Financial Regulatory Reform – Effects on Bank Holding Companies and Savings and Loan Holding Companies - Financial Services

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Reform Act"). The Reform Act consists of the conference report that reconciled the House-passed version of financial regulatory reform ("H.R. 4173") and the Senate-passed version of financial regulatory reform (the "Senate Bill"). This alert focuses specifically on the effects of the Reform Act on bank holding companies ("BHCs") and savings and loan holding companies ("SLHCs"), and supersedes the alert that we published on April 26, 2010, which focused on the potential effects of the draft of the Senate Bill that Chairman Dodd released on March 15, 2010 ("Draft Dodd Bill") on BHCs and SLHCs, as compared to the potential effects under H.R. 4173 ("April 26 Alert").

The full Reform Act and an index and links to our other Client Alerts on the Reform Act can be found through Sonnenschein's Financial Regulatory Reform website.

A. New Regulatory Regime for SLHCs

Under Title III of the Reform Act, the Office of Thrift Supervision ("OTS") will effectively be merged into the Office of the Comptroller of the Currency ("OCC"), with certain OTS responsibilities and authorities also being transferred to the Federal Deposit Insurance Corporation ("FDIC") and the Board of Governors of the Federal Reserve System ("Federal Reserve"). Specifically, the OCC will take over all functions and authority from the OTS relating to federal thrifts, and the FDIC will take over all functions and authority from the OTS relating to state thrifts. The Federal Reserve will retain its supervisory and rulemaking authority over BHCs and state member banks, and will also acquire supervisory and rulemaking authority over all SLHCs. The Federal Reserve will also become the supervisor of all subsidiaries of SLHCs other than their depository institutions. The OTS will be merged into the OCC, and the foregoing responsibilities and authorities will be transferred on July 21, 2011 unless the Secretary of the Treasury opts to delay the transfer for up to an additional six months. Effective 90 days after such date of transfer, the OTS will be abolished.

Under the Reform Act, SLHCs, but not BHCs, will experience a change in their holding company regulator. This approach mirrors the approach proposed in H.R. 4173 and the Senate Bill, but differs from the approach proposed in the Draft Dodd Bill, pursuant to which BHCs and SLHCs with $50 billion or more in consolidated assets would have been subject to the supervisory authority of the Federal Reserve, but BHCs and SLHCs with under $50 billion in consolidated assets would have been regulated either by the OCC (which would have regulated holding companies of national banks and federal thrifts with total consolidated assets under $50 billion) or the FDIC (which would have regulated the holding companies of state banks and thrifts with total consolidated assets under $50 billion).

The Home Owners' Loan Act, as amended ("HOLA"), will survive under the Reform Act. The Federal Reserve will regulate SLHCs pursuant to the HOLA, whereas it regulates BHCs pursuant to the Bank Holding Company Act of 1956, as amended ("BHC Act"). The HOLA would have survived under the Senate Bill as well, but would have been abolished under H.R. 4173, which proposed that the concept of SLHCs be abolished, and that all existing SLHCs become BHCs and be regulated pursuant to the BHC Act, like BHCs. It is important to note that, because the Federal Reserve will have rulemaking authority over SLHCs pursuant to the Reform Act, the Federal Reserve may still enact regulations that would effectively cause SLHCs to be regulated like BHCs, or similar to BHCs.

B. Analysis

Practical Effects on SLHCs.
As noted above, like the Senate Bill, but unlike H.R. 4173, the Reform Act does not eliminate the SLHC or expressly provide that SLHCs will be regulated as BHCs. Instead, SLHCs will survive and be supervised by the Federal Reserve and subject to the rulemaking authority of the Federal Reserve with the following results:

By vesting rulemaking authority over SLHCs with the Federal Reserve, existing SLHCs may become subject to activities restrictions and other new regulatory requirements to which they may not have previously been subject.
The Reform Act, like the Senate Bill, at a minimum, explicitly applies to SLHCs the "source of strength" doctrine long applicable to BHCs.
The Reform Act requires the federal bank regulators to apply to BHCs and SLHCs, at a minimum, the current leverage and risk-based capital standards that insured depository institutions must follow. Thus, SLHCs will become subject to consolidated capital requirements to which they have not previously been subject while regulated by the OTS.
The new capital standards will also have the effect of eliminating trust preferred securities ("TRUPS") as an element of Tier 1 capital for BHCs and SLHCs, after a phase-in period, with certain exceptions. Once SLHCs become subject to consolidated capital requirements, many SLHCs will not be permitted to include TRUPS as an element of Tier 1 capital. One exception to this rule is that SLHCs with less than $15 billion in consolidated assets as of December 31, 2009 will be permitted to include TRUPS issued before May 19, 2010 as Tier 1 capital. The effects of the Reform Act on the capital treatment of TRUPS for BHCs and SLHCs are discussed in greater detail in our alert on the Collins Amendment.

Reduced Incentive for State Member Banks to Convert to National Charters
In the April 26 Alert, we noted that the Draft Dodd Bill could cause the largest state chartered member banks, which are currently regulated by the applicable state banking commissioner at the bank level and the Federal Reserve at the bank level and holding company level, to consider converting to a national bank charter. However, the provisions of the Reform Act reduce this incentive to convert. The Draft Dodd Bill proposed to shift the regulation of state member banks from the Federal Reserve to the FDIC, which would have added a third regulator for state member banks and their holding companies with $50 billion or more in consolidated assets (the state banking commissioner and the FDIC at the bank level and the Federal Reserve at the holding company level). On the other hand, under the Draft Dodd Bill, national banks with $50 billion or more in consolidated assets would have had only two regulators (the OCC at the bank level and the Federal Reserve at the holding company level). Because the Reform Act provides that the Federal Reserve will retain its supervisory authority over state members banks and all BHCs, regardless of size, state member banks and their holding companies will continue to have just two regulators, and the cost and complexity of compliance for state member banks will not increase, thereby removing this incentive to convert to a national bank charter. State chartered nonmember banks and their holding companies already have three regulators, and thus already have the disadvantage of multiple regulators, and this would continue under the Reform Act. It should be noted that the terms of the Senate Bill, as amended from the Draft Dodd Bill, would have had the same effects as the Reform Act, because the Senate Bill provided for the Federal Reserve to retain its regulatory authority over state member banks.

Role of the Federal Reserve
At the beginning of the regulatory reform process, except for the OTS, the Federal Reserve was perhaps the most heavily criticized of the federal banking agencies, being accused of, among other things, virtually ignoring its consumer protection duties and lax oversight of the nation's largest and most systemically important financial institutions. Many predicted that regulatory reform would result in a significant curtailment of the Federal Reserve's powers. Chairman Dodd's original bill proposed in 2009 would have stripped the Federal Reserve of all of its bank supervisory authority over banks and holding companies and limited its role to making monetary policy. The Draft Dodd Bill stopped short of this mark, but proposed to strip the Federal Reserve of its supervisory and rulemaking authority over state member banks and holding companies of less than $50 billion in consolidated assets. However, first in the Senate Bill and then in the Reform Act, the Federal Reserve ultimately emerged with an enhanced role in regulating the banking industry. Under the Reform Act, the Federal Reserve, among other things:

retains its supervisory and rulemaking authority over all BHCs and state member banks;
acquires supervisory and rulemaking authority over all SLHCs and their non-depository institution subsidiaries;
will supervise U.S. and foreign nonbank financial companies ("Affected Nonbank Financial Companies") that are deemed systemically important by the Financial Stability Oversight Council;
will continue to be the nation's primary systemic risk regulator, as it will regulate Affected Nonbank Financial Companies and be required to establish enhanced prudential standards for BHCs with $50 billion or more in assets, although the Financial Stability Oversight Council will be involved as well;
obtains the power to regulate interchange rates for debit cards; and
gains enhanced rulemaking authority over the affiliated transaction of depository institutions.

In short, the Federal Reserve will gain important new bank regulatory powers, particularly with regard to its role in regulating holding companies and systemic risk, without losing any of its existing powers except for its consumer protection responsibilities, and emerged as one of the winners of the regulatory reform process.

Transactions with Affiliates
The Reform Act amends Sections 23A and 23B of the Federal Reserve Act, which govern transactions between depository institutions and their affiliates (including their holding companies), in various ways. Effective one year from the date on which the responsibilities and authorities of the OTS are transferred to the OCC and other federal banking regulators, the scope of "covered transactions" for purposes of Section 23A of the Federal Reserve Act will be expanded to include:

derivatives transactions to the extent they result in credit exposure to an affiliate; and
securities borrowing and lending transactions to the extent they result in credit exposure to an affiliate.

The collateral requirements in connection with covered transactions will also be expanded, such that collateral must be maintained at all times for covered transactions that are required to be collateralized, rather than only at the time the transaction is entered into. The Reform Act also expands the scope of covered transactions that are required to be collateralized and imposes additional limits on what can be used as collateral. In addition, although prior to the Reform Act subsidiaries of banks were generally not treated as affiliates for purposes of the restrictions of Section 23A, "financial subsidiaries" of banks were treated as affiliates. However, a transaction between a bank and any of its financial subsidiaries was not subject to the quantitative limit imposed by Section 23A on transactions with affiliates. Under the Reform Act, transactions between a bank and any of its financial subsidiaries are subject to the full requirements of Section 23A and 23B, including such quantitative limit.

Unprecedented Rulemaking Effort Required
As is often the case with respect to landmark legislation, lawmakers left many of the key details of financial reform to regulation. Various industry experts have estimated that the new law will require federal banking regulators to enact over 200 new regulations. Others have asserted that the rulemaking effort required to implement the Reform Act will be unprecedented in its scope and complexity and will exceed the efforts required to implement the post-September 11 measures and the Sarbanes-Oxley Act.

As a result, federal banking regulators will be compelled to enact numerous regulations implementing the Reform Act and, in doing so, will have the opportunity to shape the ultimate effect of financial reform in many critical areas, many of which will have a profound impact on holding companies and how they are regulated. These key areas include, but are not limited to:

whether the Federal Reserve will incorporate existing OTS regulations regarding the supervision of SLHCs or choose to adopt new rules similar to those in existence for BHCs;
regulations creating the Bureau of Consumer Financial Protection and the Financial Stability Oversight Council;
enactment of new leverage and risk-based capital requirements for all holding companies, including SLHCs for the first time;
enhanced prudential standards (risk-based capital requirements, leverage limits and liquidity requirements) in its capacity as the regulator of systemically important institutions, including Affected Nonbank Financial Companies and BHCs with total consolidated assets of $50 billion or more; and
regulations restricting proprietary trading under the Volcker Rule.

In each of these areas, the implementation of the Reform Act is in large part left to the relevant federal banking regulators and the Federal Reserve. To that end, for example, Section 316(c) of the Reform Act provides that by July 21, 2011, the Federal Reserve, the OCC and the FDIC shall identify the regulations, orders and procedures that were issued by the OTS or a court of competent jurisdiction which they will each enforce and each regulator must publish such regulations in the Federal Register. Likewise, Section 619 of the Reform Act requires the Financial Stability Oversight Council by January 21, 2011 to study and make recommendations on implementing the Volcker Rule provisions so as to promote the safety and soundness of banking entities, and protect taxpayers and consumers by minimizing the risk that insured depositary institutions will engage in unsafe and unsound activities.

Institutions therefore will have to wait for federal regulators to propose and enact regulations before they will be able to accurately assess the ultimate impact that regulatory reform will have on them and their operations. Our lawyers and policy professionals stand ready to assist you in understanding the federal financial regulatory process, and, where necessary, to help you design campaigns and materials to influence the outcome of that process.

C. Next Steps

The many new financial regulations that are expected to be proposed, amended, and finally adopted to implement the Reform Act will require careful review and analysis as they are likely to have a huge impact on the way that BHCs and SLHCs must conduct their business. The process for the consideration of these regulations will provide important opportunities for financial institutions, including BHCs and SLHCs that may be adversely impacted, to influence the substance of these regulations by offering comments and suggesting more attractive alternatives. Finally, as financial regulations are considered and ultimately adopted to implement the Reform Act, BHCs and SLHCs should review whether changes are required in their operations or in their regulatory compliance programs to ensure that they can comply with their new obligations under the new bank regulatory regime.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.