Federal Reserve Publishes Guidance on Managing Outsourcing Risk of Service Provider Relationships

The Federal Reserve recently added to the growing body of regulatory guidance on the topic of financial institution management of service provider outsourcing relationships by issuing its Guidance on Managing Outsourcing Risk (the Guidance). The Guidance applies to financial institutions of any asset size under the supervision of the Federal Reserve, including state member banks, banks and savings and loan holding companies (and their nonbank subsidiaries), and foreign banking organizations' U.S. operations.

On January 9, 2014, from 12 p.m.to 1 p.m. ET, Ballard Spahr will conduct a webinar regarding risk management of third-party relationships by financial institutions. The registration form is now available.

The Guidance is intended to supplement, not replace, existing guidance pertaining to the outsourcing of bank internal functions to third parties, and specifically including technology service providers. As noted in an accompanying press release, the Guidance relates to third-party service providers—including consultants. The term "service provider" is defined broadly, encompassing virtually any entity entering into a contractual relationship with a financial institution to provide business functions or activities, such as accounting, auditing, loan review, compliance, and risk management.

The guidance touches on some of the familiar risks of using service providers to perform operational functions. It also notes the responsibilities of the board of directors and senior management in establishing and overseeing the execution of appropriate risk management and related compliance structures compliant with applicable law and regulation, as well as safety and soundness considerations. In addition, it discusses elements the regulator believes to be typically associated with effective risk management programs, including:

  • Pre-decision outsourcing risk assessments and assessment of internal oversight capabilities
  • Due diligence and selection of service providers, based on review of business background and reputation, financial condition, and quality of operational and internal controls
  • Considerations and advice regarding contractual elements and provisions, including review by legal counsel before execution
  • Incentive compensation review and related considerations
  • Structures for oversight, use of performance metrics, and monitoring of service providers, including with respect to adequacy of their financial condition and internal control environment
  • Business continuity, disaster recovery, and contingency planning issues
  • A few more specialized risk considerations, such as risks attendant to foreign-based service providers, and special considerations for outsourcing internal audit functions

The Guidance is less comprehensive than the risk management guidance for third-party relationships published by the Office of the Comptroller of the Currency (OCC) in October, although is it is thematically similar. (The OCC's guidance was the subject of a previous alert.) This may be due partly to the fact that the Guidance supplements existing Federal Reserve guidance in this area, versus the OCC guidance, which rescinds certain longstanding OCC guidance.

Both sets of guidance agree that risk management processes should be commensurate with the risk and complexity of third-party relationships. The OCC, however, generally requires more extensive and rigorous oversight of relationships that involve critical activities. By contrast, the Federal Reserve seems to recognize that at least for community banks— if the numbers of such relationships are few and with highly reputable service providers—simpler risk management programs employing fewer considerations may be appropriate, even where critical business activities are being outsourced.

Glen P. Trudel  


Federal Financial Regulatory Agencies Finalize Appraisal Requirement Exemptions

The Consumer Financial Protection Bureau, the Federal Reserve, Federal Deposit Insurance Corporation, Federal Housing Finance Agency, National Credit Union Administration, and the Office of the Comptroller of the Currency have finalized a supplemental rule creating several exemptions to the appraisal requirements for higher-priced mortgage loans (HPML). Those requirements are contained in the final rule adopted jointly by the agencies in January 2013 to implement Dodd-Frank provisions mandating appraisals for HPMLs.

The final rule creates the following two exemptions that take effect on January 18, 2014 (which is the same date that the rule adopted in January 2013 becomes effective):

  • An exemption for certain refinances with characteristics common to "streamlined" refinances. To be exempt from the appraisal rules, the person retaining the credit risk of the refinancing must be the same person that held the credit risk of the existing obligation or the refinancing must be insured or guaranteed by the same federal agency that insured or guaranteed the existing obligation; the regular periodic payments under the refinance loan cannot cause the principal balance to increase, permit the consumer to defer repayment of principal, or result in a balloon payment; and the proceeds from the refinancing must be used solely to satisfy the existing obligation and pay amounts attributed solely to the costs of the refinancing.
  • An exemption for extensions of credit in the amount of $25,000 or less, indexed annually for inflation.

The final rule also creates certain exemptions for manufactured homes. Effective January 18, 2014 through July 17, 2015, all loans secured in whole or part by a manufactured home will be fully exempt from all HPML appraisal requirements. For loan applications received on or after July 18, 2015:

  • Loans secured by a new manufactured home and land will be exempt from the HPML requirement that the appraisal include a physical inspection of the property interior.
  • Loans secured by an existing (used) manufactured home and land will be fully subject to HPML appraisal requirements.
  • Loans secured only by a new or existing manufactured home and not land will be fully exempt from the HPML appraisal requirements if the creditor gives the consumer one of three types of information about the home's value.

The three types of information are for a transaction secured by a new manufactured home, the manufacturer's invoice for the home; a cost estimate of the value of the manufactured home from an independent cost service provider; or a valuation conducted by an individual who has no financial interest in the property or credit transaction, and has training in valuing manufactured homes.

The final rule also revises the exemption from HPML appraisal requirements for qualified mortgages to cover the various types of loans that are defined as qualified mortgages for purposes of the ability to repay rule.

- Richard J. Andreano, Jr.  


CFPB Updates Mortgage Rules Readiness Guide

The CFPB has issued Version 2.0 of its "2013 CFPB Dodd-Frank Mortgage Rules Readiness Guide." The Guide, originally issued in July 2013, is intended "to help financial institutions come into and maintain compliance with" the CFPB's mortgage rules finalized in January 2013 and that take effect next month. According to the CFPB, it designed the Guide "for use by institutions of all sizes."

The updated Guide reflects October 2013 amendments to the CFPB's mortgage rules. The amendments were published in the Federal Register on October 23, 2013.

- Richard J. Andreano, Jr


Regulators Revise Interagency Q&A on the Community Reinvestment Act

Recently, the federal banking agencies—the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation—issued revisions to Interagency Questions and Answers Regarding Community Reinvestment (the Interagency Q&A), originally issued in the mid-1990s and most recently amended in 2010. The new revisions, which became effective November 20, 2013, provide insured depository institutions (IDIs) and their holding companies with additional guidance on the agencies' Community Reinvestment Act (CRA) regulations. Aside from these revisions, the prior Q&As otherwise continue to apply.

The focus of the recent revisions is primarily on community development lending (CDL) and other community development activities. Depository institutions can receive CRA credit for community development activities. Among other things, the revisions are intended to provide clarification and additional guidance in the following areas:

  • How the regulators view community development activities benefiting a broader statewide or regional area that includes an IDI's assessment area
  • CRA consideration of, and documentation associated with, investments in nationwide funds
  • CRA consideration of certain community development services, such as service on a community development organization's Board of Directors
  • Treatment of loans to or investments in organizations that, in turn, invest those funds and use only a portion of the income from their investment to support a community development purpose
  • For large IDIs, the application of CDL performance to the "lending test" rating under the agencies' CRA regulations

Statewide or Regional Areas

This standard has been simplified a bit. It now requires only that examiners consider the IDI's community development activities in all statewide and regional geographies in which the IDI has its footprint. The revised standard applies even if these activities do not directly benefit the IDI's assessment area(s), provided the IDI has been responsive to community needs and opportunities in the latter.

The assessment area is defined in agency regulations to include metropolitan statistical areas (MSAs) and one or more political subdivisions (e.g., towns, cities, counties) where the IDI maintains its headquarters, branches, and ATMs, and where it makes (or has purchased) mortgage, small business, small agricultural, and consumer loans. In addition, the agencies now acknowledge that a regional area may be wholly intrastate but may also cross one or more state lines, as long as it encompasses the IDI's assessment area(s).

Nationwide Funds

This has been streamlined. An IDI may receive CRA credit for investments in a nationwide fund that benefits the IDI's assessment area(s) or the broader statewide or regional geography that encompasses such assessment area(s). Previous requirements of side letters and earmarking have now been eliminated; they are permissible but no longer required. Finally, the agencies considered but declined to adopt a separate CRA category for investments in national funds.

Community Development Service

CRA credit for community service targeted to low- and moderate-income (LMI) individuals now includes services to:

  • Students and their families from a school at which the majority of students qualify for free or reduced-price meals
  • Individuals who receive or are eligible to receive Medicaid
  • Recipients of government assistance from programs that have income qualifications equivalent to, or stricter than, the definitions of LMI in the CRA regulations (e.g., HUD section 8)

In addition, consideration as a community development service will be given for service on the board of directors of an organization engaged in community development activities.

Qualified Investments

CRA consideration is given to investments or loans made to an organization primarily engaged in community development. If the organization invests the proceeds in instruments that do not have the primary purpose of community development (e.g., Treasury securities) and only uses that investment income for that purpose, then only the latter amount will receive consideration by the examiners. On the other hand, if the investment in the instrument is intended to secure capital for leveraging purposes, to secure additional financing, or to generate a return with minimal risk until funds can be deployed toward the originally intended community development purpose, more positive consideration by the examiners is likely.

CDL in the 'Lending Test' Applicable to Large IDIs

A new Q&A explicates that a large IDI's record of making community development loans may have a positive, neutral, or negative impact on the "lending test" rating. A strong record in retail lending may counterbalance weak performance in CDL, and vice versa. Moreover, the agencies have clarified that CDL is not mandatory in all of an IDI's assessment areas; examiners will consider the lack of CDL in a particular assessment area within the context of the environment (e.g., economic, demographic, and competitive factors) in which the IDI operated during the evaluation period.

- Keith R. Fisher


Massachusetts Amends Debt Collector and Third-Party Loan Servicer Regulations

The Massachusetts Division of Banks recently amended 209 CMR 18, "Conduct of the Business of Debt Collectors and Loan Servicers." The final amended regulations clarify and establish new standards of conduct for debt collectors and third-party loan servicers. Among the changes, which took effect on October 11, 2013, the amendment enumerates examples of prohibited conduct regarding unfair servicing practices in general and mortgage loan servicing practices in 209 CMR 18.21 and 209 CMR 18.21A.  

The amended regulations direct third-party loan servicers to comply with additional requirements related to: 

  • Evaluating borrowers for loss mitigation options
  • Providing borrowers with written acknowledgement of receipt of loan modification documentation
  • Concluding the modification process before initiating foreclosure
  • Providing borrowers with contact information for a designated individual
  • Offering or accepting alternative loss mitigation options

In addition, third-party loan servicers are now required under 209 CMR 18.21 to maintain procedures to ensure accuracy and timely updating of borrowers' account information, including the posting of payment and the imposition of fees.  

Persons otherwise exempt from licensure as a debt collector or registration as a third-party loan servicer are required to comply with the fair debt collection and loan servicing practices set forth in 209 CMR 18.21 and 18.21A. 

The amendment also prohibits debt collectors from causing expense to any consumer in the form of collect telephone calls, text messages, download fees, data usage fees, or similar charges, without the consumer's express permission to communicate in that manner. Debt collectors may place non-collect telephone calls to a consumer's cell phone, however, if the consumer provides the number as his or her personal telephone number. 

- Marc D. Patterson


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