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Nutter Bank Report, June 2008
06.30.2008 | Legal Update
1. Fees May Be Imposed and Costs Passed On During Default Cure Period
2. Altering Equity Credit Lines Raises Compliance Issues, FDIC Warns
3. Auditor Attestation Compliance Deadline Extended for One Year
4. Guidance on Managing Third-Party Risks Issued by FDIC
5. Other Developments: FDIC Appeal Process and FHA Mortgage Insurance
Full Reports
During the 90-day mortgage default cure period required by recent Massachusetts legislation, a bank may charge a borrower a fee up to a specified cap for revising loan terms and may pass on other appropriate costs and expenses as long as the borrower is not assessed any fee that is attributable to the exercise of his or her right to cure the default, according to a recent Division of Banks opinion letter. In Opinion 08-016 issued on June 25, the Commissioner of Banks stated that payments made by a lender to protect its interests in the property, including but not limited to payments of real estate taxes, hazard insurance premiums, condominium fees, condominium special assessments, and other municipal charges such as water, sewer and electric, are appropriate and may be passed on to the borrower. The Commissioner of Banks "strongly encourages" lenders to advise a borrower in default, preferably when the required notice of the borrower's right to cure is provided, that the borrower remains responsible for complying with other provisions of the mortgage such as provisions requiring the borrower to make the payments specified above and that, if necessary, the lender will take steps to protect its secured status which would lead to additional charges to the borrower. The law also allows late fees and per diem interest to be charged to the borrower during the cure period.
Nutter Notes: Chapter 244, Section 35A was added to the General Laws by Chapter 206 of the Acts of 2007. Under the new law, Massachusetts homeowners facing foreclosure are entitled to a notice of statutory delinquency and a 90-day right to cure a payment default once during any 5-year period. The 90-day cure period applies to foreclosures initiated on or after May 1, 2008. Subsection (d) of Section 35A states in part that "[t]o cure a default prior to acceleration under this section, a mortgagor shall not be required to pay any charge, fee, or penalty attributable to the exercise of the right to cure a default," with the exception of late fees (as permitted under Chapter 183, Section 59 of the General Laws) and per-diem interest to cure such default. Among the fees and charges specifically prohibited by the law are attorneys' fees relating to the borrower's default that are incurred by the mortgagee during the 90-day cure period. In reviewing Chapter 206, the Commissioner of Banks concluded that the prohibition only applies to fees and charges related to curing a default, and noted that Chapter 206 amends the revision of terms statute, Chapter 183, Section 63A of the General Laws, to increase the fee that may be charged for a revision of terms of a mortgage loan from ½ of 1 percent to 1 percent of the outstanding principal loan balance or the revised balance, whichever is greater.
Banks that suspend or reduce home equity lines of credit as a result of increased risk exposure must comply with applicable consumer protection requirements, the FDIC said in Financial Institution Letter 58-2008 issued on June 26. Because home values have declined in many areas across the country and many borrowers are experiencing financial difficulties, home equity lines of credit may present increased risk, the FDIC said. In response to the growing risk of loss, banks "may appropriately reduce or suspend the . . . credit limits of some borrowers [on home equity lines of credit]" under the circumstances allowed by the Federal Reserve Board's Regulation Z which implements the Truth in Lending Act and as set forth more fully in the May 2005 Interagency Credit Risk Management Guidance for Home Equity Lending, and the October 2006 Addendum. If, for risk management purposes, a bank decides to reduce or suspend a home equity line of credit, legal requirements that protect consumers must be followed. A bank must comply with the requirements of Regulation Z, and should be aware of additional requirements under the Federal Trade Commission Act, the Equal Credit Opportunity Act and the Fair Housing Act. Banks should work with borrowers, wherever possible, "to minimize hardships that may result from such suspensions or reductions."
Nutter Notes: Regulation Z generally prohibits lenders from changing the terms of home equity lines of credit, with certain exceptions. For example, Regulation Z expressly permits lenders to prohibit additional extensions of credit or reduce the applicable credit limit during any period in which the value of the dwelling that secures the plan "declines significantly below the dwelling's appraised value" for purposes of the plan. To use this exception, a lender must determine that a "significant decline" in value has occurred. The term "significant decline" is not defined in the regulation. However, the Federal Reserve Board's Official Staff Interpretations of Regulation Z include an example indicating that, while a "significant decline" in value will vary according to the circumstances, such a decline has occurred if the unencumbered equity is reduced by 50 percent. According to the Official Staff Interpretations, a lender is not required to obtain an appraisal before suspending credit privileges, but there must be a significant decline in value. Although full individual appraisals need not be obtained, banks should have a sound factual basis for determining that a property has experienced a significant decline in value. For example, automated valuation models or local tax assessments may be used under certain circumstances.
The Securities and Exchange Commission has approved a one-year extension of the compliance deadline for smaller public companies to meet the Section 404(b) auditor attestation requirements of the Sarbanes-Oxley Act. In the June 20 announcement, the SEC said that it has received Office of Management and Budget approval to proceed with data collection for a study of the costs and benefits of Section 404 implementation, focusing on the consequences for smaller companies. The results of the study are expected to become available before the end of the extension period. With the extension, smaller companies will now be required to provide the attestation reports in their annual reports for fiscal years ending on or after Dec. 15, 2009. SEC Chairman Cox first proposed the one-year delay for small businesses in December 2007, and the SEC formally proposed the extension in February of this year. Section 404 has two provisions. Section 404(a) requires company management to assess the effectiveness of the company's internal controls over financial reporting, while Section 404(b) requires an auditor attestation on management's assessment. Larger companies, comprising more than 95 percent of the market capitalization of the equity securities markets in the United States, have been subject to both provisions since 2004.
Nutter Notes: The SEC staff will begin the collection of data through interviews and other outreach. With the key financial data for annual reports becoming available to companies this spring, the SEC staff will be moving forward with interviews and a web-based survey as part of its effort to collect "real-world data" from a broad array of companies, "analyzing what drives costs, particularly for smaller companies," and where companies and investors derive the benefits from Section 404. The SEC staff's cost-benefit study will help determine whether the new management guidance on evaluating the internal controls over financial reporting issued by the SEC in June 2007 and the Public Company Accounting Oversight Board's Auditing Standard No. 5 approved by the SEC in July 2007 are having the intended effect of facilitating more cost-effective internal control evaluations and audits of smaller reporting companies. The study includes gathering new data from a broad array of companies about the costs and benefits of compliance with the Section 404 requirements. The extension of the Section 404(b) compliance date for smaller companies is the latest in a series of SEC actions to help reduce unnecessary compliance costs for smaller companies. In 2007, the SEC issued new guidance for management's Section 404 assessment to help companies focus their reviews on key internal control issues.
The FDIC has published guidance describing risks to financial institutions that may arise from third-party relationships and recommending risk management principles to provide an outline for assessing, measuring, monitoring and controlling the risks associated with those relationships. The guidance is attached to Financial Institution Letter FIL-44-2008 released on June 6. The potential risks addressed in the guidance include strategic risk, reputation risk, operational risk, transaction risk, credit risk, and compliance risk. According to the guidance, there are four elements of an effective risk management process: risk assessment, due diligence in selecting a third party, contract structuring, and oversight. The FDIC stated that it will hold an institution's board of directors and senior management responsible for identifying and controlling risks arising from third-party relationships to the same extent as if the activity were conducted by the institution directly. The guidance indicates that the principal focus of a supervisory review of an institution's third-party risk management will be management's record of and process for assessing, measuring, monitoring and controlling third-party risks.
Nutter Notes: The FDIC's third-party risk management guidance is based on and supplements the principles contained in other guidance that has previously addressed third-party risk in the context of specific functions, such as information technology. The FDIC stated that the guidance is intended to assist in the effective management of third-party relationships, and should not be considered to be a set of required procedures. Regardless of the nature of the potential relationship, the guidance recommends that all risk assessments begin with a consideration of whether the relationship is consistent with the institution's business strategy and should include an analysis of costs, benefits, legal issues and the risks particular to the third party under consideration. The guidance also suggests that an expanded analysis may be called for if the relationship relates to a new activity or a new product or service for the institution. The guidance recommends that initial risk assessment include a review of the institution's ability to provide adequate oversight of the proposed relationship and estimates of the long-term financial effect of the relationship.
FDIC Proposes Amendments to Its Supervisory Appeals Process
The FDIC is requesting comments on a proposal to amend its Guidelines for Appeals of Material Supervisory Determinations. The proposed amendments, published on May 27, are intended to better align the FDIC's Supervisory Appeals Review Committee process with the supervisory determinations and appeals procedures of the other federal banking agencies. The FDIC's Guidelines for Appeals of Material Supervisory Determinations describe the types of determinations that are eligible for review and the process by which appeals will be considered and decided.
Nutter Notes: The FDIC proposes to modify the supervisory determinations eligible for appeal to eliminate the ability of an institution to appeal to the Supervisory Appeals Review Committee any "[f]ormal enforcement-related decisions, including determinations and the underlying facts and circumstances that form the basis of a recommended or pending formal enforcement action, and FDIC determinations regarding compliance with an existing formal enforcement action." Comments on the proposed amendments are due by July 28.
FHA Changes Policy to Facilitate Foreclosure Sales
The Federal Housing Administration announced a temporary policy change on June 13 that allows for the immediate sale of vacant foreclosed properties with FHA–backed mortgage insurance. For one year, foreclosed properties marketed and sold by property disposition firms on behalf of lenders will no longer be subject to the customary 90-day waiting period to qualify for FHA mortgage insurance.
Nutter Notes: FHA mortgage insurance is not available for a property owned by the seller for 90 or fewer days, which is meant to prevent so-called "flipping" of properties. The policy causes foreclosed properties to remain vacant for 90 days in order to qualify for FHA mortgage insurance. FHA's new policy will permit the immediate sale of foreclosed properties to legitimate borrowers wishing to use FHA-insured financing, the FHA said.
Nutter Bank Report
Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, has ranked Nutter's Banking and Financial Services practice among the top banking practices in the nation in the 2007 Chambers and Partners U.S. rankings. The "well known and well-versed" Nutter team "excels" at corporate and regulatory banking advice, according to the 2007 Chambers Guide. Visit the 2007 U.S. rankings at ChambersandPartners.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Lisa M. Jentzen. The information in this publication is not legal advice. For further information, contact:
Gene A. Blumenreich
gblumenreich@nutter.com
Kenneth F. Ehrlich
kehrlich@nutter.com
Michael K. Krebs
mkrebs@nutter.com
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