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Modifications to the California Homeowner Bill of Rights

On January 1, 2018, certain provisions of the California Homeowner Bill of Rights (“HBOR”) expired.  But contrary to what many assumed, the January 1, 2018 expiration date did not apply to all of the HBOR’s provisions, and many provisions have been replaced by new regulations.  We’ve prepared the below summary of some of the substantial changes to the law and how they will affect HBOR litigation in the future.

  • The new HBOR removes many of the distinctions between servicers conducting more/less than 175 annual foreclosures.  In most but not all respects, all servicers are treated the same going forward.
  • Changes in the private right of action/relief.
    • The HBOR still has a private cause of action, but only for material violations of section 2923.5 (pre-NOD notice requirements), 2923.7 (single point of contact), 2924.11 (dual tracking), and 2924.17 (accuracy of NOD declaration; substantiate right to foreclose).
    • Injunctive relief is available prior to the recording of a trustee’s deed.  After a trustee’s deed is recorded, a servicer may be liable for actual economic damage and the greater of treble or actual damages for material violations that are intentional or reckless.  Attorney’s fees are still available if the borrower prevails.
    • However, mortgage servicers who have engaged in “multiple and repeated uncorrected violations” of section 2924.17 are no longer liable for a $7,500 penalty.
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CFPB’s Delay in Announcing Further Delay of the Prepaid Card Rule

The Consumer Financial Protection Bureau has issued a brief press announcement that the Prepaid Card Rule would be further revised and that the effective date for compliance will be further postponed from the current deadline in April 2018.

The announcement creates more worry than relief – it’s just a tease. The announcement did not say what changes would be made or when the new deadline will be. It only said that amendments to “certain aspects” of the rule would be coming “soon after the new year.”  No doubt the Bureau meant for this announcement to be helpful to someone, but it is not clear if anyone is actually helped.

Prepaid card issuers are scrambling to implement the systems changes and new business processes necessary to support the sweeping changes required by the rule. With this announcement, they must now wonder which of those efforts will turn out to be wasted, or perhaps need to be re-worked, and they can’t pause pursuing any specific implementation efforts until the actual amendments are published. Are they supposed to trust that the extra time to be allowed by the CFPB will be sufficient to accommodate this pivot?

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New Year, New You – What’s on Your Bank’s List of New Year’s Resolutions?

With the end of the year approaching, it is time to start looking forward to 2018 and putting together that list of New Year’s resolutions. This list of annual goals can be especially important for community banks because, let’s face it, times are a-changin’ and community banks cannot afford to ignore this, especially in the face of the ostensible juggernaut that is fintech. “New Year, New You” doesn’t have to be a mantra solely for individuals; it can also be a mantra for community banks who want to make 2018 a successful year. To get you started, we have provided some suggestions that may help you turn 2018 into a very positive year for your bank.

Don’t be Consciously Blind

With such a vast amount of information thrown at us every day, I think we are all guilty of becoming consciously blind. It’s true, all the information can overwhelm us, making us turn a blind eye and ignore what everyone has to say and assume if something really important happens, someone will tell us. As a banker, you cannot afford to do this. With the promulgation of new regulations and advances in technology, it is important for community banks to remain aware of the financial landscape and evolve. Whether this means meeting revised regulations or updating technology to meet your customer’s needs, make a resolution to stay abreast of information that may affect your bank.

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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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HVCRE Gets a Reboot

HVCRE Gets a Reboot

September 27, 2017

Authored by: Jerry Blanchard

As we mentioned just a couple of weeks ago, the federal banking regulators have taken aim at the risk weighting rules for High Volatility Commercial Real Estate (“HVCRE”) loans that went into effect back in 2015. In a proposal published on September 27, 2017, the regulators seek to simplify the approach in several ways. First, the existing HVCRE definition in the standardized approach would be replaced with a simpler definition, called HVADC, which would apply to credit facilities that primarily finance or refinance ADC activities. Second, an HVADC exposure would receive a 130 percent risk weight.as opposed to the 150% risk weight for HVCRE exposure under the existing rule. The tradeoff though is that HVADC would apply to a much broader set of loans. For example, as compared to the HVCRE exposure definition, the proposed HVADC exposure definition would not include an exemption for loans that finance projects with substantial borrower contributed capital and consequently removes the restriction on the release of internally generated capital.

The definition of “primarily finance” means credit facilities where more than 50 percent of loan proceeds will be used for ADC activities. So for example, multipurpose facilities where more than 50 percent of loan proceeds finance non-ADC activities, such as the purchase of equipment, would not be considered HVADC.

As with the HVCRE rule, there are certain exemptions. HVADC would exempt permanent loans, community development loans, loans for the purchase or development of agricultural land and loans for one to four family residential.  Thus, lot development loans and loans to finance the ADC of townhomes or row homes would not be considered HVADC but raw land loans and loans to finance the ADC of apartments and condominiums generally would be considered HVADC.

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Finding the Unicorn in Lender Liability Litigation

Investors frequently talk in terms of trying to find the next unicorn, that small start-up company that is going to turn into a billion dollar valuation.  Lawyers are like that as well, always looking for that new decision where a court opens a crack in the door of some long held legal theory. Something like this occurred in the 1980’s when the courts in California held that a party could bring a tort action for the breach of the obligation of good faith. The courts were expanding a doctrine that then existed only in the area of insurance contracts. The expansion of this theory to noninsurance contracts generated universal criticism by other courts and scholars across the US and after a ten year experiment the California Supreme Court reversed its earlier decision for the following reasons: (1) the different objectives underlying the remedies for tort or contract breach, (2) the importance of predictability in assuring commercial stability in contractual dealings, (3) the potential for converting every contract breach into a tort, with accompanying punitive damage recovery, and (4) the preference for legislative action in affording appropriate remedies. [See: Blanchard, Lender Liability: Law, Practice and Prevention, Chapter 4, Bad Faith Tort Claims]

When a party enters into a loan agreement or a promissory note, one understands what the consequences of a breach might be. If a lender is found to have improperly failed to fund under a line of credit it knows that it may have to pay compensatory damages to the borrower. Likewise, guarantors understand that if the borrower fails to pay the underlying obligation the guarantor must step in and pay the obligation.  Our commercial banking industry is built on this understanding that parties will need to put the nonbreaching party into as good of condition as they would have been if there had been no breach. Damages for breach are therefore predictable.

The unicorn for borrowers counsel today is to tag a lender with punitive damages. This has traditionally been a difficult endeavor. Courts almost uniformly dismiss breach of fiduciary duty claims because absent some unusual set of facts, the normal lender/borrower relationship is not a fiduciary one. Lenders owe no special duty to borrowers or guarantors to advise them on whether a particular business transaction for which the borrower is obtaining funds is a “good” one or not. Fraud claims are a bit easier for a borrower to keep from being dismissed but such claims are subject to heightened pleading standards and require specificity in making the claim, a general claim of “fraud” without more will be dismissed.

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The Transition Away from LIBOR

LIBOR, or the London Interbank Offered Rate, is a benchmark utilized in a variety of financial transactions (including the setting of interest rates in credit agreements). It was intended to be an average of the rates at which banks can obtain unsecured funding in the London interbank market for a specified time period in a specified currency. The rate is based on submissions by banks to the LIBOR administrator (currently ICE Benchmark Administration Limited) of their good faith estimate of borrowing costs and not necessarily actual transactions. Since estimates can at times be imprecise, together with the fact that (particularly after the financial crisis) unsecured credit was not generally available to banks in the London interbank market for periods of time, LIBOR as a benchmark was ripe for reconsideration.

On July 27th, Mr. Andrew Bailey, Chief Executive of the U.K. Financial Conduct Authority (FCA) announced that the FCA will no longer require banks to submit quotes for LIBOR rates in sterling by the end of 2021, indicating that the benchmark that underpins trillions of dollars in financial contracts will be phased out by 2021 and replaced with a benchmark that is more closely tied to interest rates for actual transactions in the lending markets. This announcement has prompted plenty of concerns and more than a few troubling headlines, especially given the extremely common use of LIBOR as an interest rate benchmark in commercial credit agreements, adjustable rate mortgages and other financing arrangements.

Notwithstanding some of the more recent reactions, the financial markets have seemingly taken this development in stride without much turmoil. There are a few reasons for this. First off, there are almost 4 ½ years before this reporting requirement ends, and work has already begun to determine LIBOR’s replacement.1 Second, LIBOR may still be available even if banks are no longer required to report their quotes, although caution has been expressed not to rely on this. Last, in the commercial loan context, customary fallbacks have been built into the “LIBOR” definitions in most well-drafted credit agreements that could provide short term solutions in the event of the unavailability of the LIBOR screen rate.

While the market does seem to be generally in agreement that it is premature to attempt to craft a definitive solution to this issue now, since there is insufficient information as to what will “replace” LIBOR (and how that replacement might affect the all-in rate in any particular credit facility), market participants can take proactive steps now to prepare for the eventual transition away from LIBOR to a new benchmark rate.

First, we would recommend a review of any applicable fallback provisions mentioned above to analyze whether these provisions should be amended now (or in the next couple of years) to attempt to facilitate a smoother transition to an eventual discontinuation of LIBOR (as opposed to temporary unavailability). As highlighted by the August 3rd LSTA article, “LIBOR (Transition) in the Loan Market”, these fallbacks were designed for temporary disruptions rather than a full transition away from the use of LIBOR as a benchmark. Moreover, some fallback language is better than others. For example, some language focuses on the unavailability of the publication of LIBOR, rather than the actual underlying rate itself. If the underlying benchmark rate goes away, as opposed to just the referenced information source, the ability of an agent or designated bank to specify an alternative information source as a screen rate will be of no use. Other fallback language is much more broad, in the sense that it permits a lender or agent to determine LIBOR “in good faith” based on a variety of factors that can include, among others, an offered quotation rate to first class banks for deposits in the London interbank market by the agent or a designated bank as well as a rate determined on the basis of quotes from designated “reference banks”. This creates more flexibility in this context, but it could be argued that it gives the lender or agent too much control in an environment where the traditional LIBOR has simply disappeared.

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Counter-Cyclical Thoughts About D&O Insurance

It can be a challenge, when economic times are relatively good, to take time away from thinking about new opportunities to discuss topics like D&O insurance.  Even though I am biased, I’ll admit that, in those times, discussing the risks of potential liability and how to insure those risks can feel both a pretty unpleasant and a pretty remote thing to be discussing.  However, like all risk-related issues, it is precisely in those times when business is going well that a little bit of counter-cyclical thinking and attention can do the most good over the long haul.

As you approach your next D&O policy renewal – and particularly in the 30-60 days prior to the expiration of your current policy, there are a few things that you may want to consider.

Multi-year endorsements – what’s the catch? 

In good times, many insurers will offer packages styled as multi-year policies, usually touted as an option that allows for some premium savings and perhaps a reduced administrative burden.  However, as with all things, these advantages may come with a catch.

Many multi-year endorsements will reserve to the insurer the discretion to assess additional premium on an annual basis within the multi-year period if the risk profile of the bank changes in a material way.  So premium savings may not ultimately be realized, depending on the facts.

Beyond this, some multi-year endorsements will actually impose additional requirements on the insured to provide notice of events that could trigger the carrier’s repricing rights or other conditions.  Those obligations may be triggered when those events occur on an intra-period basis, which can set up a potential foot-fault for an organization that does not keep those requirements front of mind (which can be a practical challenge, as if those events are happening, it is likely that there are a number of issues competing for management and the board’s attention).

Companies looking at multi-year endorsements should make sure they understand fully the terms on which the multi-year option is being provided and should have counsel or an independent broker review the specific language of the proposed multi-year endorsement itself on their behalf.  In addition, while it may be tempting to use a multi-year endorsement to try to extend the renewal horizon and to try to reduce the administrative burden that comes with the renewal process, doing so may also reduce your ability to negotiate appropriate enhancements to your policy terms over the multi-year period.

Multi-year policies may be the right fit for your institution, but they should not be viewed as a one size fits all solution.  Before heading down that road, ask yourself how much is being saved and how real those savings actually are and, perhaps just as importantly, whether avoiding a broader discussion of your coverage strategy on at least an annual basis is a good thing or not.

What about the bank has changed? 

Times of economic expansion often bring with them opportunities to explore new lines of business.  In addition, substantial recent technological innovations in the financial services industries and increasing consumer demands for technological solutions have meant that not only are new market opportunities being explored but that they are being explored in new ways.  And if that isn’t enough, there is always the ever-changing regulatory and compliance landscape to contend with.

All of these trends – as well as your decisions of where and how your institution will choose to participate (or not to participate) in them – bring with them new and different risks.  To the extent that your bank has expanded its offerings, changed its footprint or portfolio mix, or otherwise changed its policies or ways of doing business, you should think about how those changes may impact your insurance needs.  It can be easy, particularly when you have a long relationship with an incumbent carrier, for the renewal process to become somewhat rote.

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HVCRE Lending: An Area of Regulatory Examination Focus

HVCRE Lending: An Area of Regulatory Examination Focus

August 24, 2017

Authored by: Bank Bryan Cave

the-bank-account

Jonathan and I are joined by our colleague, Jerry Blanchard, to discuss High Volatility Commercial Real Estate (HVCRE) Loans on the latest episode of The Bank Account.

HVCRE Loans are one of the areas of focus on regulatory exams, and we’re seeing increased attention to not only ensuring that a bank’s reported HVCRE loans are correct, but also that the bank has sufficient internal controls in place to monitor and track HVCRE lending.

Formal regulatory guidance on HVCRE lending is still rare, as the various regulatory agencies struggle to find consensus in an area that is fraught with technicalities and details.  Our colleague, Jerry Blanchard, has assisted numerous banks in evaluating overall HVCRE programs as well the application of the HVCRE requirements to countless loans.  In addition, he’s written extensively on the topic, including:

You can always follow us on Twitter.  Jonathan is @HightowerBanks, I’m @RobertKlingler, and Jerry is @Blanchard_Jerry.  Our producer, Sam Katz, is @SamathaJill1, and is not responsible for my inability to read simple copy at the end of this episode.

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Two Recent Card Payment Developments

Our Bryan Cave-affiliated sister site, the BC Retail Law Blog, recently published two posts that may be of interest to our banking, fintech and payments clients.

In “Bans on Credit Card Surcharges Face First Amendment Challenges,” the Retail Law Blog looks at how state laws that prohibit retailers from charging customers a surcharge for using a credit card are being challenged on First Amendment grounds.

For more than four decades, California’s Song-Beverly Credit Card Act of 1971 prohibited retailers from charging credit card customers such a surcharge. In Italian Colors Restaurant, et al. v. Harris, 99 F.Supp.3d 1199 (E.D. Cal. 2015), a federal judge ruled that the law unconstitutionally limits retailers’ freedom of speech. The California attorney general appealed, and the case is set for oral argument before the Ninth Circuit Court of Appeals on August 17.

One consequence of these actions may be to make credit cards more expensive to the consumer, which, in turn, could encourage further development of alternative forms of payment.

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