Written by: Nate Van Emon
On Friday, August 5, the Federal Financial Institutions Examination Council (FFIEC) requested public comment on a proposal to streamline the existing regulatory reporting requirements by eliminating and revising several Call Report data items for certain financial institutions with assets of less than one billion and domestic offices only. The proposal attempts to reduce the reporting burden for the smaller, less complex financial institutions, while still gathering the information required to allow regulators to monitor the safety and soundness of such institutions. The streamlined Call Report would remove approximately 40% of the requested data items, which eliminates 24 pages from the existing Call Report.
Specifically, the changes focus on (i) eliminating certain schedules relating to complex or specialized activities, (ii) removing data items identified as unnecessary for monitoring the safety and soundness of smaller institutions, (iii) reducing the frequency of data collection for certain data items, and (iv) removing data items that are only required for institutions larger than one billion in assets. Comments must be received within 60 days from the date the proposal is published in the Federal Register.
To view the full text of the proposal, please click here:
Written by: Steven Vetter
On July 27, 2016, the Federal Deposit Insurance Corporation (“FDIC”) issued a Financial Institution Letter regarding Prudent Risk Management of Oil and Gas Exposures. The letter states that due to the complex and highly specialized nature of loans to borrowers in the oil and gas industry, banks should be adequately prepared to deal with the accompanying volatility of this industry. Conservative underwriting, appropriate structuring, experienced and knowledgeable lending staff and sound loan administration practices were cited as prudent risk management tools to protect the bank against the inherent volatility.
To reduce the risk to FDIC supervised institutions, the letter reminds banks to spread their risk by geography, industry or borrower concentrations, whenever possible. If a bank cannot spread its risk accordingly, it is recommended that the bank assess whether setting the capital level higher than the regulatory minimum would be prudent.
The letter encourages banks that are affected by significant downturns in commodity prices to work with the afflicted companies towards a mutually-advantageous workout plan, while maintaining effective internal controls to manage such loans.
To view the full text of the FDIC guidance, click here.
Written by: George Sand
In Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), cert. denied, No. 15-610, 2016 U.S. LEXIS 4211 (U.S. June 27, 2016), Madden was a New York resident who opened a credit card account with Bank of America. The bank consolidated its credit card program into another national bank, FIA Card Services. When Madden failed to pay her credit card debt, FIA Card Services charged off the debt, and then sold the debt to Midland Funding, LLC, a debt purchaser/debt collector. Midland Funding sought to recover debt payments from Madden that carried a 27% interest rate. Madden filed suit against Midland Funding, alleging violation of the New York criminal usury law prohibiting interest rates exceeding 25%.
District court decision protects debt collector, based on preemption. The district court entered judgment for Midland Funding. The district court held that the National Banking Act, which permits national banks to charge any interest rate allowed by the law of the state where the bank is located, applied to FIA Card Service’s contract with Madden, and that FIA Card Services properly assigned its interest to Midland Funding. Because the National Banking Act preempts state law, the district court held that Midland Funding, a Delaware corporation, could charge the Delaware interest rate even though it was in excess of the New York usury ceiling.
Second Circuit finds no preemption. On appeal, in a decision that sent chills down the spine of the banking industry, the Second Circuit reversed the district court. The Second Circuit reasoned that Midland Funding is not “a national bank nor a subsidiary or agent of a national bank, nor is otherwise acting on behalf of a national bank, and… application of the state law on which Madden’s claims rely would not significantly interfere with any national bank’s ability to exercise its powers under the National Banking Act.” Because it wasn’t a national bank, Midland Funding was not afforded National Banking Act preemption, and thus violated the New York usury law. Midland Funding filed a petition for a writ of certiorari.
Solicitor General weighs in. In an intriguing twist, the United States submitted a brief highly critical of the holding of the Second Circuit, yet still urged the Supreme Court to deny the petition for review. The brief of the U.S. Solicitor General and the Office of the Comptroller of the Currency contended that the Second Circuit misunderstood section 85 of the National Bank Act. The brief argued that section 85 of the NBA allows a national bank to export the highest interest rate permitted by the national bank’s home state, that federal preemption “carries with it the power to use the loans once originated for their usual commercial purposes, which include assignment of such loans to others,” and that the NBA would be “significantly impaired” by the Second Circuit’s holding.
Notwithstanding these contentions, the Solicitor General ultimately called for denial of the petition for Supreme Court review. First, the Solicitor General argued that on remand Midland Funding may still win despite the Second Circuit’s interlocutory error. Second, the Solicitor General argued that the parties may have inadequately presented the preemption arguments. Third, the Solicitor General argued that no circuit split is present on the issue.
The Supreme Court had previously decided the issue. The government’s brief claims that there is no circuit split, but the United States Supreme Court decided the issue nearly two centuries ago when it endorsed the longstanding common-law principle that a debt may be enforced by an assignee if it was “valid-when-made” by the assignor. In Nichols v. Fearson, 32 U.S. 103, 8 L. Ed. 623 (1833), the High Court held that a loan cannot become usurious by virtue of subsequent transfer. The Court stated that “a contract, which, in its inception, is unaffected by usury, can never be invalidated by any subsequent transaction” and that this principle was a “cardinal rule”. The “valid-when-made” principle has not only been embraced by the Supreme Court, but is inherent in the NBA, which strongly supports the assignment of debt originated by a national bank. Federal courts—including the Fifth and Eighth Circuits—have followed the principle. Perhaps the best decision is from the Seventh Circuit, where Judge Posner applied his trenchant economic analysis to support the “valid-when-made” principle. Olvera v. Blitt & Gains PC, 431 F.3d 285, 2005 U.S. App. LEXIS (7th Cir. 2005). In short, not only has the Supreme Court itself already dealt with the “valid-when-made” issue, but the holding in Madden creates an unequivocal circuit split.
Negative consequences of the decision. Although the Solicitor General and the OCC issued a brief highly critical of the Second Circuit decision, they then made a contradictory recommendation based upon a suspect foundation. Therefore, the Madden decision is left in place and the precedent stands. The decision is limited to the Second Circuit—Connecticut, New York and Vermont—and may only be used as a non-binding argument against the “valid-when-made” principle in any other circuit. Well-articulated briefs prepared for Madden, including the critique of the Solicitor General, are now available to appropriately argue the merits in the lower courts of other circuits. Importantly, the Solicitor General hinted that the United States will uphold the “valid-when-made” principle whether or not an interest in loans originated and sold by a national bank is retained by that bank.
Nonbanks can no longer safely buy loans from banks that employ NBA preemption for charging interest rates in the Second Circuit. Such loans may be uncollectible. This will cause nonbank assignees to refuse purchasing certain loans made in the Second Circuit. It will also cause problems for securitization trusts that purchase loan assets from national banks. Marketplace lenders may become hesitant to originate loans in the Second Circuit. Businesses will begin to restructure legal relationships, such as keeping an increased amount of loans on bank balance sheets or appointing the bank as the master servicer to create factual bases for preemption distinct from Madden. As time passes, the real ramifications of the decisions will be presented.
A parting thought. The Supreme Court’s denial of review is very unfortunate. The Second Circuit decision focuses on federal preemption under the NBA. Remarkably, it doesn’t even mention the common-law “valid-when-made” principle, which can be applied independent of federal preemption. The Solicitor General and the OCC saw this point, yet still argued against Supreme Court review, based on a faulty finding that there was no conflict in the circuits.
Written by: Lindsay Harden
On Tuesday, the Financial Crimes Enforcement Network (FinCEN) issued Frequently Asked Questions regarding the new Customer Due Diligence rule. Affected financial institutions must comply with the new rule beginning on May 11, 2018. This rule will apply to federally regulated banks and federally insured credit unions, among other financial entities, and it imposes heightened customer due diligence requirements as well as a new requirement that covered financial institutions must verify the identity of the beneficial owners of their legal entity customers.
The FAQs offer interpretive guidance that is helpful to understanding the rule. For instance, they clarify the meaning of terms like “beneficial owner” and “legal entity,” and discuss the various exceptions to the rule. In addition, they provide clarification that the rule does not cover existing accounts, and that financial institutions are generally not responsible for incorrect information provided by their customers with respect to the identities of beneficial owners. Click here to review the FAQs and prepare your institution for the Customer Due Diligence rule.
Written by: George Sand
On June 1, 2016, the Consumer Financial Protection Bureau released a proposed rule that would restrict the ability for payday lenders to originate loans. The proposal includes both loans with a term of 45 days or less and loans with a term greater than 45 days that have an annual percentage rate greater than 36 percent and either are repaid from the consumer’s account or income or are secured by the consumer’s vehicle (payday loans, vehicle title loans and certain high-cost installment loans) (together, “Payday Loans”). Excluded from the list of Payday Loans are credit cards; student loans; non-recourse pawn loans; overdraft services and lines of credit; loans extended solely to finance the purchase of a car or other consumer good in which the good secures the loan; and home mortgages and other loans secured by real property or a dwelling if recorded or perfected.
Short Term Payday Loans
The proposed rule would require payday lenders to enhance their screening process prior to approving a short term Payday Loan. Generally, the payday lender would be required to reasonably determine that the customer will be able to meet basic living needs and verify ability to meet financial obligations as they become due. The payday lender would be required to:
- verify the consumer’s net income;
- verify the consumer’s debt obligations using a national consumer report and a consumer report from a “registered information system” as described below;
- verify the consumer’s housing costs or use a reliable method of estimating a consumer’s housing expense based on the housing expenses of similarly situated consumers;
- forecast a reasonable amount of basic living expenses for the consumer—expenditures (other than debt obligations and housing costs) necessary for a consumer to maintain the consumer’s health, welfare, and ability to produce income;
- project the consumer’s net income, debt obligations, and housing costs for a period of time based on the term of the loan; and
- determine the consumer’s ability to repay the loan based on the lender’s projections of the consumer’s income, debt obligations, and housing costs and forecast of basic living expenses for the consumer.
In addition, if a consumer approaches the payday lender for a short term Payday Loan within 30 days of a short term or long term (with balloon payments) Payday Loan, the payday lender would be required to presume a consumer is unable to pay the short term Payday Loan unless the payday lender can sufficiently document betterment in the consumer’s financial circumstances. Payday lenders would be prohibited from making a Payday Loan to a consumer that has undertaken three short term Payday Loans within a 30-day span.
Under certain conditions, a payday lender would be permitted to make short term Payday Loans without making any determination. With specific disclosures, a payday lender could make a principal loan less than $500, a second loan up to two-thirds the amount, and a third loan up to one-third the amount within a 30-day span; however, no more than six short term Payday Loans and no more than 90 days of a consumer experiencing debt would be permitted within a 12-month period.
Long Term Payday Loans
Similar to short term Payday Loans, the proposed rule would require an enhanced screening process for long term Payday Loans to reasonably determine that the customer will be able to meet basic living needs and verify consumer ability to meet financial obligations as they become due prior to approval. The proposed rule for long term Payday Loans would require all of the same determinations discussed in the previous section regarding short term Payday Loans. However, in addition, payday lenders would be required to reasonably account for volatility in the consumer’s basic living expenses, income, and financial obligations. Similar to short term Payday Loans, payday lenders would be required to assume a consumer is unable to repay a Payday Loan when the consumer that has already undertaken a Payday Loan within a 30-day span, or has expressed struggle to pay other debts of the payday lender or an affiliate. The payday lender can overcome the assumption with documented proof the consumer’s financial position has improved.
Without engaging in screening for consumer capability to repay the loan, a lender would be able to make a long term Payday Loan under a conditional exemption modeled on the National Credit Union Administration’s (NCUA) Payday Alternative Loan (PAL) program. Under the exemption, a payday lender would be required to have a principal greater than $200 and less than $1,000, fully amortizing payments, with a term of over 46 days but less than six months, among other conditions. Such loans would be required to have an application fee of over $20 and have an interest rate permitted for Federal credit unions under the PAL regulations.
In addition, a payday lender can deviate from the screening of consumers’ capability to repay the loan if a long term Payday Loan satisfies certain structural conditions. The exemption would require the long term Payday Loan to have a term more than 46 days but less than 24 months and fully amortizing payments, an annual default rate less than 5 percent, a modified total cost of credit of less than or equal to an annual rate of 36 percent, and a origination fee less than $50 or reasonably proportionate to the underwriting costs, among other conditions. If in any year the lender exceeds an annual default rate of 5 percent, the lender would be required to refund all origination fees paid by all consumers.
The proposed rule would restrict payday lenders’ collection practices. Payday lenders would be required to give at least three business days’ notice prior to each Payday Loan collection attempt from a consumer’s checking, savings, or prepaid account. The notice would contain material information surrounding the upcoming payment attempt, and electronic notices would be acceptable with the consent of the consumer. In addition, payday lenders would be prohibited from withdrawing payments from consumer accounts in the event of two consecutive failed withdrawal attempts due to a lack of sufficient funds. The payday lender would be required to notify the consumer of such event and follow procedures to receive consumer authorization to enable the payday lender to make subsequent withdrawals from the account. Such prohibition would apply to both failed attempts that are initiated through a single payment channel or different channels (e.g., automated clearinghouse system and the check network).
The proposed rule would require at origination payday lenders to furnish to registered information systems basic information for most Payday Loans, update the information over the life of the loan, and furnish information at the conclusion of the Payday Loan. Prior to originating a Payday Loan, a payday lender would be required to obtain the consumer report from the registered information system and review the report for material information.
The rule would require payday lenders to increase their documentation and recordkeeping. A lender would have to establish written policies and procedures that ensure compliance with the proposal, and follow such policies and procedures. The payday lender would be required to retain all documentation, including the loan agreement and electronic records in tabular format exhibiting origination calculations and determinations for consumers that qualify for exceptions to or overcome a presumption of unaffordability.
Comment Period and Effective Date
Comments to the proposed rule are accepted on or before September 14, 2016. The rule is projected to become effective 15 months after publication in the Federal Register.