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Regulators Propose CRA Overhaul

Regulators Propose CRA Overhaul

December 17, 2019

Authored by: Benjamin Saul and Ross Handler

On Thursday, December 12, 2019, the OCC and the FDIC issued a notice of proposed rulemaking (NPR) in an effort to modernize the regulatory framework behind the Community Reinvestment Act (CRA). Last autumn, renewed deliberations began when the OCC published an advanced notice of proposed rulemaking (ANPR) that solicited answers to 31 questions about the CRA. In response, national and state-chartered banks, trade associations, community advocates, government representatives, and others submitted nearly 1,500 individual comments. Thursday’s NPR is the culmination of the regulators’ review of these comments and proposed recommendations.

The proposed rule has received support from the OCC and the FDIC. However, the Federal Reserve has been unwilling to sign on to draft plan, leading some to speculate about prospective, competing CRA regimes. Disharmony among the regulators as to how they examine institutions under the CRA would be unprecedented, as the three prudential regulators have implemented the CRA and examined financial institutions in substantially similar manners since the law’s promulgation in the 1970s.

The proposed changes in the NPR to the CRA’s regulatory framework are significant. Key components of the revamped CRA and the NPR include:

  • Additional Assessment Areas Based on Deposit Locations: Currently, whether a bank’s activities qualify for consideration under the CRA depends on the characteristics of the activities and where those activities take place. Under the current framework, the CRA requires that banks delineate assessments areas where the bank has its main office, branches, and deposit-taking facilities, in addition to the surrounding areas where the bank originated or purchased a substantial portion of the loans in its portfolio. Under the NPR, the definition of geographic area is expanded to include areas where banks receive five percent or more of their deposits, if the banks themselves source 50 percent or more of their retail domestic deposits from outside their facility-based assessment areas. Further, the NPR permits banks to receive CRA consideration for qualifying activities outside of the assessments areas, including tribal lands and rural areas.
  • Home Mortgage Lending Restrictions: Under the current CRA framework, home mortgage loans made to high- and middle-income individuals living in low-to-moderate income (LMI) areas receive credit under CRA examination. Moving forward, such home mortgage loans would not receive CRA consideration. Mortgage-backed securities, a controversial yet CRA-eligible activity under the current CRA framework, would not receive the same credit under the NPR. Such securities would only be deemed CRA creditworthy if backed by loans to LMI borrowers and businesses.
  • A Non-exhaustive List of CRA Pre-Approved Activities: As it stands, the CRA does not provide much insight as to prequalified CRA-approved activities. The NPR proposes to create more descriptive and expansive criteria for the type of activities that qualify for CRA credit. To this end, the regulators would provide a publicly available, non-exhaustive list of activities that automatically qualify for CRA credit. Further, the NPR provides a process through which interested parties may submit additional items for consideration for inclusion on the list.
  • Increased Minimum for Small Business and Farm Loans: Under the current CRA framework, the threshold for small business loan or farm loan consideration is set at $1 million. The NPR raises the loan size to $2 million.
  • Metric-Based Benchmarks: The CRA regulations provide for different methods to evaluate a bank’s CRA performance, relative to factors such as the bank’s asset size and business strategy. Banks both small and large have commented that these different methods provide for inconsistent examination processes and results, prompting them to request more streamlined examination criteria. The new performance standards under the NPR would assess (1) the distribution and level of qualifying retail loan originations to LMI individuals, businesses, and farms within its assessment area; and (2) the total dollar value of the bank’s CRA-qualifying activities relative to its retail domestic deposits.
  • Preferential Treatment for Small Banks: Small banks, those defined as institutions with $500 million or less in assets, are provided some preferential treatment under the NPR. Small banks would have the option to be examined under the existing CRA regulatory framework or under the revised framework of the NPR.
  • New Reporting Requirements: Currently, the CRA requires banks to collect and report on a variety of data and loans. Small banks, however, are generally exempt from such requirements. Under the NPR, banks evaluated under the small bank performance standards would be required to collect, but not to report, data related to their retail domestic deposits. Additionally, banks evaluated under the NPR standards would be required to collect, maintain, and report certain data related to qualifying activities non-qualifying activities, and retail domestic deposits, and assessments areas. Banks would be required to collect and maintain all necessary data in machine-readable form.
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SEC Proposes to Modernize Derivative Regulations for Investment Funds

On November 25, 2019, the Securities and Exchange Commission voted to propose a new rule regarding the regulation of the use of derivatives by registered investment companies, including mutual funds, exchange-traded funds (ETFs) and closed-end funds, as well as business development companies. See the Press Release.

Under the new proposed rule the General Statement of Policy (Release 10666) would be withdrawn after a one-year transition period.

The new rule is in some regards similar to the Commission proposal made in 2015 with respect to the use of derivatives by funds, particularly with respect to its Value at Risk or VaR approach.

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OCC and FDIC Clarify the “Valid When Made” Debate

On November 18 and 19 of this week, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued Advanced Notices of Proposed Rulemaking (ANPRs) to clarify how state interest rate caps should apply when loans are sold across state lines.

Example of a Madden Glitch

The proposal from the OCC reaffirms the “valid when made” doctrine, on which many marketplace lenders have relied and which was central to the Second Circuit’s 2015 decision in Madden v. Midland Funding LLC, 786 F.3d 246 (2nd Cir. 2015). The Second Circuit’s decision contradicted the “valid when made” theory, whereby an obligation is considered valid under the law that applied at the time of origination. The Second Circuit held that a loan’s interest rate was no longer valid when resold to an entity in a state with a lower interest rate cap than where the loan was originally issued. In its proposed rule, the OCC “has concluded that when a bank sells, assigns, or otherwise transfers a loan, interest permissible prior to the transfer continues to be permissible following the transfer.” The OCC’s proposed rule would cut against Madden, allowing the interest rates attached to bank loans to remain valid once transferred to a bank’s fintech partner of investors.

The FDIC’s proposed rule parallels that of the OCC, but focuses on Madden’s relation to state-chartered banks. The FDIC’s proposed rule clarifies that the legal interest rate on a loan originated by a state bank remains legal even after the loan is sold to a non-bank. Speaking in a statement on Tuesday, FDIC Chairwoman Jelena McWilliams said “This proposed rule would correct the anomaly by establishing in regulations … that the permissibility of interest would be determined when a loan is made and is not impacted by subsequent assignment, sale, or transfer.” The draft regulations issued on Tuesday by the FDIC affirm that state banks are not bound by the interest rate caps of other states in which they operate. Further, the validity of the loans’ interest rates would be fixed at the time of origination.

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Public Comments Due Soon on Proposed Community Bank Leverage Ratio Rules

The public comment period for the banking agencies’ capital simplification rules for qualifying community banking organizations (i.e. the Community Bank Leverage Ratio proposal) are due on Tuesday, April 9th.

As previously discussed, the regulators have proposed a new, alternative, simplified capital regime for qualifying institutions that will deem an institution to be well-capitalized so long as it maintains a leverage ratio of at least 9% and adequately capitalized so long as it maintains a leverage ratio of at least 7.5%. While initially proposed last November, publication in the Federal Register was delayed until February of this year. As a result the comment period for the rule ends on Tuesday, April 9, 2019. Comments can be submitted online through Regulations.gov.

Through the publication of this blog post, the primary comments online appear to be the appropriate threshold for the new Community Bank Leverage Ratio. As background, EGRRCPA, the statutory basis for the reforms, obligates the regulators to apply a threshold of between 8% and 10%, and the regulators proposed 9%. Most of the submitted comments, including several from community bankers, comments from the Kansas Bankers Association and the Independent Bankers Association of Texas argue for a lower 8% ratio. Conversely, the Mercatus Center has submitted a comment supporting a 10% ratio.

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Did Congress Release Nearly All Banks from the Volcker Rule?

Yes.  

The Economic Growth, Regulatory Relief and Consumer Protection Act (EGRRCPA) provided significant regulatory relief for community banks, including broad relief from the Volcker Rule’s prohibition on proprietary trading and investments in covered funds. As previously discussed, Section 203 of EGRRCPA provided an exemption from the Volcker Rule for institutions that are less than $10 billion and whose total trading assets and liabilities are not more than 5% of total consolidated assets. The exemption provides complete relief from the Volcker Rule by exempting such depository institutions from the definition of “banking entity” for purposes of the Volcker Rule.

On December 21, 2018, the financial regulatory agencies invited public comments on a proposal to implement the EGRRCPA changes to the Volcker Rule. The proposed rule provides that an insured depository institution is exempt from the Volcker Rule if “it has, and every company that controls it has, total consolidated assets of $10 billion or less and total trading assets and trading liabilities, on a consolidated basis, that are 5% or less of total consolidated assets.” While the proposed rule is not yet effective, the Federal Reserve has previously confirmed that it would not enforce the Volcker Rule in a manner inconsistent with EGRRCPA, so the proposed rule is effectively already in place.

Based on September 30, 2018 call report data, this change to the Volcker Rule exempted approximately 97.5% of the 5,486 U.S. depository institutions. (The actual number is probably slightly less, as some of those exempted depository institutions are affiliated with larger and/or foreign banks, each of which would remain subject to the Volcker Rule.) Of note, the $10 billion asset threshold is by far the most relevant determinant of the eligible relief. Based on that call report data (which necessarily excludes any trading assets and liabilities held by a parent company), only 0.15% of depository institutions had trading assets equal to at least 5% of their total assets (and only 0.16% of the institutions had trading assets equal to 3% or more of their total assets).

While few community banks ever engaged in proprietary trading before the Volcker Rule, EGRRCPA still provides meaningful relief from the compliance obligations of the Volcker Rule, the risk of inadvertently being deemed to engage in proprietary trading, or the prohibition from investing in covered funds (or the need to ensure that vehicles that were invested in qualified for an exemption from the covered fund definition).

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A Holiday Buffet of Banking News

A Holiday Buffet of Banking News

December 28, 2018

Authored by: Robert Klingler

On December 27th, Jonathan and I returned to the studio to record the latest podcast for The Bank Account. We haven’t discussed New Year’s Resolutions, but we’ll try to return to a little more normalcy in 2019!

For those that have missing our voices, (a) please seek help… that’s not normal and (b) we were also recently guests on the ABA Banking Journal Podcast. In a lively conversation with Evan Sparks and Shaun Kern, Jonathan and I discussed our 2019 M&A Outlook for the ABA Banking Journal. For those of you who have missed that podcast (or article), I encourage you to listen/read before listening to this podcast, as we follow-up on some of these themes.

Our first substantive conversation on this podcast is a look at some of the transactions announced in the Metro Atlanta market in 2018. With State Bank’s merger with Cadence, Fidelity Bank with Ameris Bank, and National Commerce with CenterState, the Atlanta banking market, and particularly the M&A market, will look radically different in 2019 and beyond.

Following the M&A discussion, our attention turned to the newly proposed Community Bank Leverage Ratio. While it is solely a proposed rule and, if adopted in its current structure, will be an entirely optional framework for banks under $10 billion in assets, it also provides the potential for significant regulatory relief for those institutions that can take advantage of the capital (particularly risk-based) relief.

Please click to subscribe to the feed on iTunes, Android, Email or MyCast. It is also now available in the iTunes and Google Play searchable podcast directories.

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CFPB Director Kraninger – 2019 Listening Tour and Bureau Priorities

On December 11, 2018 Kathleen Kraninger, the new Director of the Bureau of Consumer Financial Protection, held a media conference. She introduced herself and answered media questions. Subsequent headlines have focused on among other things: (a) whether she would simply follow the recent course set by her predecessor Acting Director Mick Mulvaney, and (b) whether the Bureau’s recent name change would stick. Director Kraninger’s comments appeared to signal accountability, independence and curiosity. The impact on regulated institutions in 2019 and beyond remains to unfold. Here are some developments to watch in 2019.

Listening Tour 2019. Kraninger will be engaging in a listening tour to get to know the 1500 employees in the Bureau. For example, she plans to visit to San Francisco, Chicago, New York regional offices. She also indicated that she intends to connect with other regulators and constituencies including, state regulators, other related federal agencies, consumer advocates and regulated institutions.   She also indicated she will work to have a productive relationship with House Financial Services Committee and its incoming chair Maxine Waters. Earlier this month, Waters released a statement requesting Kraninger undertake specific initiatives “to put consumers first by rolling back the anti-consumer actions taken by her predecessor and allowing the Consumer Bureau to resume its work of protecting hardworking Americans from unfair, deceptive or abusive practices.”   New staffing alignments and other strategic changes may be borne form this listening tour.

Believes Regulated Industry Wants to Comply. In a nod to industry, Kraninger noted that institutions want to comply with consumer protection laws. The Bureau needs to give institutions clear rules in her view. However, she also signaled strong action for outliers, indicating that enforcement is a critical function and tool of the Bureau “fundamental to the agency’s mission.”  She also noted that “bad actors” should expect repercussions under her watch.

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Regulators Propose Community Bank Leverage Ratio Framework

On November 21, 2018, the Federal Reserve, Office of Comptroller of the Currency and the FDIC jointly published a notice of proposed rulemaking (the “NPR”) to provide an alternative capital system for qualifying banking organizations.  Specifically, the regulators have proposed a new, alternative, simplified capital regime for qualifying institutions that will deem an institution to be well-capitalized so long as it maintains a leverage ratio of at least 9% and adequately capitalized so long as it maintains a leverage ratio of at least 7.5%.

The NPR seeks to implement the community bank leverage ratio (CBLR) mandated by Section 201 of the Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”).  EGRRCPA requires the regulatory agencies to develop a CBLR of not less than 8 percent and not more than 10 percent for qualifying community banking organizations, and provides that organizations that meet such CBLR will deemed well capitalized for all purposes.  EGRRCPA further provides that a qualifying community banking organization to be a depository institution or depository institution holding company with total consolidated assets of less than $10 billion.

Summary of the NPR

The NPR establishes five criteria for an depository institution or holding company to be deemed a Qualifying Community Banking Organization:

  • Total consolidated assets of less than $10 billion;
  • Total off-balance sheet exposures of 25% or less of total consolidated assets;
  • Total trading assets and trading liabilities of 5% or less of total consolidated assets;
  • MSAs of 25% or less of CBLR tangible equity; and
  • Temporary difference DTAs of 25% or less of CBLR tangible equity.

Under the NPR, the numerator of the CBLR would be CBLR tangible equity.  CBLR tangible equity would be equal to total equity capital, determined in accordance with Call Report or Form Y-9C instructions, prior to including any minority interests, less (i) accumulated other comprehensive income (AOCI), (ii) all intangible assets (other than MSAs) including goodwill and core deposit intangibles, and (iii) DTA’s arising from net operating loss and tax credit carryforwards.

The CBLR denominator would be average total consolidated assets, calculated in accordance with Call Report or Form Y-9C instructions, less the items deducted from the CBLR numerator, except AOCI.  The NPR notes that the calculation is similar to the one used in determining the denominator of the tier 1 leverage ratio.

Under the NPR, a Qualifying Community Banking Organization may elect to use the CBLR framework at any time, so long as it has a CBLR greater than 9% at the time of the election.  Under the CBLR framework, the Qualifying Community Banking Organization will be considered well capitalized so long as it has a CBLR greater than 9%. A qualifying depository institution that previously elected to use the CBLR framework but has fallen below 9% will not be required to convert back to the regular capital system.  Instead, the following CBLR leves will serve as proxies for the PCA categories:

  • Adequately Capitalized – CBLR of 7.5% or greater;
  • Undercapitalized – CBLR of less than 7.5%; and
  • Significantly Undercapitalized – CBLR of less than 6%.

The framework for Critically Undercapitalized would remain unchanged at a ratio of tangible equity to total assets of 2% or below.  Any institution that would be deemed Significantly Undercapitalized under the CBLR framework would be required to promptly provide its appropriate regulators sufficient information to calculate the PCA tangible equity ratio.

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Basel III Treatment of DTAs and MSAs

We have heard, read and seen (and internally had) some confusion regarding the joint proposed rulemaking regarding the potential simplification of the capital rules as they relate to Mortgage Servicing Assets (MSAs) and certain Deferred Tax Assets (DTAs).

In addition to simply being complicated regulations, the regulators also have two proposed rulemakings outstanding related to these items. In August 2017, the banking regulators jointly sought public comment on proposed rules (the “Transition NPR“) that proposed to extend the treatment of MSAs and certain DTAs based on the 2017 transition period. Then, in September 2017, the banking regulators jointly sought comment on proposed rules (the “Simplification NPR“) that proposed to alter the limitations on treatment of MSAs and certain DTAs (and also addressed High Volatility Commercial Real Estate or HVCRE loans).

The Simplification NPR also addressed the interplay of the Simplification NPR and the Transition NPR. The Simplification NPR provided that the Transition NPR, if finalized, would only remain effective until such time as the Simplification NPR became effective. Accordingly, the Simplification NPR, if adopted, will ultimately control, with no transition periods for MSAs and certain DTAs following January 1, 2018.

Net Operating Loss DTAs

Importantly, neither the Transition NPR nor the Simplification NPR have any affect on the Basel III capital treatment net operating loss (NOL) DTAs. DTAs that arise from NOL and tax credit carryforwards net of any related valuation allowances and net of deferred tax liabilities must be deducted from common equity tier 1 capital. Through the end of 2017, the deduction for NOL DTAs are apportioned between common equity tier 1 capital and tier 1 capital. In 2017, 80% of the NOL DTA is deducted directly from common equity tier 1 capital, while the remaining 20% is separately deducted from additional tier 1 capital. Starting in 2018, 100% of the NOL DTA will be deducted from common equity tier 1 capital.

The end of the transition period will have the effect of lowering the common equity tier 1 capital ratio of all institutions with NOL DTAs, although the tier 1 capital and leverage ratios should remain unchanged. This impact is entirely unaffected by the adoption (or non-adoption) of the Transition NPR and/or Simplification NPR.

Similarly, other aspects of NOL DTAs are unaffected by the proposed rules. Specifically, (i) GAAP still controls the appropriateness of valuation allowances in connection with the DTA, (ii) tax laws still control the length of time over which DTAs can be carried forward, and (iii) Section 382 of the Internal Revenue Code still controls the limitation (and potential loss) of DTAs upon a change in control of the taxpayer.

Temporary Difference DTAs

Unlike Net Operating Loss DTAs, DTAs arising from temporary differences between GAAP and tax accounting, such as those associated with an allowance for loan losses and other real estate write-downs, can be included in common equity tier 1 capital, subject to certain restrictions. To the extent that such DTAs could be realized through NOL carryback if all those temporary differences were deemed to have been reversed, such DTAs are includable in their entirety in common equity tier 1 capital. Essentially, to the extent the temporary difference DTAs could be realized by carrying back against taxes already paid, then such DTAs are fully includable in capital. Carryback rules vary by jurisdiction; while federal law generally permits a bank to carry back NOLs two years, many states do not allow carrybacks.

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The CFPB Proposes Ambitious Payday Lending Regulations

On June 2, 2016, the CFPB released its long-awaited proposed regulations for payday loans, vehicle title and certain high-cost installment loans.  Comments on the proposed rules must be received on or before September 14, 2016.

While most payday lenders would need to make significant changes to their products and practices under the proposed rules, the final rules could well be delayed though legal challenges in court.  The scope of the proposal is extraordinary, even requiring a new credit reporting system, that would need to be built, to facilitate the ability-to-repay requirements of the proposal.  The CFPB is relying on its authority under the Dodd-Frank UDAAP provisions to issue the rules, which is admittedly very broad, but even that might not be enough to support this ambitious proposal.

Nevertheless, because we cannot predict how courts would ultimately rule on the CFPB’s authority, it’s important to understand the proposed rules, prepare comments, and consider what business model changes might be needed.   This article therefore summarizes the key provisions of the proposal.

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