Nutter Bank Report: June 2020

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  1. Federal Regulators Ease Restrictions on Volcker Rule Covered Funds
  2. FDIC Rule Codifies the “Valid When Made” Doctrine for Transferred Loans
  3. Examiners Receive Guidance on Effects of the COVID-19 Pandemic
  4. FDIC to Offset Insurance Assessment Effects of COVID-19 Programs
  5. Other Developments: Federal Preemption and Main Street Lending Program

1. Federal Regulators Ease Restrictions on Volcker Rule Covered Funds 

The federal banking agencies, along with the SEC and the CFTC, have issued a final rule to amend the regulations that implement Section 13 of the Bank Holding Company Act, also known as the Volcker Rule, which generally prohibits a banking entity from engaging in proprietary trading or from acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with, a hedge fund or private equity fund (each a “covered fund”). The final rule issued on June 25 is intended to address compliance uncertainty and relax limits on certain banking services and activities that the covered fund provisions of the Volcker Rule were not intended to restrict, according to the agencies. For example, the final rule modifies the Volcker Rule by permitting certain low-risk transactions (such as intraday credit and payment, clearing, and settlement transactions) between a banking entity and covered funds for which the banking entity serves as investment adviser or sponsor. According to the agencies, this change is meant to give banking entities greater flexibility to provide custody and other traditional financial services to a related covered fund, rather than requiring such services to be provided by an unaffiliated service provider. The final rule also permits banking entities to invest in or sponsor several additional types of funds that that the agencies have determined do not raise the concerns that the Volcker Rule was intended to address, such as credit funds, venture capital funds, customer facilitation funds, and family wealth management vehicles. The final rule will become effective on October 1, 2020. Click here for a copy of the final rule.

Nutter Notes: The final rule clarifies certain ambiguities in the Volcker Rule related to transactions between a banking entity and a related covered fund that would be a “covered transaction” under Section 23A of the Federal Reserve Act. For example, the final rule authorizes banking entities to engage in certain limited transactions with related covered funds that would be exempt from the quantitative limits, collateral requirements, and low-quality asset prohibitions under Section 23A, provided that such transactions meet the criteria specified in the Federal Reserve’s Regulation W. The final rule also permits a banking entity to provide short-term extensions of credit to, and to purchase assets from, a related covered fund, subject to certain limits. The final rule requires that each short-term extension of credit or purchase of assets must be made in the ordinary course of business in connection with payment transactions, securities, derivatives or futures clearing, or settlement services. The final rule also requires that each extension of credit must be repaid, sold, or terminated no later than five business days after it was originated. In addition, the final rule expressly provides that a banking entity may enter into certain riskless principal transactions with a related covered fund.

2. FDIC Rule Codifies the “Valid When Made” Doctrine for Transferred Loans

The FDIC has issued a final regulation to codify its longstanding “valid when made” doctrine that the valid interest rate on a loan is determined when the loan is made, and that any subsequent transfer of the loan will not affect the validity of the interest rate. The final rule announced on June 25 is a response to the 2015 decision of the United States Court of Appeals for the Second Circuit in Madden v. Midland Funding, LLC, which called into question the enforceability of the interest rate terms of loan agreements following a bank’s sale or assignment of a loan to a non-bank. The final rule provides that whether the interest rate on a loan is permissible is determined at the time the loan is made, and the validity of the interest rate on a loan is not affected by a change in state law, a change in the relevant commercial paper rate, or the sale, assignment, or other transfer of the loan. Under the final rule, when a state-chartered bank maintains a branch in a state (the “host state”) that is not the state in which the bank is chartered, the laws of the host state apply to the branch of the out-of-state bank to the same extent as such state laws apply to a branch in the host state of an out-of-state national bank. The FDIC’s final rule is substantially similar to a final rule issued by the OCC on May 29, 2020, that applies to national banks. The final rule will become effective 30 days after it is published in the Federal Register, which is expected shortly. Click here for a copy of the FDIC’s final rule.

Nutter Notes: The final rule also implements Section 27 of the Federal Deposit Insurance Act, which provides that a state-chartered bank may charge interest at the maximum rate permitted by the state in which the bank is located, or 1% in excess of the 90-day commercial paper rate, whichever is greater. Section 27 does not state at what point in time the validity of an interest rate should be determined in order to assess whether a state-chartered bank is receiving interest in accordance with Section 27. For example, the usury laws of the state where the bank is located could change after a loan is made, and the loan’s interest rate could be non-usurious under the old law but usurious under the new law. In addition, although Section 27 gives a state-chartered bank the right to make loans at the interest rate permitted by the bank’s home state, Section 27 does not explicitly give the bank the right to transfer the loan at that rate. According to the FDIC, the final rule resolves marketplace uncertainty about the enforceability of the interest rate terms of a loan made by a bank when the bank transfers the loan to a non-bank, which results from the ambiguities in Section 27 and the Madden ruling. In issuing the final rule, the FDIC said that the Madden ruling also has resulted in decreased credit availability for borrowers with lower credit scores.

3. Examiners Receive Guidance on Effects of the COVID-19 Pandemic

The federal banking agencies, along with the NCUA and the state bank and credit union regulators, have jointly issued guidance on the supervision and examination of depository institutions affected by the COVID-19 pandemic. According to the guidance released on June 23, federal and state examiners are instructed to consider the “unique, evolving, and potentially long-term nature of the issues confronting institutions and exercise appropriate flexibility in their supervisory response.” According to the guidance, examiners are expected to consider whether a depository institution’s management has taken appropriate actions in response to stresses caused by the COVID-19 pandemic. Examiners are also instructed by the guidance not to subject a depository institution to criticism or other supervisory action for appropriate actions taken by institutions in good faith reliance on the various policy statements issued by the agencies in connection with the COVID-19 pandemic. Click here for a copy of the interagency guidance.

Nutter Notes: The Massachusetts Division of Banks on June 23 published supplemental guidance to the interagency guidance that provides additional details about the Division’s expectations for Massachusetts-chartered depository institutions in responding to the COVID-19 pandemic and institutions’ interactions with examiners. According to the supplemental guidance, the Division’s examiners “will continue operating primarily off-site for the foreseeable future,” and institutions should be prepared for examinations to take longer than usual as a result. The supplemental guidance emphasizes the importance of risk scoping to ensure that each safety and soundness examination is conducted as efficiently as possible. The supplemental guidance also advises that risk assessment will include a discussion of the institution’s response to the government programs and regulatory relief guidance introduced in response to the COVID-19 pandemic, and that each institution should describe the impact of these programs on its operations. Click here for a copy of the Division’s supplemental examination guidance.

4. FDIC to Offset Insurance Assessment Effects of COVID-19 Programs

The FDIC has approved a final rule that mitigates the deposit insurance assessment effects of participating in the Paycheck Protection Program (“PPP”) established by the U.S. Small Business Administration (“SBA”), and the Paycheck Protection Program Liquidity Facility (“PPPLF”) and Money Market Mutual Fund Liquidity Facility (“MMLF”) established by the Federal Reserve. The final rule approved on June 22 removes the effect of participation in the PPP and borrowings under the PPPLF on various risk measures used to calculate a bank’s assessment rate, and removes the effect of participation in the PPP and MMLF programs on certain adjustments to a bank’s assessment rate. The final rule also provides an offset to a bank’s assessment for the increase to its assessment base attributable to participation in the PPP and MMLF programs, and removes the effect of participation in the PPP and MMLF programs when classifying banks as small, large, or highly complex for assessment purposes. The final rule became effective on June 26, 2020 and will apply to assessments as of April 1, 2020. Click here for a copy of the final rule.

Nutter Notes: According to the FDIC, its final rule is meant to ensure that banks will not be subject to significantly higher deposit insurance assessments for participating in the PPP, PPPLF, and MMLF, which were put in place to help stabilize the financial system in a time of economic crisis. The FDIC said that its final rule represents an attempt to balance its policy objective of mitigating the deposit insurance assessment effects of participation in the PPP, PPPLF, and MMLF, while also minimizing the extent to which a bank will pay less as a result of the final rule than it would have paid if it did not participate in the PPP, PPPLF, or MMLF. For example, the FDIC will exclude the quarter-end outstanding balance of all PPP loans from a bank’s total assets when calculating the bank’s assessment rate and the offset to a bank’s assessment amount due to the inclusion of PPP loans in its assessment base under the final rule. The FDIC said that it expects that this exclusion will result in a more complete mitigation of the assessment effects of participation in the PPP program.

5. Other Developments: Federal Preemption and Main Street Lending Program

  • OCC Publishes Guidance on Federal Preemption of State COVID-19 Relief Programs

The OCC issued guidance to national banks and federal savings associations on the OCC’s approach to federal preemption of state COVID-19 relief programs. The guidance released on June 17 reiterates that OCC regulations provide examples of the types of state laws that do not apply to federal banks’ lending and deposit-taking activities. Those examples include state limitations on terms of credit, such as the schedule for repayment of principal and interest payments, loan amortization, minimum payments and term to maturity, and state limitations on processing, origination, and servicing mortgage loans.

Nutter Notes: The guidance also states the OCC’s position that any state action that limits a federal chartered bank’s ability to foreclose on a defaulted loan and take possession of collateral, beyond what is provided for in the Coronavirus Aid, Relief, and Economic Security Act, would interfere with the federal bank’s powers to make secured mortgage loans, and therefore would be preempted. Click here for a copy of the OCC’s guidance.

  • Federal Reserve Considers Expansion of Main Street Lending Program to Nonprofits

The Federal Reserve announced on June 15 that it is seeking public feedback on a proposal to expand its Main Street Lending Program to provide access to credit for nonprofit organizations. The existing Main Street Lending Program targets small and medium-sized businesses. The proposed expansion would offer loans to small and medium-sized nonprofit organizations that were in sound financial condition before the COVID-19 pandemic.

Nutter Notes: The Federal Reserve established a special purpose vehicle to purchase participations in Main Street loans originated by eligible lenders. According to the proposal, nonprofit loan terms, including the interest rate, deferral of principal and interest payments, and five-year term, are the same as for Main Street business loans. The minimum loan size would be $250,000. Principal payments would be fully deferred for the first two years of the loan, and interest payments would be deferred for one year. Click here for a copy of the Federal Reserve’s announcement.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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