However, the interchange provision was substantially modified from its original form. Thanks to the successful lobbying efforts on the part of state governments, the prepaid industry and advocates for the unbanked community, prepaid cards used to disburse government benefits as well as reloadable prepaid cards are exempt from the interchange limits. It should be noted that such cards are exempt provided that they do not charge any overdraft fees and provide one fee-free withdrawal from the issuer’s ATM network per month.

The various lobbying efforts in support of striking the entire interchange provision from the bill proved less successful and ultimately failed. And while small issuers (i.e., issuers, together with it affiliates, having assets of less than $10 billion) are exempt from the interchange provisions, many have argued that the exemption is meaningless since small institutions will be forced to cut their interchange fees to compete with large banks.

Nonetheless, some small improvements were achieved. The modified interchange amendment allows the Federal Reserve to consider the issuer’s cost of protecting against fraud in its determination as to whether interchange rates are “reasonable and proportional.” Originally, the language only permitted the Fed to consider “incremental” transactional costs. Furthermore, the modified interchange amendment clarifies that merchants may offer discounts based upon a certain payment type (such as a credit card, debit card, check or cash) but not based on the card’s issuer or network. Finally, the ability to establish a card usage minimum dollar value (not to be less than $10) applies to the acceptance of credit cards alone, and not prepaid cards.

It is unclear exactly how the Fed will end up adjusting interchange fees so that they are “reasonable and proportional” to the issuer’s cost of processing the transactions (taking fraud and other incremental costs into consideration as well). Pursuant to the bill, the Fed will be required to draft regulations within nine months after the legislation’s passage, with the new rates to become effective 12 months after the bill is signed.

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We have many years of experience in all of the federal consumer banking regulation, and every day we work to stay current with the constantly changing regulatory environment.  We will help you avoid the regulatory minefields.  Our Retail Banking Team can assist your bank in all of the following areas:

• Deposit account agreement reviews;
• Deposit advertisement reviews;
• Overdraft policies and disclosures;
• Remote deposit capture agreements and policies;
• Automated clearing house agreements;
• Credit card, mortgage and other lending advertisement reviews;
• Credit card, mortgage and other lending disclosure and agreement reviews;
• Power of attorney interpretations;
• Trust documents and trustee power reviews;
• Individual Retirement Account transactions;
• Prepaid card programs;
• Check fraud assistance;
• Online business banking and cash management; and, of course,
• any issues arising under the Truth in Savings Act, Truth in Lending Act, Electronic Fund Transfers Act, Real Estate Settlement Procedures Act, or consumer privacy and data security laws and regulations.

Information on each of our Retail Banking Team members is attached below.  Whether you want assistance with only one project or you would like to discuss an annual retainer arrangement to cover all of your daily needs, please feel free to contact any of us.

• John D. ReVeal (john.reveal@bryancave.com; 202-508-6395)
• Linda Odom (linda.odom@bryancave.com; 202-508-6331)
• Kristine M Andreassen (kristine.andreassen@bryancave.com; 202-508-6117)
• Andrew M. Brummel (andy.brummel@bryancave.com; 816-374-3352)
• Kimberly Civins (kimberly.civins@bryancave.com; 404-572-6776)
• Jennifer Faucett (jennifer.faucett@bryancave.com; 404-572-4516)
• Robert D. Klingler (robert.klingler@bryancave.com; 404-572-6810)

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Subchapter S and Q Sub Banks Following Notice 97-5 with Respect to Expenses Relating to Tax Exempt Income
Should Consider Filing Refund Claims

On March 17, 2010, the U.S. Court of Appeals, Seventh Circuit, reversed the U.S. Tax Court’s decision in Vainisi v. Commissioner, 132 T.C. No. 1 (2009), which held that a sub-S corporation that is a bank (or in this case a bank holding company that owned a bank that had made a qualified S subsidiary or “Q-sub” election) is required, under the provisions of Section 291 of the Internal Revenue Code of 1986, as amended, (the “Code”), to increase the amount of its taxable income by 20-percent of the amount of the bank’s interest expense that is considered attributable to certain qualified tax exempt-obligations that are owned by the sub-S bank, despite the plain language of Code Section 1363(b)(4), which provides that “section 291 shall apply if the S corporation (or any predecessor) was a C corporation for any of the 3 immediately preceding taxable years.” The bank in the Vainisi case had been a Q-sub for longer than 3 years.

The 7^th Circuit’s decision is not surprising in that the IRS’ position in the Vainisi case was clearly contrary to the plain language in the Code. The IRS, through the issuance of its Notice 97-5 and with the help of Treasury through the issuance of regulations, attempted to backstop its position by relying on, as authority for its position to disallow a portion of the Q-sub bank’s interest expense, a grant of authority from Congress in a technical corrections bill for Treasury to issue regulations prescribing rules under Code Section 1361(b)(3)(A) (not Code Section 1363(b)(4)) as to when special rules in other sections of the Code will continue to be applicable to banks that make a sub-S or Q-sub election.

The decision in the Vainisi case is well-reasoned and is solid support for a sub-S or Q-sub bank and its shareholders (regardless of whether they reside in the 7^th Circuit) to file amended returns and/or claims for refunds with respect to past returns if the sub-S or Q-sub bank followed the IRS’ position in Notice 97-5 and the Treasury regulations, and reduced their deduction for interest expense by 20% of such expense attributable to certain tax-exempt obligations owned by the bank, even though the sub-S or Q-sub bank had not been a C corporation during any of the 3 immediately preceding taxable years. The decision also provides ample support for claiming a full deduction for interest expense attributable to certain tax-exempt obligations owned by the sub-S or Q-sub bank in future taxable periods as well, at least until such time as the Code is amended by Congress to provide otherwise.

We would be happy to assist any clients with the filing of amended returns and/or claims for refund. Generally, a claim for refund must be filed within three (3) years from the time the return was filed or within two (2) years from the time the tax was paid, whichever period expires later.

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There are a number of types of line of credit, and the type can make a significant difference to the Regulation O requirements. “Extensions of credit” to insiders are subject to Regulation O and therefore are subject to dollar limits, board approval for larger loans, arms’ length requirements and, if made to executive officers, additional limitations. However, two types of line of credit are not “extensions of credit” for Regulation O purposes and therefore are not subject to these limitations. Lines of credit that are not extensions of credit are:

a) Open-end credit plans of $15,000 or less so long as:

(i) The debt does not involve prior individual approval by the bank other than for the purposes of determining authority to participate in the arrangement and compliance with any dollar limit under the line; and

(ii) The terms are not more favorable than those offered to the general public.

b) Indebtedness of $5,000 or less arising by reason of an interest-bearing overdraft credit plan of the type specified in 12 C.F.R. § 215.4(e), which requires a written, preauthorized, interest-bearing extension of credit plan that specifies a method of repayment.

There are limitations to these lines of credit, per regulatory opinion, that are not particularly obvious but which must be complied with in order for these lines to satisfy the exclusion from the definition of extension of credit.

1. Only Certain Dollar Limits Apply. These lines are not subject to the dollar limitations of 12 C.F.R. § 215.4 or, for executive officers, 12 C.F.R. § 215.5, but they are subject to the dollar limitations stated in the exclusion itself: $15,000 for a general line of credit and $5,000 for an overdraft line of credit.

2. If Accessible through Overdrafts, the Credit is subject to the Limits for Overdraft Lines of Credit. If a line of credit can be accessed when the customer overdraws his or her deposit account, then it is by definition an overdraft line of credit and must satisfy the $5,000 limit. FRB Interp. Letter, Dec. 6, 1996. Likewise, such a line of credit must satisfy the other requirements of 12 C.F.R. § 215.4(e), and in particular that it be represented by a written, preauthorized, interest-bearing extension of credit plan that specifies a repayment method.

However, these two conditions apply only if the bank wants the line of credit to qualify for the exception from the definition of “extension of credit.” So long as the bank is willing to handle the line of credit like any other extension of credit to an insider, including without limitation with respect to board approval and re-approval requirements (re-approval requirements are discussed below), the $5,000 or $15,000 limits would not apply. The lines would instead be subject to the other amount limitations of Regulation O.

3. The $15,000 Line Must Have Standard Collateral. The $15,000 line of credit must not be secured by collateral of the kind not ordinarily used by the bank for such lines. FRB Interp. Letter, Dec. 6, 1996. Regulatory opinions are not clear on this issue, but it seems that the bank should be able to offer home equity lines of credit under this exception, secured by the borrower’s home, if the credit limit is $15,000 or less and the bank otherwise offers similar home equity lines to borrowers.

All lines of credit other than the two types described above (and certain credit card or check credit plans not discussed here) are fully subject to Regulation O, including all board approval requirements, dollar limitations, and the executive officer restrictions.

In general, all lines of credit to insiders, other than the $15,000 lines and the $5,000 overdraft lines discussed above, must be re-approved by the bank’s board at least every 14 months. However, if the line of credit has dollar limits such that board approval was not required when the line was made, then this 14-month re-approval requirement also should not apply. The difficulty could be in applying this exclusion in practice.

Board approval of an insider loan is technically required only if the loan, together with all other loans to that insider and his or her related interests, exceeds $500,000 or the higher of $25,000 or 5% of the bank’s unimpaired capital and unimpaired surplus. Thus, if the line of credit is below these limits and the bank has no other loans to the insider or related interests, then the line should not require board approval and likewise should not require re-approval under the 14-month rule.

Of course the difficulty is that many or most insiders that borrow from the bank will have loans in addition to the line of credit. Moreover, an insider who first gets a line of credit that does not require board approval might later obtain additional loans, with the result such that the borrower’s total debt then exceeds the dollar thresholds at which board approval is required.

This leaves a bank two options when determining its Regulation O policies and procedures: (1) always require board re-approval of lines of credit within 14 months or (2) require the Chief Credit Officer to determine prior to the 14-month deadline if the insider and his or her related interests have loans (including the line of credit) that in the aggregate exceed the 5%/$25,000/$500,000 limits and then to obtain board approval for renewal of the line only if the loans exceed these limits. Even with this approach, however, the line of credit agreement will need to require re-approval by the bank every 14 months to ensure that the bank can refuse to renew the line in appropriate circumstances.

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1. Insider Lending Pitfalls - April 11, 2010
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• Presentation Slides
• Presentation Audio (~7 MB)

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This article is Part One of a two part article on common insider lending problems that we have identified in the industry.  (Read Part Two here.) This installment focuses on the regulatory impediments to renewing insider loans.  While most comments in this article will apply to any bank that is subject to Regulation O, we also discuss a lending limit problem unique to Georgia state banks.

Under Regulation O, any loan to an insider (a) must be made on substantially the same terms as the bank provides on comparable loans to non-insiders and (b) may not involve more than the normal risk of repayment or present other unfavorable features.  These requirements can be called the “arms’ length” and the “normal risk” requirements.

It is easy to think of the normal risk requirement as simply another way of saying that the loan must be on arms’ length terms.  However, neither the Federal Reserve nor the OCC see it that way.  Under current Federal Reserve and OCC interpretations, these are separate and distinct requirements.  Accordingly, a bank can never renew a troubled loan to an insider, even if the bank would have renewed a non-insider loan on the same terms and in the same circumstances.  OCC examiners in the Southeast Region have said that an insider loan cannot be renewed unless it is at least “pass” rated.

In light of these regulatory interpretations, a bank should not renew any non-pass loan for an insider unless the insider first resigns his or her position as an insider.  In that way, the renewal would not be subject to Regulation O.  Of course the original loan approval would continue to be governed by Regulation O, but if the loan when made did not raise Regulation O problems, the fact that it later became troubled should not cause a Regulation O problem so long as the loan is not renewed.

Regulation O also limits total extensions of credit to any insider and the insider’s related interests to 15 percent of the bank’s unimpaired capital and unimpaired surplus.  This total generally may be increased by an additional 10 percent of the bank’s unimpaired capital and unimpaired surplus to the extent the loans are fully secured by readily marketable collateral.

A Georgia statute provides for a similar, but not identical, lending limit for loans to any single person or corporation.  This Georgia statute applies to non-insider loans as well as insider loans.  However, the recent amendment to this Georgia law does not affect how Regulation O is interpreted by the federal bank regulatory agencies, and we have now been advised that the Federal Reserve and the OCC will not conform their interpretations to the GA standard.  It is very important that Georgia banks be aware of this inconsistency when renewing or restructuring loans to insiders.

The purpose of the change to the Georgia lending limits was to allow banks to renew or restructure a loan that the bank otherwise could not originate as a new loan due to changes in the bank’s capital levels.  Under the amended law, the renewal or restructuring of a loan will not be subject to the Georgia lending limits so long as, among other things, no new funds are advanced or a new borrower replaces the original borrower.

The problem is that the federal bank regulatory agencies interpret the Regulation O loan amount limitations as applying to renewals and restructurings of insider loans.  If the bank’s capital levels have declined since the loan was originally made, such that the loan could not now be made within the Regulation O lending limits, the bank may not now renew or restructure that loan.

A Georgia bank will be subject to this Regulation O limit on renewals and restructurings of insider loans, notwithstanding the contrary Georgia law.  The amendment to the Georgia statute to allow renewals of loans in excess of the bank’s lending limits can be relied on only for non-insider loans.

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The Rules set forth various restrictions and guidelines with respect to gift card fees, expiration dates, and disclosures.  The Final Rules apply to any gift certificate, store gift card, or general-use gift card (including any reward/promotional card or any virtual/online gift card) that is sold or distributed to a consumer on or after August 22, 2010.

The Rules may affect any retailer, restaurant, consumer product supplier, hotel or travel provider that offers gift or reward cards – including loyalty programs – to consumers.  The Rules apply to retailers, processors and financial institutions involved in the issuance, distribution and sale of various types of gift certificate and gift card products.

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If you are a smaller reporting company that has not finalized your 10-K, you should consider adding this disclosure, or perhaps including it elsewhere in public releases or reports.  Also, to the extent you have an examination scheduled in the coming weeks and months, be prepared for an inquiry concerning this FIL.

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As some of you may know, last year we changed the rule for complying with the statutory interest-rate restrictions for banks that are less than well capitalized. The new regulation includes a streamlined safe-harbor for compliance using a national rate schedule that is published on the FDIC’s website. The rule also builds in the flexibility to identify high-cost areas. As we make these judgments, one issue that can be material in some markets is the presence of multiple branches of large banks.

As I mentioned earlier, the largest banks enjoy lower average funding costs – and the differential appears to be rising. In our judgment, this trend is driven at least in part by the market perception that some of these banks are too big to fail. It was never our intent for this regulation to disadvantage smaller banks. That is why, as of today, we have amended the question and answer document on our website to clarify that the FDIC will, as appropriate, drop multiple branches of the same banks from the calculation of locally prevailing deposit rates. I would point out that this was an issue that was flagged for us by members of our Community Bank Advisory Committee, who have made many useful suggestions like this in the meetings we have held so far. (emphasis added)

The FDIC has amended the question and answer document attached to Financial Institution Letter FIL-69-2009.

Evidence of the average rates or effective yields in a particular market area may include (but is not limited to) the following: (1) evidence as to the rates paid by other insured depository institutions in that market area; (2) evidence as to the rates paid by credit unions in that market area if the FDIC determines that the insured depository institution in question competes directly with the credit unions; and (3) evidence as to the different rates paid on different deposit products in that market area (though the FDIC will not be obligated to recognize all alleged distinctions among various deposit products as explained in greater detail below).

The FDIC recognizes that in the current environment, the spread between the funding costs for community banks and larger banks has widened in a way that reflects a variety of factors, including market perceptions about the likelihood of government support for institutions of various sizes. The materiality of this issue will vary across different geographic areas. Accordingly, in calculating prevailing local interest rates and comparing these to the national rate for the purpose of identifying high cost areas, the FDIC will, when appropriate, exclude the rates offered by multiple branches of the same bank.

Example

The prevailing rate in a market area generally is the average of rates offered by other FDIC insured-depository institutions and branches in the geographic market area in which the deposits are being solicited. In some cases, however, the FDIC may exclude branches in determining whether a bank is operating in a high-rate area (as discussed above). In any event, assuming the bank is operating in a high-rate area, the bank will be allowed to offer the prevailing local rate plus 75 basis points. The prevailing or average local rate will be based on one rate per institution for each product based on size (for example, a one year certificate of deposit less than $100,000) or one rate per institution and branch for each product based on deposit size. The methodology should be consistent across product types, and institutions should not use an all branch approach for some competitors and an entity only approach for other competitors.

The revised question and answer document also provides additional clarification regarding the treatment of “rewards checking” accounts, or other forms of deposit accounts that offer premium rates in exchange for the depositor meeting various conditions.  The clarification continues the FDIC position that such distinctions to not constitute a different type of deposit, and thus are not subject to different interest rate caps.  However, such products can be used in calculating the average rates paid on that type of account generally, i.e. checking, and thus, if in place at other branches in the market, can raise the local market cap rate on checking accounts generally.

As a final reminder, every institution seeking to rely on higher local rates must have received an individual high rate area determination from the FDIC.  Institutions cannot rely on high rate area determinations received by other banks, or by FDIC determinations that certain markets, such as the State of Georgia, are generally high rate areas.

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Recently the contractor hired by the FDIC to manage those loans has indicated that there has been a change in plans and plans are being put in place to sell the loans through a DebtX auction. Many directors have concluded that it would be in their best financial interest to try and negotiate a discount on the loan prior to its being sold to a third party. While this may make short term financial sense, there is an issue lurking in the shadows that many directors are not aware of.

A senior FDIC official recently informed a group of bankers that the supervisory side of the FDIC would look disapprovingly on any directors who discounted their director loan with Silverton on the basis that to do so caused the FDIC insurance fund to suffer a loss. While it is difficult to predict how firmly the position may be held by the FDIC, the longer term consequences may be significant if that director seeks to become involved with another bank in the future. Thus, any director, particularly management directors, should carefully weigh all of their options and seek capable legal advice before seeking to discount their loan.

There may be strategies to minimize risk to the director but those require a case by case analysis of the facts and circumstances surrounding the loan. Please contact Jerry Blanchard (404.572.6804) or your regular Bryan Cave contact if you would like to discuss these strategies.

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