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FDIC approves creation of de novo banks; proposes new industrial bank rules
On March 18, the FDIC announced (see here and here) the approval of two deposit insurance applications, which will allow for the creation of two de novo industrial banks. The first approval order will permit a California-based company to originate commercial loans to merchants that process card transactions through the company’s payments system and will operate from a main office located in Utah. The second approval order will permit a Nebraska-based corporation to originate and service private student loans and other consumer loans. The new bank will operate as an internet-only bank from a main office located in Utah. Both companies now await approval from the Utah Department of Financial Institutions.
Separately, on March 17, the FDIC announced that it is seeking comments on a proposed rule that would require certain conditions and commitments for approval or non-objection to certain filings involving industrial banks and industrial loan companies (collectively, “industrial banks”), such as deposit insurance, change in bank control, and merger filings. The proposed rule applies to industrial banks whose parent company is not subject to consolidated supervision by the FRB. The proposed rule would require a covered parent company to enter into written agreements with the FDIC and the industrial bank to: (i) address the company's relationship with the industrial bank; (ii) require capital and liquidity support from the parent company to the industrial bank; and (iii) establish appropriate recordkeeping and reporting requirements.
The proposed rule would require prospective covered companies to agree to a minimum of eight commitments, which, for the most part, the FDIC has previously required as a condition of granting deposit insurance to industrial banks. These include: (i) providing a list of all parent company subsidiaries annually; (ii) consenting to examinations of the parent company and its subsidiaries; (iii) submitting to annual independent audits; (iv) maintaining necessary records; (v) limiting the parent company’s representation on the industrial bank’s board to 25 percent; (vi) maintaining the industrial bank’s capital and liquidity requirements “at such levels deemed appropriate” for safety and soundness; (vii) entering into tax allocation agreements; and (viii) implementing contingency plans “for recovery actions and the orderly disposition of the industrial bank without the need for a receiver or conservator.” Comments on the proposed rule will be due 60 days after publication in the Federal Register.
Fed announces creation of special credit facility
On March 17, the Federal Reserve announced the creation of a special credit facility to serve as a funding backstop to facilitate commercial lending. Under the structure, the Federal Reserve Bank of New York will lend money to the newly created special purpose vehicle (SPV) on a resource basis, to be secured by the commercial loans purchased by the SPV from eligible issuers. There are limits on the maximum amount any single issuer may sell to the SPV. The SPV is scheduled to cease purchasing additional commercial paper on March 17, 2021.
Federal banking agencies raise commercial real estate appraisal threshold to $500,000
On April 2, the Federal Reserve Board, the OCC, and the FDIC (agencies) issued a joint press release announcing the adoption of a final rule, which would increase the threshold for commercial real estate transactions requiring an appraisal from $250,000 to $500,000. After receiving more than 200 comments to their July 2017 joint notice of proposed rulemaking (see previous InfoBytes coverage here), the agencies increased the threshold to $500,000, rather than $400,000 as originally proposed. The rulemaking initiative responded to financial industry concerns that adjustments had not been made to the current threshold amounts, which were set 24 years ago. In accordance with the final rule, commercial real estate transactions exempted by the $500,000 threshold will no long require appraisals, but will instead be subject to an evaluation, which is not required to comply with the Uniform Standards of Professional Appraiser Practices in order to provide a market value estimate of the real estate pledged as collateral and is not required to be completed by a state licensed or certified appraiser. However, the final rule stipulates that real-estate related transactions secured by a single one-to-four family residential property are excluded. The final rule will take effect immediately upon publication in the Federal Register.
Federal Banking Agencies Issue Proposed Rulemaking to Amend Appraisal Requirement Threshold for Commercial Real Estate Transactions
On July 19, the Federal Reserve Board, the FDIC, and the OCC issued a joint notice of proposed rulemaking to raise the threshold for commercial real estate transactions requiring an appraisal from $250,000 to $400,000 in an effort to reduce costs and streamline transactions. The proposal was issued, in part, in response to concerns raised by financial industry representatives during the Economic Growth and Regulatory Paperwork Reduction Act review process that adjustments have not been made to the current thresholds despite increases in property values and a scarcity of appraisers in rural areas. FDIC Chairman Martin J. Gruenberg issued a statement announcing that the proposal will significantly reduce the number of transactions requiring an appraisal. Evaluations, rather than appraisals, would now be required for commercial real estate transactions at or below the proposed threshold.
Comments on the proposed rule will be accepted for 60 days from date of publication in the Federal Register.
Boston Fed President Speaks on Trends and Risks in Commercial Real Estate and GSE Exposure
On May 9, Boston Fed President Eric S. Rosengren delivered a speech entitled “Trends in Commercial Real Estate” at a conference in New York. Mr. Rosengren’s remarks addressed a variety of factors influencing the market, analyzing favorable conditions as well as potential concerns.
Mr. Rosengren noted the “tailwinds” that have allowed for rising commercial real estate valuations, including low and stable inflation, accommodative monetary policy, and the relative economic strength in the U.S. compared with the rest of the world. In addition, with respect to multifamily commercial real estate in particular, Mr. Rosengren discussed the positive impact of several broader societal trends – including later marriage age, “greater urbanization and a preference among the large cohort of millennials to seek multifamily accommodations.” The Boston Fed President cautioned, however, that the conditions may not warrant the extent of the price increase in the market, and pointed to the “significant exposures” that leveraged institutions and the GSEs—whose holdings include significant guarantees of multifamily loans— have to commercial real estate. He also noted that the commercial real estate market could suffer further shock if regulatory and legislative proposals require the GSEs to reduce their holdings of multifamily loans.
California Amends Finance Lenders Law and Residential Mortgage Lending Act
The California legislature amended the California Finance Lenders Law (CFLL) allowing persons to make one commercial loan in a 12-month period without obtaining a license. This change effectively reenacts a de minimis exemption that was repealed in 2014, and is effective January 1, 2017 through January 1, 2022.
Effective September 28, 2016, the implementing regulations to the CFLL and California Residential Mortgage Lending Act (CRMLA) were amended such that subsidiaries and affiliates of exempt institutions are no longer exempt, by nature of this association, from the licensing requirements with respect to consumer and residential mortgage loans. The Department of Business Oversight filed the action to reverse through regulation previous Commissioner opinions that interpreted licensing exemptions under the CFLL and CRMLA to apply broadly to include subsidiaries of exempt financial institutions.
The definition of a lender under the CRMLA was also amended and now includes a person, other than a natural person, and a natural person who is also an independent contractor, who engages in the activities of a loan processor or underwriter for residential mortgage loans, but does not solicit loan applicants, originate mortgage loans, or fund mortgage loans. Further, the Commissioner may require a licensee who is engaged in the processing or underwriting of residential mortgage loans to continuously maintain a minimum tangible net worth in an amount that is greater than $250,000, but that does not exceed the net worth required of an approved lender under the Federal Housing Administration.
California Department of Business Oversight Issues Interpretive Guidance on SB 197
On April 27, the California Department of Business Oversight (Department) responded to a December 2, 2015 letter from the Equipment Leasing and Finance Association (ELFA) requesting interpretive guidance regarding the implementation of SB 197 (an Act to amend the California Finance Lender Law (CFLL) by adding Sections 22602, 22603, and 22604 to the California Financial Code). SB 197 authorizes licensed finance lenders to compensate unlicensed persons in connection with the referral of one or more prospective borrowers to the licensee for commercial loans if certain conditions are met such as interest rate limitations and ability to repay requirements. SB 197 expressly prohibits certain acts by an unlicensed person receiving compensation from a licensed lender in connection with commercial loans.
The Department’s April 27 letter sets forth the following guidance regarding SB 197 and the administration of the CFLL:
- Scope of SB 197: The Department advised that a licensed lender compensating a licensed broker for referrals is not an activity subject to SB 197. Furthermore, the Department confirmed that SB 197 does not apply to unlicensed brokers or other unlicensed persons who are not compensated for the referral of borrowers to a licensed finance lender. The Department, however, left open the possibility that there may exist circumstances where “lender referral fees or brokerage commissions are being included in the sale of equipment,” which would bring such compensation within the scope of SB 197.
- Jurisdiction/Scope of Licensing: ELFA asked several questions regarding the licensing of certain entities under the CFLL based on different scenarios. Although the Department declined to determine whether the hypothetical scenarios triggered licensure, the Department advised:
Lending to California citizens, or brokering loans on behalf of California citizens, are facts suggesting the lending or brokering activity is occurring in this state. We would look at other factors, such as whether a lender or broker solicits borrowers in California (directly or indirectly), and whether brokering on behalf of California borrowers is of a continuous nature. If the lender or broker's business activity has sufficient contact with California, then licensure would be required.
- Brokers and Exempt Lenders: The Department also advised that if a broker is not brokering loans made by a CFLL licensed lender, then the CFLL does not apply. In other words, if the lender is subject to CFLL licensure, then the broker would also be subject to the CFLL. Conversely, if the lender is exempt from the CFLL, such as a bank, then the lender would not be making CFLL loans and the broker would not be subject to the CFLL or need a CFLL license. This means, as noted above, SB 197 would not apply to referral arrangements utilized by either a lender or broker that is not subject to the CFLL. In determining whether a broker is required to be licensed, the Department noted that while a CFLL licensee is responsible for ensuring it is in compliance with the CFLL, a licensee may nonetheless rely on the broker’s written representations with respect to meeting certain exemptions (g., brokering five or fewer commercial loans in a 12-month period) from licensure because the Department recognized that the CFLL licensee may not have any practical means of verifying this information.
While the Department focused on ELFA’s questions regarding SB 197, which related to the commercial equipment lease finance sector, it appears the Department’s guidance may be broadly applied to all lenders engaging in business in California, including CFLL licensees, exempt entities, and unlicensed persons.
Ohio Supreme Court Upholds Dismissal of Class Action Challenging Bank's Interest Calculation Method
On November 21, the Ohio Supreme Court reinstated a lower court’s grant of summary judgment to a bank defending a putative class action challenging its interest calculation method as described in its promissory note for a commercial loan. JNT Properties, LLC v. KeyBank N.A., No. 2012-Ohio-5369, 2012 WL 5911063 (Ohio Nov. 21, 2012). The borrower alleged that the bank was in breach of contract by calculating interest using the 365/360 method, resulting in a higher effective rate than the rate stated in the promissory note. The bank maintained that the note clearly fixed the interest rate according to the 365/360 method. The trial court found in favor of the bank on summary judgment, but the appellate court reversed, concluding that the note was ambiguous and created a genuine issue of material fact as to which interest rate the note meant to impose. The Ohio Supreme Court reversed the appellate court and reinstated the trial court’s grant of summary judgment in favor of the bank. It held that the note’s “inartful use of the term ‘annual interest rate,’ which is clearly at variance with the next phrase setting the 365/360 method as the applicable method for computing interest,” does not render the clause defining the interest calculation method ambiguous. The court reasoned that the note was not so confusing that a reasonable person would think that the rate would be calculated using something other than the 365/360 method, and held that the note made clear that the term being defined was not the annual interest rate, but rather the interest computation method.