Regulatory Examinations in the Time of COVID
Since March of this year, there has been a plethora of guidance released related to examiner expectations, exceptions, and leniency being given related to several different regulations during the complications that have arisen in the banking industries specifically since COVID-19. While we won’t discuss the details of every single one of those guidances, exceptions and leniencies here, as that would fill an entire manual rather than a newsletter article, it is important to understand the current overall climate with examiners and what examiners are saying banks should expect as examiners inspect the bank during this time.
On Wednesday, August 26, 2020, Federal Reserve Board Governor Michelle Bowman spoke at the Kansas Bankers Association Conference regarding the impact of COVID-19 on the banking industry. Bowman mentioned that the FRB paused examinations in March in order for banks to be able to focus on meeting the financial needs of its customers, including the Paycheck Protection Program. The FRB has since resumed examinations of its banks but will be focusing on higher risk banks first. This would be banks that particularly have higher concentrations of loans in high risk or stressed industries or areas. Bowman reiterated what has been previously stated in guidance that the agency will remain sensitive to the unique operational challenges that banks have been facing when it comes to banking in the COVID-19 era.
Representatives from the OCC and FDIC have not made similar speeches or statements to what Bowman discussed at the Kansas Bankers Association Conference. However, the OCC and FDIC did join the FRB in June of this year in releasing Interagency guidance related to assessing Safety and Soundness in the time of COVID-19.In that guidance, the agencies states that during examinations, they would be taking bank asset size, complexity, and risk profile into account when it comes to the unique stresses that have been put on the bank at this time. The agencies will look to whether they believe the bank has adequately addressed those stresses and is responding to mitigate safety and soundness risk appropriately. The agencies reiterated that as mentioned in previous statements and guidance, if the bank followed those guidelines that allowed for certain exemptions or leniencies, the bank would not be penalized for those actions. However, if the examiners find that the bank has not adequately met the stresses and responded to mitigate safety and soundness risk at the bank outside of those express exemptions or leniencies, the examiners may consider providing feedback or in some cases downgrading the bank’s composite or component ratings under existing examination procedures.
As such, although a wealth of leniencies have been given by the agencies, the bank should still do its best to continue to follow the rules and keep safety and soundness in mind. It is more important than ever that banks thoroughly document situations where the bank has faced a hardship or difficulty related to a COVID-19 so that the examiners are fully aware of everything the bank has done in order to do its best to comply with all the rules during those hardships or difficulties.
Banks may find our pandemic toolkit generally helpful: https://compliancealliance.com/find-a-tool/by-toolkit/business-continuity-pandemic-planning
“Took You Long Enough?!”: Flood Q&As
The five federal regulatory agencies announced September 1, 2020 that they would extend the comment period on a proposal to revise the Interagency Questions and Answers Regarding Flood Insurance until November 3, 2020. These have not been updated since 2011. The reason for this extension is because of the extent of the revisions proposed by the Agencies and the challenges associated with COVID-19. The proposed Interagency Questions and Answers, which were initially issued in July 2020, provide information addressing technical flood insurance-related compliance issues.
The Q&As would be divided into 17 categories and address a myriad of topics. One would tackle potential lapses in the authorization of the NFIP so that during a period NFIP coverage is not available, lenders can continue to make loans subject to the flood insurance requirements without requiring flood insurance. Lenders would still need to make flood zone determinations, provide timely, complete, and accurate notices to borrowers, and comply with other applicable parts of the flood insurance requirements.
Another would list out what lenders would consider in reviewing a private flood insurance policy and whether it provides enough protection. Items would include deductibles comparable to borrower’s financial condition, statement of adequate notice of cancellation, appropriate terms for payment per occurrence or per loss and aggregate limits, and whether the private insurance company has financial solvency, strength and ability to satisfy claims.
In regard to effective date of flood insurance, lenders would use the loan “closing date” to determine the date flood insurance must be in place for the designated loan. Since “wet funding” and “dry funding” differ by state, the bank would refer to when a mortgage is considered officially closed. Additionally, an application and premium payment for NFIP insurance has to be provided at or prior to the closing date as it affects FEMA flood insurance effective date and any resulting 30-dya waiting period for new policies not made in connection to a triggering event.
Several questions are posed regarding detached structures. Banks are still required to provide flood hazard determinations on detached structures even though coverage is not required. The Q&As also would address when a lender must require flood insurance on a loan secured by a building under construction, what the expectation is regarding a lender’s obligation if there’s a discrepancy between a flood determination form and a flood insurance policy, and even address when the bank has a loan to a cooperative unit owner, secured by that owner’s share in the co-op, that it is not a designated loan subject to flood insurance requirements.
One of the biggest clarifications is regarding construction-to-permanent loans. The new proposed Q&A would state that construction-to-permanent loans with a construction phase before the loan converts into permanent financing would not qualify for the 12-month exemption from flood insurance premium escrow requirements, even if one phase of the loan is for 12 months or less.
Additionally, some other guidance on force placement would be mentioned. Lenders can send force-placement notices to borrowers prior to the expiration date of the flood insurance policy as a courtesy, but they are still required to send notice upon determining that the flood insurance policy actually has lapsed or is insufficient. Additionally, lenders may force place insurance and charge a borrower those costs of premiums and fees incurred in purchasing the flood insurance at any time starting from the date on which flood insurance coverage lapsed or was not sufficient. The lender would not have to wait the 45-days after providing the required notification to the borrower.
These changes are broad and will impact a lender’s compliance obligations and operations. Review the proposed Q&A here and get those comments in prior to November 3rd.
Section 1071 Regulations on the Horizon
The CFPB is now in the process of writing regulations to implement Dodd-Frank Section 1071 and has released an 80-page Outline of Proposals Under Consideration and Alternatives Considered (Outline). For a brief overview, the CFPB has also released a six-page High Level Summary of the Outline.
As you may recall Section 1071 of Dodd-Frank amended the Equal Credit Opportunity Act (ECOA) and requires the collection specific data points for the purpose of facilitating the enforcement of fair lending laws and enabling banks to identify business and community development needs and opportunities of women-owned, minority-owned and small businesses. Since the passage of Dodd-Frank in 2010, no regulations have been written to implement the requirements of Section 1071, although the CFPB is currently working to remedy this situation, although the implementing regulations may end up being somewhat different than Section 1071 as found in Dodd-Frank.
In the Outline, the CFPB divides the data points of Section 1071 into mandatory data points, and discretionary data points. Section 1071 does not specify when in the credit approval process that this data must be collected, and likewise the CFPB is also considering not specifying a particular time period in which data must be collected.
The Outline indicates that the scope of the eventual Section 1071 final rule may require financial institutions to collect and report data for all applications for credit by small businesses. Because collecting and reporting on all small businesses would encompass most women-owned and minority-owned businesses, financial institutions may not be required to collect and report Section 1071 data for any businesses that are not small businesses.
Further, the Outline discusses including a number of proposed definitions for the Section 1071 final rule, some of which are included in Section 1071 of Dodd-Frank and some of which are found in existing regulations. For example, the CFPB has proposed a broad definition of “financial institution” that includes virtually every entity that engages in any financial activity but also proposes potential size-based and/or activity-based exemptions for those institutions
The definitions of “small business,” “women-owned business” and “minority-owned business” are likely to mirror the definitions already provided in Section 1071, but the term “minority individual” may be clarified to mirror the aggregate categories used under HMDA.
In the Outline, the CFPB is proposing that covered products be those that meet the ECOA definition of credit and are not excluded under the Section 1071 final rule. The CFPB is proposing to include loans, lines of credit and business credit cards as covered products and excluding consumer credit used for business purposes, leases, factoring, trade credit and merchant cash advances.
Section 1071 does not provide a definition for the term “application,” but the CFPB is proposing to define “application” similarly to how it is defined in ECOA, and providing that the following would be excluded from the definition of application: 1) inquiries/prequalifications; 2) reevaluation, extension, and renewal requests, and 3) solicitations and firm offers of credit.
The CFPB is proposing either a balancing test or establishing a privacy threshold pursuant to the Section 1071 requirement that data collected be made publicly available annually. In accordance with Section 1071, the CFPB may retain discretion to modify the data made available to the public, if such a modification is necessary for privacy reasons.
We do not expect to see a final rule published in 2020, and as proposed in the Outline, whenever the Section 1071 final rule is published, financial institutions will have approximately two calendar years to comply. There will likely be increased activity by the CFPB related to this topic in the coming months, but it should still be quite a while until we see any actual requirements related to Section 1071.