CFPB Indicates Intent to Regulate Service Providers to Financial Institutions

Earlier this year, the Consumer Financial Protection Bureau (“CFPB”) published a Bulletin signaling its intent to regulate and exercise enforcement authority over service providers to financial institutions. Pursuant to Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act and its implementing regulation, Regulation P, the CFPB has authority over certain large banks, credit unions and other consumer financial services companies. The Bulletin notes that the CFPB’s goal is to ensure compliance with “[f]ederal consumer financial law,” which includes the Gramm-Leach-Bliley Act and its implementing regulations, the Privacy Rule and the Safeguards Rule.

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New CRE Loan Workout Rules Provide Relief and Pitfalls

On October 30, 2009, all of the federal regulatory agencies issued a new policy statement on commercial real estate (“CRE”) loan workouts. The policy statement does offer opportunities for financial institutions (“FI”) to reduce the amount of charge-offs on CRE loans, return restructured loans to a performing status faster and generally work with customers on mutually beneficial workouts. Nonetheless, the policy statement does present challenges before FIs can achieve such results, especially for those management teams seeking to “kick the can down the road” to await better days. Notably, however, the policy statement does not change regulatory reporting guidelines or the accounting requirements under generally accepted accounting principles (“GAAP”).

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The Evolving Landscape for Financial Institutions

This is the fourth client alert that I have written this year dedicated solely to the evolving landscape that banks are confronting. Nowhere is the ground shifting more than in financial institutions’ interaction with regulatory authorities. Several of these issues are discussed below. 

Commercial Real Estate
The regulators’ position with regard to commercial real estate lending (“CRE”) has changed dramatically in the past three years. In 2006, the bank regulators issued guidance regarding CRE lending. Specifically, the guidance provided that, in the event a bank’s non-owner-occupied CRE loans approached 300 percent of capital or more, then the financial institution had to ratchet up its underwriting, monitoring and other facets of risk mitigation. Nowhere in the guidelines was there a cap on CRE lending. Even still, the reaction of the banking industry to the guidelines was near pandemonium. Bankers were concerned that the guidelines would be a de facto cap. The bank regulators responded to clarify that the guidelines were merely benchmarks and were not limitations.

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Impact of Obama's Financial Regulatory Reform on Banks and Holding Companies

On Wednesday, June 17, 2009, President Obama set forth his administration’s blueprint for overhauling the financial system outlined in an 88-page white paper that touched everything from traditional banking regulation, such as capital ratios and liquidity, to nontraditional financial service firms, whose size alone impacts the overall economy. Traditional banking organizations will likely feel the greatest impact from the call for stronger capital and prudential standards for all financial firms and from the creation of the new office of the National Bank Supervisor, which will assume the duties of the Office of the Comptroller of the Currency and the ongoing duties of the Office of Thrift Supervision (“OTS”). The federal savings bank charter overseen by the OTS will be phased out under the proposal. The plan also proposes a new Consumer Financial Protection Agency with broad federal powers over consumer financial products and services, regardless of whether such products and services are offered through a bank. This article highlights aspects of the Financial Regulatory Reform white paper (the “white paper”) that are most applicable to traditional banks and their holding companies.

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Over-The-Counter Derivatives Regulatory Proposal Announced

The Treasury Department announced a plan to regulate over-the-counter derivatives today.  The plan calls for aggregating data in a clearinghouse, margin and capital requirements, as well as reporting and record keeping requirements, according to the Treasury Department press release.  Treasury Secretary Geithner additionally detailed the proposal, which will require congressional action, in a letter to Senate Majority Leader Harry Reid today.  
 
Click here for today's press release, and click here for Secretary Geithner's letter.

The Saga Continues -- More on The State of Banking 2009

On February 25, 2009, the UST announced the terms and conditions of the Capital Assistance Program (“CAP”). Under CAP, the federal banking regulators will conduct “stress tests” to evaluate the capital needs of banks with in excess of $100 billion in assets. These “stress tests” have been much discussed with regard to what approach UST will take if it determines that such institutions need additional capital and such capital is not forthcoming from private sources.

What has not been discussed is how the bank regulators will evaluate banks under $100 billion in assets on a going-forward basis. Stress testing of loan portfolios and liquidity sources that yield positive results will assist those facing regulatory pressures. For others, however, such testing will exacerbate regulatory presumptions of a financial institution’s problems. Unfortunately, there is becoming less choice here.

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The "Missing Link" in Financial Stability Plan: President Obama Announces Homeowner Affordability and Stability Plan

Yesterday President Barack Obama announced his long-awaited foreclosure prevention and loan modification plan, referred to by many as the “missing link” in the Financial Stability Plan unveiled by Treasury Secretary Geithner last week. To address the problems of homeowners unable to refinance their loans or struggling to meet their mortgage obligations, the Homeowner Affordability and Stability Plan (“HASP”) seeks to help by providing the following: (1) access for borrowers to low-cost refinancing on conforming loans owned or guaranteed by Fannie Mae and Freddie Mac, (2) a $75 billion homeowner stability initiative to prevent foreclosures and (3) additional commitments allowing the Treasury to purchase up to an additional $200 billion of preferred stock of Fannie Mae and Freddie Mac and allowing Fannie Mae and Freddie Mac to increase the size of their retained mortgage portfolios by $50 billion. The $75 billion homeowner stability initiative includes financial incentives to borrowers and servicers in connection with loan modifications, a partial guarantee of losses resulting from declines in the home price index following loan modifications, the development of “national standards” for loan modifications (to be announced by March 4, 2009) and support for the modification of bankruptcy laws to allow bankruptcy judges to modify residential mortgage loans. The White House’s description of HASP was short on details and raises a number of interesting questions about how HASP could affect mortgage loans held by private label securitization trusts.

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The State of Banking 2009

We have issued literally dozens of client alerts since the crisis in banking became acute toward the middle and fall of 2008. Despite the torrent of information that we have provided to our clients, there are a number of issues that have flown underneath the radar or which need further defining.  I have attempted to tackle certain of these issues below.

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Regulatory Consequences for Banks Participating in the TARP CPP

On January 3, 2009, John F. Bovenzi, deputy to the chairman of the FDIC, in an appearance before the Committee on Financial Services of the U.S. House of Representatives, stated that the FDIC will measure and assess in examination ratings how banks that have received government assistance have utilized these funds to meet the purposes of the U.S. Department of the Treasury’s Capital Purchase Program (CPP), implemented as part of the Emergency Economic Stabilization Act’s (EESA) Troubled Asset Relief Program (TARP).

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Treasury Department Issues Lobbying Rules and Updates Capital Purchase Program Report

The Treasury Department today issued new rules designed to limit lobbyist influence on the Emergency Economic Stabilization Act's recovery programs.  The new rules include: 1) limiting Treasury Department contacts with lobbyists regarding applying for, and disbursing recovery programs funds, 2) requiring the Office of Financial Stability to certify to Congress that each Treasury Department investment "is based only on investment criteria," 3) publishing a detailed description of banking regulators' investment review process, and 4) requiring a primary banking regulator to determine a bank's eligibility for Treasury Department capital investment.  Click here for today's press release.

Additionally, the Treasury Department released details of another round of Capital Purchase Program transactions totaling $386 billion for 23 banks.  The Capital Purchase Program allows qualified financial institutions to receive a capital injection from the Treasury Department in return for preferred stock and warrants.  Today's report discloses investments ranging from approximately $1 million to $111 million.  The Treasury Department's aggregate investments under the Capital Purchase Program now total $194.1 billion.  Click here for the Treasury Department's press release, and click here for all Capital Purchase Program transactions to date.

Executive Compensation and Corporate Governance Interim Final Rule for Issued

The Treasury Department published an Interim Final Rule providing further guidance on the executive compensation and corporate governance provisions applicable to financial institutions from which the Treasury is purchasing troubled assets through direct purchases.  The interim final rule provides one technical amendment and two clarifications to the Interim Final Rule issued in October and provides reporting and recordkeeping requirements related to the executive compensation and corporate governance provisions.  The Interim Final Rule now includes requirements of annual certifications from the CEO that the financial institution and its compensation committee have complied with the new and existing TARP executive compensation rules and that the compensation committee has reviewed senior executives' incentive compensation packages with the senior risk officers to ensure they do not encourage unnecessary risk taking.  

Click here for the Interim Final Rule, click here for the Treasury's notice to participating financial institutions, and click here for frequently asked questions.

Loan Now or Else: Congress Proposes to "Fix" TARP

On January 9, 2009, Congressman Barney Frank introduced legislation entitled the “TARP Reform and Accountability Act of 2009” (the “Accountability Act”). The use of the word “accountability” speaks volumes regarding Congressman Frank’s view that financial institutions should now answer for the enduring economic problems. Washington’s favorite sport, searching for villains, has begun.

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Private Equity Investments in Financial Institutions

Over the last 15 years, the relatively high valuations in banking, coupled with leverage limitations and other regulatory restrictions, discouraged private equity investments in financial institutions. The credit crunch and subsequent recession have marked a new era. The resulting decline in bank stock prices has sparked new interest in financials by private equity funds. The challenge is to make such investments while avoiding regulatory land mines.

Most private equity firms’ investments across industries have been made to acquire control of the target. In banking, however, most transactions involve the acquisition of a minority interest to avoid the ramifications of “control” of a financial institution. Set forth below are the regulatory issues that must be addressed if a company is in “control” of a financial institution, the definitions of control, and then some circumstances that have allowed ownership and influence without a finding of control for regulatory purposes.

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Treasury Department Releases Targeted Investment Program Guidelines and Asset Guarantee Program Report

Today the Treasury Department released guidelines and a description for the Targeted Investment Program used for the Treasury Department's investment in Citigroup on November 23, 2008.  Although there is no deadline for participation in the Targeted Investment Program, and inclusion is on a case-by-case basis for Financial Institutions as defined in the Emergency Economic Stabilization Act, the guidelines do provide eligibility considerations for the Treasury Department. Those considerations include, but are not limited to, the extent to which destabilization of such a Financial Institution could threaten the viability of creditors and counterparties exposed to the Financial Institution. Also, like the Treasury Department's Capital Purchase Program, the Targeted Investment Program requires that the Treasury Department receive warrants for shares, or another form of consideration, in return for the investment. Click here for the Targeted Investment Program's details and click here for Hunton & Williams' prior posting on the Treasury Department's investment in Citigroup.
 
The Treasury Department also released a report today outlining to Congress how it is considering using of the Asset Guarantee Program, created under the Emergency Economic Stabilization Act, to fulfill the guarantee provisions of the Treasury Department's November, 23, 2008 agreement with Citigroup.  Under the Asset Guarantee Program the Treasury Department assumes a loss position on certain insured assets held by "systemically significant financial institutions", according to the Treasury Department.  However, the report notes to Congress the Asset Guarantee Program would be used with "extreme discretion," on a case-by-case basis, and it is "not anticipated that the program will be made widely available." Click here for the Treasury Department's press release, and click here for the full report.