Washington regulatory update

"I remember when I first came to Washington. For the first six months you wonder how the hell you ever got here. For the next six months you wonder how the hell the rest of them ever got here." President Harry S. Truman

"The future ain't what it used to be." Yogi Berra    

FDIC Adopts Final Rules on Assessments and Large Bank Pricing Methodology

The FDIC on February 7th adopted a final rule pertaining to the deposit insurance assessment base. Assessment rate adjustments, deposit insurance assessment rates, dividends, and large bank pricing methodology are part of the final rule-making Many of the changes were made as a result of provisions of the Dodd- Frank Act (Dodd-Frank) that are intended to shift more of the funding for the FDIC to larger banks. There will be no FDIC dividends for the foreseeable future, but assessment rates will adjust downward as the FDIC's deposit reserve ratio increases. For large-bank pricing, the FDIC will use a scorecard combining CAMELS ratings with financial performance and loss severity scores. Except for the future assessment rate schedules, all changes go into effect April 1, 2011.

Some highlights of the final rule follow.

Deposit Insurance Assessment Base

As required by Dodd-Frank, the base for deposit insurance assessment purposes is defined as average consolidated total assets during the assessment period less average tangible equity capital during the assessment period. Average consolidated total assets are defined in the quarterly Call Reports, using a daily averaging method. Tangible equity capital is defined as Tier 1 capital and will be calculated monthly. The assessment base for a custodial bank excludes all 0 percent Basel risk -weighted assets and 50 percent of 20 percent risk-weighted assets not to exceed the total transaction account deposits linked to custody and safekeeping and fiduciary assets. Adjustments to the assessment base are also made for bankers' banks.

Assessment Rate Adjustments

Unsecured Debt. All Insured Depository Institutions (IDIs), except new institutions and insured branches of foreign banks, are "potentially subject" to a reduction in assessment rates for unsecured debt. The adjustment is capped at the lesser of 5 basis points or 50 percent of the IDI’s initial base assessment rate.

Brokered Deposits. All large IDIs and highly complex IDIs that are less than well capitalized or have a CAMELS composite rating of 3, 4, or 5, are potentially subject to an increase in assessment rates for brokered deposits if their ratio of brokered deposits to domestic deposits is greater than 10 percent. The maximum brokered deposit adjustment is 10 basis points.

IDI Debt Adjustment. All IDIs are potentially subject to an increase in assessment rates for unsecured debt held that is issued by another IDI. The depository institution debt adjustment equals 50 basis points of each dollar of long-term, unsecured debt held as an asset by an IDI when that debt was issued by another IDI, to the extent that all such debt exceeds 3 percent of the IDI's Tier 1 capital.

Assessment Rates and Dividends. The FDIC adopted a new rate schedule effective April 1, 2011 and suspended dividends indefinitely; however, in lieu of dividends, and pursuant to its authority to set risk-based assessments, the FDIC adopted progressively lower assessment rate schedules that will take effect when the reserve ratio exceeds 1.15 percent, 2 percent, and 2.5 percent. Risk categories and the use of long-term debt issuer ratings for large IDIs and large IDIs that are structurally and operationally complex or that pose unique challenges and risk in the case of failure (highly complex IDIs) have been eliminated. A large IDI will continue to be defined as it currently is (generally, an IDI with at least $10 billion in total assets). In general, a highly complex IDI will be an IDI (other than a credit card bank) with more than $50 billion in total assets that is controlled by a parent or intermediate parent company with more than $500 billion in total assets or a processing bank or trust company with at least $10 billion in total assets.

Scorecards. The FDIC will combine CAMELS ratings and certain financial measures into two scorecards -- one for most large IDIs and another for the remaining large, highly complex IDIs. Each scorecard assesses risk measures to produce two scores -- a performance score and a loss severity score -- that will be combined and converted to an initial assessment rate. The performance score measures an IDI’s financial performance and its ability to withstand stress. The loss severity score quantifies the relative magnitude of potential losses to the FDIC in the event of an IDI’s failure. Once the performance and loss severity scores are calculated, these scores will be converted to a total score. The FDIC will have the ability to adjust a large IDI’s (or highly complex IDI’s) total score by a maximum of 15 points, up or down, based upon significant risk factors that are not captured in the scorecard. The FDIC will use a process similar to the current large bank adjustment to determine the amount of any adjustments. The FDIC will seek comment on updated guidelines on the large bank adjustment process. The FDIC will not adjust assessment rates until the updated guidelines are approved by the FDIC Board of Directors.
 

Obama Administration Recommends "Path Forward" on Housing Finance/GSE Reform

The Obama Administration delivered a report to Congress that provides a "path forward " for reforming America’s housing finance market. The Plan includes the following key elements:

Wind Down Fannie Mae and Freddie Mac and Help Bring Private Capital Back to the Market. Because private capital has not returned to the housing market, it has been left to the Government to guarantee 9 out of 10 mortgages to stabilize the housing market. However, the Administration believes that, under normal market conditions, the private sector, subject to stronger oversight and standards for consumer and investor protection, should be the primary source of mortgage credit and bear the burden for losses. The report recommends using a combination of policy levers to wind down Fannie Mae and Freddie Mac, shrink the government’s footprint in housing finance, and help bring private capital back to the mortgage market.

Phasing in Increased Pricing at Fannie Mae and Freddie Mac to Make Room for Private Capital, Level the Playing Field. The Administration recommends ending "unfair capital" advantages that Fannie Mae and Freddie Mac previously enjoyed by requiring them to price their guarantees as though they were held to the same capital standards as private banks or financial institutions. This is intended to level the playing field for the private sector. Although the pace of these increases will depend significantly on market conditions, the Administration recommends bringing Fannie Mae and Freddie Mac to a level even with the private market over the next several years.

Reducing Conforming Loan Limits. To further reduce Fannie Mae and Freddie Mac’s presence in the market, the Administration recommends that Congress allow the temporary increase in those firms’ conforming loan limits (the maximum size of a loan those firms can guarantee) to reset as scheduled on October 1, 2011 to the levels set in the Housing and Economic Recovery Act (HERA).

Phasing in 10 Percent Down Payment Requirement: To help further protect taxpayers, the Administration recommends requiring larger down payments from borrowers. Going forward, it supports gradually increasing required down payments so that any mortgage that Fannie Mae and Freddie Mac guarantee eventually has at least a 10 percent down payment.

Winding Down Fannie Mae and Freddie Mac’s Investment Portfolios: The Administration’s plan calls for continuing to wind down Fannie Mae and Freddie Mac’s investment portfolio at an annual rate of no less than 10 percent per year.

Returning Federal Housing Administration (FHA) to its Traditional Role. As Fannie Mae and Freddie Mac’s presence in the market shrinks, the Administration will encourage program changes at FHA to ensure that the private sector – not FHA – picks up this new market share. The Administration recommends that Congress allow the present increase in FHA conforming loan limits to expire as scheduled on October 1, 2011, after which it will explore further reductions. The Administration will also put in place a 25 basis point increase in the price of FHA’s annual mortgage insurance premium, as detailed in the President’s 2012 Budget.
 

FDIC Issues Joint Proposal Restricting Incentive Compensation

The FDIC issued a joint notice of proposed rulemaking that would prohibit bank incentive-based compensation arrangements that encourage inappropriate risk taking, are deemed excessive, or may lead to material losses. The proposal -- mandated by the Dodd-Frank Act’s Section 956 -- does not apply to banks with total assets of less than $1 billion, but includes heightened standards for institutions with $50 billion or more in total consolidated assets. The proposal requires at least 50 percent of incentive-based payments for designated executives at the larger institutions to be deferred for a minimum of three years. Boards of directors at such institutions must identify individual employees who have the ability to expose the institution to substantial risk, and also must determine that the incentive compensation for those employees appropriately balances risk and rewards according to enumerated standards. There will be a 45-day comment period on the proposal following its publication in the Federal Register. The five federal members of the Federal Financial Institutions Examination Council, the Securities Exchange Commission and the Federal Housing Finance Agency each must approve issuing the NPR before it is published.

Chairman Bair said "This proposed rule will help address a key safety and soundness issue which contributed to the recent financial crisis – that poorly designed compensation structures can misalign incentives and induce excessive risk-taking within financial organizations. Importantly, we believe the rule will accomplish its objectives in a way that appropriately reflects the size and complexity of individual institutions. Importantly, this inter-agency proposal will apply across all types of US financial institutions, limiting the opportunity for regulatory arbitrage. Similarly, it will better align US compensation standards with those which have been adopted internationally under the framework approved by the Financial Stability Board in 2009. "
 

Federal Reserve Proposes Some Key Definitions Related to Designation of Systemically Important Nonbank Financial Companies

The Federal Reserve Board has requested comment on a proposed rule that implements two provisions of Dodd-Frank related to the designation by the Financial Stability Oversight Council of systemically important nonbank financial companies for consolidated supervision by the Fed. First, the proposed rule establishes the requirements for determining if a company is "predominantly engaged in financial activities." Under the Dodd-Frank Act, a company generally can be designated by the Council only if 85 percent or more of the company's revenues or assets are related to activities that have been determined to be financial in nature under the Bank Holding Company Act. Second, the proposed rule defines the terms "significant nonbank financial company" and "significant bank holding company." Among the factors the Council must consider in determining whether to designate a nonbank financial company for supervision by the Fed is the extent and nature of the company's transactions and relationships with other "significant" nonbank financial companies and "significant" bank holding companies. Under the proposal, a firm would be considered "significant" if it has $50 billion or more in total consolidated assets or had been designated by the Council as systemically important.Comments on the proposal must be submitted by March 30, 2011. Publication in the Federal Register is expected shortly.
 

Fed Will Not Finalize Regulation Z Rulemakings Before Transfer to CFPB

On February 1, 2011, the Federal Reserve Board announced that it does not expect to finalize three pending rulemakings under Regulation Z, which implements the Truth in Lending Act (TILA), prior to the transfer of authority for such rulemakings to the Consumer Financial Protection Bureau (CFPB).

The proposed rules were published as part of the Fed's review of its mortgage lending regulations under TILA. The first phase of the review consisted of two proposals issued in August 2009, which would have reformed the consumer disclosures under TILA for closed-end mortgage loans and home equity lines of credit. The third proposal was issued in September 2010. Among other things, the September 2010 proposal included changes to the disclosures consumers receive to explain their right to rescind certain loans and would have clarified the responsibilities of the creditor if a consumer exercises this rescission right. The September 2010 proposal also included changes to the disclosures for reverse mortgages, proposed new disclosures for loan modifications, restrictions on certain advertising practices and sales practices for reverse mortgages, and changes to the disclosure obligations of loan servicers.

General rulemaking authority for TILA is scheduled to transfer to the CFPB in July 2011. The Dodd-Frank Act requires that the CFPB issue a proposal within 18 months after the designated transfer date to combine, in a single form, the mortgage disclosures required by TILA and the disclosures required by the Real Estate Settlement Procedures Act (RESPA). In light of that mandate, and the upcoming transfer date, the Fed evaluated whether there would be public benefit in proceeding with the rulemakings initiated with the Fed's August 2009 and September 2010 proposals at this time. Because the Fed's 2009 and 2010 TILA proposals would substantially revise the disclosures for mortgage transactions, any new disclosures adopted by the Fed would be subject to the CFPB's further revision in carrying out its mandate to combine the TILA and RESPA disclosures. In addition, a combined TILA-RESPA disclosure rule could well be proposed by the CFPB before any new disclosure requirements issued by the Fed could be fully implemented. For these reasons, the Fed has determined that proceeding with the 2009 and 2010 proposals would not be in the public interest.
 

Agencies Propose Changes in Reporting Requirements for OTS-Regulated Savings Associations and Savings and Loan Holding Companies

On February 3, 2011, the federal bank and thrift regulatory agencies announced proposed changes to reporting requirements for savings associations and savings and loan holding companies regulated by the Office of Thrift Supervision (OTS). The proposed changes include a change from quarterly Thrift Financial Reports to quarterly Call Reports. The agencies--the OTS, the OCC, the FDIC, and the Federal Reserve Board--are proposing the changes pursuant to the Dodd-Frank Act. Provisions of the Dodd-Frank Act require the transfer of OTS functions to the OCC, the FDIC, the Federal Reserve Board and the CFPB on July 21, 2011. The agencies are requesting comment on the proposed changes within 60 days of their publication in the Federal Register, which is expected soon.

The proposed changes would:
  • Require savings associations to file quarterly Call Reports, beginning with the March 31, 2012, report date. Effective on that date, all schedules of the Thrift Financial Report (including Schedules CMR and HC) would be eliminated;
  • Require savings associations to file data through the Summary of Deposits with the FDIC, beginning with the June 30, 2011, report date. Effective on that date, the OTS's Branch Office Survey would be eliminated;
  • End collection of monthly median cost of funds data from savings associations, effective January 31, 2012; the last cost of funds indices would be published as of December 31, 2011; and
  • Require savings and loan holding companies to file the same reports with the Federal Reserve that bank holding companies file, beginning with the March 31, 2012, report date. Under the proposals, savings associations and their holding companies would continue their current reporting processes until the effective dates cited above.
 

Regulators to Report Widespread Weaknesses in Mortgage Servicing

Federal Reserve Governor Sarah Bloom Raskin said in a speech that federal banking regulators' review of mortgage servicing standards expected to be released later this month will show widespread weaknesses in the servicing industry, "The agencies intend to report more specific findings to the public soon, but I can tell you that these deficiencies pose significant risk to mortgage servicing and foreclosure processes, impair the functioning of mortgage markets and diminish overall accountability to homeowners," Raskin said.

Governor Raskin emphasized that "There is a need for strong corporate governance procedures for servicers that are monitored and enforced enterprise-wide to prevent process breakdowns," she said. "Servicers need sound policies and procedures that outline the rules, laws, standards and processes by which internal operations are assessed," In her view, "Senior executives need to emphasize compliance and qualitative measures over short-run cost efficiency, and need to articulate the presence of adequate quality controls and audit processes to identify risks and take timely, corrective actions where needed," she added. "Corporate leadership needs to communicate performance expectations that hold all business lines accountable to strong procedural controls."