United States: Nutter Bank Report, August 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. DOB Publishes Final Rule and Guidance on Flood Requirements
2. Federal Court Ruling Creates Uncertainty in Secondary Market for Loans
3. CFPB Provides Guidance on PMI Cancellation and Termination
4. OCC Issues Guidance to Federally Chartered Banks on Tax Refund-Related Products
5. Other Developments: Federal Preemption and Whistleblower Protections

1. DOB Publishes Final Rule and Guidance on Flood Requirements

The Massachusetts Division of Banks has released final amendments to its flood insurance regulations that implement Chapter 177 of the Acts of 2014, An Act Further Regulating Flood Insurance, which became effective on November 20, 2014. The final amendments, which include changes to the text of the model Massachusetts Notice About Flood Insurance Coverage, were published during the week of August 16 and become effective on September 11. Chapter 177 and the amended regulations define the limitation on required flood insurance coverage as the principal mortgage balance on a first or junior mortgage, "at the beginning of the year for which the policy shall be in effect." In answers to frequently asked questions ("FAQs") that accompanied the release of the final amendments to the regulations, the Division clarified that the determination of the principal mortgage balance for the purpose of establishing the maximum required flood insurance coverage amount must be based on the principal mortgage balance as of the start date of the policy term for which the flood insurance policy will be in effect, and not the start of the calendar year in which the policy is renewed. For example, if a renewing flood insurance policy year were to cover the period from June 1, 2015 until May 31, 2016, a creditor would be prohibited from requiring the homeowner to purchase or pay for flood insurance on the property in a coverage amount exceeding the outstanding principal mortgage balance as of June 1, 2015.

Nutter Notes: The Division's FAQs also clarify that compliance with Chapter 177 and the Division's amended regulations will be required when a creditor makes, increases, extends or renews a junior mortgage, home equity line of credit or home equity loan secured by a mortgage on residential property located in a special flood hazard area in which flood insurance is available under the National Flood Insurance Act. The FAQs advise the creditor to instruct the borrower to contact their insurance agent to discuss amendments to the existing flood insurance policy. Under the amended regulations, as principal on the mortgage is repaid, the owner of the property may request a reduction of coverage upon renewal of the flood insurance policy to an amount not exceeding the outstanding principal mortgage balance at the beginning of the policy year. The FAQs clarify that, absent a contractual provision to reduce the coverage to an amount not exceeding the then outstanding principal mortgage balance, if the owner of the property does not request a reduction of coverage, the flood insurance policy may be renewed for the same coverage that was in effect for the expiring policy period. The FAQs note, however, that Chapter 177 prohibits the creditor from requiring the owner to purchase or pay for flood insurance coverage for a renewal period that exceeds the outstanding principal mortgage balance or the full value of a home equity line of credit. The FAQs also advise that a creditor is not permitted to change the text of the model Massachusetts Notice About Flood Insurance Coverage provided under the Division's amended regulations. The notice provided to a borrower must strictly conform to the form of notice established under the amended regulations.

2. Federal Court Ruling Creates Uncertainty in Secondary Market for Loans

The U.S. Second Circuit Court of Appeals has ruled that a non-bank debt collector that purchased charged-off credit card loans from a national bank could not rely on the bank's federal preemption of state usury law when enforcing the interest rate terms under the loan agreements. The appeals court ruling in May reversed a federal district court ruling that upheld the availability of federal preemption for the debt collector, and the appeals court on August 12 denied the debt collector's request for a rehearing en banc. As a result of the recent denial of the debt collector's request for a rehearing, the appeals court's ruling will remain in effect in the Second Circuit (comprised of six districts within the states of New York, Connecticut and Vermont) unless it is overturned by the U.S. Supreme Court or the appeals court limits its own ruling in a decision in another case. The appeals court's ruling is inconsistent with decisions by other U.S. circuit courts of appeal, which could result in U.S. Supreme Court review of the apparent conflict among the circuits. In this case, the appeals court held that federal preemption was not available to the non-bank debt collector in collecting on a credit card loan pursuant to the terms of the loan agreement because the debt collector was acting for itself rather than as an agent of the national bank. The court's reasoning appears to ignore a long-standing principle of contractual interpretation, commonly known as the Valid When Made Doctrine, which instructs that "[t]he non-usurious character of a note should not change when the note changes hands," as stated in a 1981 decision by the U.S. Fifth Circuit Court of Appeals.

Nutter Notes: The Second Circuit decision will likely have a significant impact on the loan sale market, creating uncertainty about whether bank loans are enforceable under their original terms in the hands of a non-bank purchaser. It is relatively well-established case law that a loan assignee steps into the shoes of the originating lender and is entitled to enforce the terms of a loan in effect at the time the loan was made. As a result of the decision, non-bank purchasers of bank loans will be uncertain that they can enforce the terms of loans in which the originating bank does not retain some continuing interest, particularly some form of ownership interest on which preemption of state usury law can be assured. In addition, banks engaged in the practice of originating loans for the purpose of resale on the secondary market may need to reevaluate their strategies if the Second Circuit decision chills the resale market for bank loans. Non-bank purchasers may also demand that banks renegotiate certain terms of existing loan sale agreements to address the uncertainty created by the decision. The decision does not immediately affect loans made to residents of states other than those comprising the Second Circuit (Massachusetts is part of the First Circuit, and courts here are therefore not bound by the Second Circuit decision). However, the uncertainty created by the ruling will likely affect the secondary market in other jurisdictions. Until the Second Circuit decision is limited or overturned by further court action, the liquidity and resale value of a bank's loan portfolio may be diminished.

3. CFPB Provides Guidance on PMI Cancellation and Termination

The CFPB has issued a new compliance bulletin to provide guidance to residential mortgage loan servicers, including banks, about compliance with the private mortgage insurance ("PMI") cancellation and termination provisions of the Homeowners Protection Act of 1998 (the "HPA"). CFPB Bulletin 2015-03 released on August 4 explains the HPA requirements and describes examples from the CFPB's supervisory experience of PMI cancellation and termination procedures that violate the HPA or create a substantial risk of noncompliance. Under the HPA, a borrower may request cancellation of PMI coverage for a residential mortgage loan and, if the borrower meets certain requirements, PMI must be cancelled on the date on which the principal balance of the mortgage reaches the 80% loan-to-value ("LTV") threshold based on, at the option of the borrower, either the original value of the property regardless of the outstanding balance or the original value of the property based on actual payments. If the borrower does not meet those requirements when the principal balance of the mortgage reaches the 80% LTV threshold, the HPA provides that PMI must be canceled at a later date once the borrower meets the specified requirements. The HPA also provides that, if a borrower is current on a residential mortgage loan, PMI must automatically be terminated on the date on which the principal balance is first scheduled to reach 78% of the original value of the property securing the loan irrespective of the outstanding balance of the loan on that date. The bulletin advises servicers to be mindful that the automatic termination provision of the HPA does not permit a mortgage holder to require evidence of the property's current value, and a servicer is not required to determine the actual principal balance based on actual payments.

Nutter Notes: In addition to reaching the 80% LTV threshold, to be eligible for optional cancellation of PMI under the HPA, a borrower must have a good payment history, must be current on the loan, must satisfy any requirement of the mortgage holder for certification that the borrower's equity in the property is not subject to a subordinate lien, and must satisfy any requirement of the mortgage holder for evidence that the value of the property has not declined below the original value. In determining whether a borrower meets these requirements for borrower-requested cancellation of PMI, a servicer may require a property appraisal as evidence that the value of the property has not declined below the original value, and a servicer may require the borrower to pay for the appraisal. While the appraisal may be used to establish that the current value of the property has not declined below the original value, the bulletin cautions servicers that, for timing purposes, the cancellation date is calculated based on the original value and not the current value of the mortgaged property. An appraisal may be used only to determine whether the property's value has declined below the original value. If the property's value has not declined below the original value, the servicer must assess the timing of the borrower's PMI cancellation by calculating when the principal balance of the mortgage is scheduled to reach or has reached 80% of the original value of the property, based either on the appropriate amortization schedule or actual payments.

4. OCC Issues Guidance to Federally Chartered Banks on Tax Refund-Related Products

The OCC has issued new guidance to outline safety and soundness measures that national banks and federal savings associations should follow if they offer tax refund-related products. The new guidance, published as OCC Bulletin 2015-36 on August 4, replaces OCC Bulletin 2010-7 (February 18, 2010), which transmitted the "OCC Policy Statement on Tax Refund-Related Products," but does not supersede or amend any other OCC publication. The safety and soundness measures banks should follow if they offer tax refund-related products recommended by the OCC's guidance include ensuring that the bank's board of directors maintains sound risk management policies, procedures, and practices to oversee all tax refund-related products, implements effective internal controls and review standards for advertising and solicitations, and maintains adequate capital and liquidity levels. The OCC's guidance also recommends that banks provide appropriate disclosures that explain material aspects of the products to consumers and implement appropriate due diligence and adequate procedures to ensure that tax refund-related products provided by third parties comply with applicable guidance. The guidance cautions banks to ensure that Bank Secrecy Act compliance risk management systems should cover tax refund-related products. The OCC recommends that banks provide training programs, including certification processes that address regulatory requirements, internal policies and procedures and responsibilities for maintaining an effective compliance program.

Nutter Notes: The OCC's guidance clarifies that the term "tax refund-related products" encompasses credit products, deposit products and settlement services to transmit tax-related funds. According to the OCC, tax refund-related products present particular safety and soundness and compliance risks because of their unique repayment and cost structures and banks' reliance on third-party tax return preparers who interact with consumers. The OCC's guidance defines three main types of tax refund-related products: credit products, such as refund anticipation loans; deposit products and prepaid access cards; and settlement services, which involve the transmittal of a tax refund by the applicable tax authority to a bank-controlled account. The OCC's guidance advises that banks' risk management policies, procedures and practices for tax refund-related products should be commensurate with the complexity and nature of the products, consistent with safe and sound banking practices and relevant reporting requirements, and address all applicable consumer protection and reputation risk considerations, as well as legal compliance obligations, associated with the products.

5. Other Developments: Federal Preemption and Whistleblower Protections

  • Federal Court Strikes Down New York City Banking Ordinance

In an August 7 ruling, a federal district court held that New York City's Responsible Banking Act was preempted by federal and state law and therefore void in its entirety. The city ordinance required banks that are eligible to hold New York City's municipal deposits to disclose information about their lending decisions at a level more invasive than the Community Reinvestment Act.

Nutter Notes: Under the ordinance, the city would publish the results of banks' disclosures of their lending activity, which would then factor into whether the banks would remain eligible to hold city deposits. The court ruled that the intent of the city ordinance was to regulate depository institutions, noting that city council members believed that the mandated disclosures would change the practices of the banks subject to the ordinance. As a result, the court held that the ordinance is preempted by laws that grant bank regulatory powers to federal and state agencies.

  • SEC Interpretive Rule Clarifies Employment Retaliation Protections for Whistleblowers

The SEC issued an interpretive rule on August 4 to clarify that, for purposes of the employment retaliation protections provided by Section 21F of the Securities Exchange Act of 1934 ("Exchange Act"), an individual's status as a whistleblower does not depend on whether the individual has followed certain reporting procedures specified in the SEC's Exchange Act rules.

Nutter Notes: The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 amended the Exchange Act to establish incentives and protections for individuals to report possible violations of the federal securities laws. One SEC rule implementing the Exchange Act amendments determines whether an individual qualifies under whistleblower award and confidentiality provisions, and a separate rule controls the reporting methods that will qualify an individual for retaliation protections as a whistleblower.

Originally published August 31, 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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