Where There’s Smoke There’s Fire
The Burning Issues in the
Dodd-Frank Regulatory Reform Act
November 19, 2010
C. Bruce Crum
Gregg B. Eichner
Rusty N. LaForge
Robert T. Luttrell, III
J. Barrett Ellis
New Agencies
Eliminated Agencies
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Office of Thrift Supervision (stand alone)
Selected New Agencies
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Bureau of Consumer Financial Protection (“independent” within the Fed)
Financial Stability Oversight Council (stand alone)
Federal Insurance Office (Treasury)
New Offices of Minority and Women Inclusion (banking and securities regulators)
Investor Advisory Committee (stand alone; to advise SEC)
Office of Investor Advocate (SEC)
Office of Credit Ratings (SEC)
Credit Rating Agency Board (SEC)
Office of Financial Literacy
Office of Financial Research (Treasury)
Office of Housing Counseling (HUD)
Office of Fair Lending and Equal Opportunity (Fed)
Office of Financial Protection for Older Americans (Fed)
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Rules for Regulators
Financial Stability Oversight Council (FSOC)
Financial Stability Oversight Council (FSOC)
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Newly created agency responsible for systemic risk
Provide recommendations for capital and leverage requirements
Prevent systemic risk from threatening the financial system
10 voting members
– Treasury Secretary, Fed Reserve Chairman, Comptroller of the Currency, CFPB,
SEC, FDIC, CFTC, FHFA, NCUA, independent member named by the President
• 5 non-voting members
– OFR, FIO, state banking regulator, insurance regulator, securities regulator
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The Federal Reserve
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Consumer protection
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Systemic regulation
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Treasury must approve any lending program
Emergency lending to “individual” entities prohibited (Bear Sterns, AIG)
Collateral must be sufficient to protect taxpayers from losses
Limits on debt guarantees
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Fed will have to disclose counterparties and information of 13(3) and discount window lending and
open market transactions, with specified time delays
Limits on Fed’s Section 13(3) Emergency Lending Authority
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Will work closely with new Financial Stability Oversight Council to set tougher standards for
disclosure, capital and liquidity that will apply to banks as well as non-bank financial companies
Transparency
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Will house the new Bureau of Consumer Financial Protection
To prevent bank runs, the FDIC can guarantee debt of solvent, insured banks after meeting onerous
approval requirements from the Fed, FDIC, Treasury, the President and Congress
Supervision
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The Fed will keep its existing bank supervisory powers of both large and small banks
Creates a Vice Chairman for Supervision, member of the Board of Governors of the Fed designated
by the President, who will develop policy recommendations
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Bank Supervision
• Eliminates
– OTS
• Keeps
– Fed, FDIC, OCC
• Creates
– FSOC
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Bank Supervision (cont)
• Clear and streamlined supervision
– OTS abolished, with authority transferred to OCC; thrift charter preserved
– Elimination of regulatory overlap (less arbitrage on regulatory supervision)
– Clearer lines of responsibility among regulators on supervision
• Charter conversions
– Banks cannot convert charter to avoid an enforcement action (unless both the
old regulator and new regulator do not object)
• Volcker rule
– Prohibition on proprietary trading and restrictions on investments in hedge
funds and private equity funds
• Stronger lending limits
– Credit exposure from derivatives transactions included in banks’ lending limits
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Bank Supervision (cont)
• Supervision of Holding Company Subsidiaries
– Requires the Fed to examine non-bank subsidiaries that are engaged in
activities that the subsidiary bank can do on the same schedule and in
the same manner as bank exams
• Interest on Business Checking
– Authorizes banks to pay interest on business checking accounts,
effective one year from the date of enactment
• Dual Banking System
– Preserved; state banking system that governs most community banks
will continue to exist
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Rules for Banks
Enhanced Prudential Standards
Enhanced prudential standards for systemically important financial companies
and interconnected bank holding companies
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Discourage excessive growth and complexity
– Financial Stability Oversight Council to make recommendations for increasingly strict rules for companies that grow in size and
complexity
Volker Rule
– Prohibits proprietary trading and restricts investments in hedge funds and private equity funds
Risk-Based Capital Requirements
– Establishes a floor for capital that cannot be lower than the standards in effect today
Stricter Leverage Limits and Liquidity Requirements
– Financial Stability Oversight Council can impose 15:1 debt-to-equity ratio on systemically important companies to mitigate
threats to stability
Stress Tests
– For systemically important companies requires stress tests to be conducted by the Fed but does not specify frequency
– Bank and thrift holding companies with $10 billion or more in assets must conduct annual stress tests
Concentration Limits
– Credit exposures of systemically important companies to non-affiliates cannot exceed 25% of capital stock and surplus
Resolution Plans (Living Wills) and Credit Exposure Reporting for Systemically Important Companies
Risk Committees
– Required for systemically important, publicly traded non-bank financial companies, as well as publicly traded bank holding
companies, with total consolidated assets > $10B
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Bank Capital
• Trust Preferred (TruPS) and hybrid securities excluded from Tier 1 capital
– For banks with assets < $15B as of December 31, 2009, existing TruPS
grandfathered
– TARP preferred issuances grandfathered, regardless of the size of the
institution
• Minimum capital and leverage ratios
– Establishes a floor for capital that cannot be lower than the standards in effect
today
– Must include off-balance sheet activities in calculating new capital
requirements
– Must address risks relating to derivatives, securitized products, financial
guarantees, securities borrowing and lending, repos, concentrations in assets
where values are model-driven
– New capital requirements to be countercyclical
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Bank Capital
(cont)
Timing and Applicability of “Collins Amendment” Capital Requirements
Regulatory capital
deductions
(e.g. hybrid exclusions from Tier 1)
Banks with assets
> $15B
□ Phased in from Jan 1, 2013 to
Jan 1, 2016
□ No impact for first 2 years
□ Incremental phase-in 1/3rd per
year starting Jan 1, 2013
Banks with assets < $500M exempt
Banks with assets
< $15B
□ Grandfathered (effectively)
Leverage ratios and
risk-based capital ratios
□ Effective when new
requirements are
implemented within the next
18 months
□ Effective when new
requirements are
implemented within the next
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18 months
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OTC Derivatives: Overview
Comprehensive set of new rules to reduce counterparty risk and increase transparency
While the Dodd-Frank Act establishes the broad outline of regulation, most of the details will
be determined by the regulators (CFTC and SEC) in the months ahead
Provides for federal regulation of the derivatives markets.
Requires most derivatives trades to go through a clearinghouse and be exchange-traded and
also would require regulators to impose more stringent capital and margin requirements on
those derivatives not required to be traded on an exchange.
There are limited exemptions from these expanded regulations for certain commercial end
users of derivatives
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Banks that engage in swaps with their customers in connection with providing loans will not trigger
the definition of “swaps dealer,” which carries a host of regulatory burdens, nor will banks that use
swaps to hedge their own interest rate risk. A de minimums provision will exempt banks and other
entities that use swaps infrequently.
Important Distinctions
 Capital and margin requirements: Between dealers/major swap participants and end
users
 Central clearing by end users: Between financial and non-financial companies
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Securitization
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Risk Retention (“skin in the game”)
– Lenders required to hold at least a 5% stake in the asset-backed debt they structure and
sell
– Regulators will have flexibility to tailor risk-retention rules to specific products
– Retained credit risk may not be hedged
– 5% will not be a first loss piece; rather it must be a “vertical slice”
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Exemptions
– Qualified residential mortgage carveout
• All of the assets that collateralize the ABS must be qualified residential mortgages
• Federal banking agencies, the SEC, the Secretary of HUD and the Director of the FHFA to jointly
define the term “qualified residential mortgage”
– Loans guaranteed by the Federal Housing Administration, U.S. Department of
Agriculture, and U.S. Department of Veterans Affairs
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Disclosure
– Requires issuers to disclose more information about the underlying assets and to
analyze the quality of the underlying assets
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Interstate Branching
• Removes the Riegle-Neal provisions that allowed states to restrict de novo
interstate branching (effective immediately)
– National or state banks from any state will be allowed to branch into any other
state as if they were chartered in that state
• State statutes including a prohibition against interstate branching through
de novo establishment will become moot and will need to be revised
• Eliminates the required “opt-in” election by each state to permit interstate
branching through de novo branches.
– A majority of states did not opt-in
– In those states, for example Kansas, the acquisition of either an existing bank
or a branch of a bank in that state was the price of admission
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Interstate Branching (cont)
• Reasons for this proposed change
– The legislation initially proposed by the Treasury represents a leveling
of the interstate branch playing field between commercial banks and
federal thrifts, which have had the authority to branch nationwide
since 1992
– News reports have tagged this new nationwide de novo branching
authority as a “Big Gift for Big Banks.” The provision was introduced in
the House bill by a congressman from North Carolina, a state which a
very big bank calls home
– Theory that certain regulators would be pleased to have more
competition in some states to help pare down the excessive number
of community banks
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Interstate Branching (cont)
• The removal of the Riegle-Neal “opt-in” barrier to de novo
interstate branching in many states may dash the hopes of
banks to sell for high multiples as the price of admission
• It also will likely eliminate the variety of ways banks found to
enter other states without doing a whole bank acquisition and
merger
– These included buying shell charter skeleton banks from two merging
banks for premiums that have exceeded $1 million
– Structuring a branch acquisition so as to strip most all of the unwanted
assets and deposits at closing as well as then relocating and closing
the acquired branch
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Rules for Consumers
Bureau of Consumer Financial Protection
• Independent authority created with broad sweeping
powers within the Federal Reserve, with the specific
mandate of consumer protection on financial
products
• Independent head, budget and rule writing authority
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Established within the Federal Reserve (i.e., not an independent agency)
Director appointed by the President and confirmed by the Senate
Dedicated budget paid by the Federal Reserve System
Authority to write rules for consumer protections governing all financial
institutions – banks and non-banks – offering consumer financial products or
services
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Bureau of Consumer Financial Protection (cont)
• Accountability and authority
– Consolidates responsibilities previously held by various bank regulators,
making one office accountable for consumer protections
– Fed cannot prevent Consumer Bureau from issuing a rule
– Financial Stability Oversight Council, by a 2/3 vote, can overturn a Bureau rule
– State attorneys-general empowered to enforce certain rules issued by the
Bureau
– Authority to examine and enforce regulations
• Scope
– Banks with assets > $10B, all mortgage-related businesses, payday lenders,
student lenders, large non-bank financials
– Exemptions include auto dealers, real estate brokers, accountants and lawyers,
and insurance
– No authority over SEC registered and CFTC registered persons
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Other Consumer Protections
• Interchange fees (Durbin amendment)
– Fed has authority to limit interchange, or “swipe” fees, that merchants
pay for debit card transactions
– Fed to ensure fees are “reasonable and proportional”
– Retailers can offer discounts based on form of payment and refuse
credit cards for purchases under $10
– Merchants will be permitted to route debit card transactions on more
than one network
• Credit score
– Gives consumers free access to their credit score if their score
negatively affects them in a financial transaction or a hiring decision
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Other Consumer Protections
(cont)
• Mortgage reform
– Institutions must ensure borrowers can repay loans they are sold
– Prohibits incentives that encourage lenders to steer borrowers into more
costly loans
– Prohibits pre-payment penalties
– Establishes penalties for irresponsible lending
– Expands protections for high-cost mortgages
– Requires additional disclosures for consumers on mortgages, including
requiring disclosure of maximum a consumer
could pay on a variable rate mortgage
– Establishes an Office of Housing Counseling within HUD to boost
homeownership and rental housing counseling
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FDIC Deposit Insurance
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Change to assessment base
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Increase in reserve ratio to fund Dodd-Frank Act
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Changes the assessment base from domestic deposits to assets (minus tangible equity)
Will save community banks $4.5B over the next 3 years
Among top priorities in financial reform
Increases reserve ratio from 1.15 to 1.35 with a target date of 9/30/20
Added to replace, in part, the $19B “bank tax”, which was added to the bill in the closing hours of
consideration
Banks under $10B will be held harmless from premium increases as a result of this provision, just as
they were carved out from the “bank tax”
Increase in deposit insurance
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Permanently increases the maximum amount of deposit insurance for banks, thrifts and credit
unions to $250,000 per depositor
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Increase made retroactive to Jan 1, 2008
Offsets the implicit guarantee enjoyed by too-big-to-fail banks and keep deposits in small
communities
FDIC will insure the full amount of qualifying “noninterest bearing transaction accounts” for 2 years
beginning December 31, 2010
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Timing and Implementation
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Detailed Implementation Timeline
Topic
Timing Considerations
Bureau of Consumer
Financial Protection
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In general, changes become effective on “transfer date”, which will
be 6 – 18 months from date of enactment (possible extension up to
24 months from enactment)
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Regulators must agree and specify “transfer date” within 60 days of
enactment
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Interchange fees provision will take effect 1 year after enactment
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Fed has 9 months to gather data and set debit card interchange fees
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Fed must impose leverage and capital requirements within 18
months of enactment
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Trust preferred phase-out: In general will be phased in from Jan 1,
2013 to Jan 1, 2016
OTS elimination
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OTS abolished 90 days after transfer date
Interest on business
checking
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Effective 1 year from the date of the enactment
Interchange fees
Leverage and capital
requirements
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Pressure on Bank Profitability
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Pressure on Bank Profitability
Provisions in Dodd-Frank Act that will reduce bank profitability
□ Bureau of Consumer Financial
Protection
□ Interchange fee limits
□ Volcker Rule
□ Higher compliance costs
Restrictions on risky but historically profitable
activities
□ Higher capital requirements
Resulting in lower ROE
□ Less derivative trading revenues
$40B globally in 2009
□ Less securitization revenue
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 will reduce credit card profitability
 Arising from implementation of new
disclosure, reporting, compliance and
governance standards
□ Potential assessments
 To cover costs of unwinding failing firms
□ Funding of dozens of new
government studies
Bank regulators and the new Consumer Financial Protection Bureau will likely exert sharp
downward pressure on a full range of consumer-facing fee businesses
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Pressure on Bank Profitability
Bank Overdraft
Fees
Service Charges on Bank
Deposits
Credit Card Interchange
Fees
40
30
50
35
25
40
30
15
25
$ Billions
$ Billions
$ Billions
20
20
15
10
30
20
10
10
5
5
0

0
0
2004
2006
2008
2009E
98
'98
'99
'00
'01
'02
'03
'04
'05
'06
'07
'08
2007
2008
2009
Source: Center of Responsible Learning, FDIC, New York Times: Your Money (2010)
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Pressure on Bank Profitability
• Checking accounts costly to provide
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Processing costs
Technology costs
Costs of providing convenient access
Staff costs
Legal and compliance costs
Fraud costs
Capital costs and FDIC insurance
• Congressional action is limiting sources of revenue that support low-cost
checking
– It takes many low-balance, high-overhead accounts to fund loans
– Debit card interchange had become a stable source of revenue offsetting
some of the account costs
– Multiple service relationships help offset costs of deposit accounts
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Pressure on Bank Profitability
• Excerpts From Bank of America 8-K Filing
Made Friday, July 16, 2010
Impact of Durbin Amendment
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We estimate that our debit card revenue for 2010 will be approximately $2.9 billion.
Although subject to final rule making over the next year, we estimate that the decrease
in annualized revenue before mitigation could be as much as $1.8 billion to $2.3 billion
starting in the third quarter of 2011.
The estimated shortfall in revenue would impact the carrying value of the $22B of
goodwill currently included in the Global Card Services segment. Utilizing these revenue
estimates, the estimated impairment of goodwill to be reported in 3Q10 would
potentially be in the range of $7B to $10B. The amount of impairment recorded in 3Q10
will be after consideration of the value of mitigation initiatives applicable to Global Card
Services that exist at that time.
Pressure on Bank Profitability
• Excerpts From Bank of America 8-K Filing Made Friday, July 16, 2010
Commentary on Regulatory Reform
• CARD Act
– Total 2010 expected interest and fees impact, net of mitigation, to be roughly $1B aftertax
• Regulation E / Overdraft policy changes
– Previously disclosed 2010 impact $1 B after-tax, before any mitigation
• 4Q10 total service charges expected to reduce to roughly $2B pre-tax
• Dodd/Frank Bill
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Uncertainties remain as hundreds of rules need to be written by multiple regulators
Impacts to businesses and clients are uncertain
Impacts will be phased in over many different timeframes
Mitigations for potential impacts are under assessment
The High Cost of Reform School
The High Cost of Reform School
The High Cost of Reform School
Pressure on Bank Profitability
And BofA’s Strategy To Address Cost Of
Regulatory Reform
“We are looking at different ways that customers can provide us value for
the value we provide,” bank spokesman Robert Stickler said. “That can be the way
they interact with us, how much businesses they bring us, and if all else fails it can be
a monthly fee. That’s the strategy.”
One branch manager summed up many of the moves as an end to “selling
for free.”
Wall Street Journal
July 16, 2010
Pressure on Bank Profitability
• Conclusion
– Transaction accounts are expensive to provide
– Banks have been able to offset costs and offer free or very low cost
transaction accounts because of other revenue
– As restrictions are added reducing interchange, overdraft and other
sources of income banks must reexamine features and pricing of
accounts
– No business can be viable unless revenues exceed costs
– Congressional action is driving these services back to the days when
monthly fees, direct deposit requirements and restrictions on the
number of transactions were the norm
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