On May 22 the House passed, with broad bipartisan support (258-159), the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”), in the form previously passed by the Senate. President Trump signed the Act into law on May 24. Last year the House had passed a more far-reaching reform bill, the Financial CHOICE Act, but that bill had no chance in the Senate, primarily because of Democratic opposition to its repeal of the Volcker Rule and reforms of the Consumer Financial Protection Bureau (“CFPB”) created under the Dodd-Frank Act (“DFA”). Recognizing this, House Financial Services Committee Chair Jeb Hensarling (R-TX), who is retiring from Congress at the end of the year, agreed to allow the Act to be voted on in the House without amendment, on the stipulation that further deregulatory measures would be considered later.
While far from being a “repeal and replace” of the DFA, the Act nonetheless provides significant relief, especially for community financial institutions, from some of DFA’s more onerous requirements in three primary areas:
- Easing capital requirements, borrowing restrictions, and examination schedules for smaller bank holding companies
(“BHCs”) and savings & loan holding companies (“SLHCs”) that meet certain requirements;
- Exempting most banking entities with less than $10 billion in assets from the Volcker Rule, which prohibits proprietary trading and imposes certain other restrictions; and
- Creating a “safe harbor” under the “ability to repay” requirement for qualifying banks, thrifts and credit unions and easing the reporting burden of smaller institutions under the Home Mortgage Disclosure Act (“HMDA”).
Apart from the legislation itself, significant further regulatory relief may be in the offing at the regulatory agencies. President Trump’s nominee to head the FDIC, Attorney Jelena Williams, now has been confirmed by the Senate by a bipartisan margin of 69‑27; she replaces Martin Gruenberg, appointed by President Obama, who has been an opponent of regulatory relief. With Trump appointees now in place at the Federal Reserve (“Fed”) and the Office of the Comptroller of the Currency (“OCC”) as well, the three agencies have just released for comment proposed additional reforms to the Volcker Rule, and additional regulatory relief may be in the offing in the near future.
The remainder of this alert provides some further detail regarding the reforms under the Act.
Community Bank Relief
In both the House and the Senate, a principal impetus for reform legislation was the recognition that DFA imposed massive new compliance burdens on substantially all banking organizations, including those that are too small to have any systemic impact on the US financial system. The Act addresses this in several ways.
- Capital – banking organizations with less than $10 billion in assets can satisfy their capital requirements and be considered “well capitalized” with a leverage ratio of 8-10 percent, unless their primary regulator determines a higher ratio is required, thereby relieving them of the burden of compliance with the extensive requirements under the Basel risk-based capital framework.
- Holding company debt – The Fed’s policy statement applicable to small holding companies currently allows them to increase their holding company debt levels, if their total assets are $1 billion or less. The Act raises this threshold to $3 billion.
- Exam frequency – likewise, the cutoff for allowing the exam cycle to be lengthened to 18 months for a well-capitalized institution is raised from $1 billion to $3 billion.
The “Volcker Rule” as enacted in DFA prohibits any banking entity, which includes all FDIC-insured banks and thrifts regardless of size as well as all bank and thrift holding companies, from engaging in “proprietary (‘prop’) trading” and from investing in or sponsoring certain hedge funds, known as “covered funds.” The DFA contained an exemption from the Volcker Rule for asset managers that simply manage a fund, which is a permitted activity for banks and BHCs, but the exemption only applied if the covered fund did not share its name with the investment adviser. There is little or no empirical evidence that prop trading caused the financial crisis, and in any event there is a widespread awareness that the Volcker Rule imposes an unnecessary and highly burdensome compliance regime on community banks, even though they do little or no prop trading and were not responsible for the crisis. Accordingly, the Act softens both of these restrictions.
- Banking entities with less than $10 billion in total assets and total trading assets and liabilities that comprise no more than 5 percent of total assets are exempt from the Volcker Rule.
- The “name sharing” restriction under the Volcker Rule’s asset management exemption will no longer restrict a covered fund from sharing a name with an investment adviser, provided the adviser does not share its name with a banking organization or use the word “bank” in its name.
In enacting the DFA in 2010, Congress had determined that a principal cause of the housing bubble and subsequent financial crisis was that lenders were using lax lending standards in making mortgages, knowing they could then sell the mortgages into securitization vehicles. Accordingly, DFA imposed a stringent “ability to repay” (“ATR”) requirement on mortgage lenders. Under CFPB rules promulgated in 2013, a lender can comply with the ATR requirement in different ways, one of which is by originating a “Qualified Mortgage” (QM). When a lender originates a QM, it is presumed to have complied with the ATR requirement, which consequently reduces the lender’s potential legal liability for its residential mortgage lending activities; but QMs are limited in size and must meet certain other requirements. The Act provides an exemption from ATR for banks and other lenders under $10 billion in assets, provided the mortgages are retained in their portfolio. The presumption is that, since the lender will be retaining the risk on the loan, it will have an incentive to apply more conservative lending standards.
Raising the $50 billion threshold
The DFA as enacted mandates that all BHCs and SLHCs with more than $50 billion in assets be subjected by the Fed to “enhanced prudential standards.” Immediately upon its enactment, the Act raises the DFA threshold of $50 billion for applying enhanced prudential standards. Going forward, all BHCs with less than $100 billion in assets will now be exempt from these standards.
Within 18 months after the Act’s enactment, BHCs with assets between $100 and $250 billion will be subject to a revised framework.
- First, the Fed will retain discretion to “claw back” BHCs in this category into the enhanced standards, if it determines this is necessary for safety and soundness purposes or to mitigate a threat to the financial system.
- Second, the Fed will be required to undertake periodic “stress testing” of BHCs in this category to determine if they have adequate consolidated capital to absorb losses resulting from adverse economic conditions.
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We would caution that the Act is massive in size and contains numerous provisions not covered here. We welcome inquiries from clients with specific concerns about how the Act might affect their business. Please contact David Glass (firstname.lastname@example.org) or Nir Gozal (email@example.com) for further information.