So How Does This Affect Me?

  A Commercial Borrower’s 
Perspective of The Dodd‐Frank Wall Street Reform and 
Consumer Protection Act 
Tal Izraeli 
A R N S T EI N   &  L E H R  LLP  
120  S O UT H   R I V E RS I DE  P LA ZA  |  S UIT E   1200 
C H I C A G O , I L 6 06 06  
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tizraeli@arnstein.com 

It has been well publicized that on July 21, 2010, President Obama signed into law the 2,319
page Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), to respond to
the financial crisis and the Great Recession of 2008. Without a doubt, the Act offers the most
robust change to the U.S. financial regulatory system since the Great Depression. By way of
comparison, the Federal Reserve Act (1913) was 31 pages, the Glass-Steagall Act (1933) was
37 pages, the Interstate Banking Efficiency Act (1994) was 61 pages, the Gramm-Leach-Billey
Act (1999) was 145 pages, and the Sarbanes-Oxley Act (2002) was 66 pages. Despite the
breath and scope of the Act, the specific details and implementation of many of the key
provisions are left to be determined in the coming months and years by various regulatory
agencies (the Act contains over 240 rule making efforts and nearly 70 studies to be completed
by 11 regulatory agencies). Moreover, many commercial borrowers are wondering how these
changes may affect their ability to finance their companies.

The Act will impact not only the largest financial institutions, but also regional and
community banks, and non-bank financial companies. A primary goal of the Act is to address
risky lending practices, which some believe was at the core of the financial crisis. This article
summarizes and briefly analyzes key provisions of the Act which may have the most direct
impact on commercial lending, and identifies the agencies tasked with regulating those
provisions.

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I. Capital Reserves (Collins Amendment)

Summary: Section 171 of the Act, known as the Collins Amendment, limits the capital that
may be used by depository institutions for regulatory purposes. The limitations include
restricting the types of instruments that may be used for regulatory purposes. Section 112 of
the Act tasks the newly created Financial Stability Oversight Council with recommending to
the Federal Reserve new standards for risk – based capital, leverage, liquidity, contingent
capital, resolution plans and credit exposure reports, concentration limits, enhanced public
disclosures, and general risk management for large lenders including banks and non-bank
financial companies supervised by the Federal Reserve. The Act will incorporate new capital
standards which are now being reviewed on a global scale by the Basel Committee on
Banking Supervision (which includes federal banking agencies). The new Basel standard is
widely expected to include higher overall capital reserve requirements and further limitations
on assets which may be counted toward capital.

Impact: The Collins Amendment may, at least in the short term, diminish the amount of credit
available due to the higher capital reserve requirements on covered institutions.

II. Credit Risk Retention Requirement for Asset Based Securities

Summary: The Act requires lenders to retain a certain portion of credit risk in connection
with the issuance of asset based securities (“ABS”). ABS is broadly defined to include a fixed
income or other security collateralized by any type of self-liquidating financial asset (such as a
loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the security
holder to receive payments that depend primarily on the cash flow from the asset. Under the
Act, an issuer of an ABS must retain five percent (5%) of the credit risk for such issue, and is
prohibited from hedging or transferring the credit risk. Presumably since the lenders/issuers
will now have ‘skin in the game’, documentation for individual loans that make up such
securities, as well as the quality of appraisals (and market assumptions made for appraisals),
will be much higher and more heavily scrutinized. One exemption from the retention

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requirement will be for “qualified residential mortgages” which will include residential
mortgages deemed to be the lowest risk of default by regulators (the exact definition of
“qualified residential mortgages” will be determined by the regulators over the next year).
The specific risk retention requirements are to be determined by the Office of the Comptroller
of the Currency, the FDIC, the SEC, and the Federal Reserve.

Impact: Commercial lending standards likely will be increased along with increased scrutiny
of appraisals, assumptions and due diligence. Consequently, financial covenants may be
stricter, and loan documentation would reflect far more conservative terms such as increased
loan-to-value requirements and decreased debt service coverage ratios.

III. Reform Regulation of Credit Rating Agencies

Summary: The Act addresses an aspect of the financial crisis which is considered by many in
Congress to be a major problem in the structured financial products market. The Act
encompasses credit ratings agencies, which previously were covered under the Rating
Agency Act, thought the creation of the Office of Credit Ratings (OCR) within the Securities
and Exchange Commission (SEC). The goal of the OCR is to promote greater transparency and
reduction of conflicts of interest among credit ratings agencies. At the conclusion of a two
year study period, the SEC is to make a determination of the process by which ABS issues will
be matched with credit ratings agencies. At a minimum, credit ratings agencies will be
required to disclose more information including any assumptions underlying the ratings,
methodology, use of any third parties for due diligence, and ratings track records.

In addition, the SEC will be required to examine all Nationally Recognized Statistical Ratings
Organizations (“NRSRO” – which includes each of the major credit ratings agencies) at least
once per year and publicize its findings. NRSROs will also be required to submit an annual
report to the SEC with an assessment of its internal controls structure governing the NRSRO’s
issuance of credit ratings. The SEC will have the power to suspend or revoke the registration
of NRSROs if it determines that the internal controls are lacking. Moreover, the Act gives ABS

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investors a private right of action against NRSROs for a “knowing or reckless” failure to
conduct a reasonable investigation of the rated security with respect to the factual elements
relied upon by its own methodology for evaluating credit risk or to obtain reasonable
verification of such factual elements.

Impact: The ABS market was effectively frozen during the financial crisis. It is now slowly
coming back, although it is unlikely to increase at any significant pace at least in the
foreseeable future. Many hope the higher standards for NRSROs will cause the market to
return in a sustainable manner which will likely be significantly smaller in size than the peaks
reached prior to the financial crisis. As a result, the impact of these reforms will likely diminish
the availability of credit.

IV. The Volcker Rule

Summary: A highly publicized provision in the Act is the so-called “Volcker Rule”, which is
named after Paul Volcker, the former chairman of the Federal Reserve and current head of the
President’s Economic Recovery Advisory Board. The Volcker Rule, with few exceptions, would
bar banks from owning, investing, or sponsoring hedge funds, private equity funds, or
proprietary trading operations for their own profit. The Act broadly defines ‘banking entity’ to
include (i) insured depository institutions (i.e., banks, thrifts, credit card banks, industrial
banks, but excluding certain limited purpose trust companies), (ii) any company that controls
an insured depository institution (i.e., bank holding companies, savings and loans holding
companies, and any company that directly or indirectly controls a nonbank bank, such as an
industrial loan company or a credit card bank, including private equity firms and industrial
firms such as General Electric, that control industrial loan companies or federal savings banks);
(iii) any company that is treated as a bank holding company under the International Banking
Act (i.e., foreign banks that have U.S. branch, agency, commercial lending affiliate, and any
company that directly or indirectly controls such a bank) and (iv) any “affiliate” or “subsidiary”
of any of these entities. The Act creates a new section 13 to the Bank Holding Company Act
which generally prohibits a banking entity from engaging in proprietary trading or acquiring

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any equity, partnership, or other ownership interest in or sponsor a hedge fund or private
equity fund. As with much of the Act, the Volcker Rule is subject to further study and
recommendations by the relevant regulators [WHO?], and may take anywhere from one to
two years for enactment.

Impact: The prohibition of covered banking entities from participating in private equity and
hedge funds may decrease the number and size of private funds in the near term, which
obviously could decrease the availability of private debt and equity. On the other hand, the
elimination of those investment options for banks and non-bank lenders may result in
increased credit availability to traditional commercial borrowers.

V. “Too big to Fail” - Creation of Financial Stability and Oversight Council

Summary: In an effort to protect the economy against the ‘too big to fail’ dilemma that faced
regulators in the financial crisis, the Act has created the Federal Stability Oversight Council
(“FSOC”), which is tasked to monitor systemic risk and make recommendations to regulators.
The FSOC is to have 10 voting members and 5 non-voting members from government
agencies including the Federal Reserve, the Comptroller of the Currency, the Consumer
Financial Protection Bureau, the SEC, the FDIC, the CFTC, and other regulators (including state
regulators), and will be chaired by the U.S. Treasury Secretary. While the FSOC will have vast
responsibility to oversee the financial system, focusing particularly on gaps in the regulatory
framework and emerging systemic risks, it will have limited enforcement authority and must
rely upon recommendations to other agencies/regulators for any necessary enforcement
actions.

Additionally, the Act enables regulators to deal with failing banks and covered institutions, “in
a manner that mitigates such risks and minimizes moral hazard.” Once a financial institution
is deemed to be in financial distress by at least a two-thirds vote of the board of directors of
the FDIC, the Treasury, and the Federal Reserve, the FDIC is given authority to manage the
unwinding of the financial institution in a manner that minimizes the systemic risk to the

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broader markets and economy. The costs associated with liquidation will be covered by fees
imposed on financial firms with assets over $50 billion. To assist the FDIC, large banks and
complex financial institutions are required to periodically submit orderly liquidation plans.

Impact: The ‘too big to fail’ provisions of the Act will likely not have a significant impact in the
foreseeable future on the availability of credit, however, the cost of compliance with these
provisions will likely be passed on to borrowers.

It will likely be months, if not years, before the details of the Act are filled in. Stayed tuned for
further updates as developments occur. If you have any questions regarding the Act, please
contact Tal Izraeli at 312-876-6906 or any other Arnstein & Lehr LLP attorney with whom you
have worked.

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