United States: Nutter Bank Report, March 2014

The Nutter Bank Report is a monthly electronic publication of the firm's Banking and Financial Services Group and contains regulatory and legal updates with expert commentary from our banking attorneys.


  1. SJC Decision Limits Challenges to Foreclosure Based on Right to Cure
  2. OCC Issues New Examination Guidance on Asset-Based Lending
  3. Federal Banking Agencies Release Final Stress Test Guidance for Medium-Sized Institutions
  4. Federal Agencies Propose Regulatory Standards for Appraisal Management Companies
  5. Other Developments: Derivatives and Borrower's Interest

1. SJC Decision Limits Challenges to Foreclosure Based on Right to Cure

The Massachusetts Supreme Judicial Court recently ruled that the Massachusetts right-to-cure statute, Chapter 244, Section 35A of the General Laws of Massachusetts ("Section 35A") is not part of the foreclosure process. In its March 14 decision, the court held that the notice and right-to-cure requirements under Section 35A are instead pre-foreclosure undertakings that, when satisfied, may eliminate a default and preclude the initiation of foreclosure proceedings. The case involved a default on a home mortgage loan in which the borrower was sent a right-to-cure notice under Section 35A and failed to cure the default. After a foreclosure sale, the foreclosing lender brought a summary process action to evict the borrower. The borrower argued that the Section 35A notice he received from the mortgage servicer prior to the foreclosure, informing him of his right to cure, failed to correctly state the mortgagee of record and that, as a result, the foreclosing lender was not entitled to possession of the property because the foreclosure was not done in strict compliance with the power of sale provided in the mortgage, thereby rendering the foreclosure void. Chapter 183, Section 21, of the General Laws of Massachusetts provides that, before a mortgagee may sell mortgaged premises by public auction after a default, the mortgagee first must comply "with the terms of the mortgage and with the statutes relating to the foreclosure of mortgages by the exercise of a power of sale." The court noted, however, that Section 35A "is designed to give a mortgagor a fair opportunity to cure a default before the debt is accelerated and before the foreclosure process is commenced" (emphasis added). As a result, the court held that Section 35A "is not one of the statutes 'relating to the foreclosure of mortgages by the exercise of a power of sale'" referenced in Chapter 183, Section 21.

Nutter Notes: Chapter 35A and its implementing regulations at 209 C.M.R. 56.00 provide a process for lenders and servicers to inform a borrower of a mortgage default and to disclose repayment options in order to prevent a foreclosure. The law was amended by Chapter 194 of the Acts of 2012 to also require a mortgage lender to determine whether the value to the lender of modifying a mortgage loan of any of certain specified types would likely outweigh the value to the lender of foreclosure and, if so, the lender must make the loan modification. The court noted that the proper avenue by which a homeowner can challenge a mortgagee's compliance with Section 35A is either filing an independent equity action in the Massachusetts Superior Court, or asserting counterclaims pertaining to Section 35A in response to the mortgagee's postforeclosure summary process action in the Housing Court. While the foreclosing lender in this case was successful, the concurring opinion of one of the justices suggests that the borrower may yet have another option to block the foreclosure. In that concurring opinion, the justice referred to another recent Supreme Judicial Court decision in which the court acknowledged that a homeowner could defeat an eviction proceeding to the extent the homeowner is able to "prove that the violation of [Section 35A] rendered the foreclosure so fundamentally unfair that [the homeowner] is entitled to affirmative equitable relief, specifically the setting aside of the foreclosure sale 'for reasons other than failure to comply strictly with the power of sale provided in the mortgage.'" It remains to be seen how the lower courts will apply this "fundamentally unfair" standard.

2. OCC Issues New Examination Guidance on Asset-Based Lending

The OCC has issued a new publication titled Asset-Based Lending, which the OCC added to the Comptroller's Handbook, which provides guidance on asset-based lending to all national banks and federal savings associations. The guidance released on March 27 discusses the OCC's risk management and underwriting expectations for asset-based lending activities, provides examples of credit risk-rating assessments of asset-based lending facilities, and replaces the asset-based lending guidance for federal savings associations previously found in Section 214, "Other Commercial Lending," of the OTS Examination Handbook. According to the guidance, the OCC considers asset-based lending to be a specialized form of credit that provides a fully collateralized loan to a commercial borrower based on assets pledged as collateral and structured to provide a flexible source of working capital. The guidance distinguishes asset-based lending from operating cash flow lending on the basis of the reliance on funds provided by the conversion of working capital assets to cash to service the debt in asset-based lending. According to the guidance, credit risk is the most significant risk associated with asset-based lending because characteristics of higher default risk, such as high leverage, erratic cash flows, limited working capital, and frequently changing collateral pools, are common with asset-based credit facility borrowers. The OCC expects each bank engaged in asset-based lending activities to identify, measure, monitor and control risk by implementing an effective risk management system appropriate for the size and complexity of the bank's operations. OCC examiners' assessments of a bank's risk management systems will consider the adequacy of the bank's policies, processes, personnel and control systems.

Nutter Notes: According to the OCC's guidance, strong controls and careful monitoring are essential features of an asset-based lending program. OCC examiners expect asset-based lending policies to be written and subject to initial and periodic review and approval by a bank's board of directors. The OCC expects such policies to address, among other things, loan approval requirements that mandate sufficient senior-level oversight, staff responsibilities for establishing and maintaining sound underwriting standards, and standards for liquidity and collateral monitoring, advance rates, field audits and loan covenants. There are no aggregate limitations on asset-based lending for national banks, provided that the volume and nature of the lending do not pose unwarranted risk to the bank's financial condition. Certain limitations on asset-based lending apply to federal savings associations under the Home Owners' Loan Act ("HOLA"), and Section 160.30 of the OCC's regulations, which implements HOLA's lending and investment limits. Asset-based loans typically would be classified as commercial loans under HOLA, which cannot exceed 20% of total assets of a federal savings association, provided that amounts above 10% of total assets are used only for small business loans. However, a federal savings association may engage in asset-based lending in reliance on other authority, depending on the circumstances. For example, asset-based loans may be aggregated with other non-residential real property loans, which cannot exceed 400% of total capital. Furthermore, any portion of asset-based loans by a federal savings association secured by non-residential real property that are fully insured or guaranteed by the Economic Development Administration, the Farmers Home Administration, or the Small Business Administration are not subject to lending limits under HOLA.

3. Federal Banking Agencies Release Final Stress Test Guidance for Medium-Sized Institutions

The federal banking agencies have issued final guidance describing supervisory expectations for stress tests conducted by medium sized banking organizations—those with total consolidated assets of between $10 billion and $50 billion—as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). The final stress test guidance published on March 5 confirms that medium sized banking organizations are not subject to the Federal Reserve's capital plan rule, the Federal Reserve' annual Comprehensive Capital Analysis and Review, Dodd-Frank Act supervisory stress tests for capital adequacy or related data collections, which apply to bank holding companies with assets of at least $50 billion. Under the stress test rules implementing Dodd-Frank Act requirements, medium sized banking organizations must assess the potential impact of a minimum of three macroeconomic scenarios (baseline, adverse, and severely adverse) provided by their primary federal banking agency on their consolidated losses, revenues, balance sheet (including risk-weighted assets) and capital. According to the final guidance, a medium sized banking organization is not required to use a variable in a scenario provided by its primary federal banking agency if the variable is not relevant or appropriate to the organization's line of business. In addition, an organization may, but is not required to, use additional variables beyond those provided in the banking agencies' scenarios. Under the Dodd-Frank Act stress test rules, medium sized banking organizations must publicly disclose stress test results between June 15 and June 30 each year, with the first disclosures required in 2015.

Nutter Notes: The final guidance for medium sized banking organizations builds on the interagency stress testing guidance issued in May 2012 for all institutions with more than $10 billion in total consolidated assets. The May 2012 stress test guidance set forth the following five principles for an effective stress testing framework: the framework should include activities and exercises that are tailored to and sufficiently capture the organization's exposures, activities and risks; the framework should employ multiple conceptually sound stress testing activities and approaches; the framework should be forward-looking and flexible; stress test results should be clear, actionable, well supported, and inform decision-making; and the framework should include strong governance and effective internal controls. The final guidance for medium sized banking organizations notes that the Dodd-Frank Act stress tests may not necessarily capture an organization's full range of risks, exposures, activities and vulnerabilities that have a potential effect on capital adequacy. For example, the stress tests may not account for regional concentrations and unique business models, and they may not fully cover the potential effects on capital of an event such as a regional natural disaster. According to the guidance, the federal banking agencies expect banking organizations to consider stress test results together with other capital assessment activities to ensure that each organization's material risks and vulnerabilities are appropriately considered and reflected in its overall assessment of capital adequacy. The guidance also notes that Dodd-Frank Act stress tests assess the impact of stress scenarios on capital adequacy, and are not intended to measure the adequacy of an organization's liquidity.

4. Federal Agencies Propose Regulatory Standards for Appraisal Management Companies

The federal banking agencies along with the CFPB, NCUA and Federal Housing Finance Agency jointly have issued a proposed rule that would implement minimum requirements for state registration and supervision of appraisal management companies ("AMCs"). Under the joint proposed rule released on March 24, each state that has elected to establish an appraiser certifying and licensing agency with authority to register and supervise AMCs ("participating states") would require AMCs to register in the state, use only state-certified or licensed appraisers for federally related transactions and require that appraisals comply with the Uniform Standards of Professional Appraisal Practice ("USPAP"). The proposed rule would also require AMCs to establish and comply with processes and controls reasonably designed to ensure the selection of an independent appraiser with the requisite education, expertise and experience to competently complete the appraisal assignment and establish and comply with processes and controls reasonably designed to ensure that appraisals comply with the appraisal independence standards established under the Truth in Lending Act. The proposed rule also would require that the state certifying and licensing agency have certain authorities, including the authority to approve or deny AMC registration applications, examine AMCs, and verify that the appraisers on each AMC's appraiser network or panel hold valid state certifications or licenses. Comments on the proposed rule will be due within 60 days after the proposed rule is published in the Federal Register, which is expected shortly.

Nutter Notes: The proposed joint rule would not compel a state to establish an AMC registration and supervision program. However, beginning 36 months from the time the agencies issue a final AMC rule, AMCs will be prohibited from providing services for any federally related transaction in a state unless the AMC is registered with that state or is subject to oversight by a federal financial institution regulatory agency. The proposed rule would implement the requirements of Section 1473 of the Dodd-Frank Act, which added Section 1124 to the Financial Institution Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"). Under Section 1124 of FIRREA, states that elect to establish an appraiser certifying and licensing agency with authority to register and supervise AMCs must require that AMCs register with and be subject to supervision by the state agency, verify that only state-certified or state-licensed appraisers are used for federally related transactions, require that appraisals comply with USPAP, and require that appraisals are conducted in accordance with the statutory appraisal independence standards under the Truth in Lending Act. FIRREA defines a federally related transaction to include a credit transaction involving a federally regulated depository institution that requires the services of an appraiser. Consistent with Section 1124 of FIRREA, an AMC that is a subsidiary of a financial institution and regulated by a federal financial institution regulatory agency would be required to meet the same minimum requirements as other AMCs, but would not be required to register with a state.

5. Other Developments: Derivatives and Borrower's Interest

OCC Updates Examination Guidance on End-User Derivatives

The OCC has issued a supplement to the Risk Management of Financial Derivatives booklet of the Comptroller's Handbook that provides guidance on examination procedures to detect, monitor, and evaluate risks related to end-user derivatives and trading activities by national banks and federal savings associations. The supplement issued on March 24 includes minimum scope examination procedures for bank policies, systems, controls and governance structures related to end-user derivatives and trading.

Nutter Notes: The supplement also includes examination procedures for ongoing monitoring of portfolios with end-user derivatives and trading positions to identify new and changing risks. The OCC said that the examination procedures primarily apply to large, complex banks that use derivatives for both trading and risk management purposes.

Division of Banks Proposes Safe Harbor for Qualified Mortgages

The Division of Banks has issued a proposal to amend its borrower's interest regulation to establish an additional safe harbor for any home mortgage loan that meets the definition of a Qualified Mortgage under the CFPB's Ability to Repay rule. Under the amended regulation, a Qualified Mortgage would be deemed to be in the borrower's interest under 209 CMR 53.00.

Nutter Notes: Lenders in Massachusetts, including banks, are prohibited by Chapter 183, Section 28C of the General Laws from refinancing a home mortgage loan that was made within the last 60 months unless the refinancing is in the borrower's interest. The Division plans to hold a public hearing on the proposed amendments on Wednesday, April 9, 2014 at 10:00 a.m. at 1000 Washington Street, Hearing Room 1-E, Boston, Massachusetts.

Originally published March 31, 2014

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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