vulnerabilities, making a reasonable determination of how much impact the stress event or factor might have on earnings and capital, and incorporating the resulting analysis into the bank’s overall risk management process, asset/liability strategies, and strategic and capital planning processes. The guidance suggests that a simple, stressed loss-rate analysis based on call report categories may provide an acceptable foundation for most community banks to at least determine if additional analysis is necessary. The OCC said that banks should primarily focus on concentrations of credit or loan portfolio segments that are significant to the overall business strategy. According to the guidance, loss stress rates may be derived from a review of historical loss experience during previous stressful periods, historical market experience, or other estimates. If a stress test reveals critical vulnerabilities, the guidance recommends that the bank’s management and board take steps to mitigate those risks. Depending on the nature of the vulnerability, the bank’s response may include modifying loan growth, revising the risk tolerance strategy, adjusting the portfolio mix and underwriting criteria, altering concentration limits or other policies and procedures, and strengthening capital.

2. Federal Court Decides HOLA Preempts a Massachusetts Mortgage Law

A federal trial court in Massachusetts recently ruled that the Home Owners’ Loan Act (HOLA), the federal law that provides for the chartering, regulation and supervision of federal savings banks and other savings associations, preempts a Massachusetts law that limits the amount of insurance a borrower may be required to purchase to insure a home in connection with a home mortgage loan. The September 21 decision by the federal court came in a class action suit brought against a federal savings bank by Massachusetts home mortgage loan borrowers. The federal savings bank’s loan agreement required the home mortgage loan borrowers to maintain insurance on the mortgaged properties in an amount equal to the outstanding principal balance of the home mortgage loan. However, Chapter 183, Section 66 of the General Laws of Massachusetts prohibits lenders in Massachusetts from requiring borrowers to purchase insurance in an amount greater than the replacement cost of buildings on the mortgaged property. In finding that the Massachusetts law is preempted by HOLA, the federal court relied on the analytical framework set forth in former Office of Thrift Supervision (OTS) regulations that provide an illustrative list of types of state laws that are presumptively preempted, which includes any state law that limits a lender’s ability to require “private mortgage insurance, insurance for other collateral, or other credit enhancements.” 

    Nutter Notes: Under the Dodd-Frank Act, federal savings banks are now subject to the same preemption standards that apply to national banks, which is a conflict preemption standard rather than an occupation of the field standard. However, the Dodd-Frank Act preemption standards became effective for federal savings banks on July 21, 2011, after the activities subject to the class action case took place. As a result, the court applied the broader occupation of the field preemption standards set forth under the OTS’s old regulations implementing HOLA in this case. The OCC issued a final rule implementing the preemption provisions of the Dodd-Frank Act in 2011 that largely preserved the OCC’s approach to the preemption of state laws under prior rules. The Dodd-Frank Act precludes preemption of state law for national bank and federal savings bank subsidiaries, agents and affiliates. It also codifies the legal standard for preemption set forth in a 1996 U.S. Supreme Court decision. The final OCC rule also revised the OCC’s visitorial powers rule to recognize the ability of state attorneys general to enforce applicable state laws against national banks and federal savings banks as authorized by such laws.

3. CFPB Publishes Debt Collection Examination Guidance

The Consumer Financial Protection Bureau (CFPB) has published a field guide that examiners will use to determine whether large banks and nonbanks engaged in debt collection are complying with the Fair Debt Collection Practices Act (FDCPA) and related federal consumer financial laws. The guide released on October 24 is an extension of the CFPB’s general Supervisory and Examination Manual. According to the guide, CFPB examiners will evaluate the quality of the regulated entity’s compliance management systems, review practices to ensure they comply with federal consumer financial law, and identify risks to consumers throughout the debt collection process. The guide covers the CFPB’s examination procedures for depository institutions with assets of more than $10 billion for compliance with the FDCPA, the Fair Credit Reporting Act and Regulation V, governing furnishers of information to consumer reporting agencies, the Gramm-Leach-Bliley Act and Regulation P, governing when financial institutions can share nonpublic personal information with third parties, the Electronic Fund Transfer Act and Regulation E, and the Equal Credit Opportunity Act and Regulation B. The CFPB announced that its examinations would focus on whether debt collectors are properly identifying themselves to consumers and properly disclosing the amount of debt owed, whether debt collectors are using accurate data, whether debt collectors have an adequate consumer complaint and dispute resolution process, and whether debt collectors have harassed or deceived consumers in pursuit of money owed. 

    Nutter Notes: Among the examination priorities expressed in the guide is the CFPB’s concern about whether regulated entities adequately oversee service providers used in conducting debt collection activities. According to the guide, the CFPB will assess whether large banks and other regulated entities request and review service providers’ policies, procedures, internal controls, and training materials to ensure that service providers conduct appropriate training and oversight of employees or agents that have consumer contact or compliance responsibilities. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) gave the CFPB supervisory authority over a variety of institutions that may engage in debt collection, including large depository institutions and their affiliates, and nonbank entities in the residential mortgage, payday lending, and private education lending markets, as well as their service providers. The Dodd-Frank Act also requires the federal banking agencies to coordinate with the CFPB to ensure that examination processes for compliance with federal debt collection laws and other federal consumer financial laws are enforced consistently, which may cause the federal banking agencies’ examination priorities to reflect those of the CFPB in areas such as debt collection.

4. OCC Revises Short-Term Investment Fund Rules

The OCC approved a final rule that revises the requirements imposed on short-term investment funds (STIFs) managed by U.S. banks and federal branches of foreign banks. The final rule published on October 9 will require STIFs to operate with a primary objective to maintain a stable net asset value (NAV) of $1.00 per participating interest, have a dollar-weighted average portfolio maturity of 60 days (revised down from 90 days), and have a dollar-weighted average portfolio life maturity of 120 days. The final rule will also require banks managing STIFs to adopt portfolio and issuer qualitative standards, concentration restrictions, and standards to address contingency funding needs, adopt pricing procedures that reflect the value of the STIF’s assets at amortized cost and the market value of the STIF’s assets, and adopt procedures for stress testing the STIF’s ability to maintain a stable NAV. Banks managing STIFs will be required to implement procedures to report adverse stress testing results to the bank’s senior risk management, provide monthly disclosures to STIF plan participants and the OCC, and notify the OCC before or within one business day after the occurrence of certain adverse events related to a STIF. The final rule applies to national banks, federal savings associations, and federal branches of foreign banks that act in a fiduciary capacity and manage a STIF. The final rule will become effective on July 1, 2013. 

    Nutter Notes: A STIF is a type of collective investment fund (CIF) that operates pursuant to a plan that governs a bank’s fiduciary management and administration of the fund. A CIF is a bank-managed fund that holds pooled fiduciary assets that meet specific criteria established by the OCC’s fiduciary activities rules at 12 CFR Part 9. For admissions to and withdrawals from a STIF, a bank may value STIF assets on an amortized cost basis, provided that the STIF plan includes certain requirements, rather than marking the assets to market, which is the valuation method required for other CIFs. In order to qualify for this exception under the OCC’s current fiduciary activities rules, a STIF’s plan must require the bank to maintain a dollar-weighted average portfolio maturity of 90 days or less, accrue on a straight-line or amortized basis the difference between the cost and anticipated principal receipt on maturity, and hold the fund’s assets until maturity under usual circumstances. Because a STIF’s investments are limited to shorter-term assets and those assets generally are required to be held to maturity, differences between the amortized cost and mark-to-market value of the assets are relatively rare, absent atypical market conditions or an impaired asset. According to the OCC, the changes to the STIF rules add safeguards designed to address the risk of loss to a STIF’s principal and procedures to protect fiduciary accounts from undue dilution of their participating interests in the event that the STIF loses the ability to maintain a stable NAV.

5. Other Developments: Credit Card Rules and Large Bank Stress Tests

  • Proposed Rule Would Make it Easier for Stay-at-Home Spouses to Get Credit Cards

The CFPB on October 17 proposed amendments to existing regulations to make it easier for spouses or partners who do not work outside of the home to qualify for credit cards. The proposal would allow a stay-at-home spouse or partner to rely on shared income from his or her spouse or partner when applying for a credit card account. Comments on the proposal will be due within 60 days after publication in the Federal Register, which is expected shortly. 

    Nutter Notes: The Credit Card Accountability, Responsibility and Disclosure Act (CARD Act) requires that credit card issuers evaluate a consumer’s ability to make the necessary payments before opening a new credit card account. Under the Federal Reserve’s regulations implementing the CARD Act, a credit card issuer generally may only consider the individual card applicant’s income or assets.

  • Federal Banking Agencies Release Large Bank Stress Testing Rules

The FDIC, Federal Reserve and OCC announced on October 9 final rules that implement the company-run stress testing under the Dodd-Frank Act, which requires all financial companies with total consolidated assets of more than $10 billion that are regulated by a primary federal financial regulatory agency to conduct an annual company-run stress test. The final rules will become effective on the date they are published in the Federal Register, which is expected shortly. 

    Nutter Notes: In general, institutions with assets greater than $50 billion are required to begin stress testing this year. Financial companies, including banks and bank holding companies, with between $10 billion and $50 billion in total assets will be required to begin conducting their first company-run stress tests in the fall of 2013 and will not have to publicly disclose the results of their first stress tests.

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 2012 Chambers and Partners review praises Nutter banking lawyers as “extremely focused” and “very effective,” and reports that clients praise Nutter banking lawyers for their “clarity of thought” and “rational, constructive, advice.” 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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