The Proposed Elimination of the Federal Thrift Charter: Wide Ranging Consequences for Financial Institutions

On June 17, 2009, the Obama Administration released its white paper setting forth its comprehensive plan for financial regulatory reform (the "Reform Plan"). The Reform Plan contains a number of recommendations and proposals that are intended to address perceived weaknesses in the U.S. financial regulatory system and prevent future economic and financial crises. This is the first in a series of bulletins that will discuss the details of the Reform Plan and the impact it will have on the financial services industry. Today, we examine the key proposals affecting the chartering and regulation of savings and loan associations and savings banks (collectively referred to as thrifts) and savings and loan holding companies ("SLHCs"), including, most significantly, the proposal to eliminate the federal thrift charter.

The Reform Plan is in an early stage of consideration and its fine points are yet to be developed. However, if its broad themes mature into law (and it seems inevitable that some of them will), federal thrift institutions, state and federal mutual holding companies, and the insurance companies, credit unions, and non-financial entities that rely on these institutions and their charters in operating their businesses, may face difficult choices. State chartered banks, savings banks and savings and loan associations will also be affected. All financial institutions should immediately begin to evaluate the impact of the Reform Plan on their business plans and strategic objectives and continually evaluate their options as the legislation moves forward and takes shape.

I. Details of the Reform Plan

With respect to thrifts and SLHCs, the Reform Plan proposes to:

  • Eliminate the federal thrift charter - The federal thrift charter would be eliminated, subject to undefined "reasonable transition arrangements." After the elimination, all federal thrifts that wish to remain federally chartered would become, and would be supervised and regulated as, national banks.
  • Retain the interstate branching rules applicable to federal thrifts and apply them to state and national banks - National and state banks would be given the same unrestricted ability that federal thrifts currently have to establish interstate branches de novo, subject to certain consumer protections and deposit concentration caps. All of the remaining restrictions on interstate branching by national and state banks would be eliminated and states would be prohibited from "imposing minimum requirements on the age of in-state banks that can be purchased by out-of-state banks."
  • Create a new national bank supervisor (the "NBS") - The NBS would regulate and supervise all federally chartered depository institutions and all federal branches and agencies of foreign banks. The NBS would replace the Office of the Comptroller of the Currency (the "OCC") and the Office of Thrift Supervision (the "OTS") and would inherit the OCC's and the OTS's responsibilities and authorities to require reports, conduct examinations, impose and enforce prudential requirements and conduct overall supervision. This new agency would be led by a single executive and would have separate status within the Treasury. It is anticipated that, with the elimination of the federal thrift charter, the NBS would be a continuation of the OCC, and the OTS would be effectively eliminated as a regulator.
  • Require SLHCs to become bank holding companies ("BHCs") - In connection with the elimination of the federal thrift charter, SLHCs (including grandfathered unitary SLHCs) would become BHCs and would be subject to (i) consolidated supervision and regulation by the Federal Reserve Board (the "FRB") and (ii) the provisions of the Bank Holding Company Act, including consolidated capital requirements and activity restrictions. Former SLHCs would be given five years to conform to the activity restrictions of the Bank Holding Company Act.
  • Create a new consumer financial protection agency (the "CFPA") - The CFPA would be the single primary federal consumer protection supervisor and would have "supervisory, examination, and enforcement authority over all entities subject to its regulations, including regulations implementing consumer protection, fair lending, and community reinvestment laws, as well as entities subject to selected statutes for which existing rule-writing authority does not exist or is limited (e.g., the Fair Housing Act to the extent it covers mortgages, the Credit Repair Organization Act, the Fair Debt Collection Practices Act, and provisions of the Fair Credit Reporting Act)." The CFPA would assume from the federal banking regulators "all responsibilities for supervising banking institutions for compliance with consumer regulations, whether federally-chartered or state-chartered and supervised by a federal banking regulator."
  • These proposals are intended to further the Reform Plan's larger recommendation to promote robust supervision and regulation of financial firms by, among other things, reducing opportunities for private sector arbitrage of the U.S. financial regulatory system and ensuring that similar financial institutions are subject to similar levels of supervision and regulation.

II. Effect of the Reform Plan on Thrifts and SLHCs

The Reform Plan outlines some of the expected effects of these proposals but fails to address a number of transitional and other issues that could have a major effect on thrifts and SLHCs. These issues include:

  • Capital requirements for SLHCs - Unlike BHCs, SLHCs are not subject to formal consolidated capital requirements. SLHCs' consolidated capital is presently evaluated by the OTS on a case-by-case basis through the ability of the OTS to enforce safety and soundness requirements, with the OTS focusing primarily on double leverage issues and the related impact on capital distributions from thrifts to their SLHCs. With the elimination of the federal thrift charter, SLHCs would be subject to the Bank Holding Company Act and would be required to satisfy the same consolidated capital requirements as BHCs. The Reform Plan does not specify or recommend a transition period for compliance with these capital requirements. Depending on the length of the transition period, large numbers of SLHCs could be forced to compete with one another to raise capital in a short period of time.
  • Activity restrictions on grandfathered unitary SLHCs - Grandfathered unitary SLHCs and their nonthrift subsidiaries are currently exempt from the nonbanking activity restrictions of the Bank Holding Company Act and are permitted to engage in commercial activities with minimal limitations. Under the Reform Plan, the walls between banking and commerce are intended to be strengthened by requiring grandfathered unitary SLHCs and their subsidiaries to comply with the nonbanking activity restrictions of the Bank Holding Company Act. These activity restrictions generally prohibit BHCs from engaging in activities other than those that are "closely related to banking" as set forth in the FRB regulations or otherwise approved by the FRB. As mentioned above, grandfathered unitary SLHCs would have five years to conform to the activity restrictions of the Bank Holding Company Act. However, this may prove difficult for highly diversified entities and force them to either curtail certain activities or divest their banking subsidiary and relinquish their new bank holding company status.
  • Potential erosion of federal preemption - Federal thrifts currently enjoy somewhat broader protection based on federal preemption of state laws than national banks, particularly with respect to lending laws and regulations. The Reform Plan does not specify how preemption of state laws would be handled following the elimination of the federal thrift charter or how long federal thrifts would have to comply with any state laws that are no longer preempted. Importantly, in connection with the Reform Plan's proposal to establish the CFPA, the Reform Plan states that the CFPA's rules "would serve as a floor, not a ceiling" and that "states should have the ability to adopt and enforce stricter laws." In addition, the Reform Plan proposes that states be given "concurrent authority to enforce regulations of the CFPA" and that the CFPA "should coordinate enforcement efforts with the states." While it is unclear how the balance between federal and state consumer protection regulation will ultimately play out under the proposed new regulatory regime, it would appear that federal preemption could be eroded significantly. Under such circumstances, banks and thrifts should expect more burdensome regulation not only from newly empowered states, but also from federal regulators.
  • Regulation of state chartered thrifts - It is unclear how state chartered thrifts will be regulated at the federal level under the Reform Plan. Currently, in addition to being regulated by their applicable state banking authority, (i) state chartered savings associations are regulated at the federal level by the OTS and (ii) state chartered savings banks are regulated at the federal level by either the Federal Deposit Insurance Corporation (the "FDIC") or the FRB, depending on whether they have elected to become a member of the FRB. The Reform Plan provides that "the FRB and the FDIC would maintain their respective roles in supervision and regulation of state chartered banks," but it is unclear whether "state chartered banks" is intended to include state chartered savings banks. Likewise, the Reform Plan provides language that implies, but does not make clear, that the NBS will take over the OTS's supervisory and regulatory role with respect to state chartered savings associations. Given the Reform Plan's focus on reducing fragmentation in federal regulation and ensuring that similar financial institutions are subject to similar regulations, it is possible that federal regulation of all state chartered thrifts would be consolidated into one federal agency (with the exception of federal consumer protection regulation, which would be controlled by the CFPA as proposed by the Reform Plan).
  • Status of mutual institutions - The Reform Plan is silent as to the future of federal mutual thrifts and both state and federal mutual holding companies. By definition, the national bank charter is for stock institutions so it is not possible for a federal mutual thrift to convert to a national bank charter without also undertaking demutualization. Unless the national bank charter is modified to contemplate mutual banks, federal mutual thrifts may be faced with the choice of converting to a state thrift or savings bank charter when the federal thrift charter is eliminated or converting to stock form. Institutions in states lacking a mutual charter option may face more limited choices. Moreover, the provisions of the Reform Plan requiring all holding companies of financial institutions to become BHCs would move the regulation and supervision of state mutual holding companies to the FRB. While the FRB has experience regulating these institutions, its policy positions regarding dividend waivers and establishing exchange ratios in connection with second step conversion transactions have been problematic. Unless clarity comes quickly as to the future regulation of mutual holding companies or the process for federal-to-state or mutual-to-stock conversion, mutual institutions and mutual holding companies may wish to consider the benefits of undertaking these transactions early, under the certainty of existing rules.
  • Consequences for credit union demutualization transactions - The Reform Plan anticipates retaining a separately regulated credit union industry. However, elimination of the federal mutual thrift charter could remove one strategic option for credit unions seeking to raise capital or reorganize their businesses. Under current law, credit unions seeking access to the capital markets or expanded business powers typically do so by demutualizing. Current federal rules require, in the first instance, conversion to a federal mutual thrift followed by a mutual-to-stock conversion under the prevailing OTS rules. The Reform Plan does not indicate whether a federal demutualization option for credit unions will be preserved.
  • Loss of tax benefits - To the extent that a federal thrift has remaining tax bad debt reserves, any conversion to a national bank charter could result in an adverse tax consequence. The Reform Plan is silent on any potential tax consequences to thrifts due to the elimination of the federal thrift charter.

III. Next Steps

Congress has scheduled hearings on the details of the Reform Plan, and the various constituencies affected by the Reform Plan have started their lobbying efforts. It is too early in the process to predict the final outcome of the legislative process, but we strongly encourage all financial institutions to follow the process closely and immediately begin to evaluate the potential impact of the Reform Plan on their strategic plans and consider available alternatives.