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Nutter Bank Report, April 2008
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1. Overdraft Protection Not an Extension of Credit, Court Rules
2. Banks Urged to Curb Dividends to Preserve Capital
3. Treasury Issues Blueprint for Financial Regulatory Reform
4. Registration of Property in Foreclosure Required in Boston
5. Other Developments: OTS NPV Model and Massachusetts Wage Laws
Full Reports
1. Overdraft Protection Not an Extension of Credit, Court Rules
A bank’s coverage of overdrafts on a consumer’s demand deposit account did not constitute an extension of credit for purposes of the Truth in Lending Act, according to a recent California federal district court ruling. The court’s March 17 decision held that the bank did not violate TILA and Regulation Z by charging account-holders a fee for each overdraft the bank paid. The plaintiff depositors claimed that the overdraft protection feature of the bank’s debit cards violated TILA’s prohibitions against issuing unsolicited credit cards, among other things. The depositors alleged that the bank’s discretionary overdraft protection policy created a credit agreement and the overdraft fees imposed by the bank were finance charges. The depositors argued that the bank’s promotional materials, which might be read to suggest that overdraft protection was a guaranteed account feature, should be incorporated into the account agreement. The court held that “promotional materials are not agreements,” and cited standard principles of contractual interpretation for the proposition that “promotional materials [that] directly contradict a subsequent . . . agreement” cannot support the conclusion that the parties agreed in writing to the payment of overdrafts. The court noted that its conclusion would be the same even if the bank paid overdrafts routinely or automatically because such a course of conduct is not sufficient to imply that a contract existed.
Nutter Notes: The foundation of the court’s decision was the Federal Reserve’s interpretation of TILA and the applicable terms of Regulation Z. The court gave significant deference to the Federal Reserve’s amicus brief, which concluded that banks are not “creditors” under Regulation Z or TILA when they extend discretionary overdraft protection. Regulation Z defines a creditor as someone who (1) regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments and (2) to whom the obligation is initially payable. Under the first element, there must be either a written agreement for the borrower to repay in more than four installments or a finance charge (or both). However, a charge imposed for paying an overdraft is not a finance charge “unless the payment [of the overdraft] and the imposition of the charge were previously agreed upon in writing” under Regulation Z. Since the bank at all times retained discretionary authority to grant or withhold overdraft protection and to terminate or reduce the overdraft limit, the court found that the bank was not legally bound to extend the funds, that the fees imposed for doing so were thereby not finance charges and that the overdraft protection was not an extension of credit subject to TILA. While other courts have ruled that overdraft fees do not constitute finance charges, this appears to be the first federal court decision addressing whether the discretionary payment of an overdraft constitutes an extension of credit. While the case may be persuasive to a court in Massachusetts, it would not be controlling precedent. An appeal filed by the plaintiff depositors is currently pending.
2. Banks Urged to Curb Dividends to Preserve Capital
Federal Reserve Bank of Boston President Eric S. Rosengren in a recent speech encouraged banks to consider reducing or suspending dividends to preserve capital. He acknowledged in his April 18 remarks at the Federal Reserve Bank of Richmond’s 2008 Credit Markets Symposium that equity capital raised recently by financial institutions has offset recent credit losses. However, Rosengren expressed concern that there may be little additional systemic buffer should further losses occur. Rosengren said, “[i]ncreases in capital not only reduce solvency risk but also have salutary macroeconomic implications.” To the extent that financial institutions react to losses by shrinking their balance sheets rather than raising equity to maintain a desirable capital-to-assets ratio, credit becomes less available for borrowers. Rosengren pointed out that the reluctance of many lenders to continue to make subprime mortgage loans is an obvious example of reduced credit availability, and that other credit needs may go unmet as institutions shed assets and reduce exposure to loans that may be adversely impacted by current market conditions and a slowing economy.
Nutter Notes: Rosengren noted that a number of large financial institutions have already reduced their dividends, and urged institutions to continue to assess whether a cessation of dividends or additional reductions in dividends would be advisable. Though Rosengren’s advice was directed primarily at larger banks, he believes that smaller institutions may face similar concerns if there is a steep decline in residential and commercial real estate prices. He asserted that the last nine months of financial instability have predominantly affected large financial institutions. Large institutions often held the complicated financial instruments that were most susceptible to declines in value. Smaller banks generally have not held complicated financial instruments, so they have been relatively insulated from the financial disturbances and pressure on capital-to-assets ratios. However, significant real estate price declines would likely cause increased mortgage defaults beyond the subprime market, resulting in capital concerns for smaller banks that may be less able to attract new equity investors, Rosengren said. The Federal Reserve Bank of Boston regulates, supervises and examines bank holding companies and state chartered banks that are members of the Federal Reserve System.
3. Treasury Issues Blueprint for Financial Regulatory Reform
The U.S. Treasury Department has released an expansive proposal to overhaul financial services regulation in the United States. The Blueprint for a Modernized Financial Regulatory Structure released on March 31 presents a series of short-, intermediate- and long-term recommendations meant to improve the competitiveness of the U.S. financial markets while strengthening consumer protection and improving market stability. The short-term recommendations include creating a new federal commission for mortgage origination to evaluate, rate, and report on the adequacy of each state’s system for licensing and regulating participants in the mortgage origination process. The report also recommends enhancing the Federal Reserve’s authority to provide temporary, emergency funding while recognizing the broader regulatory issues associated with providing discount window access to non-depository institutions. Intermediate-term recommendations include eliminating the federal thrift and credit union charters and merging the OTS, OCC and NCUA, creating an optional federal charter for insurance, and unifying oversight of futures and securities by merging the SEC with the CFTC. The long-term recommendation is to create an objectives-based regulatory structure consisting of a market stability regulator, a prudential regulator and a business conduct regulator focused exclusively on financial institutions, plus a federal insurance guarantee corporation and a corporate finance regulator.
Nutter Notes: Treasury’s proposed mortgage origination commission would subject participants in the mortgage origination process that are not employees of federally regulated depository institutions to uniform minimum licensing qualification standards. The commission would periodically evaluate and audit the adequacy of state systems for regulating mortgage market participants, including licensing, supervision, and enforcement. The evaluations would grade the overall adequacy of a state system by descriptive categories indicative of a system’s strength or weakness, and the evaluation would be issued publicly to provide incentives for states to address weaknesses and strengthen their own systems. The report suggests that such evaluations could be used by asset securitizers or GSEs as part of their underwriting process and disclosure practices, and that some underwriters may choose to exclude mortgages from poorly rated states in newly created mortgage-backed securities. The report proposes the creation of a single federal insured depository institution charter to replace national bank, federal thrift and federal credit union charters, the creation of a federal insurance institution charter for insurers offering retail products with some type of government guarantee, and the creation of a federal financial services charter for all other types of financial services providers.
4. Registration of Property in Foreclosure Required in Boston
A new Boston city ordinance requires all residential property owners, including mortgagees in possession of residential property, to register vacant properties and properties in foreclosure with the Inspectional Services Department and maintain them in accordance with relevant sanitary codes, building codes and regulations concerning property maintenance. The Ordinance Regulating the Maintenance of Vacant, Foreclosing Residential Properties, which was previously adopted by the City Council of Boston, was approved by the Mayor on March 3. Under the ordinance, residential property owners must designate a person responsible for the security and maintenance of vacant property. Properties in foreclosure must be registered within seven days after the foreclosure process has been initiated. The Commissioner of the Inspectional Services Department may fine residential property owners up to $300 for each failure to register property or properly identify the person responsible for vacant property. Residential property owners may also be fined $300 for each week the property is not properly maintained. The ordinance requires that the person responsible for maintenance of a vacant property, such as a property management company engaged by the mortgagee, inspect the property on a monthly basis during the vacancy and post contact information on a sign visible from the street. The ordinance went into effect in March, but no fines may be assessed until June.
Nutter Notes: The ordinance was approved in response to the rise in the number of foreclosed homes across the City of Boston, which has resulted in an increase in vacant houses that often create an attractive public nuisance and sometimes create a safety hazard. Some homes are in violation of multiple aspects of state and local building codes, and the city has found enforcement of the building and sanitary codes to be difficult when a mortgagee has taken possession of the property. The city’s concerns include unoccupied buildings susceptible to vandalism, open structures that are unsafe, unlocked houses, unshoveled snow that renders sidewalks impassable, yards full of refuse, overgrown grass and bushes and unsecured swimming pools that are not only a threat to children but become havens and breeding grounds for rodents and infectious insects. The ordinance is modeled after code enforcement measures adopted by cities in the Midwest and California that face some of the highest foreclosure rates in the country. The City of Revere also approved a similar ordinance last year that was modeled on a similar ordinance adopted by Wilmington, Delaware in 2003.
5. Other Developments: OTS NPV Model and Massachusetts Wage Laws
- OTS Adjusts Net Portfolio Value Model
The OTS announced that its quarterly Interest Rate Risk Exposure Reports will not display results for the minus 200 basis points (bps) scenario until further notice. The interim changes to the NPV Model were published in a memorandum to chief executive officers dated April 21, which also announced temporary modifications to the requirements of TB 13a relating to the definitions of “interest rate sensitivity measure” and “post-shock NPV ratio.”
Nutter Notes: Current interest rate scenarios used in the NPV Model assume an instantaneous parallel shift in the Treasury yield curve of plus and minus 100, 200, and 300 bps. Since the yield on the three-month Treasury bill was 1.38% on March 31, the NPV Model will not produce results for the minus 200 bps scenario for the quarter ending March 31, 2008.
- Treble Damages Now Automatic for Violation of Wage and Hour Laws
The Massachusetts legislature has added new damages rules to the wage and hour laws automatically imposing treble damages for any violation by an employer of Massachusetts wage and hour laws, whether or not the violation is intentional. Chapter 80 of the Acts of 2008 became law without the Governor’s approval on April 14, and becomes effective on July 13.
Nutter Notes: Treble damages for violations of the Massachusetts wage and hour laws were previously available only where the employer had willfully and intentionally committed the violation. Employers in other jurisdictions may typically assert a good-faith defense to wage and hour damages claims. Massachusetts is the first state in the country to impose automatic treble damages for wage and hour violations.
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
Tel: (617) 439-2889
Kenneth F. Ehrlich
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