Ten Things a Community Banker Should Know about the Dodd-Frank Act

July 26, 2010 at 8:37 pm Leave a comment

On July 21, 2010, President Obama signed into law the historic financial regulatory reform bill known as the Dodd-Frank Wall Street Reform and Consumer Protection Act. While much of the Act applies to only very large banks, there are many provisions that apply to community banks. We have selected 10 provisions of the Act that will affect community banks.

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.

Entry filed under: Uncategorized.

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