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Nutter Bank Report, September 2009

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1.  Federal Reserve to Examine Nonbank Subsidiaries for Consumer Compliance
2.  OTS Issues Accounting Guidance on Other-Than-Temporary Impairment of Securities
3.  Rating Agencies May Be Sued for False or Misleading Credit Ratings, Court Rules
4.  FDIC Plans to Terminate Debt Guarantee Program in October
5.  Other Developments: Truth in Lending and Deposit Insurance Coverage

Full Reports

1.  Federal Reserve to Examine Nonbank Subsidiaries for Consumer Compliance

The Federal Reserve will conduct risk-focused consumer compliance supervision of nonbank subsidiaries of bank holding companies engaged in activities covered by the consumer protection laws and regulations that the Federal Reserve has the authority to enforce. The Federal Reserve’s supervisory activities announced in a Consumer Affairs letter dated September 14 will also include investigations of consumer complaints against nonbank subsidiaries of bank holding companies. Although the letter does not clarify whether the supervisory policy applies to subsidiaries of insured depository institutions in a holding company structure, we have received independent confirmation from Federal Reserve staff that director or indirect subsidiaries of banks, such as operating subsidiaries, will not be examined by the Federal Reserve under the policy (although subsidiaries of state member banks will continue to be subject to Federal Reserve supervision). The Federal Reserve said that it will update or create institutional profiles and consumer compliance risk assessments for nonbank subsidiaries by the end of the first quarter of 2010 and identify and schedule necessary supervisory work by the end of the second quarter of 2010. The process may involve onsite reviews for some institutions to further the development of the institutional profiles and consumer compliance risk assessments.

Nutter Notes:  The Federal Reserve has authority to examine nonbank subsidiaries for compliance with the Truth in Lending Act, Equal Credit Opportunity Act, Home Ownership and Equity Protection Act, Fair Credit Billing Act, Consumer Leasing Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, Home Mortgage Disclosure Act, Truth in Savings Act, the Real Estate Settlement Procedures Act, and any Federal Trade Commission Act rules. In addition to the investigation of consumer complaints, supervisory activities will include continuous monitoring, discovery reviews, and target or full-scope examinations with transaction testing. Examinations of nonbank subsidiaries will result in ratings based on the Consumer Compliance Risk Management rating system (Strong, Satisfactory, Fair, Marginal, or Unsatisfactory) that is included in the Federal Reserve’s draft Risk-Focused Consumer Compliance Supervision Program. The results of targeted and full-scope examinations will be transmitted in writing to senior management of the nonbank subsidiary and the bank holding company. The examination report will highlight any significant findings and recommendations for corrective action. The results of any consumer compliance examination will be incorporated into an overall Consumer Compliance Risk Management rating assigned to each nonbank subsidiary each calendar year.

2.  OTS Issues Accounting Guidance on Other-Than-Temporary Impairment of Securities

The OTS has issued guidance to thrift institutions concerning accounting for other-than-temporary impairment of securities held for investment. The guidance, originally issued to OTS examination staff, was published in a CEO memo on September 3. Securities are considered impaired under U.S. generally accepted accounting principles (GAAP) when their fair value declines below their amortized cost basis. A thrift’s management, and not the external auditor, is responsible for assessing whether the fair value decline represents a temporary or other-than-temporary impairment at each Thrift Financial Report reporting date. That assessment can directly affect the accounting treatment, impacting earnings and regulatory capital. In certain circumstances involving debt securities, other-than-temporary impairment analysis is separated into two components. The credit loss component is recognized in earnings, and the amount related to all other factors (the non-credit loss component) is recognized in other comprehensive income, net of applicable taxes. According to the OTS guidance, the most significant publications from the Financial Accounting Standards Board on the issue in 2009 are FASB Staff Position (FSP) Emerging Issues Task Force (EITF) 99-20-1 entitled Amendments to the Impairment Guidance of EITF Issue No. 99-20 (issued on January 12) and FSP Financial Accounting Standards FAS 115-2 and FAS 124-2, entitled Recognition and Presentation of Other-Than-Temporary Impairments (issued on April 9).

Nutter Notes:  The OTS guidance advises that other-than-temporary impairment is distinguishable from permanent impairment, and that assessing other-than-temporary impairment is complex and involves significant judgment. There are no bright-line tests, so each assessment depends on the specific facts and circumstances associated with the individual security and the institution. The factors that should be considered differ depending upon whether the impaired security is a debt or an equity security. Important factors for assessing the impairment of a debt security include the relative size of the decline in fair value (severity) and the length of time the security has been impaired (duration). Other factors include adverse conditions specific to the security or the issuer’s industry or geographic area, historical and implied volatility of the fair value of the security, payment structure, failure of the issuer to make a scheduled payment, any rating change, and any changes in fair value after the balance sheet date. Important factors for assessing the impairment of an equity security include the intent and ability of the institution to hold the security for any anticipated recovery of fair value, and the severity and duration of the impairment. The OTS also advises public and private thrift institutions to apply the factors described in FASB Accounting Standards Codification (ASC) 320-10-35 and FASB ASC 320-10-S99-1.

3.  Rating Agencies May Be Sued for False or Misleading Credit Ratings, Court Rules

A federal court has ruled that certain nationally recognized statistical rating organizations may be sued for fraud by institutional investors who purchased highly rated notes issued by a structured investment vehicle (SIV). A September 9 opinion by the U.S. District Court for the Southern District of New York held that the rating agencies are not entitled to immunity under the First Amendment. The court also held that the ratings assigned by the rating agencies were not entitled to protection as non-actionable opinions. The case involves two institutional investors who purchased notes issued by a SIV that received the rating agencies’ highest ratings, the same ratings usually assigned to U.S. Treasury securities, commonly understood to mean that the notes were stable, secure and safe investments according to the court. The assets held by the SIV, in turn, included a combination of investment grade asset-backed securities, residential mortgage backed securities and collateralized debt obligations. The SIV was unable to repay its debt as it came due because of the low quality of those underlying assets and declared bankruptcy. The plaintiff investors claimed that the rating agencies did not genuinely or reasonably believe that the ratings assigned to the notes were accurate and sued the rating agencies to recover their losses on the liquidation of the securities.

Nutter Notes:  Typically, the First Amendment protects rating agencies from liability arising from their issuance of credit ratings and reports on securities because the ratings are considered matters of public concern. In this case, the ratings were disseminated only to select investors in a private placement of the notes and not to the general public. As a result, the court concluded that the First Amendment protections that normally protect a rating agency’s rating should not apply. While, in general, a rating on a note is essentially an opinion about the likelihood of repayment and generally does not provide the basis for a lawsuit, here the court found that an opinion may nevertheless serve as the basis for a lawsuit if the person who gave the opinion does not “genuinely and reasonably believe it or if it is without basis in fact.” In this case, the court found that the plaintiff investors alleged facts that, if true, could prove that the rating agencies knew that the credit ratings assigned to the notes were false. The court also found that the rating agencies’ compensation, unknown to the investors, was contingent upon the receipt of the desired ratings for the notes, which may show motive to communicate allegedly false ratings.

4.  FDIC Plans to Terminate Debt Guarantee Program in October

The FDIC will allow the Debt Guarantee Program, a component of the Temporary Liquidity Guarantee Program, to expire on October 31, 2009 in accordance with the current regulation governing the program. The FDIC proposed two alternatives for the termination of the program in a notice of proposed rulemaking released on September 9. Under the first proposed alternative, the Debt Guarantee Program would expire on October 31, meaning participating institutions could not issue FDIC guaranteed debt after October 31 and the FDIC’s guarantee of existing qualified debt would expire no later than December 31, 2012. Under the second proposed alternative, the Debt Guarantee Program would expire on October 31, but the FDIC would establish a six-month emergency guarantee facility to be made available in emergency circumstances upon application to and approval by the FDIC. The emergency guarantee facility would be available to insured depository institutions and to other participating entities that have already issued FDIC-guaranteed debt under the Debt Guarantee Program by September 9, 2009. Each applicant to the emergency guarantee facility would be required to demonstrate an inability to issue non-guaranteed debt to replace maturing senior unsecured debt as a result of market disruptions or other circumstances beyond the applicant’s control. Written comments on the proposals may be submitted to the FDIC by October 1, 2009.

Nutter Notes:  The FDIC adopted the Temporary Liquidity Guarantee Program in October 2008 as part of a coordinated effort by the FDIC and other federal agencies to address disruptions in credit markets and the resulting inability of financial institutions to obtain funding and make loans to creditworthy borrowers. The Debt Guarantee Program initially permitted participating entities to issue FDIC-guaranteed senior unsecured debt until June 30, 2009, with the FDIC’s guarantee for such debt to expire on the earlier of the maturity of the debt (or the conversion date, for mandatory convertible debt) or June 30, 2012. The FDIC’s final rule generally extended for four months the period during which participating institutions could issue FDIC-guaranteed debt. The final rule also extended the expiration of the guarantee period from June 30, 2012 to December 31, 2012. As a result, participating institutions may issue FDIC-guaranteed debt through and including October 31, 2009, and the FDIC’s guarantee expires on the earliest of the debt’s mandatory conversion date, the stated maturity date, or December 31, 2012. If an emergency guarantee facility is approved under the second proposal for phasing out the program, senior unsecured debt issued on an emergency basis or before April 30, 2010 would be guaranteed by the FDIC until a date no later than December 31, 2012, and would be subject to an annualized participation fee of at least 300 basis points.

5.  Other Developments: Truth in Lending and Deposit Insurance Coverage

  • FFIEC Releases Revised Truth in Lending Examination Procedures

The Task Force on Consumer Compliance of the Federal Financial Institutions Examination Council recently approved new Truth in Lending interagency examination procedures under Regulation Z. The revised procedures released on September 21 replace the Regulation Z interagency examination procedures released in August.

Nutter Notes:  The revised examination procedures incorporate the amendments to Regulation Z approved by the Federal Reserve in July 2008, which become effective on October 1. Those amendments cover unfair, abusive, or deceptive mortgage lending and servicing practices, including rules applicable to a newly defined category of higher-priced mortgages aimed at subprime closed-end residential mortgage loans.

  • FDIC Approves Final Deposit Insurance Coverage Rules

On September 9, the FDIC approved a final rule extending the temporary increase in the standard maximum deposit insurance amount to $250,000 through December 31, 2013. The FDIC is encouraging institutions to post a statement next to the official FDIC teller station sign notifying customers of the extension.

Nutter Notes:  The FDIC also approved regulations to simplify the rules for insuring revocable trust accounts, commonly known as payable-on-death accounts and living trust accounts, and mortgage servicing accounts. The final rules adopt changes first approved as interim rules in October 2008.

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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