United States: Nutter Bank Report, July 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. Fed Publishes Examination Guidance on Loan Sampling for Community Banks
2. Banking Agencies Release Guidance for HELOCs Nearing Their End-of-Draw Periods
3. FDIC Clarifies Supervisory Approach to Third-Party Payment Processors Accounts
4. CFPB Proposes New HMDA Reporting Requirements
5. Other Developments: Borrower's Interest, Ability-to-Repay and CAMELS Guidance 

1. Fed Publishes Examination Guidance on Loan Sampling for Community Banks

The Federal Reserve has issued guidance that updates loan sampling expectations for examinations of community state member banks and clarifies when statistical sampling is expected to be used. The July 22 guidance, published as Supervision and Regulation Letter SR 14-7, also establishes minimum coverage expectations for judgmental samples for full-scope and asset quality target examinations. According to the guidance, Federal Reserve examiners are expected to select for review a sample of loans that is of sufficient size and scope to enable them to reach "sound and well-supported conclusions about the quality of, and risk management over, a community state member bank's lending portfolio." The guidance describes the criteria examiners should consider when selecting loan samples for review. For example, for community state member banks with composite and Asset Quality ratings of 1 or 2 that have not materially changed the composition of their loan portfolios or their credit administration practices, and whose most recent overall SR-SABR rating is not 1D, 1F, 2D or 2F, examiners are expected to use the statistical loan sampling procedures outlined in Supervision and Regulation Letter SR 02 19 for C&I and CRE loan samples. For all other community state member banks, examiners are expected to draw a judgmental sample that includes a selection of large, insider, problem, watch, renewed and new credits. The guidance includes a table that shows the percent coverage of loan samples as a factor of the Asset Quality component rating and whether the bank's credit risk management is rated as strong, acceptable or weak.

     Nutter Notes: The examination guidance, which applies to state member banks with $10 billion or less in total consolidated assets, also provides loan sample guidance for the examination of retail consumer loans. According to the guidance, the supervisory review and classification of retail consumer loans should be carried out in accordance with the procedures set forth in the Commercial Bank Examination Manual and Supervision and Regulation Letter SR 00-8, and should generally be limited to past due and nonperforming assets. The guidance requires that if a bank has a concentration (i.e., 25% percent or more of risk-based capital) in retail consumer loans, examiners should review the bank's underwriting standards and policies, and related risks and controls. In such cases, the guidance also directs examiners to consider sampling a portion of credits in those segments (for example, residential mortgages or HELOCs) of the bank's retail loan portfolio with a high concentration in order to assess risks and the adequacy of underwriting, internal controls and credit risk management practices. The guidance requires that examiners select a judgmental sample size that is "commensurate with concentration and credit risks and sufficient for the examiner to assess the quality and risks of the portfolio."

2. Banking Agencies Release Guidance for HELOCs Nearing Their End-of-Draw Periods

The federal banking agencies, the NCUA and the Conference of State Bank Supervisors have issued joint guidance that describes core operating principles that should govern the oversight of home equity lines of credit ("HELOCs") nearing their end-of-draw periods. The Interagency Guidance on Home Equity Lines of Credit Nearing Their End-of-Draw Periods released on July 1 encourages effective communication with borrowers about the pending reset of periodic payments to begin repayment of the principal amount of the HELOC, and provides broad risk management principles. According to the guidance, examiners will review financial institutions' HELOC end-of-draw risk management policies and procedures for provisions that address five risk management principles: prudent underwriting for renewals, extensions and rewrites; compliance with existing regulatory guidance; use of well-structured and sustainable modification terms; appropriate accounting, reporting and disclosure of troubled debt restructurings ("TDRs"); and appropriate segmentation and analysis of end-of-draw exposure in allowance for loan and lease losses estimation. For example, the risk management principles point out that existing regulatory guidance recommends that HELOC underwriting criteria should include debt service capacity standards, creditworthiness standards, equity and collateral requirements, maximum loan amounts, maturities and amortization terms. The guidance on modifications clarifies that TDR treatment is appropriate when a lender grants a concession to a borrower that it would not otherwise consider because of the borrower's financial difficulties. The agencies expect each institution to apply the HELOC end-of-draw guidance in a manner commensurate with the size and risk characteristics of its HELOC portfolio.

     Nutter Notes: The HELOC end-of-draw guidance also describes examiners' expectations for risk management policies and procedures specific to HELOCs nearing their end-of-draw periods. According to the guidance, examiners will generally expect institutions to generate reports that provide a clear understanding of end-of-draw exposures and identify higher-risk segments of the portfolio. The guidance recommends that such reports identify contractual draw period transition dates for all HELOCs, showing maturity schedules in the aggregate and by significant segments of performing and non-performing borrowers, and distinguishing between performing borrowers that are higher risk and those that are not. The guidance also recommends contacting borrowers through outreach programs. Examiners will generally expect management to begin contacting borrowers about the end-of-draw transition well before their payment reset date, to engage in periodic follow-up with borrowers and respond effectively to issues, according to the guidance. Examiners also expect management to have quality assurance, internal audit and operational risk management functions perform targeted testing, commensurate with the volume of the financial institution's HELOC exposure, of the full process for managing end-of-draw transactions, according to the guidance. The agencies expect that community institutions with smaller HELOC portfolios, few portfolio acquisitions or exposures with lower-risk characteristics may be able to use less-sophisticated processes for monitoring their portfolios. The guidance points out that when an institution outsources all or a portion of HELOC management, the institution remains responsible for ensuring that the vendor complies with applicable laws, regulations and supervisory guidance.

3. FDIC Clarifies Supervisory Approach to Third-Party Payment Processors Accounts

The FDIC has published guidance clarifying that account relationships with third-party payment processors ("TPPPs") which facilitate payment transactions for certain types of merchant clients are neither prohibited nor discouraged. The July 28 guidance published as Financial Institution Letter no. FIL-41-2014 addresses a misperception that the FDIC said arose from earlier FDIC guidance and an informational article on TPPPs which contained lists of examples of types of merchants that had been associated with higher-risk activity when the guidance and article were released. According to the new guidance, it is the FDIC's policy that banks that properly manage customer relationships are neither prohibited nor discouraged from providing services to any customer operating in compliance with applicable law. The FDIC announced that, as part of the clarification of its supervisory policy with respect to account relationships with TPPPs, the FDIC has removed the lists of examples of merchants associated with higher-risk activity from its prior guidance and informational article. The focus of the FDIC's supervisory approach, according to the new guidance, is to ensure that banks have adequate procedures for conducting due diligence, underwriting and ongoing monitoring of account relationships with TPPPS. The FDIC said that banks that follow the prior guidance will not be criticized for establishing and maintaining relationships with TPPPs.

     Nutter Notes: According to the new guidance, banks that establish accounts for TPPPs should assess their risk tolerance for this type of activity and develop an appropriate risk management framework, including policies and procedures that address customer due diligence, underwriting and ongoing monitoring. The lists of examples of merchant categories associated with higher risk activities in the FDIC's prior guidance and the article illustrated trends identified by the payments industry at the time. Those examples included activities that could be subject to complex or varying legal and regulatory environments, activities that may be prohibited for certain consumers, such as minors, and activities that may result in higher levels of complaints, returns, or chargebacks. Account relationships with TPPPs involved in the listed activities are not prohibited or discouraged according to the new guidance, provided that banks manage such account relationships in accordance with the prior guidance. The FDIC said that it will review and assess the extent to which a bank with TPPP accounts follows the prior guidance as part of the FDIC's regular safety and soundness examinations.

4. CFPB Proposes New HMDA Reporting Requirements

The CFPB has proposed a rule to amend the reporting requirements under the Home Mortgage Disclosure Act ("HMDA"), implemented by the CFPB's Regulation C, with an emphasis on information about consumers' access to mortgage credit. The July 24 proposed amendments to Regulation C are also intended to simplify reporting requirements for home mortgage lenders, including banks, according to the CFPB. The Dodd–Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") requires the CFPB to update HMDA reporting to include specific information that could help identify potential discriminatory lending practices and other issues in the home mortgage loan marketplace. That information includes, for example, property value, term of the loan, total points and fees, duration of any teaser or introductory interest rates and the applicant's or borrower's age and credit score. The proposed amendments would require lenders to report more information about underwriting and pricing, such as an applicant's debt-to-income ratio, the interest rate of the loan and the total discount points charged for the loan. The CFPB said that the additional information would help regulators determine how the Ability-to-Repay rule is affecting the market. The CFPB also believes that the additional information would help the CFPB monitor developments in certain markets, such as multi-family housing, affordable housing and manufactured housing. The proposed amendments would also require lenders to report most loans related to dwellings, including reverse mortgages and open-end lines of credit. Comments on the proposed amendments must be submitted to the CFPB by October 22, 2014.

     Nutter Notes: Currently, a bank that satisfies HMDA's general reporting requirements must report HMDA data even if the bank makes only a single home purchase or refinance loan in a given year, while non-bank mortgage lenders may be required to report only if they make at least 100 loans. Under the proposed amendments to Regulation C, all lenders, including banks, would generally be required to report HMDA data only if they make 25 or more closed-end loans or reverse mortgages in a year. The CFPB believes that the new reporting threshold would reduce the number of small banks required to report HMDA data by 25%. The proposal would also eliminate reporting requirements for certain home improvement loans. Under the proposed amendments, lenders that make a large number of reported transactions would be required to report HMDA data on a quarterly, rather than an annual, basis. The CFPB said that it hopes to better align HMDA data reporting requirements with industry standards for collecting and transmitting data on home mortgage loans and applications. For example, the proposed rule would incorporate certain Mortgage Industry Standards Maintenance Organization data standards into the HMDA reporting requirements. Finally, as part of the rulemaking process, the CFPB said that it will consider ways to improve public access to HMDA data and what new technological tools would make the reporting process more efficient, ease data formatting requirements and help lenders prevent reporting errors.

5. Other Developments: Borrower's Interest, Ability-to-Repay and CAMELS Guidance 

  • Amendments to Borrower's Interest Rule Creates Safe Harbor for Qualified Mortgages

The Massachusetts Division of Banks has issued final amendments to the Documentation and Determination of Borrower's Interest rule effective as of July 18 that establish a safe harbor for most home loans that meet the definition of a "Qualified Mortgage" under the regulations of the CFPB.

     Nutter Notes: Under the amended rule, any Qualified Mortgage other than a Qualified Mortgage that is also a "higher cost" home loan, would be deemed to be in the borrower's interest under the Massachusetts regulation. The safe harbor even applies to Qualified Mortgages under the CFPB's small creditor exemption. 

  • CFPB Exempts a Borrower's Heirs from the Ability-to-Repay Rule

The CFPB on July 8 issued an interpretive rule to clarify that, when a borrower dies, the name of the borrower's heir generally may be added to the mortgage without triggering the requirements of the CFPB's Ability-to-Repay rule. Because an heir has already acquired the title to the home, the creditor is not required to determine the heir's ability to repay the mortgage before formally recognizing the heir as the borrower, according to the interpretive rule.

     Nutter Notes: The CFPB said that the interpretive rule can also apply to effectively exempt other transfers from Ability-to-Repay rule requirements, including transfers to living trusts, transfers during life from parents to children, transfers resulting from divorce or legal separation, and other family-related transfers. 

  • OCC Issues Guidance for Federal Mutual Thrifts on CAMELS Ratings Factors

The OCC issued guidance on July 22 that clarifies the factors that examiners will consider in rating mutual federal savings associations for each component of the Uniform Financial Institutions Rating System (more commonly referred to as CAMELS). The guidance, published as OCC Bulletin 2014-35, also may be relevant for certain stock federal savings associations that are part of a mutual holding company structure.

     Nutter Notes: The guidance noted that the OCC's rescission of OTS executive compensation guidance has created some uncertainty for federal mutual savings associations. The new guidance in very general terms clarifies the OCC's expectations for executive compensation by federal mutual institutions, including those that might offset their inability to offer traditional equity incentives by offering alternatives such as phantom stock plans.

Originally published July 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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