Bank Lawyer's Blog

OTS Reduces The Regulatory Burden

On November 24, 2004, the OTS published in the Federal Register a proposed regulation concerning the Community Reinvestment Act, and an Interim Final Rule to reduce the burden of application and regulatory reporting requirements. The proposed CRA changes have garnered the press coverage. The OTS proposes to allow large (over $1 billion) savings associations to change the manner in which they are judged for CRA compliance purposes, including permitting them to elect to be judged solely by the lending test (as are smaller thrifts), as opposed to the present limitation of 50% (with 25% being based on "community service" and 25% on investments). The proposed changes would also permit the thrift to allocate the percentages among the 3 categories. In so doing, the OTS is again breaking ranks with the other federal bank regulatory agencies, which do not allow such flexibility.

Effective October 1, 2004, the OTS raised the asset limit for being evaluated under the CRA "small lender test" to $1 billion. That change was controversial enough. The latest proposal has already brought howls of protest from community development groups and from Democratic lawmakers. Expect the howls to grow louder.

Of perhaps more interest to smaller thrifts are some of the changes made by the Interim Final Rule issued on the same day. The Interim Final Rule is effective January 1, 2005 (comments must be received by January 24, 2005). Among those are the following:

• Elimination of the requirement for prior OTS approval to re-designate a home office or branch.
• Elimination of prior OTS approval for certain "highly rated institutions" to change the location of a branch or home office, or to establish a new branch office. A notice of the proposed change will have to be published in a local paper, and an application or notice filed if a comment letter is received that opposes the action (unless the OTS decides that such an application is not required).
• Elimination of notices for short-distance relocations.
• Elimination of restrictions on the establishment of drive-in or pedestrian offices.
• Elimination of the requirement for OTS approval to approve loans and contracts at agency offices.
• Elimination of the requirement to display the equal housing lender logotype and legend only where the ad is for loans made for the purpose of purchasing, constructing, improving, repairing, or maintaining a dwelling, or for loans secured by a dwelling.

There are other beneficial changes incorporated with the Interim Final Rule, and the rule should be reviewed to determine all of them.

As only one example of the importance of such seemingly minor changes is the benefit to those thrifts that use "agency offices" to originate mortgage loans. The ability to approve loans and contracts at such offices gives the thrift much more flexibility in its operations. Prior to this change, all loan approvals could take place only at the home office or a branch office. While the advisability of delegating loan approval to an agency office must otherwise "make sense" from business operations and safety and soundness standpoints, it gives added flexibility to thrifts.

These changes are further evidence that the OTS continues to attempt to reduce the regulatory burden on its decreasing base of thrifts, and to thereby enhance the attractiveness of the federal thrift charter.
---Kevin Funnell

Loan Participations: Banks Dodge A FASB Bullet

The Financial Accounting Standards Board (FASB) has apparently decided (according to participants in recent discussions with FASB) not to issue a ruling that would have precluded or severely impaired the ability of FDIC-insured banks to sell loan participations. Because of a rarely-used provision of federal law that gives the FDIC as receiver for a failed bank the right of set-off against the bank's "creditors," FASB had initially proposed, as part of its review of FASB Statement 140, to treat sales of loan participations by FDIC-insured institutions as secured borrowings by the selling banks, not as sales of assets.

For small banks particularly, the ability to transfer the loan participation interest sold "off its balance sheet" through sale treatment is important. In many cases, the sale not only spreads credit risk to the loan participants, but frees up capital to make additional loans. Also, treating a loan participation "sale" as a secured borrowing reduces, rather than increases, capital. For many small banks, the regulatory lending limit on loans to a single borrower, being tied to a relatively small percentage of a bank's "unimpaired capital and surplus," can easily prevent the bank from making a loan of sufficient size to a valuable customer. Sale treatment for the sale of loan participation interests to other banks, with the selling bank remaining the "servicer" of the loan, allows the bank to make the loan and at the same time retain the customer relationship with the borrower. The proposed FASB action would have posed a severe problem to many such banks.

FASB will issue a discussion draft of a revised Statement 140 later this year or early in 2005, and will allow public comment before taking further action. Currently, FASB is debating whether a "true sale" legal opinion must be obtained in every case, or whether accountants will have the option to require such a legal opinion before rendering their own opinion as to "sale treatment," and what other conditions must exist before "sale" treatment will be accorded the sale of a loan participation interest. One of the issues that (as of the October 27 FASB meeting) continues to divide the Board is whether a "custodial arrangement" must be entered into in connection with sales of loan participation interests. No decision has yet been reached on this issue.

Although the final FASB decision is a work-in-progress,  and may end up being another "attorney relief" measure, banks who depend upon loan participation sales as an important part of their business plan at least should take comfort in knowing that these sales should still be afforded "sale" treatment for balance sheet purposes, albeit with possible additional legal and documentation burdens.
---Kevin Funnell

OTS Extends Preemption to "Exclusive Agents"

OK, so we ARE preoccupied with federal preemption. In our defense, it seems that there’s so much happening these days on this front that it’s difficult to keep up with it all.

The OTS released a legal interpretation on October 25, 2004 that holds that federal savings associations and their operating subsidiaries may use "agents" to market, solicit and service their deposit and loan products, and that state licensing and registration requirements that do not apply to the association do not apply to the agents. For example, some of our clients are federal savings banks that originate single-family residential mortgage loans in many different states. The association and its employees are not required to comply with such state laws as those that require mortgage lenders and brokers to be licensed by the appropriate state authority. According to the OTS, federal associations may now use "exclusive agents" to perform mortgage marketing, solicitation, origination and servicing services and those agents do not have to be licensed by the state in connection with its performance of such activities for the association.

The interpretive letter sets forth a number of requirements and restrictions that apply to federal associations that wish to use such agents. Before entering into any such agency relationship, the association must contact and "consult with" its OTS Regional Office and submit a business plan or proposal with "in-depth information" about how the arrangement with the agents will be structured and carried out.

In the specific arrangement approved by the OTS in the interpretive letter, the agents is not allowed to sell financial products for any entity other than the association; the agent has no authority to bind the association; the agent has no authority to accept cash or other deposits from customers, cash checks, disburse loan proceeds, or collect or accept loan payments; and the agent is an independent contractor. The agent is paid commissions on consummated transactions. Other associations that follow those guideposts in structuring their agency relationships should have an easier time with the OTS. Deviations from those points may not be prohibited, but will may delay the approval process.

In addition, the interpretive letter sets out the following "minimum conditions" (additional conditions may be imposed by the OTS on a case-by-case basis) that must be met:

The association and the agent must enter into a written agreement that (1) sets forth the rights, duties, and obligations of each, including those with respect to training; (2) describes the nature of the relationship between the two parties; (3) expressly sets forth the association's right to monitor and review the activities the agent performs for the association; and (4) expressly sets forth OTS's statutory authority to regulate and examine and take an enforcement action against the agent with respect to the activities it performs for the association, and the agent's acknowledgment of OTS's authority;

The association must establish a system that provides the agent with in-depth training about the association's products and services, as well as applicable law. Such training should be designed to insure that agents will be adequately educated about the association's products and services, the distinctions between insured and non-insured products, and relevant law (e.g., truth in lending, truth in savings, real estate settlement procedures, equal credit opportunity, fair lending, etc.) that may apply to the agents' marketing, solicitation, and customer service activities. Such training must be provided before an agent commences marketing or other service activities on behalf of the association; thereafter, the association will review and update the training material on an annual basis and ensure that each agent receives training as needed. Training records must be available for review by OTS examiners;

The association must adopt a detailed compliance program to ensure adequate monitoring, supervision, and control over the agent and the activities the agent performs on behalf of the association. The compliance program must be reviewed by the association's board of directors and senior management on an annual basis and must include:

    o An annual review of the compliance program conducted under the auspices of the compliance officer to determine if the agents are operating in compliance with the association's established policies and procedures regarding the marketing, solicitation, customer service, or other activities related to the association's authorized banking products or services;

    o An annual internal or external audit review of the compliance program, including a review of the training component;

    o Compliance and audit reports, together with evidence of appropriate actions to address findings, to be provided to the association's board of directors;   

    o A system for tracking and resolving consumer complaints in a timely manner. An annual report regarding consumer complaints and their resolution shall be provided to the association's board of directors;

    o A review and approval process for all customer disclosures, advertising, and other promotional material; and

    o Any other requirements or conditions that the association's OTS Regional Office deems appropriate for that particular institution. Moreover, the written agreement between the federal savings association and its agent shall specify that the association, as well as the agent, is subject to control and supervision by the appropriate OTS Regional Office or OTS Headquarters. This control and supervision includes, but is not limited to, the ability to require that:

    The association obtain OTS's approval (or non-objection) before entering into a contractual arrangement with the agent, including the right to approve specific contractual language;

    The association and/or the agent submit periodic reports to OTS; and

    The association modify or terminate its relationship with the agent.

    o The designation of a compliance officer dedicated to the development, implementation, and management of the association's compliance program. This person will have responsibility for the oversight of the agents that perform marketing, solicitation, customer service, or other activities related to the association's authorized banking products or services.

The interpretation opens up interesting possibilities. As only one example, a mortgage loan origination office that has been structured as a "net branch" of a federal savings association, run by the federal association’s employees, could now be structured as an independently owned entity whose employees are the employees of the "exclusive agent" of the federal savings bank and not of the savings association itself. This could be an advantage in attracting and retaining loan producers who need federal preemption of state licensing laws but still want to retain some ownership in the "originating vehicle." The savings association could relieve itself of the employer-employee relationship with the loan originators.

In a couple of footnotes, the OTS observes that RESPA compliance must be considered (for example, the compensation of the agents must not violate the anti-kickback and unearned fee prohibitions of RESPA); however, while it is easier to justify RESPA compliance on employee compensation, this should not present an insurmountable obstacle where agent's compensation is concerned. There are other issues that must be dealt with, as well; however, overall, this is another encouraging example of the OTS’s continued drive to keep the federal thrift charter an attractive financial institution charter.
---Kevin Funnell

The Limits of Preemption

It may seem that we’re fixated on federal preemption, but the fact is, these issues keep arising in everyday practice. One such issue is the issue of whether state versions of the Uniform Commercial Code (UCC) are preempted by the OCC’s preemption regulations. I wasn’t aware that there was any reasonable doubt that such state laws are not preempted by federal law. Nevertheless, when a client asked me the question and I checked the current status of the law, I learned that I was assuming something that was of doubt to more people than I had thought.

The OTS preemption regulation (applicable to federal savings associations and savings banks) specifically states that it does not preempt state "contract and commercial law." The UCC is clearly a "commercial law." The OCC preemption regulation, (applicable to national banks) specifically states, however, that it does not apply to state law on "contracts" (no specific mention of "commercial law"). It was enough of a concern for the OCC to issue an Interpretive Letter dated June 10, 2004 (and released September 28, 2004) that confirms that the provisions of the UCC are not preempted by the OCC regulation.

The OCC released the same day another Interpretive Letter dated August 19, 2004 in which the OCC confirmed that state unclaimed property and escheat laws that do not have the effect of dissolving the deposit contract between the depositor and the national bank, are not preempted by the OCC's preemption regulation. In addition, state authorities have "visitorial powers" to review a national bank’s records "solely to ensure compliance with applicable State unclaimed property or escheat laws upon reasonable cause to believe that the bank has failed to comply with such laws." Actually, this is a mere restatement of the law prior to the adoption, earlier this year, of the OCC’s preemption regulation, but this Interpretative Letter removes any doubt that prior law might have changed as a result of the adoption of that regulation.

---Kevin Funnell

Taking Care of Veterans

In good news for veterans and for lenders, the US Congress earlier this week passed and sent to the White House the Veterans Benefits Improvement Act of 2004. Among many other things, the Act now allows VA loans of up to the Federal Home Loan Mortgage Corporation's conforming loan limit, which is currrently $333,700. This is a substantial increase, and is expected to help many veterans who live in high-cost housing areas. It also extends the VA guaranty for adjustable rate loans through 2008, another important housing benefit to veterans.

Helping our service men and women is always a wise course, but particularly in times such as these.
---Kevin Funnell

Preemption vs. Predation

In October, a punch and a counter punch were thrown in the US House of Representatives over the OCC's vigorous extension of the principle of federal preemption of state law, as applied to national banks and their operating subsidiaries. Throwing the first punch, Rep. Barney Frank of Massachusetts, the ranking Democrat on the House Financial Services Committee, introduced H.R. 5251, the "Preservation of Federalism in Banking Act," that would prevent the OCC from extending federal preemption principles to sate consumer protection laws of general application, permit state attorneys general to enforce such laws against national banks, and generally preventing the OCC from extending federal preemption to the operating subsidiaries of national banks unless such preemption is specifically provided by an Act of Congress.

Representative Frank has been an outspoken critic of the OCC's regulations, adopted earlier this year, that confirmed and codified rulings and interpretations of the OCC as to the inapplicability to national banks and their operating subsidiaries of a wide variety of state laws. Frank has been mostly vocally concerned with the preemption of state predatory lending laws, laws that generally restrict fees, charges, rates and practices of subprime lenders that are deemed to be "unfair" or "predatory." The OCC, on the other hand, takes the well-supported position that it is merely codifying in a single series of regulations basic principles of long standing under the National Bank Act, as interpreted by the agency and supported by the courts.

The counter punch was the announcement that same month of the cooperation of two members of the same committee, Republican Bob Ney of Ohio and Democrat Paul Kanjorski of Pennsylvania, to create bipartisan legislation to establish uniform standards govern subprime lending and to prevent predatory lending practices. Such national legislation is likely to have strong appeal to most subprime lenders if only to eliminate a plethora of non-uniform state laws. It is likely that national banks will accept such national standards in return for deflating the primary impetus that ostensibly drives criticism of federal preemption. The OCC should support reasonable standards for that reason, and because it gives the agency a more definitive "road map" for determining and enforcing predatory practices, rather than internally generated standards based upon safety and soundness principles.

HR 5251 is expected to go nowhere this year, and will likely be reintroduced by Frank early in 2005. Ney and Kanjorski's proposed legislation is likely to be introduced at about the same time. Chances are good for the adoption of a federal standard for predatory lending next year. Stay tuned.

Sailing in under the radar, as always, are federal savings association regulated by the OTS. The OTS has vigorously preempted state predatory lending laws for federal thrifts and their operating subsidiaries. Those rulings have generated less controversy because the universe of federal thrifts is so much smaller than that of national banks.  On the other hand, federal thrifts will have much less influence in the content of those standards. As always, "size matters."
---Kevin Funnell