Dodd-Frank and Borrowers’ Costs

The Dodd-Frank Act (“DFA”), approved by Congress and the President in 2010 and effective April 1, 2011, affects almost every aspect of the U.S. financial services industry. The purpose of DFA is to restore public confidence in the financial system, preventing another financial crisis, and allowing any future asset bubble to be detected and deflated before a crisis like that of 2009 occurs again.

The regulations within DFA, and no doubt its myriad of supporting administrative rules, will significantly increase regulation of the financial services industry. Many questions about its impact remain and will be revealed over the coming months and years. The purpose of this article is to identify on a preliminary basis the impact of DFA on financial institutions and the corresponding trickle-down effect on commercial borrowers.

DFA imposes significant new regulations on banking organizations as well as providing the Federal Reserve with authority to regulate lenders other than banks—such as insurance companies and investment firms (if they predominantly engage in lending activity and are identified by the federal government as institutions that should be regulated based on their funding sources and other risk-based criteria).

DFA will increase the cost of doing business for banks. Local community banks estimate that the additional regulatory cost of DFA compliance could be in the range of $700,000 to id=”mce_marker”.2 million. This is on top of all the other regulatory requirements that banks must adhere to from the Federal Reserve, the Federal Deposit Insurance Corporation, and other state and federal agencies.
DFA creates the Consumer Financial Protection Bureau. This new federal agency has a mandate to issue regulations, determine compliance with DFA, and implement enforcement actions under rules that it will create over the next two or more years.

Given the added regulatory costs, it should come as no surprise that financial institutions will do their best to pass along DFA costs and DFA compliance to commercial borrowers.

Loan document language, developed by larger banks already likely to be followed by most banks making business and real estate loans, includes a provision requiring borrowers to pay toward the bank each increased cost resulting from DFA “regardless of the date” when the cost-triggered change occurs. This means that to the extent that the banks’ regulatory costs go up, these costs may be passed on to borrowers without regard to whether a loan was entered into before the effective date of DFA. These new costs can be passed along either as a fee or as added interest cost. It has been the case that lenders generally included the “increased cost” clause only for situations in which laws or rules changed after a loan was closed. Now, banks are very concerned and want the broadest possible protections from increased costs in loan documents. It is important for a borrower to watch out for language of this type and negotiate provisions to the borrower’s benefit.

In addition to higher potential loan costs for real estate and commercial borrowers, the more stringent loan document provisions could slow the rebound in lending that has otherwise increased at many banks, especially those that have emerged from the financial crisis with plenty of capital to loan.

Real estate and business borrowers will find that it is not just banks that are affected by DFA. Insurance companies and other lenders that are substantially in the business of making commercial and real estate loans will also have to comply with DFA. Also, the cost of real estate and commercial loans could increase as a result of a provision in DFA requiring banks and others that package loans to retain the risk of what they are selling to third-party investors.