April 2023 Newsletters

One Loan with Different Classifications

Let’s say you have a closed-end loan that is secured by a primary dwelling made by ABC Bank which is going to be satisfied and replaced by a loan from your bank.  How would you classify this loan?  It depends on the regulatory purpose.

If you were reporting this loan for HMDA it would be a refinancing, because to meet the HMDA definition of refinancing the loan must be a new dwelling-secured obligation that satisfies and replaces an existing dwelling-secured debt obligation by the same borrower.  The above loan meets those criteria.  Looking further at the definition of refinancing in the HMDA regulations it applies to either open-end credit or closed-end credit, and a HMDA refinancing could be either for a consumer purpose or for a business purpose.

Compare that with a Regulation Z refinancing, which is defined as closed-end consumer purpose loan made to a consumer that satisfies and replaces an obligation undertaken by the same consumer. For a loan to be a Regulation Z refinancing it must also be extended by the same financial institution that extended the original loan. If your bank makes a loan to satisfy and replace a loan made by ABC Bank, as proposed above, that loan is not considered a refinancing for Regulation Z purposes. For it to be a Regulation Z refinancing, your bank must be satisfying and replacing a loan made by your bank.

The term “refinancing” can be further confused as some banks have internal policies to refer to certain loans as “refinancing” or “cash out refinancing” when there is no satisfaction and replacement taking place. The common theme for both HMDA and Regulation Z refinancings is satisfaction and replacement, but banks will often internally refer to a loan secured by a primary dwelling which is owned free and clear and might be best described as a “home equity loan,” as a “cash out refinancing.” When it comes to classifying a loan, be sure to focus on for which regulation or purpose you’re doing the classifying.

Another regulatory example of this involves home equity loans. In Regulation Z consumer purpose real-estate secured loans are categorized as having one of four purposes: purchase, refinancing, construction, or home equity. Any loan that is not a purchase, refinancing, or construction loan falls into the catch-all purpose of home equity. A loan secured by a commercial property that was being used for debt consolidation or purchasing personal property like a boat or vehicle would be considered a home equity loan, despite not being secured by anyone’s home.  Internally banks probably would not call this a home equity loan, even though it would be a home equity loan for Regulation Z purposes. For HMDA reporting purposes this loan would fall into the HMDA catch-all of “other,” which is what happens when the loan isn’t used for the purchase of a dwelling, home improvement or a refinancing.

So, a particular loan could be reported one way on the HMDA LAR, another way on the Closing Disclosure, and a third way in the bank’s internal system, under the right circumstances. Therefore, it’s important to keep track of how each loan is classified for which purpose and on which documentation. Should you have any questions as to how to classify a loan for which regulation or which purpose, don’t hesitate to reach out to us on the hotline for help.

FDIC’s Supervisory Highlights Illuminates Problem Areas

The FDIC recently released their March 2023 Supervisory Highlights, which begins with a discussion of the most frequently cited violations. According to the FDIC, because of the methodology used in examinations, the most frequently cited violations normally represent the greatest for consumer harm. The top regulatory areas cited included:

1) Regulation Z: problems with disclosing closing cost information on the Closing Disclosure.

2) UDAP: charging multiple NSF fees for the re-presentment of the same transaction without disclosures that clearly explain the institution’s policy for fees and re-presentments.

3) Flood Insurance: problems having sufficient flood insurance in place at the time of a MIRE event (when a loan is made, increased, renewed, or extended).

4) Regulation E: problems with investigating consumer reported errors and reporting the results to consumers within the required timeframe.

5) Regulation DD: problems with the timing and content requirements of deposit account disclosures.

More or less, the FDIC’s findings matches what we at Compliance Alliance hear and see from our members in asking questions of our hotline staff. The aforementioned areas continue to be the source of questions ranging from the simple and straightforward to the complex and convoluted.

In addition to the most frequently cited violations, the Supervisory Highlights also noted some of the more significant compliance issues identified by examiners in 2022, which included:

1) RESPA section 8 violations where a bank contracted with third parties that identified and contacted consumers in order to steer and influence the consumer’s selection of the bank as their lender. The March 2021 Supervisory Highlights discussed the difference between a lead (allowed) and a referral (not allowed), and how the facts and circumstances surrounding the activity could cause leads to be considered referrals, particularly if the payment for the lead is for activity that affirmatively influences the section of a particular lender.

2) FCRA issues involving financial institutions that purchased information from consumer reporting agencies about consumers’ credit activity (such as identifying those consumers who recently applied for a mortgage loan), but failed to provide consumers with firm offers of credit, either verbally or in writing, when contacting the consumer. The FDIC noted that this contact by the bank to the identified consumer should have included that a) an offer of credit was being made, b) the offer was guaranteed if the consumer continued to meet the credit criteria, c) the offer was a prescreened offer based on the consumer’s credit report, and d) the consumer could opt out of future prescreened offers.

3) SCRA problems when applying interest in excess of the 6% maximum to the principal loan balance, without the servicemember’s authorization. Among the protections provided by the Servicemembers Civil Relief Act is upon notice and a copy of military orders, the interest reduction of any pre-service loans to 6% for the period of active-duty service (and for an additional year after the end of active duty for mortgages). The SCRA also prohibits accelerating principal, which would include applying any excess interest to the loan balance without giving the servicemember a choice as to how they’d like to receive the funds (apply to loan balance, cash refund, apply to current or future payments, etc.). To comply with the requirement of the SCRA, banks should offer the servicemember options as to how they’d like to receive the funds resulting from a reduction in the interest rate and follow the servicemember’s request.

4) Fair Lending concerns of such significance that the matters were referred to the Department of Justice. Problematic areas included: a) redlining due to a lack of branching activity and marketing in certain areas, b) pricing for indirect automobile financing which incentivized dealer discretion and ultimately led to different pricing on a prohibited basis, and c) policies related to the pricing or underwriting of credit that used screening methods that included prohibited bases in the credit decision process.

We at Compliance Alliance work hard all day, every day to try and help our members avoid costly and time-consuming violations. From our training and tools to our publications and answering specific questions on our hotline. Never hesitate to reach out to us for help with a problem you’re facing. All the aforementioned problems could have been prevented by seeking help, which is exactly what we do. If you’ve got a problem, chances are we’ve written about it, trained on it, have a tool for it, but even if not, we can answer the question on the hotline. You’re not alone in the compliance battle: we’re here to help!

CFPB Clarifies “Abusive Acts or Practices”

In 2010, Congress passed the Consumer Financial Protection Act of 2010 (CFPA) in hopes of rooting out what they saw as “abusive conduct.” The CFPB recently issued a Policy Statement to help explain how the CFPB determines what is abusive conduct by providing examples which they hope provide a framework for financial institutions to identify behavior which might violate the CFPA. Under the CFPA, there are abusiveness prohibitions: 1) being unclear about a product or service, and 2) using circumstances to take an unreasonable advantage of a consumer.

The first prohibition is further described as material interference with the ability of a consumer to understand a term or condition of a consumer financial product or service. Material interference could include actions that withhold, de-emphasize, confuse, or hide information which hinders a consumer’s ability to understand terms and conditions. Buried disclosures (see below), physical or digital interference (see below), overshadowing (see below), and various other means of manipulating consumers’ understanding could all be considered material interference. Intent is not required for material interference to occur, and an institution could unintentionally materially interfere with their customer’s ability to understand their financial product or service.

Buried disclosures could include disclosures that limit comprehension of information, including things like fine print, complex language, jargon, the omission of terms or conditions, and the timing of a disclosure. Digital interference would include user experience manipulations such as the use of pop-up or drop-down boxes, multiple click-throughs, or similar methods. Overshadowing would include the prominent placement of certain content that interferes with the comprehension of other content.

The second prohibition is further described as a taking unreasonable advantage of: a) gaps in understanding: a lack of understanding of the material risks by the consumer related to costs or conditions of the product or service, b) unequal bargaining power: the inability of the consumer to protect their own interests in selecting or using a financial product or service, or c) consumer reliance: the consumer’s reasonable reliance on a financial institution to act in the consumer’s interests.

An advantage can include a variety of monetary and non-monetary benefits to institution, such as increased market share, revenue, cost savings, profits, reputational benefits, as well as other operational benefits. An “unreasonable” advantage is a little bit harder to quantify as the guidance leans on Webster’s dictionary to define the term as “exceeding the bounds of reason or moderation.” The guidance does not go into further detail as to exactly how “reason” or “moderation” might be defined.

Taking unreasonable advantage of gaps in understanding might be further understood to include things like not understanding the consequences or likelihood of default and the loss of future benefits but could also include things like the length of time it will take to benefit from the product or service, or the process that determines when fees are assessed. A lack of understanding by the consumer doesn’t require untruthful statements, under the CFPB’s guidance, and the consumer’s allegation of a lack of understanding is sufficient to prohibit a financial institution from taking unreasonable advantage.

Taking unreasonable advantage of unequal bargaining power can exist if consumers do not have the ability to protect their own interests. This unequal power may exist at the time the product or service is obtained, during the life of the product or service, or both. This imbalance in power is often seen in the amount of time needed to obtain products and services as well as the time needed to remedy problems. Other examples of unequal bargaining power involve third parties with whom the consumer does not establish a relationship, but are nonetheless obligated to deal with, such as credit reporting companies, debt collectors and third-party loan servicers. In these third-party situations the consumer has no ability to choose the provider and may have limited recourse should they encounter a problem with the provider.

Taking unreasonable advantage of a consumer’s reasonable reliance happens when a consumer has a reasonable expectation that a company will act in the consumer’s best interest when helping them make a decision. Reasonable reliance may occur when a company holds itself out as acting in consumer’s best interests, or when a company helps consumers select market providers.

This guidance from the CFPB may stir you to want to take another look at your policies or procedures to avoid abusive acts or practices. If you have any questions about the process, or about whether certain activity could be considered an abusive act or practice, please reach out to us on the hotline.

Section 1071 Finally Arrives

On March 30, one day before the deadline to publish the final rule, the Consumer Financial Protection Bureau (CFPB) issued the long-delayed Section 1071 final rule. As you may recall, Section 1071 of Dodd-Frank amended the Equal Credit Opportunity Act (ECOA) and requires the collection specific application data points for the purpose of facilitating the enforcement of fair lending laws and enabling banks to identify business and community development needs and opportunities of women-owned, minority-owned, and small businesses. The final rule covers both closed-end loans and open-end lines of credit, with limited exceptions.

Under the final rule small businesses will be able to self-identify as minority-owned or women-owned and will also be able to identify if the business is “LGBTQIA+”-owned. The final rule makes it clear that banks will be able to rely on the information provided by the business, or appropriate third-party sources for certain data points, when compiling Section 1071 required data.

Under the final rule data collection is triggered by the submission of a “covered application” by a small business. An application for Regulation B purposes is defined as an oral or written request for an extension of credit that is made in accordance with procedures used by a financial institution for the type of credit requested.

For Section 1071 purposes, certain “applications” are not covered applications, even if they are considered applications under the existing Regulation B definition of application.  Specifically, covered applications for purposes of this rule do not include 1) reevaluation, extension, or renewal requests on existing business credit accounts, unless the request seeks additional credit amounts; 2) inquiries and prequalification requests; or 3) certain solicitations, firm offers of credit, and other evaluations that the institution initiates.

Rather than relying on the SBA determination of what a small business is, under the Section 1071 final rule, a “small business” is defined having gross annual revenue under $5 million in the preceding fiscal year. The final rule also anticipates updates to this size standard to account for inflation, not more than every five years.

One notable change between the proposed rule and the final rule, the threshold for “covered credit transactions” has been set at 100, rather than 25 (as was the case under the proposed rule) in each of the two preceding calendar years. Another noteworthy change from the proposed rule is that lenders will not be required to use their own determinations to collect race and ethnicity via visual observation or surname if an in-person applicant does not provide it directly; instead, the final rule requires that these data be reported based only on information provided by the applicant.

The final rule has several mandatory compliance dates, depending on the number of covered credit transactions originated by the institution. For those that originate at least 100 covered credit transactions but fewer than 500 in the two preceding years (2022 and 2023) data collection must begin starting January 1, 2026. Those originating least 500 covered credit transactions but fewer than 2,500 loans in both 2022 and 2023, data collection must begin starting April 1, 2025. Those originating 2,500 or more covered credit transactions in both 2022 and 2023, data collection must begin starting October 1, 2024.

At 888 single-spaced pages, there’s a lot to this rule, so you may have questions. Feel free to reach out to us on the hotline and we’ll help you navigate getting ready for your mandatory compliance date 18-32 months from now.