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Happy Holidays: CFPB Advisory Opinions!

On November 30, 2020, the Consumer Financial Protection Bureau (“CFPB”) set forth procedures for the issuance of advisory opinions provided as interpretive rules to resolve regulatory uncertainty, effective immediately. Under this new advisory opinion schema, the CFPB concurrently released two advisory opinions: one on earned wage access products and one on private education loans.

Advisory Opinions

A request for an advisory opinion must include:

  • Identity of the person or entity seeking the opinion, or the person or entity submitted a request on behalf of a third part (e.g., outside counsel, in which case clients need not be identified);
  • Statement about the absence of investigation or litigation;
  • All material facts about an actual fact or course of action that is (a) within the CFPB’s purview and (b) that the person or entity is engaged in or is planning to engage in;
  • A description of the uncertainty or ambiguity, including (a) identification of the regulatory or statutory provision at issue; (c) a proposed interpretation of the law or regulation; and (d) an explanation of why that proposed interpretation is an appropriate resolution of the uncertainty or ambiguity;
  • Identification of information that should be treated as confidential.

Each advisory opinion will be specific to the facts provided, which the CFPB will not generally investigate independently, making it important that the request include a clear description of any material facts. Where the advisory opinion permits for a safe harbor, as provided for in the Truth in Lending Act (“TILA”), Equal Credit Opportunity Act, Electronic Fund Transfer Act, Real Estate Settlement Procedures Act, and Fair Debt Collection Practices Act, that fact will be explained in the advisory opinion. The scope and terms of an advisory opinion will be set out in the advisory opinion itself.

The CFPB will weigh multiple factors in determining whether to issue an advisory opinion on a specific topic, including issues that it has previously noted that are of significant importance or where clarification would provide significant benefit, and where the CFPB has not previously addressed a highlighted ambiguity. Conversely, the CFPB may decide an advisory opinion is not the appropriate tool for responding to an inquiry. In particular, issues where the CFPB is actively investigating or enforcing a related matter or a rulemaking is proposed or being planned.

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Use of Alternative Data in Underwriting Receives ‘OK’ from Federal Regulators

On Tuesday, December 3, 2019, U.S. federal banking regulators issued an interagency statement supporting the evaluation of alternative data when assessing consumers’ creditworthiness. Recognizing that the use of alternative data may improve the speed and accuracy of credit decisions, the agencies hope to address the difficulty facing consumers who are often unable to obtain credit from traditional credit sources. According to FinRegLab, a nonprofit research organization, an estimated 45 million to 60 million consumers lack the credit history needed to generate satisfactory credit scores. Further, millions more do not have access to affordable credit due to low scores and low incomes. The use of alternative data in the rendering of credit decisions may improve credit opportunities, as firms may choose to use these alternatives for those applicants who would otherwise be denied credit.

One such data source is a borrower’s cash flow as an alternative to the traditional credit-evaluation system. Although not an entirely novel concept, and an already well-established part of the underwriting process, some firms are now automating the use of cash flow data to determine a borrower’s ability to repay loans. These newer automation methods have been found to improve the measurement of a borrower’s income and expenses. Most importantly, the automation of a borrower’s cash flow better illustrates income patterns over time from multiple sources as opposed to evaluating a single income source; the borrower information gleaned from these alternative sources is more robust and comprehensive than the information relied upon by traditional credit-evaluation companies. As the regulators highlight in their interagency statement, “cash flow data are specific to the borrowers and generally derived from reliable sources, such as bank account records, which may help ensure the data’s accuracy.”

To the extent firms are using or contemplating using alternative data, the agencies encourage responsible use of such consumer data. As the sources of alternative data grow, both banks and non-banks will need to determine which types of alternative data might carry more risk to consumers – and do their best to minimize or justify the use of such data sources. Although cash flow data provides a relatively unbiased predictor of loan repayment ability, some lenders have garnered fair lending scrutiny for their use of certain alternative data such as borrower occupation, education and information from social media. As the agencies made clear in their statement, lenders considering the use of alternative data must take steps to ensure consumer protection risks are “understood and addressed.” Accordingly, it will remain vitally important for lenders leveraging alternative data to do so within a well-developed fair and responsible lending program that includes, among other things, periodic fair lending testing.

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Establishing a Sustainable Sales Culture

the-bank-accountWalt Moeling joined us on March 29th for the latest episode of The Bank Account with a lively discussion of bank sales tactics.  In this regulatory environment, banks need to balance growth goals with expectations for scrutiny of their sales tactics.  Regulators, investors, the press and consumers are all paying more attention to bank sales tactics.

While none of us hopes to be asked whether we “want fries with that?” as we conduct business with a bank teller, looking out for potential bank products that could benefit the bank’s customers presents an opportunity for both the bank and the customer to be better off.

You can also follow us on Twitter with Walt (kind of) at @MoelingW, Jonathan at @HightowerBanks, and me at @RobertKlingler.

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Interagency CRE Guidance Update

Interagency CRE Guidance Update

February 4, 2016

Authored by: Jerry Blanchard

In the ancient world kings and emperors regularly sought advice from the Oracle at Delphi when making important decisions. The Oracle would respond to questions, sometimes in poetry, other times in prose, in a manner that sometimes required some interpreting. For example, King Croesus of Lydia asked about the wisdom of his taking on the Persian empire. The Oracle replied that “If you attack you will destroy a great kingdom.” Proving that one should always ask for details, Croesus lost the battle and the Persians, under Cyrus the Great, conquered his kingdom.

Some say that the closest thing we have to the Oracle at Delphi today is the triumvirate of the federal banking regulators, the Federal Reserve, the FDIC and the OCC. The “Oracle” prognosticates and bankers guide their business activities accordingly. Well, perhaps. There was that prediction back in 2006 called “Concentrations in Commercial Real Estate Lending, Sound Risk Management Policies” when the regulators pointed out that CRE concentration levels at community banks had increased from 156% of total risk based capital in 1993 to 318% in the third quarter of 2006. They noted that some banks had begun to relax underwriting standards as a result of strong completion for such loans. Overall, the guidance was a “soft” sort of warning that bankers needed to make sure they understood how to manage the risk they were undertaking. A year or so later the economy was collapsing and banks beginning to fail.

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Georgia Garnishment Statute Held Unconstitutional

The recent opinion of Judge Marvin Shoob in the Strickland v. Alexander case has created a great deal of confusion among banks about their duties in responding to a summons of garnishment in Georgia.  In that opinion, Judge Shoob declared the Georgia garnishment statute to be unconstitutional on multiple grounds. Primary among the  grounds cited by Judge Shoob was the absence of any notice to the debtor of the existence of statutory exemptions which shield certain funds from garnishment or the procedures available to assert those exemptions.  It is unclear whether the decision will be appealed, modified, or cured by subsequent legislation.  Numerous esoteric questions have been raised by the legal community about the validity of the opinion, but those questions are beyond the scope of this post.

Whether Judge Shoob’s opinion is appealed, modified or cured by the Georgia General Assembly, banks currently face significant questions in its wake.  The most important of these questions is “should a bank continue to answer summons of garnishment or not.”  Many Georgia banks understandably have questions about their potential liability to both creditors and debtors by continuing to participate in the garnishment process.  While banks could choose to litigate the validity of every single summons that they have received or subsequently receive, that is hardly a practical or economical strategy for most of our banking clients.

An initial option available to any bank during this time is to contact the creditor which served the summons and ask that the summons be withdrawn. This may be effective since questions of liability are also being faced by the very creditors who are seeking to use the garnishment process.

If the creditor will not withdraw the summons, and pending a resolution of the constitutional issues by the courts or the General Assembly, the next best option is (1) to continue answering summons of garnishment after performing an appropriate review for the existence of funds covered by statutory exemptions and (2) to pay the non-exempt funds into the registry of the court.  Doing so will eliminate any risk the bank may run to the creditor which served the summons of garnishment through default or otherwise.  Moreover, since a summons is essentially a court order, the bank will have a strong argument that its actions are both justified and in good faith.  We note that even Judge Shoob found that the bank involved in the Strickland v. Alexander case could not be found liable for responding to the summons.  See Strickland Order at p. 9.

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FDIC asks “You Actually Read that Footnote?”

Revised Guidance on Third Party Payment Processors

The FDIC issued a “clarification” on July 28 to the effect that banks had gone overboard in their reaction to the FDIC’s expressed concerns about third party payment processors. The pressure the banks have been subjected to is related to “Operation Choke Point” where the Justice Department, with the assistance of the federal bank regulators, have attempted to block of the flow of funding to certain businesses such as payday lenders by attacking the ability of third party payment processors who deal with the targeted businesses to maintain deposit accounts  with commercial banks. The expressed regulatory reason for this was that banks were exposed to undue reputational risk by assisting such companies to stay in business. While the ability of some of the underlying companies to operate across state lines is currently being litigated by various parties across the US including local cities, the FTC and the New York Attorney General, the businesses for the most part conduct businesses where they are located.

Operation Choke Point has received a great deal of publicity, particularly since it seeks to cut off funding to businesses whose operations are not illegal. The rub being that regardless of what you believe the merits of payday lending to be, once an agency of the federal government decides to put the squeeze on one line of commercial business, what stops them from picking on other lines business. In other words, why do they get to pick and choose who the winners and losers might be and isn’t there some risk that politics can raise its ugly head in the process.

The FDIC and the OCC published Guidance in November of 2013 where they define Reputation Risk as:

Reputation risk is the risk arising from negative public opinion. Deposit advance products are receiving significant levels of negative news coverage and public scrutiny. This increased scrutiny includes reports of high fees and customers taking out multiple advances to cover prior advances and everyday expenses. Engaging in practices that are perceived to be unfair or detrimental to the customer can cause a bank to lose community support and business.

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S Corp Banks Swing for the Fences, Settle for a Single

On July 21, 2014, the FDIC issued a Financial Institutions Letter (FIL) on the impact of the capital conservation buffer restrictions under Basel III on S Corporation banks.  The guidance essentially states that, even though Basel III restricts an S Corporation bank’s ability to pay tax distributions if it does not maintain the full capital conservation buffer, the FDIC will generally approve requests to pay tax distributions if no significant safety and soundness are present.  The succinct guidance probably raises more questions than answers.  Among those questions are the following.

  • Would a bank that does not meet the capital conservation buffer requirements ever really be 1 or 2 rated and experiencing no adverse trends?
  • Does the FDIC believe Obamacare and the related net investment income tax will be repealed?  What about state income taxes?  The factor limiting the dividend request to 40% may ignore what is actually required to allow shareholders to fund their tax liabilities.
  • What is an “aggressive growth strategy?” Is it the same as an intentional growth strategy?
  • If your institution is a national bank, a Fed member bank, or a bank holding company with more than $500 million in consolidated assets, will the Fed and the OCC follow suit and issue similar guidance?

At the end of the analysis, the guidance is probably similar to the current capital rule stating that 1 rated institutions may have a leverage ratio as low as 3.0% and still be considered “adequately capitalized.”  That rule has little practical impact in that it is awfully hard to find an institution with a 3.0% leverage ratio that is 1 rated.  Similarly, we believe any institution that meets the guidelines set forth in the FIL would almost certainly have no need to make this request.  Indeed, the FIL itself seems to acknowledge that fact.

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OCC Issues New Third-Party Relationship Risk Management Guidance

On October 30th, the OCC issued new guidance on third-party relationships and associated risk management. The Bulletin, OCC 2013-29, rescinded and replaced prior guidance on this subject (OCC Bulletin 2001-47 and OCC Advisory Letter 2000-9) but specifically retained numerous other OCC and interagency issues on third-party relationships as listed in Appendix B to the Bulletin.

The Bulletin states that the OCC expects a bank to have risk management processes that are commensurate with the level of risk and complexity of the relationship. It details the expected management of all aspects of third-party relationships and is more specific than prior guidance about the responsibility of a bank’s board of directors for overseeing the management processes. For example, the board must ensure an effective process is in place, approve the bank’s risk-based policies governing third-party management, review and approve plans for using third parties, approve contracts with third parties, review management’s ongoing monitoring of the relationships and hold accountable those employees who manage the relationships.

While the Bulletin focuses on third-party relationships that involve “critical activities,” a bank’s judgment of what is critical could be subject to second guessing, particularly if the bank experiences difficulties with consumers or the examiner otherwise believes that the bank’s risk management process is weak.

Read More on BryanCavePayments.com.

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FDIC Sounds the Alarm (again) on Interest Rate Risks

On October 8, 2013, the FDIC published Financial Institution Letter FIL-46-2013 to re-emphasize the importance of prudent interest rate risk management.  The FDIC’s tone was sharper than in the Advisory on Interest Rate Risk Management collectively published by the financial regulators over three years ago on January 6, 2010.

The FDIC identifies the nationwide trend of institutions reporting “a significantly liability-sensitive balance sheet position” and says in the letter that it “is increasingly concerned that certain institutions may not be sufficiently prepared or positioned for sustained increases in, or volatility of, interest rates.”  That is strong language!  The FDIC is clearly signaling its intent to focus intensely on the issue in upcoming examinations.

Some of the FDIC’s specific concerns about banks with a liability-sensitive balance sheets in a rising rate environment include:

  • Decline in net interest income;
  • Run-off of deposits;
  • Rate sensitive liabilities (e.g., deposits) re-pricing faster than earning assets.
  • Severe depreciation in a bank’s holdings of long-duration bonds;
  • Liquidity shortfalls resulting from dependence on a long duration bond portfolio for liquidity;
  • Decline in regulatory and equity capital due to investment portfolio depreciation; and
  • Negative publicity from drops in GAAP equity.

One of the asset-liability management practices the FDIC expects banks to use is the consideration of risk management strategies.  The FDIC reminds banks of the full array of interest rate risk management options, including:

  • rebalancing earning asset and liability durations,
  • proactively managing non-maturity deposits,
  • increasing capital, and
  • hedging.
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Regulators’ “No Stress” Message to Smaller Banks Only Tells Part of the Story

On May 14, 2012, the Federal Reserve, FDIC and the OCC released a joint statement confirming that that banking organizations with total consolidated assets of $10 billion and under will not be required to conduct formal stress tests.  Management of many smaller banking organizations had been concerned that the stress testing required of larger banks would “trickle down” in an informal sense to smaller banks.  With this regulatory statement, that concern is alleviated, at least in the official sense.

We continue to believe that the heightened (or perhaps renewed) emphasis on risk management by the regulators will affect banks of all sizes.  It is likely that regulators, directors, and shareholders of all banks will want to confirm that management has identified the key risk factors affecting the institution and that the board has established the institution’s tolerance for accepting those risks and implemented any appropriate mitigants.

We recommend that banks of all sizes, even the smallest community banks, undertake an enterprise risk management analysis to identify the key risks facing the institution.  The board of the institution, as a subpart of its strategic planning function, should review those risks and establish the institution’s risk tolerance with respect to each category of risk (many consultants will capture this analysis in a “risk appetite statement”).  Establishing and understanding those risk tolerances will form a roadmap for setting and executing the institution’s strategic initiatives.  In implementing this analysis, some institutions may undertake some level of stress testing with respect to certain risks.

This risk management analysis is a natural adjunct to the self examination process used we recommend using in preparing for a regulatory exam (see our prior “Self Exam” post).  While the self exam process is typically more focused on the bank’s current position and past performance and this risk management analysis is more forward-looking, both processes require an introspective review.  Senior regulators have repeatedly confirmed to us (and we have seen in practice) that where banks take the initiative in implementing credible risk management programs and other pre-examination preparation, the examiners are much more likely to defer to the judgment of management and the board of the bank – with the result being a much better interaction with regulators (who, in an ideal scenario, can be a partner in the risk identification process).

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