United States: The Reform Act Cuts Red Tape For Community Banks

On May 24, 2018, in what The Wall Street Journal described as "the most significant change yet" to the Dodd-Frank Wall Street Reform and Customer Protection Act (the "Dodd-Frank Act"), President Trump signed into law the Economic Growth, Regulatory Relief and Consumer Protection Act (the "Reform Act"). The legislation passed on a bipartisan basis in both houses of Congress (with Democrats providing 33 of 258 "yea" votes in the House of Representatives and 16 of 67 "yea" votes in the Senate) and was co-sponsored by, among others, both of Virginia's Senators: Tim Kaine (D) and Mark R. Warner (D).

The stated purpose of the Reform Act in the Act itself is "to promote economic growth, provide tailored regulatory relief, and enhance consumer protections, and for other purposes" (emphasis added). Echoing this goal, the Office of Management and Budget stated in a Statement of Administration Policy, "The net impact of this legislation will be to foster economic growth by expanding prudent lending, reducing regulatory costs, and strengthening the ability of consumers to protect their credit records, while ensuring the proper oversight and regulation of the financial system."

A key intention of the Reform Act is to "right-size" certain regulations for financial institutions, including, in particular, community banks and their holding companies. Or, as Senate Majority Leader Mitch McConnell (R) put it in a statement issued upon House passage of the Reform Act: "Small banks and credit unions have struggled to comply with one-size-fits all regulations...[T]his legislation reflects a bipartisan, bicameral consensus that lenders deserve targeted relief from the enormous regulatory burden imposed by Dodd-Frank."

To that end – and as described in our earlier client alert – the Reform Act refines financial institution regulatory requirements to create a more tiered regulatory framework based on an institution's asset size. The Reform Act responds to concerns from the banking industry that, despite the lower risk posed by regional and community banks, the oversight and compliance obligations imposed by the Dodd-Frank Act and other post-financial crisis regulations unnecessarily burdened, or at a minimum disproportionately burdened, these banks with compliance costs and organizational challenges.

As all community bankers know, when it comes to bank legislation and regulation, the devil is often in the details. And many of the details regarding regulatory relief for community banks may not be known for some time due to the need for federal banking regulators to issue rules implementing certain of the Reform Act's changes. Some of the more significant provisions of the Reform Act that require rulemaking include the following, discussed in greater detail in our prior client alert :

  • Simplified Capital Requirements – Required rulemaking by federal banking regulators to develop a "community bank leverage ratio" of between 8 and 10 percent for banks and bank holding companies with less than $10 billion in assets (or "qualifying community banks"), compliance with which would exempt a "qualifying community bank" from certain existing capital requirements. The Reform Act does not give a deadline for adoption of these rules.
  • Higher Threshold for "Small Bank Holding Company" Status – Required revision, within 180 days of passage of the Reform Act, by the Federal Reserve of its Small Bank Holding Company Policy Statement to cover institutions up to $3 billion in assets, as opposed to the current asset threshold of $1 billion.
  • Short Form Call Reports – Required rulemaking by federal banking regulators to reduce call report reporting requirements for banks with less than $5 billion in assets. The Reform Act does not give a deadline for adoption of these rules.

Given the delayed implementation of many provisions of the Reform Act, the Act's full effect on the financial sector and its benefit to the community banking community, in particular, will remain uncertain for the time being.

With that said, the Reform Act does contain a number of provisions intended to lessen the compliance burden on community banks and which are self-executing and immediately effective.

The balance of this client alert focuses on three such immediately effective provisions of the Reform Act relating to real estate and mortgage lending that may be of particular near-term benefit to community banks and help community banks compete with larger financial institutions and non-bank mortgage lenders.

  • Expanded Definition of Qualified Mortgages – The Reform Act expands the definition of a "Qualified Mortgage" or "QM" to include any residential mortgage loans held in portfolio by banks with less than $10 billion in consolidated assets. Such loans will be considered QMs and meet the "ability to repay test" under the Truth in Lending Act if the loans:
    • Do not include a prepayment penalty,
    • Do not have points and fees that exceed 3 percent of the loan amount, and
    • Do not have negative amortization or interest-only features.

The bank must also document the debt, income and financial resources of the borrower.

Note that this QM designation may not transfer to another financial institution if the residential mortgage loan is sold, although the designation would likely transfer if the loan is acquired via a merger with another financial institution and the loan is retained in the acquirer's portfolio.

  • Appraisal Exemption for Qualifying Rural Loans – The Reform Act exempts certain federally-related mortgage loans from appraisal requirements under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, provided that:
    • The property is in a rural area,
    • The lending bank satisfies specified standards in trying to find a state-certified or state-licensed appraiser and is unable to do so within customary and reasonable fee and timeliness standards for comparable appraisal assignments, and
  • The transaction value is less than $400,000.

Any loan that takes advantage of this appraisal exemption will likely be subject to limitations on its transfer that may reduce the loan's marketability to investors in the secondary mortgage market, except under certain conditions, such as when the loan enters bankruptcy.

  • Home Mortgage Disclosure Act Reporting – The Reform Act amends the Home Mortgage Disclosure Act ("HMDA") to exempt institutions from new reporting categories added by Dodd-Frank and the HMDA rule adopted by the CFPB regarding closed-end mortgages and home equity lines of credit ("HELOCs"). Banks that originate less than 500 closed-end mortgage loans or 500 HELOCs in each of the two preceding years are now exempt from the disclosure requirements under the HMDA, provided that the bank has not received a "needs to improve" Community Reinvestment Act ("CRA") rating during the last two exams or a "substantial noncompliance" CRA rating during the last exam. The change regarding HELOCs will not initially affect reporting because, for 2018 and 2019, the HELOC reporting threshold is 500 transactions in each of the preceding two calendar years under a temporary CFPB rule.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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