On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act") which significantly amends Federal oversight of the financial industry. While much media attention has focused on issues covered by the Act that primarily affect only large financial institutions, such as how to resolve entities that are "too big to fail" and regulate derivatives trading by complex financial holding companies, the Act also includes several provisions that will profoundly affect how community banks, thrifts and small bank and thrift holding companies will be regulated in the future. These provisions, among other things, abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules governing interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage and impose new capital requirements on bank and thrift holding companies. With these changes, which are described below, the Act may represent the most significant financial legislation affecting community banks and thrifts in the post-Depression era.
Elimination of Office of Thrift Supervision
While the Act eliminates the Office of Thrift Supervision (the "OTS") and transfers its powers and functions to the other federal banking agencies, it also preserves the thrift charter. The Act transfers to the Office of the Comptroller of the Currency (the "OCC") all functions of the OTS relating to federal savings associations and all rulemaking authority relating to savings associations, and to the Federal Deposit Insurance Corporation (the "FDIC") all functions of the OTS relating to state savings associations. The Act also transfers to the Federal Reserve Board (the "FRB") all functions of the OTS relating to savings and loan holding companies and their non-depository institution subsidiaries, and the regulation of loans to insiders and transactions with affiliates and tying arrangements. These changes will become effective one year following enactment of the Act, although this deadline may be extended to a date no later than 18 months following enactment. No later than the effective date of the transfer of these responsibilities, the OCC, FDIC and FRB are to publish regulations that will apply to the entities they are to regulate for the first time under the Act.
Ninety days following the transfer of its powers and functions to the other banking agencies, the OTS will be abolished and its employees will be transferred to the OCC and FDIC. Federal savings associations will be regulated under the authority of a newly-appointed Deputy Comptroller of the Currency with responsibility for the supervision and examination of federal savings associations. Although the Act does not abolish the thrift charter, it eliminates one of the key benefits of retaining the thrift charter, which is having a single regulator at the holding company and thrift levels. The Act also reduces the benefits of federal preemption previously accorded federal savings associations and, after five years, will subject savings and loan holding companies for the first time to minimum leverage and risk-based capital requirements (discussed below). The elimination of these key benefits formerly associated with operating as a thrift, coupled with concerns that the OCC may soon impose national bank standards on thrifts or that Congress may abolish the federal thrift charter altogether, may encourage federal thrifts to convert to a national bank or state commercial bank charter. The Act permits a thrift that converts to a bank charter to retain any out-of-state branches it operates notwithstanding any federal or state law to the contrary.
Regulation of Bank Holding Companies and Savings and Loan Holding Companies
Under the Act, the FRB retains its current authority as the sole regulator of bank holding companies and acquires the additional authority, formerly exercised by the OTS, to regulate savings and loan holding companies. The Act authorizes the FRB to examine the bank-permissible activities in which a holding company's non-depository institution subsidiaries engage to determine whether those activities present safety and soundness concerns to the holding company's bank or thrift subsidiaries. This provision will authorize the FRB to examine, for example, a bank holding company's mortgage banking or mortgage broker subsidiaries. The FRB is to coordinate with any state banking agency with jurisdiction over the subsidiary in conducting these examinations. The Act establishes the appropriate Federal banking agency for the lead depository institution subsidiary of the holding company as the backup regulator for the holding company's subsidiaries that engage in bank-permissible activities. With this authority, the appropriate Federal banking agency may examine the subsidiary if the FRB does not timely conduct an examination itself and may, based upon the results of its examination, initiate an enforcement action against the subsidiary if the FRB does not timely act upon the agency's request to initiate the action.
A separate provision of the Act directs the Government Accountability Office (the "GAO") to carry out a study within three years of the enactment date to determine whether it is necessary, in order to strengthen the stability of the financial system, to eliminate the exemption from registration as a bank holding company provided under current law for savings and loan holding companies. Presumably, this study could provide the basis for future legislation to eliminate the distinction under current law between savings and loan holding companies and bank holding companies.
Consolidated Capital Requirements for Bank Holding Companies and the Treatment of Trust Preferred Securities
The Act imposes stricter consolidated capital standards on depository institution holding companies, although last-minute negotiations between House and Senate conferees led to the inclusion in the final version of the Act of several exemptions that primarily benefit smaller bank holding companies and savings and loan holding companies. The original Senate version of the Bill would have required the appropriate federal banking agencies to establish minimum leverage and risk-based capital requirements on a consolidated basis for insured depository institutions and their holding companies that are no less than the capital requirements currently in effect for banks. The adoption of this provision would have resulted in small bank holding companies and thrift holding companies becoming subject for the first time to consolidated capital requirements and would have precluded trust preferred securities and preferred stock issued pursuant to the Troubled Assets Repurchase Program ("TARP") from being included in Tier 1 capital.
Final negotiations between House and Senate conferees completely exempts from these provisions:
- Securities issued to the U.S. government pursuant to the TARP
program prior to October 4, 2010;
- Any Federal Home Loan Bank; and
- Small bank holding companies with less than $500 million in assets and that do not engage directly or indirectly in significant nonbanking activities (although a small bank holding company that currently qualifies for this exemption would become subject to the new capital standards in the future once it exceeds $500 million in assets).
The final version of the Act also includes a grandfather provision for securities issued before May 19, 2010 by a bank holding company with less than $15 billion in assets as of December 31, 2009 and by an organization that was a mutual holding company as of May 19, 2010. This provision will allow these entities to continue to treat these securities, for as long as they remain outstanding, as Tier 1 capital to the extent permitted under existing FRB capital requirements. Finally, an entity not covered by these exceptions and grandfather provisions will be permitted to defer any required regulatory capital deductions with regard to securities issued prior to May 19, 2010 incrementally over a three-year period beginning January 1, 2013. Savings and loan holding companies, regardless of asset size, have five years to comply with the minimum leverage and risk-based capital requirements, although those with over $15 billion in assets, like similarly-sized bank holding companies, will need to phase out over three years any trust preferred securities they issued prior to May 19, 2010. Securities issued after May 19, 2010 are immediately subject to the Act's stricter consolidated capital standards unless they are covered by one of the above exemptions or grandfather provisions.
Changes to Source of Strength Doctrine
The Act creates for the first time a statutory basis for the "source of strength" doctrine asserted by the Federal banking agencies. The Act authorizes the FRB to require a bank holding company, savings and loan holding company, or other company that controls a depository institution to serve as a source of financial strength for any of its depository institution subsidiaries. For this purpose, "source of financial strength" means the holding company's ability to provide financial assistance to a depository institution subsidiary in the event of the subsidiary's financial distress. While the FRB has long asserted that a bank holding company must serve as a source of financial strength for its financial institution subsidiaries, there has not been, until now, a statutory basis for this doctrine.
Changes Affecting Mutual Holding Companies
Under existing law, a mutual holding company may elect to waive the receipt of dividends from its mid-tier stock holding company or its subsidiary stock savings association. Ordinarily, a mutual holding company will choose to waive its receipt of dividends so that larger dividends may be paid to minority shareholders.
The Act requires that future dividend waivers must be approved by the FRB and require a resolution of the board of directors of the mutual holding company concluding that the proposed waivers are consistent with the fiduciary duties of the board to the mutual members of the mutual holding company. The FRB may not object to a waiver sought by a mutual holding company that reorganized prior to December 1, 2009, if it previously waived dividends, assuming the FRB determines the waiver is not detrimental to the safe and sound operation of the savings association. The Act authorizes the FRB to object on any basis to a dividend waiver request from any other mutual holding company. The FRB will likely consider in reviewing dividend waiver requests, among other factors, whether approval would be consistent with a mutual holding company's ability to serve as a source of strength for its savings association subsidiary.
The Act also directs the appropriate banking agencies to consider dividends waived by mutual holding companies in determining an appropriate exchange ratio in a full conversion to stock form, except for mutual holding companies reorganized before December 1, 2009. These changes take effect on the transfer date of OTS supervisory responsibilities to the FRB and the FDIC.
Expanded De Novo Branching Authority
The Act amends the interstate branching provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. These amendments will authorize a state or national bank to open a de novo branch in another state if the law of the state where the branch is to be located would permit a state bank chartered by that state to open the branch. Under prior law, an out-of-state bank could open a de novo branch in another state only if the particular state permitted out-of-state banks to establish a de novo branch.
Deposit Insurance Overhaul
Increase in Coverage. In a surprising development, the Act makes permanent the increase in the deposit insurance coverage limit of $250,000 that was otherwise scheduled to return to $100,000 on January 1, 2014. The addition of this provision to the Act in final negotiations was unexpected because neither the original House nor Senate Bills included a similar provision. The Act also makes this increase in deposit insurance coverage retroactive to cover any bank failures occurring between January 1, 2008 and October 3, 2008 before the deposit insurance limit was temporarily increased to $250,000. This retroactive application of the expanded deposit insurance limit will benefit uninsured depositors in IndyMac Bank FSB and several other banks that failed before deposit insurance coverage was temporarily increased.
Unlimited Guaranty of Transaction Accounts. The Act also extends for two years the unlimited FDIC guarantee of noninterest bearing transaction accounts without regard to the $250,000 deposit insurance limit. This latter provision will expire on January 1, 2013. The Act's unlimited guarantee of transaction accounts applies to all insured depository institutions (including federally insured credit unions), and not just those that elect to participate, and applies only to transaction accounts on which interest is neither paid or accrued. The temporary guarantee program implemented by the FDIC in 2008 covered only depository institutions that opted to participated in the program and covered transaction accounts that paid an interest rate of up to .25%.
Calculation of Assessments. The Act also changes how the FDIC will calculate future deposit insurance premiums payable by insured depository institutions. The Act directs the FDIC to amend its assessment regulations so that future assessments will generally be based upon a depository institution's average total consolidated assets minus the average tangible equity of the insured depository institution during the assessment period, whereas assessments were previously based on the amount of an institution's insured deposits.
The minimum deposit insurance fund rate will increase from 1.15% to 1.35% by September 30, 2020. The cost of the increase will be borne by depository institutions with assets of $10 billion or more.
The Act also provides the FDIC with discretion to determine whether to pay rebates to insured depository institutions when its reserves exceed certain thresholds. Previously, the FDIC was required to give rebates to depository institutions equal to the excess once the reserve ratio exceeded 1.50%, and was required to rebate 50% of the excess over 1.35% but not more than 1.5% of insured deposits.
Payment of Interest on Business Checking Accounts
The Act includes a provision long sought by the banking industry that will permit depository institutions for the first time to pay interest on business checking accounts. This provision will become effective one year after the date of the Act's enactment. This change will likely require the FRB to amend its Regulation D establishing reserve requirements for depository institutions and could significantly reduce or eliminate the need for depository institutions to offer sweep account products to their commercial customers. The banking agencies will likely address these issues during the one-year interim period before this provision becomes effective.
Restrictions on Conversions of Troubled Banks
The Act prohibits troubled financial institutions from converting to a different charter. In particular, the Act prohibits a bank or thrift that is subject to a cease and desist order or other formal enforcement action, or that is a party to a memorandum of understanding with its primary federal regulator or appropriate State bank supervisor regarding a significant supervisory matter or a final enforcement action by a State Attorney General, from converting to a different charter. The Act includes an exception to this prohibition for conversion transactions where the appropriate Federal banking agency or State bank supervisory that issued the cease and desist order or memorandum of understanding does not object to the proposed conversion within 30 days of receiving notice of the charter conversion and the plan to address the significant supervisory concern from the federal banking agency which will supervise the converted depository institution. The plan to address supervisory concerns must be implemented after the conversion and the depository institution must comply with any final enforcement action of a State Attorney General.
Establishment of Bureau of Consumer Financial Protection
The Act establishes the Bureau of Consumer Financial Protection (the "Bureau") as an independent entity within the FRB. The Director of the Bureau will be appointed by the President and confirmed by the Senate, and will operate largely outside of the control of the FRB itself. The Act provides the Bureau with authority to write consumer protection regulations that will apply to all entities, including banks and non-banks, that offer consumer financial services or products. The Financial Oversight Council may overturn a regulation promulgated by the Bureau if it determines that the rule would jeopardize the safety and soundness of the banking system or the stability of the financial system.
The Act authorizes the Bureau to enact consumer protection regulations that will apply to all "covered persons," which the Act defines as any person that engages in offering consumer financial products or services. The Act divides oversight and enforcement powers with regard to these regulations between the Bureau and the other Federal banking agencies based upon a financial institution's size. The Bureau will be responsible for supervising and enforcing its regulations against banks and credit unions with assets of $10 billion or more and their respective affiliates (other than those entities specifically exempted from the Bureau's authority, including broker dealers and insurance companies), all mortgage-related businesses (including lenders, servicers, mortgage brokers and foreclosure relief companies) and large non-bank financial companies (such as large payday lenders, debt collectors, and consumer reporting agencies). Importantly, while banks, thrifts and credit unions with total assets of less than $10 billion will be subject to the consumer protection regulations enacted by the Bureau, their compliance with these regulations will be supervised and enforced by their primary Federal banking regulator, and not by the Bureau.
New Limitations on Federal Preemption of State Consumer Protection Laws
The Act scales back the authority previously exercised by the OCC and the OTS to preempt state consumer protection laws. The Act authorizes the OCC to preempt only state consumer laws that "prevent or significantly interfere with the exercise by a national bank of its powers." Previously, the OCC claimed much broader authority to preempt state laws that "obstruct" or "impair" a national bank's operations, a standard that effectively led to the OCC preempting all state consumer protection laws as they were applied to national banks. The Act also provides that State consumer financial laws will, in the future, apply to each subsidiary and affiliate of a national bank that is not itself a national bank. This provision effectively revokes prior OCC interpretations stating that Federal law preempts the application of State consumer protection laws to operating subsidiaries of national banks. The Act also applies to Federal savings associations and their subsidiaries and affiliates the same preemption standards that apply to national banks.
State Attorney Generals are permitted under the Act to enforce non-preempted laws against federal depository institutions; states will also be free to enact additional consumer protections beyond those that may be adopted by the Bureau and will have power to enforce their own regulations as well as the Bureau's.
Changes to Asset-Backed Securitization Process
The Act directs the Federal banking agencies to adopt rules requiring an issuer or other entity creating an asset-backed security, such as a mortgage-backed security, to retain an economic interest in a portion of the credit risk for the assets underlying the security. In particular, the entity creating an asset-backed security must retain not less than five percent of the credit risk of any asset that is not a "qualified residential mortgage" that it transfers, sells or conveys through the issuance of an asset-backed security. The Federal banking regulators, the Securities and Exchange Commission, the Secretary of Housing and Urban Development, and the Director of the Federal Housing Finance Agency are to define the term "qualified residential mortgage" taking into account certain factors set forth in the Act. The Act also directs the Securities and Exchange Commission to prescribe regulations to require an issuer of asset-backed securities to perform due diligence on a security's underlying assets and disclose its findings to prospective investors.
Industrial Loan Company Moratorium
The Act imposes a moratorium on the FDIC's approval of any application for deposit insurance coverage received after November 23, 2009 from an industrial bank, credit card bank or trust bank that is controlled by a commercial firm. Moreover, subject to limited exceptions, commercial firms may not acquire control of industrial banks, credit card banks or trust banks. This moratorium will expire three years following enactment of the Act. During this period, the Act directs the GAO to carry out a study to determine whether it is necessary, in order to strengthen the stability of the financial system, to eliminate the exemption from registration as a bank holding company provided under current law for industrial loan companies, credit card banks or trust banks.
Mortgage Reform and Anti-Predatory Lending
Title XIV of the Act, the Mortgage Reform and Anti-Predatory Lending Act, includes a series of amendments to the Truth In Lending Act with respect to mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments. With respect to mortgage loan originator compensation, except in limited circumstances, an originator is prohibited from receiving compensation that varies based on the terms of the loan (other than the principal amount). The amendments to the Truth In Lending Act also prohibit a creditor from making a residential mortgage loan unless it determines, based on verified and documented information of the consumer's financial resources, that the consumer has a reasonable ability to repay the loan. The amendments also prohibit certain pre-payment penalties and require creditors offering a consumer a mortgage loan with a pre-payment penalty to offer the consumer the option of a mortgage loan without such a penalty. In addition, the Act expands the definition of a "high-cost mortgage" under the Truth In Lending Act, and imposes new requirements on high-cost mortgages and new disclosure, reporting and notice requirements for residential mortgage loans, as well as new requirements with respect to escrows and appraisal practices.
Interchange Fees for Debit Cards
Under the Act, interchange fees for debit card transactions must be reasonable and proportional to the issuer's incremental cost incurred with respect to the transaction plus certain fraud related costs. Although institutions with total assets of less than $10 billion are exempt from this requirement, competitive pressures are likely to require smaller depository institutions to reduce fees with respect to these debit card transactions.
Other Provisions Affecting Savings Associations
Grandfathered unitary savings and loan holding companies may continue to conduct nonfinancial activities, but subject to the FRB's discretion to require that financial activities be segregated in an intermediate holding company which would facilitate supervision of such entity by the FRB. Grandfathered unitary savings and loan associations must be a source of strength for these intermediate holding companies.
Savings associations that fail to meet the Qualified Thrift Lender test become subject to activities restrictions applicable to national banks, have branching rights of national banks, and may only grant dividends permitted to national banks, necessary to meet obligations of their controlling company, and specifically approved by the OCC.
Savings and loan holding companies may engage in activities permissible for financial holding companies if they satisfy the same requirements applicable to bank holding companies that are financial holding companies.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
