The New Proposed Mortgage Regulations: One Size Fits All?

New rules coming out of Washington, D.C., will impact the mortgage market and banks big and small. Among them, the Consumer Financial Protection Bureau (CFPB) has proposed rules regarding mortgage disclosures. The agency says it is attempting to simplify and write plain English disclosures for consumers. Comments on the proposals are due Nov 6. In addition, the CFPB will require lenders to make sure a mortgage holder qualifies for a mortgage, or has the ability to repay the loan, creating what’s essentially a series of check boxes for lending departments, as well as restrictions on loan terms.

Because banks both large and small will be required to comply, Bank Director asked attorneys to weigh in on the CFPB’s proposed mortgage regulations.

Should community banks be exempted from the Consumer Financial Protection Bureau’s proposed rules on mortgage disclosure and qualifying mortgages?


Robert-Monroe.jpgYes.  Community banks need to be exempted from the Consumer Financial Protection Bureau’s proposed rules on mortgage disclosure and qualifying mortgages, as community banks have been and are subject to regulatory oversight on mortgage disclosures rules.  There is no need for the CFPB to be involved in the supervision of community banks.  Why do we need two regulators to oversee this issue and many other banking issues when federal bank regulators were adequately doing their jobs?  One major problem that lead to the current crisis revolved around unregulated mortgage originators, not disclosure rules.  Let bankers and their prudential regulators continue with regulatory oversight of mortgage disclosure rules and keep the CFPB out of community banks.

—Bob Monroe, Stinson Morrison Hecker

Peter-Weinstock.jpgFirst, the current proposed definitions of qualified mortgages and qualified residential mortgages will continue the current inequity in the mortgage market.  Essentially, people like me can refinance their mortgage to 3 percent with zero closing costs, while other people who desperately need to refinance cannot qualify.  Thus, there needs to be some overall sanity brought to mortgage regulation.  Beyond that, mortgage regulation needs to cover the entire food chain.  The CFPB can reduce the burden on smaller financial institutions regarding such matters as assessing a customer’s ability to repay a loan.  If the system of regulation mandates a cost structure that only large financial institutions can absorb, then the result will be the unintended (and the CFPB says undesirable) consequence of a market in which only the multi-trillion dollar institutions can participate.

—Peter Weinstock, Hunton & Williams

Jonathan-Wegner.jpgSmall banks are struggling to keep up with the new rules, and already, we’ve seen some small institutions enter into what amounts to mortgage referral relationships with bigger banks that have enough horsepower in their compliance departments to keep up with all of the new rules.  The CFPB needs to implement reasonable accommodations for these smaller institutions.  Otherwise, they may very well regulate these banks out of a fundamental piece of their business.

—Jonathan Wegner, Baird Holm

oliver-ireland.pngRegulatory compliance costs have always fallen more heavily on community banks than on large banking companies because of the smaller volume of transaction over which community banks must distribute compliance costs.  These costs make it more difficult for community banks to compete with larger banks on the basis of price. These considerations argue in favor of exempting community banks from proposed rules on mortgage disclosure and qualifying mortgages. On the other hand, when dealing with consumer protection issues, consumer advocates may argue that it is unfair and confusing to consumers to exempt anyone from consumer protection requirements. Despite these arguments, the presence of unregulated providers in a market provides a point of reference and a practical check on the potential for regulatory requirements to lead to a diminution in, or even unavailability, of key services and should ultimately benefit consumers.

—Oliver Ireland, Morrison Foerster

With the New Focus on the Consumer, the Buck Stops (And Starts) with the Board

stop-start.jpgForward-thinking financial institutions are future-proofing their risk and compliance programs. They are detecting tracking and understanding not only emerging issues, trends and regulatory requirements, but also the next big areas of potential vulnerability. We are hearing from our bank clients that regulatory risk is at the top of the list. While bank directors do not need to be technical compliance experts, they do need to actively oversee compliance management and have an understanding of the changes coming.

Board members can play a central role in the process of re-focusing compliance on what’s important to regulators, and a key trend is a new focus on “fairness” or “impact” to the consumer.  This concept is being led by the Consumer Financial Protection Bureau (CFPB), but quickly accepted by the other agencies. On September 25th the Federal Deposit Insurance Corp. (FDIC) released FIL-41-2012 which “reorients” the consumer examination score to be “based primarily on the impact to consumers.” During regulatory examinations, regulators will evaluate the board’s involvement (or lack thereof) in ensuring that programs are properly articulated and followed.

The Role of the CFPB

The Consumer Financial Protection Bureau has tremendous supervisory and enforcement authority and is already changing the mindset for what compliance means. The CFPB, which examines banks above $10 billion in assets, wants institutions to develop a “culture of compliance,” that focuses more on the risk to the consumer than the potential fines or violations a bank may receive if a violation is found. With the changes in the Dodd-Frank Act to the definition of Unfair, Deceptive, or Abusive Practices (UDAAP), which is now under the domain of the CFPB and applies to all banks and thrifts, it isn’t enough for financial institutions to simply meet regulatory requirements. Now, the way banks relate to customers is important. This dramatically changes the role and responsibilities of not just the compliance department, but of everyone within the bank. In addition, although CFPB is leading this effort, the new FDIC change highlights the need for institutions of all sizes to pay attention to this shift.

There is hope, however, for banks willing to be proactive in addressing the consumer-centric approach.

Culture Change

To be successful, the board needs to embrace an integrated approach to compliance risk management that reflects a consumer-centric viewpoint. This consumer centric approach should be so woven into your business that your employees do not think of it as compliance—instead they look at it as fundamental to their jobs.  This culture needs to promote proactive and forward thinking. In a culture of compliance, the consumer is not the province of a single department, but rather the responsibility of the entire organization.

Compliance Management System

Expect Change. Your compliance program needs to adjust to address the four interdependent parts of the CFPB’s compliance management system, including board and management oversight, compliance program, compliance audit and the enterprise approach to responding and analyzing consumer complaints. The complaint management system may need to be revamped to ensure that management is utilizing the consumer complaint data to understand how products and services impact consumers. In addition to the standard complaint resolution process, your institution will need to ensure they are capturing both written and verbal complaints at all consumer touch points, feeding them into a system that allows for trending analysis, and ultimately changes in processes, supports, controls, and or products.  Don’t forget that your program needs to hold your partners and vendors to the same standards that you hold your own business to.

Consumer Risk Assessments

The first thing the CFPB will do is conduct a compliance risk assessment that evaluates the risks to consumers arising from products, polices, procedures and practices. In preparation, your enterprise risk management and/or compliance risk program needs to be able to identify and respond to risks to the consumer. This risk assessment will likely illuminate risk areas not previously a focus of compliance, raise questions about activities that may currently be considered standard in the industry, and accordingly require changes in operations that staff may resist.

Your systems need to be able to identify risks to both the bank AND to the consumer.  In order to accomplish this, compliance can no longer operate in isolation. Business lines must not only be included, but also assume it is their job to understand the risks to their operations, and have accountability to make the necessary changes within their operations to reduce these risks.

Staff members in different business lines must not only be included, but also assume it is their job to understand the risks to their operations, and have accountability to make the necessary changes within their operations to reduce these risks. To support a change in culture, compliance or risk management cannot be the only areas that the board holds accountable. 

So how do you achieve a culture of compliance, where all employees are held accountable for risk?

The compliance program must change from focusing on past errors and the latest hot topics to evaluating and managing the potential risk to the organization—and to the consumer—generated by both internal and external sources. A forward-thinking organization can identify the next hot issue by proactively evaluating potential risks and adapting compliance programs to mitigate the risks to both the bank and the consumer. The proactive risk-based approach will put you ahead of the new consumer-centric examination approach and ensure the new hot issue doesn’t impact you or your customers.

Groping Toward Mortgage Compensation Rules

cutting-money.jpgRecently the Consumer Financial Protection Bureau (CFPB) issued a set of proposed rules on mortgage loan originations that include restrictions on compensation that will make it difficult for banks to structure bonus plans for their mortgage loan originators.

I wrote about this issue back in May, after the bureau had issued guidance stating that banks are permitted to make contributions to a mortgage loan originator’s 401(k) or some other type of qualified plan out of a profit pool derived from mortgage loan originations. However, the CFPB declined to indicate at the time whether banks could pay bonuses to originators based on the profitability of a pool of mortgage loans as part of a non-qualified incentive compensation plan. The distinction is important because in the case of a qualified plan like a 401(k) we’re talking about an individual’s future retirement income, while with a non-qualified bonus plan we’re talking about cash in their pocket today.

First a little bit of important background. Underlying this issue of mortgage originator bonuses is the focus of federal regulatory agencies—including the CFPB—on so-called compensation risk. During the subprime mortgage boom, originators often received extra compensation if they steered borrowers to higher cost loans, which often meant low-income borrowers paid more for their loans than they should have. The Federal Reserve Board proposed stricter rules on mortgage origination compensation in September 2010 under the Truth in Lending Act. Rulemaking authority for the Act was transferred to the bureau under the Dodd-Frank Act, and now the bureau is finishing what the Fed started.

Mortgage originators aren’t the only bankers impacted by all this attention on compensation risk. Banks are also being forced to change their incentive compensation practices for other kinds of lending activity, including commercial real estate and C&I lending. Generally speaking, the regulators don’t want lenders to be rewarded purely on volume; they want to see bonus payments spread out over a longer period of time than, say, just one quarter; and they want the size of the payout tied to the performance of the underlying loan portfolio over some reasonable period of time so lenders don’t get paid upfront for loans that later go bad. And in the case of mortgage originators, regulators don’t want them to be incentivized to screw their customers by pushing them unwittingly into high cost loans when they would qualify for a cheaper loan.

It was not clear last May whether the CFPB would allow banks to pay its mortgage originators any kind of bonus that wasn’t tied to a qualified plan. “Every bank is trying to do a better job of tying compensation to the profitability of the underlying business,” says Kristine Oliver, vice president at Pearl Meyer & Partners. But the bureau has now issued a proposed rule for non-qualified bonus plans that will make that goal much more difficult. Under the latest proposal, banks may pay employees a bonus derived from a pool of mortgage loans only if three conditions are met:

  • Compensation may not be based on the terms of the loans that were originated, so an employee can’t be rewarded for producing more of one kind of loan versus another.
  • The employee can’t have originated more than five mortgage transactions during the last 12 months.
  • However, if the individual’s transactions exceed five, the bonus pool can based on mortgage revenue limited to 25 or 50 percent of the overall revenue in the pool. The bureau has proposed two percentage cap alternatives, 25 percent and 50 percent.

The proposal does address the concern some people had that branch managers who originate an occasional mortgage might not be allowed to receive a bonus based on the profitability of their branches if the branch’s revenue included, say, points or mortgage origination fees. Now those individuals can receive a bonus even if the branch’s revenue includes some mortgage related revenue.

“The bureau has proposed a diminutive exemption,” says Richard Andreano, Jr., a partner in the Washington, D.C. office of Ballard Spahr LLP. “That would work for [occasional originators] but doesn’t work for someone who does more than five but still doesn’t do a whole lot of originations.” An example might be someone manages a mortgage production office and originates more than five loans a year, but is still a low volume producer compared to their rest of their team, so they don’t qualify for a bonus based on mortgage revenue.

More importantly, the proposed cap on the percentage of mortgage-derived revenue that can be included in a bonus or profit-sharing plan will make it impossible for banks to structure incentive compensation plans that will reward their originators solely on the profitability of their business. To get around the cap, banks will have to enlarge the categories of revenue that bonus payments are based on to include other kinds of loans in the mix. That would make it more of a company-wide incentive plan—especially if the cap is as low as 25 percent—which might be what the regulators prefer, but could be a less powerful incentive than a plan where mortgage originators were the only participants.

“That’s where the bureau wasn’t willing to go,” says Andreano.

Banks and other financial services companies that are impacted by the proposed rules have until Oct. 16 to submit their comments to the CFPB. Dodd-Frank requires the bureau to adopt final mortgage originator rules by Jan. 21, 2013, so banks should expect a final rule by then. Unfortunately, as Oliver points out, “People are starting to pull together their incentive plans for 2013,” so any assumptions they make now—like, for example, will the allowable cap be 25 percent or 50 percent—could be subject to change.

Dodd-Frank Round-Up: Where We Are and What Needs to Be Done

future-signs.jpgIt’s been two years since the Dodd-Frank Act was passed, and regulators have published 8,800 pages of regulations ironing out the details of the law. Many rules still have not been written, leaving huge portions of the Act in limbo. This article takes a look at the status of major pieces of the legislation with an eye towards the impact on commercial banks and the banking system.


About: The recent financial crisis highlighted risks taken by individual companies in a highly interconnected financial sector. Dodd-Frank established a framework for monitoring and regulating this systemic risk. 

Past Developments: The newly created Financial Services Oversight Council released its final rule for designating nonbank systemically important institutions. The top banking firms recently released their “living wills,” or plans to unwind themselves in the event of failure without government or taxpayer assistance. 

Future Developments: The Federal Reserve will finalize capital requirements for large institutions as well as the specific rules for implementation of Basel III, an international agreement that strengthens capital requirements and adds new regulations on bank liquidity and leverage.

—From: Weil, Gotshal & Manges LLP, “The Dodd-Frank Act: Two Years Later,”  For access to their full report, click here.



About:  The Durbin Amendment part of Dodd-Frank, which caps debit card interchange fees for banks above $10 billion in assets, has likely had the greatest immediate impact on the banking industry, as it went into effect in October of last year.

Past Developments:  The impact on banking revenues has been swift. The industry reported a $1.44 billion loss of revenue in the fourth quarter of 2011, resulting in an annualized $5.75 billion loss if this pattern holds, according to Novantas LLC, a New York City-based consulting firm.

Future Developments:  It is still uncertain whether banks under $10 billion in assets will be able to charge more for debit card interchange than bigger banks in the long term, but so far, the smaller banks haven’t reported a loss of income in aggregate.


About: Dodd-Frank requires institutions to show that their incentive arrangements are consistently safe and do not expose their firms to imprudent risk. 

Past Developments: The Securities and Exchange Commission implemented rules last year requiring publicly traded companies to take advisory shareholders votes on executive compensation, also known as “say on pay.” It also implemented rules on the independence of compensation committees and compensation advisors, as well as on “golden parachute” payments to executives.

Future Developments: Dodd-Frank included a provision that instructed agencies to issue guidelines on incentive compensation. Although proposed more than a year ago, they have not been finalized.

—From the Securities and Exchange Commission and Deloitte LLP’s “Dodd-Frank Act Two-Year Anniversary: Seven Takeaways on Dodd-Frank’s Impact on Compensation.”  For access to their full report, click here.


About:  The CFPB is the first federal agency focused solely on consumer financial protection, and it holds responsibilities previously managed by several other regulators.  The CFPB has examination authority over banks, thrifts and credit unions with $10 billion or more in assets, as well as some large nonbank financial service companies that previously escaped federal regulation, such as payday lenders.

Past Developments: With a new director in place, the CFPB has not simply been implementing rules it inherited from other regulators, but promulgating many new, substantive rules. 

Future Developments: Further rulemaking may help illuminate the meaning of “unfair, deceptive and abusive” acts and practices, which the CFPB is tasked with eliminating, especially in the context of mortgage servicing and origination. New mortgage disclosure documents are in the process of being finalized.

—From Weil, Gotshal & Manges LLP,  “The Dodd-Frank Act:Two Years Later.”  For access to their full report, click here.


About: Dodd-Frank amends the residential mortgage portions of several federal housing statutes. Among other things, mortgage originators now owe a duty of care to borrowers.  

Past Developments: Creditors are now required to make a reasonable and good faith determination that a consumer has a reasonable ability to repay a residential mortgage.

Future Developments: The CFPB is considering rules to implement provisions of Dodd-Frank that would address mortgage loan originator qualifications and compensation. 

—From Morrison & Foerster’s “Dodd-Frank at Two.”  For access to the full report, click here.


About:  The Dodd-Frank Act is designed to provide a comprehensive framework for the regulation of the over-the-counter derivatives market to provide greater transparency and reduce risk between counterparties.

Past Developments: The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have both been missing statutory deadlines.

Future Developments: It is yet to be determined specifically how these provisions will be applied across borders and to what extent they will cover U.S. operations of foreign firms. 

—From Deloitte LLP’s “Dodd-Frank Act Two-Year Anniversary: Five Takeaways on Dodd-Frank’s Impact on Derivatives.”  For access to their full report, click here.


About: The Volcker rule prohibits banks and bank holding companies from engaging in proprietary trading or owning private equity and hedge funds, with some exceptions. It is considered one of the most controversial aspects of Dodd-Frank.

Past Developments: The Fed, FDIC, OCC, and SEC jointly issued the proposed rule, which further defined key terms such as “banking entity,” “proprietary trading,” and “covered fund,” as well as outlining exceptions to the rule’s prohibitions.  If proposed in its present form, many investment products having nothing to do with private equity or hedge funds will be prohibited.

Future Developments: Lawmakers and regulators are pushing for the final rule by the end of the year, but affected financial institutions will have until at least July 21, 2012 to conform to the rule.

—From Weil, Gotshal & Manges LLP, “The Dodd-Frank Act: Two Years Later.”  For access to their full report, click here.


 About: Based on “lessons learned” from the financial crisis, regulators are examining more critically the quality of capital held by U.S. banking organizations as well as credit risks. 

Past Developments: In early June 2012, the U.S. banking agencies published for comment a series of three regulatory capital rulemakings in accordance with the international Basel III agreement, two of which would substantially revise the current regulatory framework. Comments on the proposals are due September 7.

Future Developments: Many of the new capital guidelines and rules haven’t gone into effect and will be gradually phased in over a period of a year or up to a decade, depending on the size of the bank and the rule.

—From Morrison & Foerster’s “Dodd-Frank at Two.”  For access to their full report, click here.

Dodd-Frank Enters Its Terrible Twos

two-yrs-old.jpgI’ve been writing about the banking and financial services industry since the mid-1980s and during that time, only the Federal Deposit Insurance Improvement Act of 1991, which was enacted after an earlier banking crisis, and the Sarbanes-Oxley Act of 2002, which was a byproduct of corporate accounting scandals such as Enron, come close. But those reform laws were much narrower in their focus, and much less ambitious. I don’t believe that even the Glass-Steagall Act of 1933, the historic Depression-era law that separated commercial and investment banking, was nearly as broad in scope as Dodd-Frank, although banking and the capital markets in the 1930s obviously weren’t as large and sophisticated as they are today.

And that might be why the federal regulatory agencies that were tasked to write nearly 250 new rules have fallen well off the pace that Congress set for them when it passed Dodd-Frank. According to a recent analysis by the Davis Polk law firm, approximately 63 percent of the required rules whose deadlines have passed have either not been proposed or not finalized. “The deadlines were always ridiculously unrealistic, which is something I tried to say at the time,” says former Comptroller of the Currency John Dugan, now a law partner at Covington & Burling in Washington.

“Some of the regulatory agencies just don’t have the staff resources” that are required to write a blizzard of new rules, adds Brian Gardner, senior vice president for Washington research at the investment banking firm Keefe, Bruyette & Woods. Gardner says that in particular the Commodity Futures Trading Commission has struggled to write new rules for how the derivatives market will be regulated going forward, although it has made progress.

Dugan, who finished his five-year tenure at the Office of the Comptroller of the Currency just three weeks after President Barack Obama signed Dodd-Frank into law, believes its greatest impact has been the Durbin Amendment—which allows the Federal Reserve to regulate the amount of debit card interchange fees that banks may charge—and the establishment of the Consumer Financial Protection Bureau (CFPB).

I would concur with Dugan’s assessment. According to the consulting firm Novantas LLC, Durbin-inspired restrictions on debit card income will cost the industry upwards of $5.75 billion in annualized revenue—and this at a time when many banks are struggling to grow their top lines because of poor loan demand. And by creating the CFPB, Congress established a new regulatory regime for the consumer financial services marketplace. This new regulator, which I wrote about in our second quarter issue, potentially could have an enormous impact on the banking industry over time.

Interestingly, Gardner says the bureau has moved more slowly to exercise its enforcement and rule making authority than he would have expected at the two year mark. He also believes the presidential election could have a significant impact on the bureau’s future. You’ll recall that CFPB Director Richard Cordray received a recess appointment from Obama when Senate Republicans blocked his confirmation over their displeasure with how the bureau was structured.  Should Obama lose to Mitt Romney and the Republicans also take control of the Senate, a President Romney would be able to appoint a director more to his liking—presumably, one less inclined to meddle in the industry’s business. “You could see the bureau taking a different direction,” Gardner says.

There is still a lot of work ahead for all those beleaguered federal regulators, including the writing of the hotly debated Volcker Rule—which would severely restrict the proprietary trading activities of commercial banks. Also yet to be finalized or in some cases even proposed are new rules on securitization, new capital requirements for banks and several very important initiatives in the mortgage area. The CFPB has been tasked by Dodd-Frank to develop a qualified means test to determine whether a borrower has the ability to repay a loan. A group of federal regulators has also been working on a new risk retention rule that would require lenders to retain 5 percent of the loans they sell into the securitization market, although an initial proposal would have exempted securitizations made up of qualified mortgage, commercial or auto loans from the requirement. These rules have not been finalized yet and until they are, mortgage originators who sell their loans to third parties that securitize them won’t know how much capital (if any) they will have to set aside to meet the requirement.

The House Committee on Financial Services will be holding hearings this week on Dodd-Frank, and if you didn’t already know how House Republicans feel about it, all you have to do is go to the committee’s website (, where you’ll see a full throated attack on the law. Repealing Dodd-Frank is a dream that many Congressional Republicans have, but that’s as unlikely as the country going back on the gold standard. Even if Romney beats Obama and Republicans hold the House and regain the Senate, Congressional Democrats might still have enough strength to frustrate their plans. “I think it would be very difficult to get a full repeal of Dodd-Frank,” says Dugan.

And that means, like it or not, the most detested financial reform law of all time will probably be around to celebrate many more birthdays. 

Debate: How Will the CFPB Impact Banks?

As the Consumer Financial Protection Bureau gets underway, compiling data and taking complaints, there is still a large amount of uncertainty about the impact on banks. Although technically only supervising banks with more than $10 billion in assets, the ripple effect in this industry is what worries smaller banks. We asked legal experts in the field what they thought the most immediate effect would be for banks. Many lawyers believe the CFPB will impact banks in a big way, and may reduce lending and the availability of credit across the board. 

What is the most immediate effect that the Consumer Financial Protection Bureau will have on banks?

geiringer.jpgThe most immediate effect that the CFPB will have for banks over the $10 billion threshold is that their compliance examinations will now be conducted by an agency whose mission is based solely on consumer protection.  For banks under the $10-billion asset threshold, the primary potential impact is that the CFPB will promulgate consumer protection regulations for these smaller banks, even though it will not generally examine them.  This may create a disconnect in the CFPB’s understanding of smaller institutions and exacerbate the current one-size-fits-all compliance approach about which community banks have expressed concern.  In addition, all banks should be prepared to respond to postings on the CFPB’s website, which prominently invites the public to “submit a complaint” about their financial institutions.

—John Geiringer, Barack Ferrazzano Kirschbaum & Nagelberg LLP

charles_washburn.jpgBanks and other insured depository institutions with total assets of more than $10 billion and their affiliates are serving as guinea pigs as the CFPB develops its examination staff, standards and procedures. Banks that have gone or are currently going through CFPB compliance examinations have reported that the experience is very challenging. Accordingly, large banks need to double check the effectiveness of their compliance function before the CFPB comes calling.

—Chuck Washburn, Manatt, Phelps & Phillips, LLP

John-Gorman.jpgThe cost and compliance burden [of the new CFPB] will put a damper on consumer lending, but it will be more pronounced with respect to banks with assets in excess of $10 billion.  It is already happening.  Almost by necessity, the CFPB is taking or will take a one-size-fits-all approach to regulation, such that the problems associated with the worst and least regulated entities are presumed to be the industry norm, and all participants’ conduct will have to comport with a regulatory reaction that is based on the lowest common denominator.  When the CFPB issues rulemaking, the bank regulators, who will police the conduct of the under-$10-billion banks, will not want to be viewed as lax enforcers.  The cost and risk of lending will increase for all banks.  That will result is less lending.

– John Gorman, Luse Gorman Pomerenk & Schick, PC 

Mark-Chorazak.jpgWith uncertainty over how the Bureau’s approach to supervision and enforcement and its priorities will evolve during the next several years, an important task for banks, regardless of asset size, has been to establish good working relationships with Bureau staff. For larger banks with assets over $10 billion, such relationship building is critical in light of the Bureau’s exclusive examination authority and primary enforcement authority for compliance with federal consumer financial laws. However, smaller banks with assets of less than $10 billion also have an incentive to build a solid reputation with Bureau staff. Although it has no examination and enforcement authority over smaller banks, the Bureau may participate in examinations conducted by the prudential banking regulators (“on a sampling basis”), refer enforcement actions and require reports from these institutions.

—Mark Chorazak, Simpson Thacher & Bartlett LLP

Peter-Weinstock.jpgRegardless of whether the Consumer Financial Protection Bureau (“CFPB”) has supervisory authority over a financial institution or not, its presence, seemingly atop the regulatory pantheon, will mean increased costs on financial institutions and reduced availability of credit.  It is too early to say how the CFPB will maintain a balance between regulation and cost of compliance, on one hand, and availability of reasonably priced credit, on the other hand.  Recent indications do not look good for financial institutions or credit availability.  A classic example is the CFPB’s statements regarding unfair, deceptive, abusive acts and practices (UDAAP).  The CFPB has indicated that a financial institution needs to evaluate whether a proposed customer, such as an elderly customer, understands all of a product’s terms.  The consequences for financial institutions that are out of compliance with issues such as UDAAP are quite severe.  Financial institutions will err on the side of not making certain loans, rather than expose themselves to losses.

– Peter Weinstock, Hunton & Williams, LLP

John-ReVeal.jpgBanks with more than $10 billion in assets also are already undergoing CFPB compliance examinations.  Even those banks that believed they were fully prepared have been surprised by the scope and duration of these examinations.  The pre-examination information requests alone often exceed in scope what bankers would face in an entire examination cycle that included all aspects of compliance and safety and soundness. Banks with less than $10 billion [in assets] are not subject to the direct compliance examination authority of the CFPB, but will still incur significant costs.  First, the CFPB has the primary responsibility for developing and implementing new consumer protection regulations.  These costs will come in the future, but banks of all sizes will need to contend with these new regulations. 

—John ReVeal, Bryan Cave

What Bank Audit Committee Members Should Focus on Now

out-to-sea.jpgRobert Fleetwood is part of the financial institutions group and is the head of the group’s securities law practice area at law firm Barack Ferrazzano Kirschbaum & Nagelberg LLP in Chicago. Here, he talks about the increasing demands for capital and the trickle down impact of the Dodd-Frank Act, topics for the upcoming Bank Audit Committee Conference in June.

What are the kinds of questions you think audit committee members should be thinking about?

Many of our clients, particularly our private community banks, have recently been asking: “Where will we be in five years? What do we need to be thinking about?” With today’s regulatory environment, signs of recovery in the general economy and continued advances in technology, these are critical questions that all directors should be asking. I will be participating in a peer breakout focused on community banks at Bank Director’s upcoming Bank Audit Committee Conference to discuss some important issues for audit committee members.  Capital is of particular importance for all banks and I will discuss potential future capital requirements and what institutions can be doing now. I will address the role of the audit committee in risk management and the emergence of full risk committees. I will also talk about the mergers and acquisitions process and what all organizations should consider, whether or not they may participate in an M&A transaction.

Two of my partners will also speak at the conference. Joseph Ceithaml will participate in a breakout session regarding best practices that audit committees should consider to improve performance and will touch on topics including committee responsibilities, charters, the agenda-setting process, communication between meetings and committee membership. Additionally, John Geiringer will speak on some important regulatory issues, including recent Federal Deposit Insurance Corp. lawsuits and what boards of banks can learn from them to improve their practices.  

Will regulators require higher levels of capital in the future? How can community organizations access capital?

There continues to be debate about whether capital is king to a financial institution’s health and well-being, or whether other factors, such as liquidity, are actually more important. Regardless of one’s viewpoint, it is clear that regulators and investors place a heavy emphasis on capital levels and that this will continue into the future. Basel III, Dodd-Frank and the unquantified “regulatory expectation” will shape what future capital requirements will be for all institutions, regardless of size. Not only are higher capital levels expected, but the components of capital will also change, with a clear bias toward more permanent common equity. A key question for community banks is whether they will need to raise additional capital to implement their strategic plans and, if so, how will they raise the necessary amount. Many community banks have relied on directors and existing shareholders for additional capital. Changes to the private placement rules included in the recently adopted Jumpstart Our Business Startups Act (the JOBS Act) may make it easier for banks to solicit others in their community for additional capital.

Will Dodd-Frank have a significant impact on community banks? What do audit committee members need to know?

The Dodd-Frank Act has certainly played a significant role in financial institutions’ strategic planning over the past two years. However, there is still uncertainty over Dodd-Frank, with many questioning how it will be completely implemented and affect community financial institutions. There is also the potential impact of the upcoming elections and events outside the U.S. financial services industry. Almost two years after the enactment of Dodd-Frank, about 75 percent of the required rulemaking has yet to be completed. Of the rules that have been completed, only about half have become effective.  Over the last six months, regulatory agencies have begun to promulgate some of the major systemic risk rules that primarily affect the largest financial institutions. Many of the controversial proposals that attract most of the media attention are geared toward these larger institutions, including the Volcker Rule, capital stress testing and the preparation of the so-called institutional “living wills.” 

Many of the rules that will ultimately be developed under the Act will likely have a trickle-down effect on smaller institutions, either through actual regulation or prudential supervisory guidance. Additionally, regulators are currently focused on consumer compliance issues, with the new Consumer Financial Protection Bureau leading the way, and many of those rules are becoming more subjective in nature, making monitoring and ensuring compliance more difficult. With all of this uncertainty, all directors, including audit committee members, will need to closely monitor regulatory developments and continue to plan for increased regulatory and compliance costs. 

Confusion Reigns on Mortgage Compensation

lost.jpgYou probably thought the Consumer Financial Protection Bureau (CFPB) was just focused on, well, consumer protection, but the new agency has an important voice on certain compensation matters as well. And the beleaguered home mortgage industry, which really doesn’t need any more challenges right now, is waiting on the bureau to clarify whether mortgage loan origination compensation rules—first adopted by the Federal Reserve Board in September 2010 under Regulation Z—prevents the payment of performance bonuses to mortgage loan originators (or, to lapse into industry jargon, MLOs) as part of a non-qualified incentive compensation plan.

Rulemaking authority for Regulation Z, otherwise known as the Truth in Lending Act, was transferred to the CFPB by the Dodd-Frank Act, and in December 2011 the bureau issued interim final rules that recodified the Fed’s earlier restrictions on mortgage loan origination compensation. On the face of it, those restrictions were fairly straightforward. “Subject to certain narrow restrictions, the Compensation Rules provide that no loan originator may receive (and no person may pay to a loan originator), directly or indirectly, compensation that is based on any terms or conditions of a mortgage transaction,” according to CFPB Bulletin 2012-02, released on April 2 of this year.

In an official staff commentary issued by the Fed shortly after the rule was adopted, compensation was defined to include salaries, commissions and annual or periodic bonuses. Terms and conditions were deemed to include a loan’s interest rate, loan-to-value ratio or prepayment penalty.

I suppose it makes sense in our hyper-regulated world that the CFPB’s consumer protection authority would extend to MLO compensation because one of the more pernicious industry practices is steering, where borrowers—often low income people with poor credit histories—are unknowingly directed toward a more expensive mortgage that provides higher compensation to the originator than a cheaper loan.

Rod Alba, vice president and senior regulatory counsel at the American Bankers Association in Washington, says that up to this point the Fed’s commentary—including its amplification of “compensation” and “terms and conditions”­­—was easy enough to understand. But the commentary also stated that MLO compensation may not be based on a “proxy” for a term and condition. The CFPB bulletin explained it thusly: “[C]ompensation may not be based on a factor that is a proxy for a term and condition, such as a credit score, when the factor is based on a term and condition such as the interest rate on a loan.”

For Alba and others, that statement leaves too much to the imagination. “What the hell is a proxy?” he asks. “Well, a proxy is anything that would stand in the place of a term and condition. The problem with that is no one knows what it means. It was brought up in the commentary to the rule, not in the rule itself.”

More specifically, it’s unclear how banks can structure an incentive compensation program for their MLOs that won’t end up violating the rule. Alba worries that that any plan based on a profitability metric—whether it’s the profitability of a mortgage operation or even the bank itself—could run afoul of the rule if profitability is later judged to be an impermissible proxy. The regulatory rationale, I suppose, is that MLOs might still be tempted to engage in abusive practices like steering if they stand to gain under a performance-driven bonus plan that benefits the entire bank.

“Performance-based bonuses do fall into [the] proxy [definition] because the bonuses are derived from the loans,” Alba says. “That means [performance-based] bonuses are gone.”

“When they inherited this [from the Fed], the bureau didn’t clarify it,” adds Alba. “This rule is a mess!”

The CFPB has tried to provide some clarity about the compensation rule. In Bulletin 2012-02, the bureau states that banks “may make contributions to qualified plans like for loan originators out of a pool of profits derived from loans originated by employees under the Compensation Rules.” This would include 401(k) plans, which are the primary retirement programs for most employees today.

However, the bulletin did not provide guidance about how the rules apply to non-qualified plans like the ones that Alba is worried about.

Another confusing issue is the definition of an MLO. Is it someone who underwrites home loans? Or would the MLO designation also apply to, say, a branch manager who referred the borrower to an underwriter and might have played some role in negotiating the loan? If the latter turns out to be the case, then they would also fall under the rules and might not be eligible for a bonus paid out by a non-qualified plan.

Susan O’Donnell, a managing director at New York-based Pearl Meyer & Associates, relates the case of a client bank whose CEO might not be eligible to receive a bonus based on the bank’s performance because he has a license to originate loans and thus could be considered an MLO.

“If you fall into that category, then you can’t participate in any program that is tied to the profitability of the bank,” O’Donnell says.

How soon this mess gets cleaned up is anyone’s guess. In Bulletin 2012-02, the bureau points out that Dodd-Frank contains a provision that also deals with mortgage origination compensation and it must adopt a final rule to satisfy that requirement by Jan. 21, 2013. The bureau anticipates providing “greater clarity on these arrangements” in connection with that effort. But does that mean banks will be operating in the dark in terms of their MLO incentive compensation plans until next January? We don’t know.

The CFPB did not respond to an interview request on the matter. Neither did the Office of the Comptroller of the Currency, which along with the Federal Deposit Insurance Corp. (FDIC), has enforcement authority for Regulation Z at banks under $10 billion in assets. A spokesman for the FDIC declined to make an agency official available for an interview, but he did send along a Financial Institution Letter—FIL-20-2012—that was sent out to FDIC-supervised banks on April 17, 2012.

The FDIC’s letter framed the issue in pretty much the same fashion as the CFPB bulletin, and acknowledged that the CFPB has yet to provide any guidance about non-qualified incentive compensation plans for MLOs.

The letter concluded with this vague statement, which was probably meant to clarify the FDIC’s own enforcement perspective on MLO bonus plans, but probably didn’t clarify anything: “FDIC Compliance Examiners will review institution compensation programs in light of the Compensation Rules, and consider the specific facts of the institution’s compensation program, the totality of the circumstances at each financial institution, and the institution’s efforts to comply with the Compensation Rules.”

Hmmm… Good luck bankers!

Fairness to Consumers Is the New Emphasis in Banking Regulation

Get ready. Even small banks and thrifts are going to be affected by a post-crisis shift in regulation toward what’s fair and transparent to consumers, says Tim Burniston, until recently a senior associate director with the Federal Reserve Board’s Division of Consumer and Community Affairs. In that position he was detailed to the Consumer Financial Protection Bureau (CFPB) to develop its large depository institution supervision program. He now heads the consulting practice at Wolters Kluwer Financial Services.

What will be the impact of the new CFPB?

This is an agency that has unprecedented reach, authority and concentration of power. It has not only supervision responsibility for depository institutions with assets above $10 billion and their affiliates, and nonbank institutions, but rulemaking responsibilities transferred to it for 18 federal statutes, including the Truth in Lending Act and the Equal Credit Opportunity Act. It has enforcement powers for addressing wrongdoing by those who violate regulations and it acts on consumer complaints. Among other things, the CFPB has the authority to write rules that prohibit abusive practices, which are forbidden by the Dodd-Frank Act.

How is this creating a new tone for supervision?

Fairness is really the lens through which the CFPB will likely look at practices and processes across an institution’s product and services life cycle. The agency is focusing on the concept of risk to consumers. That represents a big departure from what banks have been used to, where the emphasis was traditionally placed on risk to the bank itself.

How will this change the exam process?

The CFPB has a responsibility to ensure that institutions follow the laws, so there is a technical compliance element to their work, but they are also looking at supervision from a consumer risk perspective. The CFPB has stated that the goal of its large bank supervision program is to “prevent harm to consumers from unlawful financial practices and ensure that markets for consumer financial products and services are fair, transparent and competitive.”

What specifically is the CFPB interested in regulating?

CFPB’s charge is quite broad, and I am not surprised by what it has shown an interest in so far. They did a town hall meeting on payday lending. They did another on checking accounts and just launched an inquiry into overdraft programs with a focus on order processing, marketing, misleading information and customer demographics. They released mortgage servicing and origination examination procedures. They issued a proposal on remittances. We see them starting to take a look at issues that consumer advocates have raised questions about during the last few years. The regulation of non-depository companies, which includes payday lenders and debt collectors, is challenging. These entities largely have not been subject to routine federal supervision in the past. The CFPB’s nonbank supervision program in accordance with Dodd-Frank is risk-based, which means it will concentrate on those entities that pose the greatest risks to consumers. To regularly examine every one of them would require huge numbers of staff.

How will the CFPB impact banks below $10 billion?

Although there is a growing recognition and empathy for the regulatory burdens faced by smaller institutions, there is also the reality that the CFPB will have influence in the supervisory and regulatory community. It is a part of the Federal Financial Institutions Examination Council, which is a body that tries to promote uniformity in the exam process, and the CFPB director sits on the Federal Deposit Insurance Corp. (FDIC) board as well. The CFPB’s voice will be heard in those agencies.

How can bank directors monitor management’s progress in addressing these changes?

No one is expecting directors to be technical compliance experts, but it’s important for directors to be aware of, and to understand, what the hot button issues are so they can ask good questions of management and ask what steps the institution is putting in place to address those issues. One place for the board to start is with questions about how the supervisory emphasis on fairness and transparency could affect their institution.

But if you’re less than a $10-billion asset institution, should you still be preparing for an exam where fairness to consumers is emphasized?

Yes. I think that fairness in how consumers are treated will continue to be prominent in the post-crisis supervisory environment. In addition to the CFPB, over a year ago, the FDIC re-established a dedicated consumer protection division. They had merged their former compliance division within the safety and soundness group in 2002 and have now broken it back out again. That’s a good example of how this is not just about the CFPB and not just about big banks.

CFPB’s New Director Promises to View Community Banks Differently

richard-corday.jpgThe new director of the Consumer Financial Protection Bureau sent out a peace offering to a crowd of community bankers last week, many of whom are nervous about the prospects of the new, consumer-friendly federal agency that will regulate the financial marketplace.

“Community banks simply did not cause the financial crisis,’’ said Richard Cordray at the Independent Community Bankers of America National Convention and Techworld in Nashville. “So as we work to clean up the mess that the crisis created, we must be mindful of the fact that community banks were among those most harmed by the mortgage frenzy, the ensuing credit crunch and the deep recession that cratered our local economies.”

The agency’s new rules can and will impact community banks, but the agency will conduct examinations only of non-bank financial companies and banks above $10 billion in assets.

Cordray said his agency will take into account how community banks work and their input when devising rules for the financial industry. He said that his agency has gotten 30,000 comments on proposed mortgage disclosure forms.

“One of our most important rulemaking will implement a new statutory requirement that lenders make a good faith and reasonable determination that a borrower can repay the mortgage,’’ he said, adding that he says community bankers have always done that.

“When the world went mad all around us, you did not stray,’’ he said.

He said the goal is to ensure that consumers are not steered into loans they cannot afford. Other provisions will impact mortgage servicing, including new disclosure requirements, force-placed insurance, and how payments are credited to a consumer’s account.

“Here, our principal is the fair treatment of borrowers,’’ he said. “Where it makes sense to treat community banks different from other institutions, we have pledged to consider doing so.”

He also asked bankers to report abuses in the industry to his agency, including wrongdoing among non-bank lenders, whom he said robbed community bankers of market share preceding the financial crisis.

“Where do you see corners being cut? Where do you see standards being bent or stretched? Where do you see the law being violated?” he said.

A few bankers attending the meeting said they were encouraged by his words, but wanted to see the CFPB in action before forming an opinion.

“It’s a matter of translating his words into a culture,’’ said George Guarini, president and CEO of Bay Commercial Bank in Walnut Creek, California, which has more than $270 million in assets. “It’s good that he had his staff listening in [to the speech]. I buy his vision but it’s a matter of translating that to action.”

Others were worried about the CFPB investigating complaints against banks submitted directly to the federal agency.

The CFPB encourages people on its web site to submit complaints against banks and private student lenders. It also asks for complaints about checking accounts. The agency promises to follow up by contacting the financial institution for a response.

“It’s an atom bomb,’’ said Tom Clifford, president and chief credit officer for First Community Bank of Bedford County, a $315-million asset bank in Shelbyville, Tennessee.

The CFPB also has launched an “inquiry” into overdraft practices.

“We are also seeking public feedback on a sample “penalty fee box” that could appear prominently on the checking account statements of consumers who overdraw their accounts,’’ and would highlight the fees that customer paid in penalties, Cordray said in a speech last month on the topic.