Friday, February 5, 2016

On February 2, 2016, Freddie Mac and Fannie Mae took another step towards helping sellers of loans manage risk more effectively, and in turn, strengthen the home lending system.

Through concurrently released announcements, Freddie Mac and Fannie Mae, at the direction of the Federal Housing Finance Agency (FHFA), jointly announced the Independent Dispute Resolution (IDR) process. Freddie Mac’s Bulletin 2016-1 explains that the IDR process provides sellers of loans an opportunity to request a neutral third party arbitrator to settle disputes regarding alleged loan-level origination defects. This announcement marks the completion of the selling representation and warranty framework, which was first introduced on September 11, 2012 in Bulletin 2012-18.

Each referenced Freddie Mac Bulletin includes updates to the Single-Family Seller/Servicer Guide, which contains Freddie Mac’s selling and servicing requirements. Similarly, Fannie Mae concurrently distributes these statements as Announcements, which update the Fannie Mae Selling Guide. Beginning with Bulletin 2012-18, Freddie and Fannie have limited those situations when remedies, such as a repurchase demand, will be sought, and have provided sellers with a clearer framework under which to issue loans. This goal was advanced by Bulletin 2014-8, which introduced relaxed acceptable payment history requirements, and Bulletin 2014-21, which better clarified situations that do not qualify for relief from the remedy provisions.

The Disputes

The IDR process is available for disputes related to alleged loan-level origination defects for Mortgages acquired by Freddie or Fannie on and after January 1, 2016. A defect occurs when a Mortgage sold to Freddie or Fannie does not comply with the requirements in the purchase agreement (i.e. breaches of representations or warranties). As explained by the newly implemented remedies framework provided by Bulletin 2015-17, Freddie and Fannie will categorize each origination defect in one of three ways: (1) Findings; (2) Price-Adjusted Loans; or (3) Significant Defects.

Only defects categorized as “significant defects” may require the repurchase of the mortgage or a repurchase alternative, such as an indemnification agreement. A significant defect is one that either necessitates a change to the price on which the Mortgage was acquired or results in the Mortgage being unacceptable for purchase had the true and accurate information about the Mortgage been known at the time of purchase.

Essentially, if the defect resulted in the wrong price being paid for the Mortgage or caused Freddie or Fannie to purchase a Mortgage that did not meet the requirements of the purchase agreement, it is a “significant defect.”

The Process

In the event of an alleged “significant defect,” Freddie or Fannie will issue a demand for repurchase or other remedy. The seller then has the opportunity to correct the defect or appeal the demand. If the issue is not resolved, the seller can again appeal, rebut, or provide further evidence that the defect does not exist or has been corrected. In instances that remain unresolved after the second appeal, an escalation process is available. Bulletin 2016-1 explains that Freddie and Fannie will update the appeal and escalation processes in 2016, in order to more clearly describe the ability of sellers to appeal and escalate prior to initiating the IDR process.

If the dispute remains unresolved after the appeals and escalation steps are completed, either the seller, Freddie, or Fannie may elect the IDR process. The IDR process, while new and not fully incorporated into the Freddie and Fannie guides, will provide a cost-effective and clearly defined alternative to bringing a claim in court. Bulletin 2016-1 sets forth components that the IDR process will incorporate, such as timelines for initiating IDR and selecting a neutral arbitrator, the option of each party to use legal counsel and experts, and a hearing with an arbitrator conducted by telephone or videoconference, among others. Lastly, the party that does not prevail at the IDR hearing will be responsible for paying the prevailing party a “Cost and Fee Award” in the amount of 10% of the unpaid principal balance of the related Mortgage at the time the Mortgage was acquired.

The Result

The IDR process will likely only apply to a small share of disputes, given that the current appeal and escalation process will remain (and be improved upon). However, the new IDR process should provide confidence for lenders, because there now is an opportunity to resolve disputes regarding alleged origination defects without needing to bring a claim in court. Importantly, Bulletin 2016-1 anticipates that the IDR process will also become available for servicing-related disputes in the future, which will be yet another step towards Freddie and Fannie’s goals of ensuring liquidity in the housing finance market and providing greater access to credit for borrowers.

If you have any questions or would like further information regarding the foregoing or anything related to this topic, please contact Chris Dueringer at (310) 576-2183 or Jason Stavely at (310) 576-2173.

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Thursday, February 4, 2016
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In the ancient world kings and emperors regularly sought advice from the Oracle at Delphi when making important decisions. The Oracle would respond to questions, sometimes in poetry, other times in prose, in a manner that sometimes required some interpreting. For example, King Croesus of Lydia asked about the wisdom of his taking on the Persian empire. The Oracle replied that “If you attack you will destroy a great kingdom.” Proving that one should always ask for details, Croesus lost the battle and the Persians, under Cyrus the Great, conquered his kingdom.

Some say that the closest thing we have to the Oracle at Delphi today is the triumvirate of the federal banking regulators, the Federal Reserve, the FDIC and the OCC. The “Oracle” prognosticates and bankers guide their business activities accordingly. Well, perhaps. There was that prediction back in 2006 called “Concentrations in Commercial Real Estate Lending, Sound Risk Management Policies” when the regulators pointed out that CRE concentration levels at community banks had increased from 156% of total risk based capital in 1993 to 318% in the third quarter of 2006. They noted that some banks had begun to relax underwriting standards as a result of strong completion for such loans. Overall, the guidance was a “soft” sort of warning that bankers needed to make sure they understood how to manage the risk they were undertaking. A year or so later the economy was collapsing and banks beginning to fail.

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Thursday, January 14, 2016
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(Note: Part 1 is available here.)

One of the problem areas that came up during the recession was the accounting treatment for loan participations and loan sales. The difficulty arose from the fact that FASB changed the guidance for how to recognize a “true sale” several times over the last decade and not all banks realized that their form documents needed to be changed to reflect those changes. The current guidance is now found in Accounting Standards Codification Topic 860 “Transfer and Servicing” (formerly FAS 166 “Accounting for Transfers of Financial Assets”) which itself was an update of FAS 140 “Accounting Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

If we go back ten years ago, there were several different variations on how loan participations divided distributions from loan payments among the parties. Pro rata is perhaps the most common but it was also typical to see both LIFO (last in first out) and FIFO (first in first out) arrangements. The older accounting treatment allowed an institution using any these different distribution models to be treat the transaction as a true sale, thus removing the asset from its books. The accounting treatment today is dramatically different. Under ASC 860, neither LIFO nor FIFO participations transferred on or after the beginning of a bank’s first annual reporting period that began after November 15, 2009 qualify for sale accounting and must instead be reported as secured borrowings.

Many banks actually used preprinted loan participation forms where one simply checks the block showing whether distributions were shared pro rata, LIFO, or FIFO and continued to use such forms after the FAS change. This resulted in interesting situations where pieces of the same loans can receive differing accounting treatments. For example, assume that Bank A originated a $1 million loan on June 1, 2009 and sold 50% of it on a LIFO basis to Bank B on the same date. Assuming that it meets all of the tests necessary to move an asset off of its books then Bank A can treat that as a true sale. If Bank A later sells another 10% of the loan to Bank C on March 1, 2010, also on a LIFO basis, that transfer will not be treated as a true sale and must be accounted as a secured loan by Bank C to Bank A.

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Tuesday, January 12, 2016

There has never been a more challenging time to be a bank director. The combination of today’s hugely competitive banking market, increased regulatory burden and rapid technological developments have raised the bar for director oversight and performance. In response, an increasing number of community banks have begun to assess the performance of directors on an annual basis.

Evaluation of board performance is done in many ways, and ranges from an assessment by the board of its performance as a whole to peer-to-peer evaluation of individual directors. Public company boards are increasingly being encouraged by institutional investors and proxy advisory firms to conduct meaningful assessments of individual director performance. The pace of turnover and change on most bank boards is slow, and more often the result of mandatory retirement age limits than focus by the board on individual director performance. This may be untenable, however, as the pace of external change affecting financial institutions often greatly exceeds the pace of changes on the bank’s board.

While some institutions prefer a more ad hoc approach to assessing the strengths and weaknesses of the board and its directors, we suggest that a more formal approach, perhaps in advance of your board’s annual strategic planning sessions, can be a powerful tool. These assessments can improve communication between management and the board, identify new skills that may not be possessed by the current directors, and encourage engagement by all directors. If used correctly, these assessments often provide valuable information that can focus the board’s strategic plan and help shape future conversations on board and management succession.

So what are the key considerations in designing an effective board evaluation process? Let’s look at some points of emphasis:

  • Think big picture. Ask the board as a whole to consider the skill sets needed for the board to be effective in today’s environment. For example, does the board have a director with a solid understanding of technology and its impact on the financial services industry? Are there any board members with compliance experience in a regulated industry? Does the board have depth in any areas such as financial literacy, in order to provide successors to committee chairs when needed? Do you have any directors who graduated from high school after 1985?
  • Develop a matrix. Determine the gaps in your board’s needs by first writing down all of the skill sets required for an effective board, and then chart which of those needs are filled by current directors. Then discuss which of the missing attributes are most important to fill first. In particular, consider whether demographic changes in your market will make recruiting a diverse and/or female candidate a priority.
  • Determine the best approach to assessment. Engaging in an exercise of skills assessment will often focus a board on which gaps must be filled. It can also focus a board on the need to assess individual board member performance. Many boards are not prepared to launch into a full peer evaluation process, and a self-assessment approach can be a good initial step. Prepare a self-assessment form that touches upon the aspects of being an effective director, such as engagement, preparedness, level of contribution and knowledge of the bank’s business and industry. Then, have each director complete the self-assessment, with a follow-up meeting scheduled with the chair of the governance committee and lead independent director for a conversation about board performance. These conversations are often the most impactful part of the assessment process.

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Thursday, January 7, 2016
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Watching loan participation activity over the last decade has been like watching the progression of a car on a roller coaster. The early to mid-2000’s showed the car heading ever upward and then in 2008-09 it hurtled downwards at breakneck speed. The last several years have shown a resurgence as the car begins climbing slowly back up the track. Not surprisingly, the FDIC has taken notice of that trend and issued a Financial Institution Letter on Effective Risk Management Practices for Purchased Loans and Purchased Loan Participations in November of 2015.

The reasons why lenders want to sell either loan participations or whole loans and others want to purchase them remain the same today as they were a decade ago. Sellers may have loan to one borrower issues that a loan participation may cure, they may be seeking to reduce overall exposure to a particular borrower or industry or they may find that providing loan product for other institutions is a profitable venture as it may generate gains on sale as well as servicing income depending on how the sale is structured. Buyers are looking to broaden their geographic and industry diversity in order to better manage the overall credit risk inherent in their portfolio and it may be more cost-effective to source loans from another lender than trying to originate them yourself. Another, more recent development, has been the purchase of loans from peer-to-peer non-bank lenders who operate on a national basis.

When the US economy hit the skids in the 2007-2010 time frame with its corresponding bank failures, it became clear that in many situations loan participations had not generated the expected benefits. There were several reasons for this, the most significant being that simply obtaining geographic diversity of ADC loans still left a lender susceptible to outsized losses when that segment of the economy ground to a halt. Too many community banks failed to realize that true diversity in a loan portfolio means that ADC can only be a portion of the entire portfolio, not the entire portfolio, even if you have geographic diversity. The perceived reduction in risk was therefore illusory.

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Wednesday, January 6, 2016
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London and New York Partner Judith Rinearson authored a “Bankthink” opinion piece posted on the front page of American Banker  on Dec. 28 regarding differences in how the payments industry is perceived and supported in the U.S. and Europe.

“My biggest surprise after moving to London in September is how far the U.S. has to catch up to the United Kingdom and other European Union countries in the fintech and payments innovation race. Compared with their U.S. counterparts, U.K. and EU regulators are really trying to encourage payment innovation through licensing regimes. One thoughtful and pragmatic step taken by the U.K.’s payments regulator, the Financial Conduct Authority, was to ask industry for its input on appropriate policy. But the U.K. and EU’s bigger advantage is how their ‘e-money’ and payment service licensing processes work compared with U.S. state money transmitter laws.”

Click here to read her full article.

Rinearson is leader of Bryan Cave’s global Prepaid & Emerging Payments Team and has recently been named co-chair of the firm’s new Fintech Team.

Sunday, January 3, 2016
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Byran Cave filed an amicus brief on behalf of the Georgia Bankers Association and the Georgia Chamber of Commerce in the Bickerstaff v. SunTrust Bank litigation currently pending before the Georgia Supreme Court in which a bank customer seeks to certify a class action against SunTrust to challenge the propriety of certain overdraft charges.

The trial court below ruled that while the plaintiff could opt out of an arbitration clause in the deposit agreement with SunTrust to pursue such challenges in his own right, the plaintiff could not do so on behalf of a class. The Georgia Court of Appeals affirmed the trial court ruling that “the deposit agreement contract and its arbitration clause prohibit [plaintiff] from altering others’ contracts where he is neither a party nor in privity with a party.” The plaintiff in the case then petitioned the Georgia Supreme Court to grant certiorari in the case. Certiorari was granted in September to resolve the issue.

Bryan Cave was thereafter retained by both the Georgia Banker’s Association and the Georgia Chamber of Commerce to weigh in and support the fundamental proposition that the deposit agreements should be honored by the courts and that strangers, such as the plaintiff, should not be permitted to interfere with such contracts under the guise of the class action rules. Bill Custer and Jen Dempsey of Bryan Cave, along with former Supreme Court Justices George Carley and Hardy Gregory appeared as counsel on behalf of the GBA and Chamber as amici. The case has now been fully briefed and oral arguments are set for January 4, 2016.

Thursday, December 31, 2015
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On October 30, 2015, the Department of Education issued regulations to impose requirements on the marketing and terms of deposit and prepaid accounts offered to students at educational institutions that participate in Federal student aid programs. According to the DOE, the regulations are intended to ensure that students have convenient access to their title IV, Higher Education Act program funds, do not incur unreasonable and uncommon account fees on their title IV funds, and are not led to believe that they must open a particular financial account to receive Federal student aid. Most of these new rules take effect on July 1, 2016.

On December 16, the CFPB published a Safe Student Account Toolkit “to help colleges evaluate whether to co-sponsor a prepaid or checking account with a financial institution.” The Toolkit includes a Scorecard that can be used by schools when selecting a third-party vendor for student accounts and an Administrator Handbook designed to help school administrators gather relevant information to review, compare and evaluate accounts offered by different financial institutions.

The CFPB’s Toolkit provides guidance on the new DOE regulations, but with a focus on those provisions that are designed to protect students. The CFPB can bring and has brought enforcement actions against colleges under federal consumer protection laws. Their issuing of the Toolkit should be understood as a warning that they also will be enforcing the consumer protection portions of the DOE rules, though perhaps under their unfair, deceptive and abusive practices statute.

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Wednesday, December 30, 2015
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Consumer borrowed money from Lender. Consumer defaulted, and Lender began to foreclose, including all the usual steps: arranging for property inspection, hiring counsel, etc. After about a year,Consumer sought to reinstate the loan, and asked Lender how much it would cost. Lender responded in writing, with an itemized list of expenses to be paid, plus an estimate of additional costs (clearly marked as estimates) that Lender may incur over the next month if it continued to exercise remedies. (After all, this would not be the first time in recorded history that a borrower swore it would make good on the loan – and then didn’t.)

Consumer paid the entire amount required to reinstate the loan, including Lender’s estimated out-of-pocket expenses. A few months later, Lender refunded the estimated expenses which it didn’t incur after all. What’s the big deal? Why is this unusual? Why are you reading this, and why did we write about it? Well, in the 11th Circuit, including any estimated future charges or expenses in a reinstatement letter (or a loan payoff, as your authors can’t see any reason why this remarkable ruling wouldn’t also apply to payoff letters) violates the federal Fair Debt Collection Practices Act if your loan documents don’t clearly allow for that inclusion (and most don’t – we checked). This is the ruling in Prescott v. Seterus, Inc., 2015 U.S. App. LEXIS 20934 (11th Cir. Dec. 3, 2015).

See Bryan Cave’s Bankruptcy & Restructuring Blog for more information about this opinion, and the steps that you can and should do to address.

Wednesday, December 9, 2015

On November 6th, the FDIC issued an advisory letter discussing risk management practices that FDIC-supervised banks should implement with regards to purchased loans and loan participations. While the FDIC acknowledges the benefits accruing from the purchase of these loans and loan participations, such as achieving growth goals, diversifying credit risk, and deploying excess liquidity, the FDIC also recognizes that purchasing banks have oftentimes relied too heavily on lead institutions when administering these types of loans. In such a case, over-reliance on the lead banks has resulted in significant credit losses and failures of the purchasing institutions. Thus, while the FDIC reiterates its support for these types of investments, the FDIC also reminds banks to exercise sound judgment in administering purchased loans and participations.

A summary of the key takeaways from the FDIC’s advisory letter follows below:

  • Banks should create and utilize detailed loan policies for purchased loans and loan participations.  The loan policy should address various topics, including but not limited to: defining loan types that are acceptable for purchase; requiring independent analysis of credit and collateral; and establishing credit underwriting and administration requirements unique to these types of purchased loans.
  • Banks should perform the same level of independent credit and collateral analysis for purchased loans and participations as if they were the originating bank. This assessment should be conducted by the purchasing bank and should not be contracted out to a third party.
  • The agreement governing the loan or participation purchase should fully set out the roles and responsibilities of all parties to the agreement and should address several topics, including the requirements for obtaining timely reports and information, the remedies available upon default and bankruptcy, voting rights, dispute resolution procedures, and what, if any, limitations are placed on the purchasing bank.
  • Banks should exercise caution and conduct extensive due diligence when purchasing participations involving out-of-territory loans or borrowers in an unfamiliar industry. Banks should also exercise due diligence, including a financial analysis, prior to entering into a third-party relationship, to determine whether the third party has the capacity to meet its obligations to the purchasing bank.
  • Finally, banks should not forget to include purchased loans and loan participations in their audit and loan review programs and to obtain approval from the board before entering into any material third-party arrangements.

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