Interstate branching. Interstate branching is permitted, effective July 22, 2010. An institution may now branch into a new state by acquiring a branch of an existing institution or by setting up a new branch, without merging with an existing institution in the target state. A depository institution’s ability to establish a de novo branch may, however, be limited by a state’s restrictions on branching for banks already in that state (such as geographic limitations). This change creates opportunities for community banks looking to acquire branches from struggling depository institutions in states where the community bank does not currently have a presence. It may also increase competition within the community bank’s home state, as a significant legal barrier to entry no longer exists.

Interchange fees. Interchange fees must be “reasonable and proportional to the cost” of the card network’s expense for processing the transaction. Card issuers which, together with their affiliates, have less than $10 billion in assets are exempt from this interchange transaction fee limitation. However, the cap on interchange fees for large banks will create market pressures that force fees down for all institutions. Community banks can expect a drop in interchange revenue. This section of the Act is effective one year from enactment and final rules can be expected within nine months.

Consumer Financial Protection Bureau. The Act creates a new Consumer Financial Protection Bureau (CFPB) under the Federal Reserve that will have rule-making, enforcement and investigative authority over consumer financial protection statutes. We can expect to see many new consumer protection regulations during the next few years. Many of those regulations will increase compliance costs for depository institutions or limit the fees they can charge. Community banks may find it more difficult than larger institutions to absorb the increased compliance costs and reduction in income.

Unfair, deceptive, or abusive acts or practices prohibited. The new CFPB is specifically authorized to take action and promulgate rules to prohibit unfair, deceptive or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product. Unfair and deceptive acts are already prohibited by the Federal Trade Commission Act and many state laws. The term “abusive” is new. The Act provides minimal guidance as to what activities will be considered “abusive.” This will likely be an area of significant consumer litigation in the future. It is important to note that state attorneys general are specifically granted the authority to enforce the regulations promulgated by the CFPB against national banks and federal thrifts, which will likely result in increased enforcement of consumer regulations.

Loss of federal preemption. Subsidiaries of national banks and federal thrifts will lose the benefits of federal preemption. National banks or federal thrifts with subsidiaries that do not comply with state laws in reliance on federal preemption need to think about changes to their structure or complying with state laws with which they are not currently in compliance. An example would be a mortgage subsidiary of a national bank that does not currently comply with state mortgage licensing or lending laws.

Elimination of OTS. The Office of Thrift Supervision is eliminated. The OCC will regulate federal thrifts, the FDIC will regulate state-chartered thrifts and the Federal Reserve will regulate savings and loan holding companies. Federal thrifts need to plan for the change in regulator and their holding companies need to plan for both the change in regulator and the new capital requirements.

Mortgage lending. The Act makes significant changes to the requirements for making mortgage loans. Common practices such as stated income loan applications, yield spread premiums, prepayment penalties and mandatory arbitration provisions are prohibited or restricted. New regulations will require a lender to verify a mortgage borrower’s ability to repay the loan. A violation of the “ability to repay” standard may be raised as a foreclosure defense by a borrower against the lender. The Act creates a safe harbor for “qualified mortgages,” which must meet several criteria, including points and fees of less than 3 percent of the loan amount. Community banks will have to assess whether they can justify the increased compliance and management costs in order to continue to originate mortgage loans.

Trust preferred securities and holding company capital requirements. Small bank holding companies (less than $500 million in assets) and medium sized bank holding companies (less than $15 billion in assets) are not required to make a capital deduction for trust preferred securities issued before May 19, 2010. This is a rare piece of good news from the Act for those institutions. Medium-sized holding companies, however, will have the same type of risk-based capital and leverage capital requirements that are required of an insured depository institution. This change will make it more difficult for those companies to meet capital requirements or raise capital to support their bank subsidiaries, growth and acquisitions.

Changes to deposit insurance assessment base. The Act changes the assessment base to relate to the liabilities of the institution rather than the institution’s deposits. The assessment base will be an amount equal to the average consolidated total assets of the insured depository institution during the assessment period, minus the sum of the average tangible equity of the insured depository institution during the assessment period and an amount that the FDIC determines is necessary to establish assessments consistent with the risk-based assessment system found in FDIA 7(b)(1) for a “custodial bank” or a “banker’s bank.” Whether this will result in an increase in deposit insurance assessments for any institution depends on that instituton’s mix of assets and liabilities.

Transactions with affiliates. The Act expands the scope of Section 23A of the Federal Reserve Act, which imposes quantitative limits and qualitative standards on a depository institution’s transactions with affiliates. The Act adds securities lending transactions, repurchase agreements and derivative transactions as “covered transactions.”

Interest on Demand Deposits. The Act repeals the prohibition on depository institutions paying interest on demand deposits, effectively allowing depository institutions to offer interest checking to business customers. This will increase community banks’ cost of funds as they will need to pay interest on demand deposits of business entities to retain such customers.

Yes, that is actually eleven things! It was difficult to narrow down 2,300 pages of the Act. There are many other provisions that affect community bankers, so expect to hear more from us in the near future.

For more information, please contact the attorneys in our Banking & Financial Services Group.

Application to Smaller Banking Organizations

            Although the proposed guidance only applied to banking organizations supervised by the Federal Reserve, the final guidance applies to all banking organizations supervised by the Agencies.  However, the final guidance is expected to have less impact on smaller banking organizations, which, unlike their larger counterparts, may not need to implement systematic and formalized policies, procedures and processes.  Whether or not an organization is considered “large” is determined under the relevant agency’s standard.  The guidance permits flexibility for customized arrangements.

Scope

            The guidance applies to senior executives and other employees who, either individually or as part of a group, have the ability to expose the baking organization to material amounts of risk.  “Senior executives” includes, at a minimum, “executive officers” within the meaning of Federal Reserve Regulation O (12 C.F.R. § 215.2(e)(1)) and, for publically traded companies, “named officers” within the meaning of the Securities and Exchange Commission’s rules on the disclosure of executive compensation (17 C.F.R. § 229.402(a)(3)).

Key Principles

            The final guidance embodies the same three key principals as the proposed guidance:

1. Incentive compensation arrangements 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. These arrangements should be compatible with effective controls and risk-management;
3. These arrangements should be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

More Information

            The final guidance will be effective on the date of its publication in the Federal Register.  A complete copy of the final guidance can be found here.

Developed under the Fair and Accurate Credit Transaction Act of 2003, the Rule has already been enforced by banking regulators for most financial institutions since November, 2008.  The FTC has interpreted enforcement of the Rule as having a surprisingly wide application for the non-financial institution businesses that it regulates.  Under the FTC’s interpretation, any business that bills customers after providing goods or services is a “creditor” subject to the Rule. This includes many health care providers, construction companies and other merchants and service providers.  If such “creditors” have “covered accounts” (as defined in the Rule), they must adopt an identity theft prevention program. That program must be designed to identify, detect, and respond to patterns, practices, or specific activities – known as “red flags” – that might indicate identity theft.

It is precisely the wide scope of the FTC’s interpretation of the Rule which has caused the delays.  Initially, many business did not believe the Rule applied to them.  After the FTC opined that many service providers, including attorneys and health care providers, would be subject to the Rule, industry trade associations have attempted to limit the application of the Rule through various forums.  On October 29, 2009, the American Bar Association secured a decision in federal district court that the Rule does not apply to lawyers, which the FTC is appealing.  More recently, in May 2010, the American Medical Association, along with the American Osteopathic Association and the Medical Society of the District of Columbia,  filed a lawsuit against the FTC to prevent application of the Rule to physicians after unsuccessfully petitioning the FTC to reconsider its broad interpretation of the Rule.  That lawsuit is still pending.

A full copy of the FTC’s May 28, 2010 press release is available here.

In consenting to two Orders from the OTS, Woodforest Bank agreed to cease certain unsafe or unsound practices identified by the OTS, including the origination of loans with a low probability of repayment, unfair, misleading or deceptive marketing or advertising practices and disclosures in connection with the Bank’s overdraft protection program.  Under the terms of the agreement, the Bank will set aside more than $12 million to pay restitution to existing and past Bank customers harmed by the Bank’s overdraft protection practices, as well as pay $400,000 as a civil money penalty. 

On April 29, 2010, the OTS also published proposed Supplemental Guidance on Overdraft Protection Programs in the Federal Register, which, if finalized, would update the Guidance on Overdraft Protection Programs previously issued by the OTS in 2005.  In its proposed Supplemental Guidance, the OTS emphasized that thrift institutions must accurately represent the features of overdraft protection programs and clarify that overdraft protection is not a “free” account feature, while disclosing applicable program fees to the customer. The OTS also highlights a thrift institution’s responsibility to explain to customers that payment of overdrafts by the thrift institution is discretionary and to disclose circumstances under which the institution will not pay an overdraft.  Additionally, the proposed Supplemental Guidance advises thrift institutions to provide customers with information regarding alternatives to overdraft protection and place reasonable aggregate limits on overdraft fees.  Comments to the proposed Supplemental Guidance are due on or before June 28, 2010.  The proposed Supplemental Guidance may be found here: http://www.ots.treas.gov/_files/482132.pdf.

• All data containing personally identifiable information (PII) must be encrypted on the wire and as its transmitted across public networks or wirelessly.  This means, for example, that PII must be sent over HTTPS, not HTTP and must be encrypted when stored in SQL Server.  This rule has significant implications for database applications.
• All PII data stored on laptops or other portable devices, such as smartphones and USB drives must be encrypted.
• Backup tapes must be encrypted on a prospective basis.

Penalties for noncompliance are enforced through Massachusetts General Law Title XV: Regulation of Trade, chapter 93A, section 4.  Civil money penalties may be assessed of up to $5,000 per breach or lost record, as well as reasonable costs of investigation and litigation, including attorneys fees.  Any data breach must be reported to both the Office of Consumer Affairs and Business Regulation and the Attorney General. 

The law became effective March 1, 2010 and can be found here: http://www.mass.gov/Eoca/docs/idtheft/201CMR1700reg.pdf. 

Answers to Frequently Asked Questions regarding the rule can be found here: http://www.mass.gov/Eoca/docs/idtheft/201CMR17faqs.pdf.

FDIC Board of Directors Approves Notice of Proposed Rulemaking to Revise Deposit Insurance Assessments

On April 13, 2010, the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) approved a Notice of Proposed Rulemaking (NPR) to revise the deposit insurance assessment system for large institutions, which pose unique and concentrated risks to the Deposit Insurance Fund.  Under the proposal, risk categories and long-term debt ratings would no longer be used. The FDIC would continue to use the supervisory ratings as a factor in measuring risk. The FDIC would replace the financial ratios currently used with a scorecard consisting of well-defined financial measures that are more forward looking and better suited for large institutions. The proposal also includes questions about how to incorporate other risk measures, like the quality of underwriting or risk management practices, in the future.

The proposal would create two scorecards: one for large institutions and the other for highly complex institutions. A highly complex institution would be defined as an insured depository institution with greater than $50 billion in total assets that is fully owned by a parent company with more than $500 billion in total assets. The designation also would apply to a processing bank and trust company with greater than $10 billion in total assets. Each scorecard would have two components—a performance score and loss severity score—that are of particular interest to the FDIC as an insurer. Two scores would be combined to produce a total score, which would be translated into an initial assessment rate. Similar to the current system, the FDIC would retain an ability to make limited discretionary adjustments.

The entire proposed rule is available by clicking here.

FDIC Board of Directors Approves Extension of Transaction Account Guarantee Program

On April 13, 2010, the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) approved an interim rule to extend the Transaction Account Guarantee (TAG) program to December 31, 2010. Last year the program was extended to June 30, 2010. Under the TAG program, customers of participating insured depository institutions are provided full coverage on transaction accounts. The interim rule gives the Board discretion to extend the program to the end of 2011, without additional rulemaking, if it determines that economic conditions warrant such an extension.

The TAG extension will provide a continued stable funding source for participating banks and will help them maintain their ability to secure low-cost, large deposits, thereby preserving their deposit franchise value and supporting the rebuilding of their earnings and capital, which in turn protects the Deposit Insurance Fund.

Nearly 6,400 insured depository institutions, about 80 percent of the industry, continue to participate in the TAG program and benefit from the guarantee provided by the FDIC. These institutions held an estimated $266 billion of deposits above the insured deposit limit and guaranteed by the FDIC through the TAG program as of the end of 2009. Under the interim rule, participating institutions can opt out effective July 1, 2010. Last year the Board adjusted the assessment rate to make it risk based and approved an increase in the rates; the current rates will remain unchanged under the interim rule. The Board also voted to require TAG assessment reporting be based on average daily account balances and to reduce the maximum rate that can be paid for qualifying NOW accounts to 0.25 percent from 0.50 percent.

The entire interim rule is available by clicking here.

Federal Regulators Release Model Consumer Privacy Notice Online Form Builder

On April 15, 2010, eight federal regulators released an Online Form Builder that financial institutions can download and use to develop and print customized versions of a model consumer privacy notice.

 The Online Form Builder, based on the model form regulation published in the Federal Register on December 1, 2009, under the Gramm-Leach-Bliley Act, is available with several options. Easy-to-follow instructions for the form builder will guide an institution to select the version of the model form that fits its practices, such as whether the institution provides an opt-out for consumers.

 To obtain a legal “safe harbor” and so satisfy the law’s disclosure requirements, institutions must follow the instructions in the model form regulation when using the Online Form Builder.

The Online Form Builder is available by clicking here.

A complete copy of the Administrator’s Interpretation can be found here.

In a statement, Senator Dodd indicated he planned to hold a full committee markup the week of March 22nd.

The article is available by clicking here.