Dodd-Frank Wall Street Reform and Consumer Protection Act: IMPACT ON COMMUNITY BANKS August 4, 2010 Jim SheriffTom Homberg Patrick MurphyJohn Reichert Pete Wilder

2 Order of Presentation

3 Introduction The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama on July 21, Dodd-Frank will impact the financial services industry more extensively than any banking legislation since the 1930s.

4 Overview Act calls for more than 250 new regulations and 65 “studies.” Act establishes a major new federal bank regulatory agency, the Consumer Financial Protection Bureau, with an annual budget of over $500 million and more than 1,000 employees. Dodd-Frank will impact community banks’ loan and deposit- taking activities, FDIC insurance premiums, capital requirements and corporate governance matters.

5 Residential Mortgage Reform “Duty of care” – originators may not steer a customer to a loan product for which they lack the ability to repay, or that has “predatory characteristics or effects.” CFPB regulations to be issued over the next few years will require lenders to make a “reasonable and good faith determination” that consumer is able to repay the loan according to its terms. No more “no-doc” or “low-doc” loans. Penalties for failure to follow these minimum standards, include a new defense for borrowers in foreclosure actions. Ban on “yield spread premiums” and other incentive payment formulas for mortgage brokers. New limitations on prepayment penalties.

6 Residential Mortgage Reform (continued) Safe harbor presumption with respect to certain “qualified mortgages.” “Qualified mortgages” – –No negative amortization; –Payment schedule must fully amortize the loan during the loan term (generally excludes “balloon” mortgages); –Consumer may not have the right to defer principal payments; –Total points and fees may not exceed 3 percent; –Term generally may not exceed 30 years.

7 FDIC Insurance Change in FDIC assessment base from deposit base to average consolidated total assets minus average tangible equity. Permanent increase in SMDIA to $250,000 as of July 21, No limit on insurance on noninterest-bearing transaction accounts from December 31, 2010 through January 1, Interest-bearing transaction accounts permitted beginning July 21, Deposit Insurance Fund: –Reserve no longer capped at 1.5 percent; –No longer required to refund excess amounts in the DIF; –Minimum reserve ratio of 1.35 percent to be achieved by September 30, 2020.

8 Examination/Enforcement of Non-bank Subsidiaries All non-bank subsidiaries not currently regulated by a state or federal agency now subject to examination by the Federal Reserve – same manner/frequency as if activities conducted by lead bank. Fed’s examination authority will be subject to the CFPB’s authority with regard to activities under CFPB’s jurisdiction. Fed is permitted to conduct examinations of non-bank sub- sidiaries in a joint or alternating manner with state regulators. If largest bank subsidiary is a state nonmember bank, the FDIC or the OCC, as applicable, may exercise “back-up authority” to examine activities of non-bank subsidiaries on Fed’s behalf. Examinations will consider whether activities engaged in by non- bank subsidiary pose a material threat to the safety and soundness of its insured depository institution affiliates. Fed may take (or the “back-up” agency can recommend) enforcement action against non-bank subsidiaries.

9 Consumer Financial Protection Bureau, TILA Changes and UDAP Consumer Financial Protection Bureau –New independent executive agency within the Federal Reserve System. –Created to take over most of the consumer protection functions under TILA, RESPA, HMDA, the Fair Debt Collection Practices Act and the Fair Credit Reporting Act, among others. –Broad rulemaking authority over federal consumer protection laws includes identifying unlawful, unfair, deceptive or abusive acts and practices. –Authority over persons engaged in offering or providing a consumer financial product or service.

10 CFPB, TILA, UDAP (continued) –CFPB will have exclusive examination authority and primary enforcement authority over institutions with more than $10 billion in assets; lesser authority over smaller banks. Most consumer provisions of the Act will become effective on the date that authority over consumer financial regulation is transferred to the CFPB. CFPB may prohibit or limit mandatory predispute arbitration provisions, but only after conducting a study. Civil penalties for violation of CFPB. TILA exemption threshold increased from $25,000 to $50,000.

11 Elimination of the OTS Office of Thrift Supervision is currently the primary federal regulator for over 750 federal and 400 state-chartered thrifts. OTS will be abolished within 90 days after the transfer of powers to the other banking agencies, which must occur within one year after enactment of the Act (this can be extended by an additional six months by the Secretary of Treasury). Although OTS will be abolished, the Act does not eliminate thrift charter itself.

12 Elimination of the OTS (continued) OTS will be merged into the OCC and its powers divided among existing banking agencies: –FDIC: Supervisory authority over state thrifts. –OCC: Supervisory authority over federal thrifts and rulemaking authority for federal and state thrifts, except in areas delegated to the Fed. –Federal Reserve: Supervisory and rulemaking authority for savings and loan holding companies and rulemaking authority for federal and state thrifts with respect to affiliate transactions, loans to insiders and anti-tying prohibitions.

13 De Novo Interstate Branching Removal of the restrictions on interstate branching in the 1994 Riegle-Neal Act. Until Dodd-Frank, banks generally have been limited in their ability to establish branches outside of their home state without acquiring a whole institution, and could only do so in states that had “reciprocity” with their state. Under the Act, national banks and state banks may branch in any state if, under the laws of the state in which the branch is to be located, a state bank chartered by that state would be permitted to establish the branch.

14 Federal Preemption The Act has halted the expansion of federal preemption for national banks and federal thrifts. OCC and the courts may only preempt “state consumer financial law” if: –application of law would discriminate against national banks, –state law “prevents or significantly interferes” with exercise of the national bank’s powers, or –state law is preempted by other federal law. Restrictions: –preemption determinations must be made on a case-by-case basis; –OCC must periodically review each preemption determination and publish its decision to continue or rescind the determination; and –OCC must publish a quarterly list of all preemption determinations. New standard of legal review encourages greater judicial scrutiny of OCC preemption determinations. Eliminates preemption for subsidiaries of federally chartered banks.

15 Minimum Leverage and Risk-Based Capital Standards “Collins Amendment.” Requires bank regulators to establish new minimum leverage and risk-based capital requirements on holding companies by January Eliminates “hybrid capital” instruments, such as TruPS, in Tier 1 capital by certain institutions (however, debt and equity instruments issued to the Treasury Department under the TARP program are permanently includable in Tier 1 capital). Rules depend on size and type of company. hybrid capital instruments included in Tier 1 capital minimum leverage/ risk-based capital requirements effective: BHC: Assets > $15Bphased out between 1/1/2013 and 1/1/2016 upon issuance of regulations BHC: Assets $500M – $15B grandfathered if issued before 5/19/10 BHC: Assets < $500Mexempt Thrift holding company: Assets > $15B phased out between 1/1/2013 and 1/1/2016 July 2015 Thrift holding company: Assets < $15B exempt Mutual holding companies grandfathered if issued before 5/19/10

16 Executive Compensation at Financial Institutions By April 2011, Federal regulators (including the Fed, the OCC and the FDIC) must jointly issue regulations or guidelines –prohibiting incentive-based compensation arrangements that encourage inappropriate risks that could lead to material financial loss; and –requiring covered financial institutions to disclose the structure of their incentive compensation arrangements to their regulators. Regulations or guidelines must be “comparable to” existing standards under Section 39(c) of the Federal Deposit Insurance Act. Does not apply to banks with less than $1 billion in assets – “covered financial institution” is defined as a bank or bank holding company, thrift or thrift holding company, credit union or broker dealer with assets over $1 billion.

17 Accredited Investor Standard Important for small bank holding companies seeking to raise capital. “Accredited investor” –No change in income standard ($200,000 in annual income, or $300,000 in joint annual income with their spouse); but –effective immediately, the $1 million net worth standard will exclude the investor’s primary residence. Any company currently conducting a securities offering that relies on some or all of its investors being “accredited” will have to take immediate steps (including revising the subscription agreement) to implement the new definition.

18 Small Public Companies Executive Compensation All SEC-registered companies: –“Say on Pay”– nonbinding shareholder vote on executive comp beginning January 21, –“Say on Golden Parachutes” – merger vote after January 21, –Broker discretionary voting eliminated. –Pay and performance disclosure and internal pay equity disclosure – subject to further SEC rulemaking. Listed companies (not “OTCBB” or “Pink Sheets”): –Independence of compensation committee members. –Standards for hiring compensation committee advisers. –Incentive compensation clawback following a restatement arising from material noncompliance with financial reporting requirements.

19 Small Public Companies (continued) Corporate governance SEC may issue rules permitting shareholders to use company’s proxy solicitation materials to nominate director candidates. SEC must issue rules requiring companies to disclose why they have separated, or combined, positions of chairman and CEO. Risk committee: –publicly-traded BHC with assets of $10 billion. –Federal Reserve may apply to smaller publicly traded BHCs. Sarbanes-Oxley Item 404 exemption Issuer with a public float of less than $75 million is exempt from Sarbanes-Oxley §404(b) attestation-of-internal-control. SEC must study how to reduce burden of complying with Section 404(b) for companies with market cap $75M – $250M.

20 Interchange Fees Federal Reserve must set interchange rates in electronic debit- card transactions involving issuers with more than $10 billion in assets. Federal Reserve is directed to regulate the “reasonableness” of the fees and issue rules by March Merchants may discriminate based on payment type (debit vs. credit) and may set minimum payment amounts to accept cards.

21 Conclusion Dodd-Frank ultimately establishes a new regulatory framework for the entire financial institutions industry. The Act will significantly affect larger institutions with which community banks do business. All financial institutions will be subject to heightened regulatory scrutiny and oversight. Many of the requirements imposed by Dodd-Frank on larger organizations may eventually become “best practices” for institutions of all sizes.