The Dodd-Frank Act: A Look at the Immediate Impacts

By: KAREN L. GRANDSTRAND & KARLA L. REYERSON

August 26, 2010

The landscape of the financial services industry changed drastically on July 21, 2010, when President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The uncertainty the industry felt prior to the Act’s passage as to how this new law would affect the nation’s financial services providers was not alleviated upon passage of the bill, given its volume, its breadth, and the massive number of regulations that are required to implement most of its provisions.

The Dodd-Frank Act, despite its length, is only a blueprint for reforms the government has been struggling to make in recent years. There are positive provisions in the Act, such as the end of the “too big to fail” philosophy and increased regulatory oversight of some previously unregulated competitors of traditional financial institutions. Other provisions, however, have the potential to significantly increase regulatory compliance costs for financial institutions, raise the cost of credit, and continue the trend of overseeing traditional financial institutions more closely than other entities engaged in the same activities.

Most of the provisions of the Act are not effective until months (or in some cases years) from now. Many provisions, such as the mortgage loan changes, require that regulations be proposed and finalized before the industry will know how to implement the necessary changes. The effects of other provisions, such as the creation of the Consumer Financial Protection Bureau, will not be known until well after those provisions become effective. However, several important provisions that financial institutions should take particular notice of now are scattered throughout the multitude of new provisions that will take effect later.

Accredited Investor Definition Revised

For those banks or holding companies that are currently selling or planning to offer to sell additional shares in order to raise capital, a change to the definition of “accredited investor” could affect the outcome of those offerings. A company that is conducting a share offering must comply with securities laws that prescribe certain information that potential investors must receive. The more unsophisticated the potential investors are, the more detailed the information provided must be. However, some of these disclosure rules do not apply depending on the characteristics of the potential investors. For example, if all of the individuals being offered the shares are “accredited investors,” then organizations do not need to provide audited financial statements, which can be costly.

Generally, securities laws define an “accredited investor” as an investor who is financially secure enough to be able to withstand the loss of his or her investment.  Prior to passage of the Dodd-Frank Act, individuals were allowed to include the value of their principal residence when determining whether they met the accredited investor requirements. However, as of July 22, 2010, individuals and couples may no longer rely on the value of their homes in determining whether they meet that threshold. Consequently, for financial institutions and holding companies that are in the middle of or are considering an offering only to accredited investors, the potential investor pool may have just shrunk.

Deposit Insurance Limit Raised

The Dodd-Frank Act permanently raises the deposit insurance limit to $250,000, effective July 22, 2010. This provision was not surprising since the government had already temporarily raised the limit to $250,000 through December 31, 2013. The FDIC issued final regulations implementing this change on August 10, 2010, with an immediate effective date. To comply with the new regulations, depository institutions are required to replace the official FDIC signs to reflect the permanent increase in the FDIC deposit insurance limit. Signs should be replaced without delay and no later than January 3, 2011. The FDIC will provide depository institutions with new signs free of charge, including decals, counter signs, and electronic versions of the new official sign. Signs will be available for order at https://vcart.velocitypayment.com/fdic/.

Escrow Requirements Amended for Higher-Priced Mortgage Loans

The Dodd-Frank Act makes certain changes to the escrow requirements for higher-priced mortgage loans governed by the Home Ownership and Equity Protection Act (HOEPA). The Truth in Lending Act currently requires that an escrow account for the payment of property taxes and mortgage-related insurance premiums be created before consummation of consumer loans secured by either (a) a first lien on the consumer’s principal dwelling with an APR exceeding the average prime offer rate for a comparable transaction by 1.5% or more; or (b) a subordinate lien on a dwelling with an APR exceeding the average prime offer rate by 3.5% or more.

Pursuant to the Dodd-Frank Act, loans that are not eligible for purchase by Freddie Mac or Fannie Mae because their loan sizes are too great (Jumbo Loans) must meet the escrow account requirement only if the loan’s APR exceeds the applicable average prime offer rate by 2.5% or more. The determination of whether other HOEPA protections apply, such as the ability to repay requirement and restrictions on prepayment penalties, continue to be based on the 1.5% threshold.

Technically, the effective date of this provision under the Dodd-Frank Act is July 22, 2010. However, the Board of Governors of the Federal Reserve System (Board) has proposed rules acknowledging that by no longer requiring escrow accounts for certain Jumbo Loans, creditors may be prohibited from continuing to require escrow accounts under certain state laws and that it will take time for creditors to adjust their systems to avoid requiring escrow accounts for the affected Jumbo Loans. Therefore, the Board is seeking comment on whether to make the final rules implementing the Dodd-Frank Act provisions effective upon publication or at some later date. Based on the language of the proposed rules, it appears the Board does not expect creditors to comply with the Dodd-Frank Act’s provisions until the implementing regulations become effective. Financial institutions that offer higher-priced mortgage loans that qualify as Jumbo Loans should watch for final rules to be published by the Board.

De Novo Interstate Branching Permitted

Effective July 22, 2010, the Dodd-Frank Act generally permits all banks to branch into other states by opening a new branch or purchasing a branch from another financial institution, to the extent that banks chartered under the state in which the new branch is located can do so. In the past, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle-Neal) barred all financial institutions, except for thrifts, from branching into other states unless they purchased or merged with a bank located in the other state. Now that barrier is lifted. Institutions branching into another state will still need to adhere to the host state’s laws that are applicable to financial institutions within that state, such as home town protection laws that limit branching into smaller towns. This change makes state and national banks more competitive with thrifts, which have always been able to create de novo branches in other states.

Elimination of the Office of Thrift Supervision

The Dodd-Frank Act will eliminate the OTS. The supervision of federal savings associations will be transferred to the OCC, and supervision of state savings associations will be transferred to the FDIC. The OCC will also have rulemaking authority over both state and federal savings associations, except that the Federal Reserve Board will have rulemaking authority with regard to affiliate transactions, loans to insiders and tying arrangements. Supervision and rulemaking authority over savings and loan holding companies will be vested in the Federal Reserve Board.

The Home Owners Loan Act, which currently governs thrifts, will remain largely intact. The federal thrift charter is preserved, and the OCC is given the authority to grant new thrift charters at its discretion, although the OCC has not indicated whether it intends to authorize new federal thrifts in the future.

The transfer of OTS authority to the other regulators will occur in July of 2011 unless extended for six additional months, as is permitted in the Act. While these changes do not occur immediately, the pending change in the oversight of thrifts, along with certain provisions of the Dodd-Frank Act that even the playing field between thrifts and other banks (such as the de novo branching provisions), may affect the value of thrift charters today.

FDIC Announces Open Door Policy

The FDIC has announced an open door policy for regulatory reform rulemaking that is intended to make it easier for the public to give input and track the many rules that will be promulgated to enforce the provisions of the Dodd-Frank Act. As part of this policy, the FDIC has indicated the public will have the opportunity to participate in the rulemaking process before the rules are drafted or proposed.

Meetings between senior FDIC officials and private sector individuals regarding how the Dodd-Frank Act should be interpreted or implemented will be publicly disclosed. The FDIC will also hold a series of roundtable discussions with external parties on implementation issues, which will be available for public viewing via webcast. Any interested party may request a meeting with FDIC officials or staff by submitting a form to be provided on the FDIC’s webpage. The public may also submit their views on implementation issues via email, which will become part of the record and be posted on the FDIC website. FDIC information regarding financial reform is available at http://www.fdic.gov/financialreform/.

Takeaway

During the next months and years, financial institutions will see an onslaught of proposed and final regulations implementing the vast changes set forth in the Dodd-Frank Act. Financial institutions will need to be vigilant in order to keep abreast of, and ultimately implement, all the changes. Fredrikson will provide updates as significant provisions of the Act become effective or are implemented through regulation.