United States: Nutter Bank Report, February 2015

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.

Headlines
1. Fed Proposes Rules to Expand Flexible Capital Standards for Small Holding Companies
2. Federal Court Rules that a Non-Borrower Has Standing to Assert TILA Rescission Rights
3. Federal Agencies Publish Joint Guidance on Student Loans with Graduated Payments
4. FFIEC Issues New Guidance on Risk Management for Technology Service Providers
5. Other Developments: Equal Access and Securitization Exposures

1. Fed Proposes Rules to Expand Flexible Capital Standards for Small Holding Companies

The Federal Reserve has issued a proposed rule to expand the applicability of its Small Bank Holding Company Policy Statement ("Small BHC Policy Statement") from bank holding companies with less than $500 million in total consolidated assets to bank holding companies and savings and loan holding companies with less than $1 billion in total consolidated assets. The proposed rule released on January 29 would implement a recent amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") that expands the coverage of an exemption from the new Basel III regulatory capital requirements for small bank holding companies under the Dodd-Frank Act. As a result, bank holding companies and savings and loan holding companies with less than $1 billion in total consolidated assets that satisfy the requirements of the Small BHC Policy Statement will not be subject to the new regulatory capital requirements mandated by the Dodd-Frank Act. The exemption does not apply to any depository institution subsidiary of either a small bank holding company or a small savings and loan holding company. The Small BHC Policy Statement, which is Appendix C to Part 225 of the Federal Reserve's rules and regulations, currently allows bank holding companies with less than $500 million of assets that are not engaged in any nonbanking activities involving significant leverage and that do not have a significant amount of outstanding debt held by the general public to follow less-stringent regulatory standards when acquiring other financial institutions. The Small BHC Policy Statement also allows qualifying small bank holding companies to incur comparatively greater amounts of debt than larger holding companies in order to acquire other financial institutions. Public comments on the proposed rule are due by March 4.

     Nutter Notes: Currently, the Small BHC Policy Statement only applies to bank holding companies with pro forma consolidated assets of less than $500 million and does not cover savings and loan holding companies. Section 171(b)(5)(C) of the Dodd-Frank Act exempts small bank holding companies that were subject to the Small BHC Policy Statement as in effect on May 19, 2010 from the new leverage and risk-based regulatory capital requirements imposed under Section 171 of the Dodd-Frank Act. The recent amendment to the Dodd-Frank Act provides for a transition period that allows qualifying small bank holding companies and small savings and loan holding companies with assets of less than $500 million to be excluded from the new regulatory capital requirements under the provisions of Section 171 of the Dodd-Frank Act until the amendments to the Small BHC Policy Statement issued by the Federal Reserve become effective. In addition, the Federal Reserve has proposed to eliminate quarterly consolidated financial reporting requirements for bank holding companies and savings and loan holding companies that have less than $1 billion in total consolidated assets and meet the qualitative requirements of the Small BHC Policy Statement, and instead require parent-only financial statements.

2. Federal Court Rules that a Non-Borrower Has Standing to Assert TILA Rescission Rights 

A federal district court in Georgia has recently ruled that a non-borrower has standing to assert rescission claims under the federal Truth in Lending Act ("TILA") to cancel a home mortgage loan. The January 23 ruling came in a case in which the plaintiff, the wife of the borrower, signed a security deed creating a security interest in her and her husband's principal dwelling to guarantee a promissory note on which her husband is listed as the sole borrower. The bank delivered a notice of right to cancel to the wife at the loan closing. Two days later, the wife signed the notice of right to cancel and delivered it to the bank, indicating that the she wished to cancel the transaction. The bank apparently ignored the wife's request to rescind and filed the security deed. The bank asked the court to dismiss the wife's rescission claim because TILA grants the right of rescission to the "obligor," arguing that the term obligor does not include someone who is not obligated to repay a debt. The court disagreed, holding that extending the right of rescission to a person whose residence serves as collateral for a debt furthers the purpose of TILA, which established a "national policy of protecting consumers whose residences may be jeopardized by operation of all types of security interests acquired by creditors in the home improvement industry," according to the court. 

     Nutter Notes: The court's ruling relies in part on a Federal Reserve interpretation of the term obligor as used in Regulation Z, which implements TILA. In that interpretation, the Federal Reserve said that a guarantor who "offers his home as security for a rescindable consumer credit transaction should have the right to rescind because the guarantor is in a situation very similar to that of the borrower." The Federal Reserve reasoned that the guarantor is an obligor who is liable on the promissory note, a security interest is taken in the guarantor's principal dwelling, and the consumer credit transaction is not exempt from rescission. The court found it reasonable to extend the Federal Reserve's reasoning to a spouse who is not liable on the promissory note but has given a security interest in the spouse's principal dwelling because the alternative would place such a spouse in a position of "incurring some of the burdens of consumer credit transactions–here, the pledge of her principal dwelling–without any of the protections afforded to the individuals who receive all of the benefits of those transactions." The court's ruling is not controlling for courts in Massachusetts, but a court in Massachusetts presented with a similar issue may choose to follow the Georgia court's interpretation.

3. Federal Agencies Publish Joint Guidance on Student Loans with Graduated Payments

The federal banking agencies and the CFPB have issued guidance on originating private student loans with graduated repayment terms that are structured to provide for lower initial monthly payments that gradually increase. The February 2 guidance, entitled Guidance on Private Student Loans with Graduated Repayment Terms at Loan Origination, advises financial institutions that originate private student loans with graduated repayment terms to prudently underwrite the loans and provide disclosures that clearly communicate the timing and the amount of payments to help borrowers understand the loan's terms and features. The guidance notes that graduated repayment terms are available under certain federal student loan programs, but that the credit risk associated with federal student loans differs from that of private student loans, which are not guaranteed or originated by the federal government. The guidance recognizes that, although most federally guaranteed student loans provide for a grace period before the first payment becomes due to help borrowers transition to the post-education period, borrowers may prefer the flexibility offered by private student loans with graduated repayment terms that may better align borrowers' income levels with loan repayment requirements, provide flexibility to repay the debt sooner if borrowers' incomes increase more quickly than projected, and may help long-term probability of full repayment.

     Nutter Notes: The guidance advises financial institutions to consider six principles in their policies and procedures for underwriting private student loans with graduated repayment terms. The first is ensuring orderly repayment by imposing repayment terms that require timely loan repayment and are appropriately calibrated according to reasonable industry and market standards based on the amount of debt outstanding. The guidance also advises that graduated repayment terms should avoid negative amortization or balloon payments. The second principle is avoiding payment shock. The guidance advises that graduated repayment terms should result in monthly payments that a borrower can meet in a sustained manner over the life of the loan. Third is aligning payment terms with a borrower's income. The guidance advises that graduated repayment terms should be based on reasonable assumptions about the borrower's ability to repay. Fourth is providing borrowers with clear disclosures in compliance with all applicable laws and regulations. Fifth is compliance with all applicable federal and state consumer laws and regulations and reporting standards, such as the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, federal and state prohibitions against unfair, deceptive, or abusive acts or practices and TILA. Sixth is contacting borrowers before the start of the repayment period and before each payment reset date to help establish student debt as a personal priority for borrowers and to help borrowers respond effectively to payment increases.

4. FFIEC Issues New Guidance on Risk Management for Technology Service Providers

The FFIEC has updated its examination guidance for information technology to add a new appendix that contains guidance on financial institution and technology service provider risk management processes to ensure the availability of critical financial services. The February 6 guidance, entitled Strengthening the Resilience of Outsourced Technology Services, was published as Appendix J to the FFIEC's Business Continuity Planning Booklet, which is part of the FFIEC Information Technology Examination Handbook. The new guidance advises that a bank's reliance on third-party service providers to perform or support critical operations does not relieve a bank of its responsibility to ensure that outsourced functions are conducted in a safe and sound manner. The guidance recommends that vendor oversight programs should provide the framework for bank management to identify, measure, monitor and mitigate the risks associated with technology outsourcing. In particular, a bank should ensure that its third-party service providers do not negatively affect its ability to recover information technology systems and return critical functions to normal operations in a timely manner, according to the guidance.

     Nutter Notes: The new guidance provides advice about examiners' expectations in four areas: Third-Party Management, Third-Party Capacity, Testing with Third-Party Technology Service Providers, and Cyber Resilience. Third-party management refers to a bank's responsibility to control the business continuity risks associated with its vendors and their subcontractors. The guidance advises that a bank's third-party management program should be risk-focused and provide oversight and controls commensurate with the level of risk presented by the outsourcing arrangement. Third-party capacity refers to the potential impact of a significant disruption on a vendor's ability to restore services to multiple clients. According to the guidance, examiners will expect banks and their vendors to identify and prepare for potentially significant disruptive events, including those that may have a low probability of occurring but would have a high impact on the bank. Testing with third-party technology service providers refers to validating business continuity plans with vendors and providing considerations for a robust third-party testing program. The guidance advises that a testing program should be based on a bank's established risk prioritization and evaluation of the criticality of the functions involved. Cyber resilience refers to aspects of business continuity planning unique to disruptions caused by cyber security events. The guidance recommends that banks and their vendors incorporate the potential impact of a cyber security event into their business continuity planning process and ensure appropriate resilience capabilities are in place.

5. Other Developments: Equal Access and Securitization Exposures

  • HUD Provides Guidance on Equal Access to Housing in HUD Programs

HUD issued guidance on February 6 on the Equal Access to Housing in HUD Programs Regardless of Sexual Orientation or Gender Identity Rule for program eligibility for HUD assisted and insured housing programs. The guidance clarifies, among other things, that sexual orientation and gender identity should not and cannot be part of any lending decision by a bank or other lender when originating an FHA-insured mortgage.

     Nutter Notes: HUD issued the equal access rule, which is intended to ensure that housing across HUD programs are open to all eligible individuals regardless of actual or perceived sexual orientation, gender identity, or marital status, on February 3, 2012. The rule applies to program eligibility for all HUD assisted and insured housing programs.

  • Federal Banking Agencies Release a Calculation Tool for Securitization Exposures

The federal banking agencies have issued an automated tool to assist banking organizations subject to the agencies' new regulatory capital rules to calculate risk-based capital requirements for individual securitization exposures. Specifically, banking organizations that use the rules' Simplified Supervisory Formula Approach ("SSFA") to calculate risk-based capital requirements for securitization exposures may use the tool issued on February 13 to calculate capital requirements for such exposures.

     Nutter Notes: According to the agencies, the SSFA is designed to apply relatively higher risk-based capital requirements to the more risky junior tranches of securitizations that are the first to absorb losses, and relatively lower requirements to the most senior tranches. The agencies said that the automated tool, available through their websites, requires five inputs to calculate the risk-based capital requirement for a securitization exposure per the requirements of the SSFA.

Originally published February 27, 2015

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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