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Community Banks: Key Changes Caused by Dodd-Frank Wall Street Reform and Consumer Protection Act

September 28, 2010

This summer, a new federal law called the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into law by President Obama. This new federal law contains hundreds of new provisions that are intended to address some of the perceived abuses within the financial services industry that contributed to the economic crisis in recent years. Given the complexity of the Act, it will be some time before the implications of the new law and regulations are fully realized.

This advisory summarizes only certain key aspects of the Act that specifically affect financial institutions and their holding companies with less than $10 billion in total consolidated assets. In addition, see the separate advisories that summarize key changes specifically affecting SEC-reporting companies and mortgage brokers, lenders, and servicers

  • New Capital Requirements. The Act requires federal banking regulators to adopt minimum leverage and risk-based capital requirements on a consolidated basis for all insured depository institutions and their holding companies. These new capital ratios cannot be less than nor quantitatively lower than the ratios currently in effect for depository institutions. As a result, trust preferred securities will no longer count as Tier I capital for bank holding companies; however, existing trust preferred securities issued prior to May 19, 2010 are grandfathered if the issuing company had less than $15 billion in total consolidated assets at December 31, 2009 or was a mutual holding company on May 19, 2010. In addition, the new rules will not apply to bank holding companies that are subject to the Federal Reserve’s Small Bank Holding Company Policy Statement (i.e., most bank holding companies with consolidated assets of less than $500 million). In addition, debt and equity securities issued under TARP prior to October 4, 2010 will be excluded from any regulatory capital deductions.
  • Source of Strength Obligation. The Act requires that bank holding companies or any company that controls an insured depository institution, whether or not the company is a bank holding company, serve as a “source of strength” for their subsidiary depository institutions. The federal bank regulators will be issuing regulations to implement this new requirement.
  • Deposit Insurance Assessment Base. The assessment base for FDIC deposit insurance purposes is being changed. In general, the assessment base will now equal the average total consolidated assets of an insured depository institution minus the sum of the average tangible equity of the insured depository institution during the assessment period. This change could result in deposit insurance premiums dropping by up to one-third.
  • Deposit Insurance Limits. The federal deposit insurance limit has been permanently increased from $100,000 to $250,000. The unlimited federal insurance on the net amount of noninterest-bearing transaction accounts under the Transaction Account Guarantee Program (TAGP) has been extended from December 31, 2010 to December 31, 2012; however, the definition of the accounts covered is more restrictive than currently in place under the TAGP.
  • Debit Interchange. The Federal Reserve is directed to set interchange rates for debit-card issuers with more than $10 billion in assets that will not account for the full cost of supporting debit transactions. Merchants will be allowed to discriminate or discount based on payment type and to set minimum payment amounts for acceptance of debit and credit cards. Although smaller banks are exempt, these new rules are expected to significantly reduce community bank debit interchange income.
  • Compensation Disclosures and Practices. If a financial institution has at least $1 billion in assets, it will be required to disclose the structure of its incentive-based compensation arrangements to its federal banking regulators. In addition, such financial institutions will be required to prohibit compensation arrangements that encourage inappropriate risks.
  • Creation of Consumer Protection Bureau. A new federal Consumer Protection Bureau (the “Bureau”) has been established. Although the Bureau will be part of the Federal Reserve, it will have authority independent of the Federal Reserve. The Bureau has been charged with implementing existing federal consumer protection statutes and has been given supervisory authority, including the power to conduct examinations and to take enforcement actions, with respect to depository institutions with more than $10 billion in consolidated assets (which may be measured by including affiliates). Depository institutions under the $10 billion threshold will continue to be supervised by the banking agencies but will be required to comply with the rules of the new Bureau. Providers of consumer financial services other than depository institutions will also be subject to the Bureau’s new rules. Some of these providers will also fall under the Bureau’s supervisory and enforcement authority. Such supervised companies will include most residential mortgage firms (including affiliates of depository institutions with $10 billion or less in consolidated assets), certain “larger participants” (to be defined by regulation) in other consumer financial markets, private student lenders, and payday lenders. In addition, certain “service providers” to depository institutions and to other covered non-depository providers of consumer financial products and services will fall under the Bureau’s supervisory authority, based on the parameters of the Bank Service Company Act.
  • Less Preemption of State Laws for National Banks. Historically, national banks and their subsidiaries have not been required to comply with a host of state laws as a result of such laws being “preempted” by federal law. The Act changes this such that preemption of a “state consumer financial law” will apply to benefit a national bank only if: (1) application of the state law would have a discriminatory effect on national banks as compared to state banks; (2) the state law prevents or significantly interferes with the national bank’s exercise of its powers; or (3) the state law is preempted by another provision of federal law other than the Act. The Act goes further with respect to subsidiaries and affiliates of national banks by specifying that “state consumer financial laws” will apply to a subsidiary or affiliate of a national bank (unless the subsidiary or affiliate is another national bank) to the same extent that the state law applies to any person or entity. In other words, subsidiaries and affiliates of national banks may lose much, if not all, prior benefit of preemption of state laws.
  • Interstate Banking. The Act will allow national banks and state banks to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.
  • Affiliate Transactions. The types of transactions covered by the rules restricting transactions with affiliate (implemented by Regulation W) are being expanded to include repurchase agreements, derivatives transactions, and securities borrowing and lending.

Please contact your Varnum attorney for more information, or contact one of our banking attorneys.

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