Background
On March 14, the United States Senate passed S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act, which if enacted would provide significant regulatory relief to smaller financial institutions, including community banks, credit unions, midsize banks, small regional banks, and custody banks. The goal of S. 2155 is to allow these smaller financial institutions to redirect their focus and resources to lending and other day-to-day operations instead of compliance with rules that were primarily intended for larger, complex institutions. The bill received significant bipartisan support with 26 cosponsors, including 13 Republicans, 12 Democrats, and 1 Independent, and it ultimately passed the Senate by a vote of 67 – 31.
S. 2155, however, still has some challenges becoming law, and its ultimate outlook remains uncertain. S. 2155 will become law if the House passes it in its current form and then it is signed by the president. If it is amended by the House, it can still become law so long as the House and Senate agree to resolve their differences in the conference committee process and both chambers pass a conference bill that is ultimately signed by the president. The White House praised the passage of S. 2155 in the Senate, and it appears that the president will sign any similar bill that comes to his desk.
The problem, however, is whether S. 2155 can get to the president’s desk at all. Republicans in the House of Representatives have been critical of the bill because it falls short of making the broad, sweeping changes to the Dodd-Frank Act found in the Financial CHOICE Act of 2017, which passed the House on June 8, 2017. In fact, Chairman of the House Financial Services Committee Rep. Jeb Hensarling (R-TX-5) has stated that further negotiations between the House and Senate must take place before the House will take any action on S. 2155. On the other hand, some Democratic Senators who supported the bill have indicated that they will not negotiate and may oppose the bill in conference if it is amended by the House. Accordingly, something has to give or it will not become law, and it is unclear whether House Republicans or Senate Democrats are willing to compromise.
S. 2155 in its current form would provide welcome relief from a number of specific Dodd-Frank provisions. If the House decides to amend S. 2155, it would almost certainly increase and broaden the amount of relief currently provided for in the bill. Thus, from a regulatory relief perspective, the legislation, if enacted, can only get better from here. The ultimate question, however, is how far can the House go without losing the support of Senate Democrats.
Helpful Provisions
S. 2155 makes a number of changes to provisions of Dodd-Frank and other federal laws regarding consumer mortgages, credit reporting, and loans to veterans and students. The bill is divided into six titles: Title I, Improving Consumer Access to Mortgage Credit; Title II, Regulatory Relief and Protecting Consumer Access to Credit; Title III, Protections for Veterans, Consumers, and Homeowners; Title IV, Tailoring Regulations for Certain Bank Holding Companies; Title V, Encouraging Capital Formation; and Title VI, Protections for Student Borrowers.
Below is a brief explanation of some of the more notable provisions in the current bill, with emphasis on several provisions that could be especially helpful if ultimately enacted.
1. Portfolio Qualified Mortgage Loans. Dodd Frank established an “ability to repay” qualification requirement, whereby creditors must evaluate a loan applicant’s income and indebtedness to confirm that such customer has the “ability to repay” the loan. Of course, one would think that this would be of paramount interest for any lender regardless of being required to do so by the federal government, but there was a particular concern that lenders were originating and closing risky loans, and then selling them to third parties or into securitization pools, so that the lender that actually originated and closed the loan did not bear the ultimate credit risk of nonpayment.
Unfortunately, the pendulum here swung pretty far in the overregulated direction, and the CFPB adopted rules and regulations under Dodd Frank that were complex, burdensome and very difficult to apply with any degree of certainty. Without regard to all of its various calculations, requirements and standards, however, the CFPB confirmed that so long as a mortgage loan met its requirements to constitute a “Qualified Mortgage” (“QM”), the loan would be presumed to satisfy the regulation. So, lenders were highly motivated to make QM loans because otherwise they could have no certainty of avoiding Dodd Frank liability, statutory damages and regulatory criticism.
One of the QM categories commonly used by creditors to meet this new standard was that of a “portfolio” QM. To do that, the creditor must be deemed a “small creditor,” meaning that it originated 2000 or fewer loans in the prior year and that it had less than $2 billion in assets. The QM originated by the small creditor must still meet certain underwriting and other requirements set out in the CFPB regulations, but the debt to income ratio test was not required. Finally, and most importantly to address the perceived risk that lenders were originating and selling loans to avoid credit risk entirely, the loan generally had to be retained by the originating lender in its portfolio for at least three years.
S. 2155 would make several changes, some of which are helpful and others of which are perhaps less helpful. On the “helpful” side of things, the size threshold would be for insured depository institutions (banks/credit unions) that are less than $10 billion in asset size, and there is not a maximum limit on the number of loans. So, this permits many more institutions to now qualify for this relief than would have been the case previously; naturally, non bank lenders are unhappy because this protection would shift over to covering banks and credit unions and exclude non depository lenders.
It is also helpful that S. 2155 would remove some of the other product feature requirements mandated by Dodd Frank to qualify as a QM, and the underwriting guidance would be less complex and restrictive. But, the three year holding period has been eliminated, and so the loan would maintain its QM status only so long as it remains held by the original depository institution that made the loan (subject to exception for transfers to other small lenders).
2. Small Bank Capital Ratio. Every bank and bank holding company must maintain a level of capital that provides financial support to the institution for absorbing credit losses and other portfolio stress. Regulators have set various minimum amounts that must be held and have created increasingly complex categories of tier 1 and tier 2 capital, the calculation of which may sometimes use risk weighting of the institution’s assets in making the calculations, and which regulations generally have set capital standards lower than regulators generally would require in practice. For example, although the current leverage ratio requirement for an entity to be considered “well capitalized” is five percent, the FDIC or State Banking Department would probably want to see a bit more of a capital cushion at banks they examine and regulate.
A particular complexity of the current capital requirement rules and regulations arises from the requirement that certain capital ratios be determined based on a risk weighting of the assets owned by the bank. In other words, the more risky the asset (compare for example the risk of a U.S. Treasury Security against the risk of a credit card loan for a picture of how different asset classes can have different risks of nonpayment), the more capital should be maintained as a buffer to absorb losses.
S. 2155 would provide a new basis for assessing the capital adequacy of an institution that is less than $10 billion in assets. A new leverage ratio known as a “Community Bank Leverage Ratio” (“CBL Ratio”) would be established, and this CBL Ratio would be set by the regulators somewhere between eight and 10 percent, and it would be calculated without any risk weighting of the institution’s assets. Then, for any institution that maintains a CBL Ratio at or above the established regulatory standard, such institution would be deemed not only to have satisfied the CBL Ratio requirement, but such institution would also be deemed to have met all other leverage and risk based capital requirements. So, calculating capital adequacy would become a much easier process for community banks.
3. HVCRE Capital Relief. Several years ago, new capital rules defined a category of commercial real estate lending characterized as “High Volatility Commercial Real Estate (“HVCRE”). For such loans, institutions were required to use a 150 percent risk weighting, which made such loans more burdensome and less financially attractive to institutions because of the increased cost of capital associated with such loans. For more information, please see Bradley’s prior articles and discussions on HVCRE in the ABA’s Spring 2015 Banking Traditions and in the December 2017 ABA Board Briefs publications.
As you know, the HVCRE rules have created extraordinary uncertainty, largely arising from the vague and ambiguous language of the regulation. There have been numerous questions on how to determine if a loan was an HVCRE loan in the first instance, and assuming such to be the case, how to administer such loan and how, if ever, to determine whether such loan might move out of the HVCRE category and accordingly out of the 150 percent risk weighting for capital.
S. 2155 would modify this by creating a new category of loan known as a High Volatility Commercial Real Estate Acquisition Development Construction loan (HVCRE ADC loan). The legislation then requires the regulators to modify all of their prior capital requirements applicable to HVCREs to comport to the new rules and requirements for HVCRE ADC loans. The legislation provides extensive detail to address and resolve many of the issues that have created such uncertainties for loan origination and administration, and makes certain other changes. If ultimately enacted, this aspect of S. 2155 would particularly benefit banks of all sizes to understand more clearly, with more “bright lines,” the requirements and compliance methods for dealing with this type of lending.
4. Home Mortgage Disclosure Act. The new regulatory requirements on collecting HMDA data became effective Jan. 1, requiring collection and reporting of many additional data fields on the institution’s loan application registry. The banking community has been required to invest substantial time and capital into preparing for these new requirements. S. 2155 would exempt banks from the new HMDA requirements (not the former requirements) if they originated fewer than 500 closed end mortgage loans and fewer than 500 home equity lines of credit in each of the preceding two years. As a result, certain small bank lenders may gain relief from these burdensome new requirements, although the timing of this relief, occurring after bank lenders have already presumably implemented new systems and processes for the collection of such data, is less than ideal from a timing standpoint, and so this “relief” may be too late to provide effective relief. In all likelihood, banks that have established new systems will continue collecting data, but potentially this could be an area where even greater relief might be provided in the final legislation. For now, HMDA remains a regulatory challenge of collecting and reporting data exactly in the classifications which the federal regulators have mandated, and institutions have continued and likely will continue to expend resources in compliance efforts with this increasingly intrusive regulation.
5. Exam Cycle. Smaller community banks may also benefit from S. 2155’s regulatory relief provided to smaller depository institutions and bank holding companies. Currently, the Federal Reserve’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement provides simplified and expedited reporting and other standards for “small” bank holding companies, which are considered to be those below $1 billion in assets. This threshold amount to be considered “small” would be increased to $3 billion.
The examination cycle also can turn on the size of the institution, and the eligibility for an extended examination cycle is similarly being increased from the current threshold of $1 billion to a new threshold of $3 billion in assets. This would be welcome relief for well capitalized and well managed institutions so that they could qualify for 18 month instead of 12 month exam cycles.
Conclusion
Like any compromise legislation, S. 2155 contains provisions that will be helpful to some, unhelpful to others, and less helpful overall than might have been hoped for. That said, the changes generally would represent significant relief from a number of Dodd Frank regulatory requirements and should generally benefit banks of all sizes, and accordingly, if ultimately enacted, the legislation should be very helpful for Alabama banks.
Dave Dresher, left, is a partner in the Banking and Real Estate Practice Group, resident at Bradley’s Birmingham office, where he represents banks and lenders in all aspects of state and federal lending and regulatory law. Ryan P. Robichaux is a senior attorney in the Birmingham office of Bradley Arant Boult Cummings LLP. As a member of the Government Affairs Practice Group, Ryan specializes in political advocacy and compliance, where he represents clients before the executive and legislative branches of government in Washington, D.C., Montgomery, Alabama and other states.
