Bank Regulatory News and Trends

In this edition:

• Supreme Court rules president can fire CFPB director – but keeps agency intact.
• FDIC finds bank earnings fell nearly 70 percent in first quarter.
• Stress tests and sensitivity analyses: Fed bars share buybacks, caps dividends for big banks.
• New requirements for living wills to include actions in response to the coronavirus.
• FDIC finalizes “valid when made” rule.
• Agencies finalize Volcker Rule modifications.
• PPP application deadline extended, and other developments on SBA emergency loan program.
• Main Street Lending Program now open for applications.
• CFPB rescinds limits on payday lenders.
• Federal banking agencies issue principles for small-dollar loans.
• Fannie Mae and Freddie Mac update guidance on originations, appraisals and selling due to COVID-19.
• FinCEN issues guidance on BSA/AML due diligence requirements for hemp-related business customers.
• Hemp/cannabis banking provision in House financial services funding bill.

Supreme Court rules president can fire CFPB director – but keeps agency intact. The nation’s highest court has decided that the president does indeed have the authority to remove the director of the Consumer Financial Protection Bureau (CFPB) at will. But the justices rejected the argument that the court should strike down the rest of the Dodd-Frank law that established the consumer watchdog bureau. In a split 5-4 decision authored by Chief Justice John Roberts, the court found that restrictions on the removal of the CFPB director violate the Constitution’s separation of powers. Under Dodd-Frank, the director may be removed from the position only for “inefficiency, neglect of duty, or malfeasance in office.” But the decision rejects the request to hold that, if the leadership structure is unconstitutional, the court should strike down the rest of the act creating the CFPB as well. “We therefore hold that the structure of the CFPB violates the separation of powers,” Roberts wrote in the decision joined by the court’s four other more conservative-leaning justices. “We go on to hold that the CFPB Director’s removal protection is severable from the other statutory provisions bearing on the CFPB’s authority. The agency may therefore continue to operate, but its Director, in light of our decision, must be removable by the President at will.”

• Trump Administration Solicitor General Noel Francisco said that the CFPB effectively answers to no one during oral arguments in March, and CFPB Director Kathleen Kraninger herself told Congressional leaders last year that she believed the provision that the director could be fired only for cause and not at the president’s will was unconstitutional.
• Justice Elena Kagan wrote in a dissent joined by the three other more liberal-leaning justices that, in the wake of 2008 financial crisis that led to the creation of the CFPB, Congress and former President Obama determined that the agency “needed a measure of independence,” leading to the for-cause-only removal restrictions.
• The US Court of Appeals for the 9th Circuit had ruled that the removal restrictions do not violate the Constitution, citing a 1935 Supreme Court decision rejecting the argument that the structure of the Federal Trade Commission, with five members who could only be removed for cause violated Article II of the Constitution.

FDIC finds bank earnings fell nearly 70 percent in first quarter. The Federal Deposit Insurance Corporation (FDIC) on June 16 reported reduced profitability among its insured institutions during the first quarter of 2020. But the banking agency also found reasons for reassurance as loan and lease balances and deposits registered strong growth, asset quality metrics remained stable and the number of institutions on the Problem Bank List remained low. FDIC’s Quarterly Banking Profile indicates that aggregate net income totaled $18.5 billion in first quarter 2020, a decline of $42.2 billion (69.6 percent) from a year ago, for the 5,116 FDIC-insured commercial banks and savings institutions. The decline in net income is a reflection of deteriorating economic activity as the COVID-19 pandemic began to set in during the first quarter. This decline was broad-based, with 55.9 percent of all institutions reporting year-over-year declines in net income. The share of unprofitable institutions increased from a year ago to 7.3 percent. The average return on assets ratio fell from 1.35 percent in first quarter 2019 to 0.38 percent in first quarter 2020. Other key top-line findings of the quarterly profile include:

• Net interest margin declined from a year ago to 3.13 percent;
• Community banks reported a 20.9 percent decline in net income from a year ago;
• The deposit insurance fund's reserve ratio declined to 1.39 percent; and
• During the first quarter, two new banks opened, 57 institutions were absorbed by mergers, and one bank failed.

"The banking industry has been a source of strength for the economy in the first quarter despite unexpected shocks. Although bank earnings were negatively affected by increases in loan loss provisions, banks effectively supported individuals and businesses during this downturn through lending and other critical financial services," FDIC Chairman Jelena McWilliams said.

Stress tests and sensitivity analyses: Fed bars share buybacks, caps dividends for big banks. The Federal Reserve Board on June 25 released the results of its supervisory stress tests for 2020, along with first-time sensitivity analyses conducted to assess the resiliency of large banks under three hypothetical recessions or downside scenarios resulting from the COVID-19 pandemic. Based on the results, the Fed will require all 34 large banks that participated in the exercise to resubmit their capital plans later this year to reflect current stresses and help banks re-assess their capital needs and maintain strong capital planning practices during what the Fed called “this period of uncertainty.” In previous years, that had been required only for banks that did not pass the tests. The Fed said it will also conduct additional analysis each quarter to determine if adjustments are necessary. In aggregate, the Fed reported that loan losses for the 34 banks ranged from $560 billion to $700 billion in the sensitivity analysis and aggregate capital ratios declined from 12 percent in the fourth quarter of 2019 to between 9.5 percent and 7.7 percent under the hypothetical downside scenarios. Based on these results, the Fed ordered banks to suspend share buybacks and capital dividends for the third quarter of this year to preserve capital. The Fed said it will allow dividends of recent income according to a formula. While most firms tested under the scenarios would remain well capitalized, a U-shaped or W-shaped recovery would cause several banks to approach minimum capital levels, the Fed said.

New requirements for living wills to include actions in response to the coronavirus. The Federal Reserve and the FDIC on July 1 jointly announced targeted information requests for the eight global systemically important banks (GSIBs) to guide their next resolution plans, which are due by July 1, 2021. The 2021 plans – commonly known as living wills – must include the usual core elements, such as capital, liquidity, and recapitalization strategies. Banks’ living wills describe their strategies for rapid and orderly resolution in bankruptcy in the event of material financial distress or failure of the firm. But for the first time, the GSIBs will also be required to incorporate lessons learned from its response to the coronavirus into their resolution planning process. The agencies said that this will be the first targeted resolution plan. The requirements are spelled out in a Targeted Resolution Plan template letter dated June 29. Following a rule change last year, GSIBs are required to update their living wills every two years, rather than annually, and alternate between a full plan and a targeted plan.

FDIC finalizes “valid when made” rule. The FDIC on June 25 issued a final regulation to codify the agency’s longstanding guidance that the valid interest rate for a loan is determined when the loan is made, and will not be affected by a subsequent sale, assignment, or other transfer of the loan. The rule reaffirms the longstanding ‘valid when made’ doctrine, a nearly 200-year-old principle in contract law. That time-honored understanding had been called into question by the 2015 decision in the Madden v. Midland Funding, LLC case where the US Court of Appeals for the Second Circuit ruled that federal law did not permit a non-bank third-party that purchased bank-issued credit card debt to collect on the debt because the interest rate was beyond what the purchaser could charge. In codifying FDIC’s longstanding guidance – interpreted and applied to state banks through an opinion of the agency’s General Counsel issued in 1998 but never specified by regulation – the final rule addresses marketplace uncertainty regarding the enforceability of the interest rate terms of a loan agreement following a bank’s assignment of a loan to a non-bank. The finalized regulation is intended to provide certainty around loans into the secondary market.

• For more details on the FDIC’s regulation and the issues surrounding the Madden case, please see this July 2 DLA Piper Alert.
• As reported in the June 5, 2020, edition of Bank Regulatory News and Trends, the OCC finalized its regulation to codify the valid-when-made principle on May 29.

Agencies finalize Volcker Rule modifications. Five financial regulatory agencies have approved final amendments to the covered funds portion of the regulations implementing the Volcker Rule. The Federal Reserve, FDIC, Office of the Comptroller of the Currency (OCC), Securities and Exchange Commission and the Commodity Futures Trading Commission announced the publication of the final rule on June 26. The final rule modifies the Volcker Rule's prohibition on banking entities investing in or sponsoring hedge funds or private equity funds, known as covered funds. The final rule is broadly similar to the agencies’ proposed rule from January, with a few key exceptions:

• A new exclusion for family wealth management vehicles that are not organized as trusts to be owned by up to five closely related persons of the family customers (rather than three, as originally proposed).
• A US banking entity and its associated parties may own up to 24.9 percent of the ownership interests in a foreign public fund that is sponsored by the US banking entity, instead of up to 14.9 percent.
• A loan securitization vehicle may hold certain debt securities that represent up to 5 percent of the aggregate value of the securitization vehicle’s assets.
• A qualifying foreign excluded fund (QFEF) is not subject to the Volcker Rule compliance program requirements that are otherwise applicable to banking entities.
• Banks may enter into lower risk principal transactions with a related covered fund, regardless of whether that covered fund is a “securities affiliate” as defined in Regulation W.
• The types of events that qualify as “cause” for removal of an investment manager for purposes of the ownership interest definition are clarified.

The agencies made no substantive amendments to the proprietary trading provisions or the compliance program requirements of the Volcker Rule other than to provide exemptions for QFEFs. The agencies also confirmed in the preamble that the final amendments do not modify or revoke any of the Volcker Rule FAQs previously issued by staff of the agencies, unless otherwise specified. The Volcker Rule generally prohibits banks from engaging in proprietary trading and from acquiring or retaining ownership interests in, sponsoring, or having certain relationships with a hedge fund or private equity fund. Like the proposal, the final rule modifies three areas of the rule by:

• Streamlining the covered funds portion of rule;
• Addressing the extraterritorial treatment of certain foreign funds; and
• Permitting banks to offer financial services and engage in other activities that do not raise concerns that the Volcker Rule was intended to address.

The rule will be effective on October 1.

PPP application deadline extended, and other developments on SBA emergency loan program. President Trump on July 4 signed into law legislation to reauthorize lending under the Paycheck Protection Program (PPP) through August 8, 2020. The Senate had passed the measure on June 30, the original filing deadline for PPP loans, and the House approved it the next day, both by unanimous consent. Although some House Democrats initially favored attaching conditions requiring greater transparency from the Administration on how the funds are being spent, House leadership ultimately agreed to a clean extension of the program. The legislation, S. 4116, also separates the authorized limits for commitments under the PPP from other Small Business Administration (SBA) loan programs. On July 6, as the program restarted after a five-day interruption, SBA and the Treasury Department subsequently released additional data on PPP loan recipients.

• In early June, Congress passed and the president signed the Paycheck Protection Program Flexibility Act of 2020, which modified provisions related to the forgiveness of loans made to small businesses, establishing a minimum maturity of five years for a paycheck protection loan with a remaining balance after forgiveness. That measure also extended the covered period during which a loan recipient may use the funds for certain expenses while remaining eligible for forgiveness and raised the non-payroll portion of a forgivable covered loan amount from 25 percent to 40 percent.
• A pending proposal in both houses of Congress would authorize new lending under PPP to small businesses with 100 employees or fewer, including sole proprietorships and self-employed individuals. On June 18, Senate and House Democrats introduced the Prioritized Paycheck Protection Program (P4) Act, which would also extend the program through the end of the year. Senate supporters of the P4 Act said they are pursuing bipartisan negotiations on the legislation, but currently the bill has only Democratic co-sponsorship.
• The amount of funding still available for the PPP is more than $138 billion, according to the latest Paycheck Protection Program (PPP) Report issued by the SBA.
• On June 26, SBA published in the Federal Register an interim final rule (IFR) on new eligibility criteria for PPP.
• On May 28, 2020, SBA announced that $10 billion of round 2 PPP funding will be available exclusively for loans made by Community Development Financial Institutions (CDFIs). CDFIs provide capital to low-income and traditionally underserved communities. SBA and Treasury stated that these funds are being allocated to CDFIs to ensure that the PPP provides relief to all communities in need during the COVID-19 crisis.
• On May 22, the SBA issued an IFR providing borrowers and lenders with guidance on requirements governing the forgiveness of PPP loans. On the same day, SBA issued another, contemporaneous IFR informing borrowers and lenders of SBA’s process for reviewing PPP loan applications and loan forgiveness applications. The SBA may review a PPP Borrower Application Form (SBA Form 2483 or lender's equivalent form), Loan Forgiveness Application Form (SBA Form 3508 or lender's equivalent form) and related documentation to determine if the borrower may be ineligible for a PPP loan or to receive the loan amount or loan forgiveness amount claimed by the borrower, at any time, in its discretion.
• In a June 26 report to Congress on how federal agencies are administering emergency programs adopted in response to the COVID-19 pandemic, the Government Accountability Office (GAO) found that the PPP had limited safeguards and insufficient guidance and oversight planning, increasing the likelihood that borrowers may misuse or improperly receive loans.
• PPP is a $669-billion business emergency loan program established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act to help certain businesses, self-employed workers, sole proprietors, certain nonprofit organizations, and tribal businesses continue paying their workers during the pandemic.

Main Street Lending Program now open for applications. The Federal Reserve on June 15 announced the long-awaited opening of its $600 billion emergency lending program for small to mid-sized business. The Federal Reserve Bank of Boston announced that the Main Street Lending Program (MSLP) has opened for lending registration. Forms and agreements for lenders can be found on the program site and eligible lenders can now register through the program’s lender portal. MSLP, administered by the Boston Fed, intends to purchase 95 percent of each eligible loan that is submitted to the program, meaning that the Fed will share in the risk that would otherwise be absorbed solely by lenders. This is intended to help create additional balance sheet capacity for lenders to extend more loans. The program will also accept loans that were originated under the previously announced terms, if funded before June 10, 2020. As one of several emergency lending facilities established under the CARES Act, the program is designed to help credit flow to small and medium-sized businesses that were in sound financial condition prior to the COVID-19 pandemic but now face cash flow interruptions. It offers five-year loans with floating rates, with principal payments deferred for two years and interest payments deferred for one year. Loans range in size from $250,000 to $300 million. More information, including answers to frequently asked questions (FAQs) can be found here.

• Also on June 15, the Fed announced that it will be seeking public feedback on a proposal to expand MSLP provide access to credit for certain nonprofit organizations.
• On June 8, the Fed announced the latest changes to certain material terms of MSLP and published updated, expanded, and clarified guidance. Those changes are discussed in greater detail in this June 11 DLA Piper Alert.

CFPB rescinds limits on payday lenders. The CFPB on July 7 issued a final rule overturning underwriting requirements on payday lenders that had been issued by the previous director of the agency. CFPB said it had decided to rescind the mandatory underwriting provisions of the previous rule, released in October 2017 shortly before then-Director Richard Corday stepped down, “after re-evaluating the legal and evidentiary bases for these provisions and finding them to be insufficient.” The Cordray rule, scheduled to go into effect in November of this year, would have required lenders to verify borrowers’ income and debts to determine if they could afford the loans. CFPB said its newly adopted rule on small dollar lending would “maintain consumer access to credit and competition in the marketplace” in the 32 states that currently allow small dollar lending. But the final rule does not rescind or alter the payments provisions of the 2017 rule and the bureau is seeking to have them become effective, although those provision are currently stayed by court order. At the same time, the bureau also issued guidance clarifying the payments provisions’ scope and assisting lenders in complying with those provisions. “We will continue to monitor the small dollar lending industry and enforce the law against bad actors,” CFPB Director Kathleen Kraninger said.

• The director’s assurances did not assuage critics of the payday lending industry, including Congressional Democrats and consumer advocacy organizations. Senator Sherrod Brown (D-OH), the senior Democrat on the Senate Banking Committee, decried the new rule in a July 7 statement. Brown and several of his colleagues had sent a May 13 letter calling for an inspector general investigation into allegations of improper political influence on the drafting process for the rule. And the consumer groups Public Citizen, Americans for Financial Reform Education Fund, the Center for Responsible Lending and the National Consumer Law Center have previously indicated that they will take legal action, arguing that CFPB violated the Administrative Procedure Act that requires rigorous research and analysis, not just a policy disagreement, to change existing rules.

Federal banking agencies issue principles for small-dollar loans. Four federal banking agencies on May 20 issued Interagency Lending Principles for Offering Responsible Small-Dollar Loans. The Federal Reserve, FDIC, the OCC and the National Credit Union Administration issued these principles to encourage supervised banks, savings associations, and credit unions to offer responsible small-dollar loans to customers for both consumer and small business purposes. Recognizing the important role small-dollar loans play in meeting customers’ needs for credit from temporary cash-flow imbalances, unexpected expenses, or income shortfalls during periods of economic stress, natural disasters, or other extraordinary circumstances such as the public health emergency created by COVID-19, the agencies’ core lending principles state:

• Loan products should be consistent with safe and sound banking, treat customers fairly, and comply with applicable laws and regulations;
• Depository institutions should effectively manage the credit, operational, compliance, and other risks associated with the products they offer.
• Loan products should be underwritten based on prudent policies and practices governing the amounts borrowed, frequency of borrowing, and repayment requirements.

The principles cover both open-end lines of credit with applicable minimum payments and closed-end loans with shorter-term single payment or longer-term installment payment structures.

Fannie Mae and Freddie Mac update guidance on originations, appraisals and selling due to COVID-19. On June 11, Fannie Mae provided the latest in a series of updates to Lender Letter 2020-03: Impact of COVID-19 on Originations, and Lender Letter 2020-04: Impact of COVID-19 on Appraisals. And on May 28, Freddie Mac issued Bulletin 2020-19: Selling Guidance Related to COVID-19. The two government-sponsored enterprises are working closely together under the guidance of the Federal Housing Finance Agency (FHFA) to offer temporary measures to help ensure lenders have the clarity and flexibility to continue to lend in a prudent and responsible manner.  The most recent updates from Fannie Mae extend the application dates for these temporary policies to July 31. In its previous update from May 28, Fannie Mae addressed the underwriting of borrowers with self-employment income, as does Freddie Mac’s May 28 bulletin. The agencies are requiring additional documentation regarding self-employment income. The agencies also provide guidance on the assessment of the business income and note that in some cases the seller may need to obtain additional documentation. Fannie Mae also addresses HomeStyle Renovation loans, and Freddie Mac also addresses CHOICERenovation mortgages, delivery requirements for no cash-out refinance mortgages, and the purchase of delinquent mortgages in forbearance.

• On May 13, FHFA announced that Fannie Mae and Freddie Mac were making available a new payment deferral option to allow borrowers who are able to return to making their normal monthly mortgage payment the ability to repay their missed payments at the time the home is sold, refinanced, or at maturity. Previously, homeowners in forbearance were given the option of modifying their loans.
• On June 17, FHFA announced that Fannie Mae and Freddie Mac will extend their single-family moratorium on foreclosures and evictions until at least August 31, 2020. The foreclosure moratorium applies to enterprise-backed, single-family mortgages only and had been set to expire on June 30.
• And on June 29, FHFA announced that Fannie Mae and Freddie Mac will allow servicers to extend forbearance agreements for multifamily property owners with existing forbearance agreements for up to three months, for a total forbearance of up to six months. While the properties are in forbearance, the landlord must suspend all evictions for renters unable to pay rent. The forbearance extension is available for qualified properties with an enterprise-backed multifamily mortgage experiencing a financial hardship due to the coronavirus national emergency.

FinCEN issues guidance on BSA/AML due diligence requirements for hemp-related business customers. The Financial Crimes Enforcement Network (FinCEN) on June 29 issued Guidance Regarding Due Diligence Requirements under the Bank Secrecy Act for Hemp-Related Business Customers (FIN-2020-G001). The Agriculture Improvement Act of 2018 (the 2018 Farm Bill) removed hemp from the definition of marijuana in the Controlled Substances Act (CSA) and directed the establishment of a regulatory framework for the legal production of the crop. FinCEN’s guidance states that financial institutions must conduct customer due diligence (CDD) for all customers, including hemp-related businesses, such as beneficial ownership collection and verification. Financial institutions must also establish appropriate risk-based procedures for conducting ongoing CDD. For customers who are hemp growers, financial institutions may confirm compliance with state, tribal government or the US Department of Agriculture (USDA) licensing requirements, as applicable, by either obtaining (i) a written attestation by the hemp grower that they are validly licensed, or (ii) a copy of such license. As with any customer, FinCEN expects financial institutions to tailor their BSA/AML (anti-money laundering) programs to reflect the risks associated with a customer’s particular risk profile and file reports required under the BSA. Because hemp is no longer a Schedule I controlled substance under the CSA, financial institutions are not required to file a Suspicious Activity Report on customers solely because they are engaged in the growth or cultivation of hemp in accordance with applicable laws and regulations.  

Hemp/cannabis banking provision in House financial services funding bill. The Financial Services and General Government Appropriations legislation approved by a House Appropriations Subcommittee on July 8 contains a provision protecting financial institutions from being penalized for providing financial services for legal hemp or cannabis businesses. Section 631 of the legislation bars the use of federal funds to penalize a financial services firm “solely because the institution provides financial services to an entity that is a manufacturer, a producer, or a person that participates in any business or organized activity that involves handling hemp, hemp-derived cannabidiol products, other hemp-derived cannabinoid products, marijuana, marijuana products, or marijuana proceeds, and engages in such activity pursuant to a law established by a State, political subdivision of a State, or Indian Tribe.” The legislation must still be approved by the full Appropriations Committee and then the full House. The measure will also require Senate approval and be signed by the president before it becomes law.

If you have any questions regarding these new requirements and their implications, please contact any of the authors or your DLA Piper relationship attorney.

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This information does not, and is not intended to, constitute legal advice. All information, content, and materials are for general informational purposes only. No reader should act, or refrain from acting, with respect to any particular legal matter on the basis of this information without first seeking legal advice from counsel in the relevant jurisdiction.