Understanding Call Recording Compliance

An NSCCA member submitted a question on call recording to be researched and answered by Spillane Consulting for this blog. (That’s what we’re here for!)

This member is about to start recording phone calls between consumers and the collections department. They had a specific question related to one of the compliance requirements, which we WILL get into. But first a background on this issue for everyone else.

In General: Pros and Cons of Call Recording

For companies trying to prove compliance and to monitor customer service levels, call recording is an enticing option. It can be useful in defending against a lawsuit or regulatory action (or on the offensive in a bankruptcy or foreclosure proceeding).

Of course, the sword is double-edged … call recordings can be used against you. Sometimes call recording makes it harder to make contact with a consumer because of the disclosure sometime required to begin the conversation, i.e. “Hello, this call may be recorded … *click.”

Compliance Issue: Massachusetts Wiretap Law

If your bank decides call recording is a great idea, make sure to comply with the Massachusetts law against secretly recording conversations. This Massachusetts law is stricter than most states. In most states, a company can record conversations with consumers without consent (there is a Federal law against secret recordings, but it only prohibits a 3rd party secretly recording another conversation). But some states, like California and Massachusetts, a stricter rule applies that requires both parties’ consent. MA Chapter 272, Section 99. These “two-party” or “dual consent” states prohibit call recording of any private conversation without both parties consenting to the recording. In these states, a bank that wants to record conversations with consumers must disclose the recording at the beginning of the call.

The two-party consent rule recently made headlines in California. Wells Fargo was fined $8.5 million for failing to disclose that calls were recorded. There’s a similar judgment against Houzz.com.  And sports fans might remember the recording of Donald Sterling’s racist remarks that led to his downfall as owner of the Los Angeles Clippers.

Specific Question of the Day

So far doesn’t sound too difficult, right? Just inform consumers up front that the call will be recorded. Well one NSCCA member is struggling with whether this is strictly required with every single person spoken to, as sometimes a single call will require speaking to multiple persons before getting to the actual consumer.  So do we need to give this disclosure to absolutely every person who answers the phone? Sometimes our callers get routed from person to person, secretary to administrator, department to department, before being able to speak to the actual person they’re trying to contact in the first place. Do we need to repeat “This call may be recorded” every single time?

Receptionist: Hello, this is Smith Paper Company.
Bank: This call is being recorded…. Hi, this is Jim from ABC Bank, may I speak to Jane Consumer?
Receptionist: I think Jane is downstairs in shipping, let me transfer you.
Shipping Department:  Hello?
Bank: This call is being recorded…. Hi, this is Jim from ABC Bank, am I speaking with Jane Consumer?
Shipping Department: No, sorry. Jane is in her office, let me transfer you.
Jane’s Office: Hello?
Bank: This call is being recorded…. Hi, this is Jim from ABC Bank, am I speaking with Jane Consumer?
Jane’s Office: No, sorry. I’m Jane’s executive assistant. Jane’s off today, would you like to leave a message?

And on it goes …. You see the annoyance? Wouldn’t it make more sense just to wait and give the disclosure to Jane Consumer after confirming she was on the phone?

Specific Answer of the Day

In short, Yes, the disclosure should be given to every person. But good news, it can be preceded by an introductory greeting. Like this: “Hi, my name is Jim from ABC Bank. This call is being recorded. May I speak to Jane Consumer”?

Now, some companies may choose to push the boundaries and delay disclosure until confirming the identity of the consumer. That, of course, would be even better.  But we do not recommend this and I’ll explain why below.

“Introductory Greeting” Exception.

Instead of starting every single call off with a robotic “This call is being recorded.” disclosure, best practice is to permit an introductory greeting followed immediately by the disclosure. The wiretap law prohibits recording a conversation. Is it a conversation before the other party even gets a chance to respond? The law doesn’t allow this expressly, but the California consent order against Wells Fargo makes this clear (and there’s no reason to think the same interpretation would not be adopted here):

“Wells Fargo … shall make a clear, conspicuous, and accurate disclosure (the ‘Recorded Call Disclosure’) to any such consumer of the fact of recording, and to make such disclosure immediately at the beginning of any such communication. The  Recorded Call Disclosure may be preceded by an introductory greeting that identifies the caller and entity on whose behalf the call is being made.

So this will help call recorders a little. Remember the disclosure is still given before the other party has a chance to respond. But can we go even further and delay giving the disclosure until confirming that we’re speaking to the correct person.

Disclosure Only to Right Person

In the example above with Jim, the receptionist, the shipping department, the secretary, and Jane, can Jim avoid telling everyone that the call was being recorded except for Jane? Is it permissible for him to wait and only Jane that the call is being recorded?

Some institutions are acting as if this is the case. Maybe, under these specific facts, this is a legitimate risk-based decision. After all, why on earth would these people complain or consider a lawsuit against ABC Bank? They had meaningless conversations of under 5 seconds.

While I understand the logic, I do not recommend this approach. The problem is that you do not know in advance when you’re speaking to the consumer. Therefore, if you delay the disclosure until confirming identity, there will be many cases where substantive pieces of conversation are spoken before the disclosure occurs. Imagine these scenarios where the consumer could reveal something significant before the disclosure was given:

Bank: Hello this is Jim from ABC Bank. May I speak to Jane Consumer?
Jane: Stop calling me at work, I’m not paying your stupid car loan!
Bank: Hello, this is Jim from ABC Bank. May I speak to Jane Consumer?
Jane: (pretending to be someone else) Nooo, I’m sorry you have the wrong number. Please don’t call here again.

So here you have two conversations that you might very want to use later with your defense against a complaint or in a collection proceeding. But you have two upset consumers. And, worse yet, you have two consumers with legitimate arguments that ABC Bank violated the Massachusetts law against secret recording.

So, to avoid complications like this, we recommend giving the disclosure up-front (after an introductory greeting) with every person spoken to.

Final Note:  I realize a simple fix would be for the call recording software to be turned on only after the disclosure is given. While I suppose that might lead to other problems (employees forgetting to turn on, for example), in any case it doesn’t appear that most technological solutions available offer this option.

 And that’s all, folks. Thanks for submitting the question to us for research!

Ben Giumarra, Esquire
Director of Regulatory Affairs
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
www.scapartnering.com

 

Understanding and Disclosing the Homestead Declaration

Filing a Declaration of Homestead is one of those things that you might know a little about and recognize, but not really understand fully what it is and how it works. It can also be an additional recording fee required to be disclosed, and is subject to 10% tolerance, which means if your deed and mortgage recording fees equal $300, and a $35 homestead declaration fee wasn’t disclosed on the LE, then you’d be $5 over tolerance. It’s useful then to understand what the homestead declaration is, how it works, and who is qualified to file one.

Background:  In 2010, MA updated the Homestead Act (Mass. Gen. Laws, Ch. 188) to give an automatic homestead protection of $125,000 to an owner’s primary dwelling. Residents have the option to file a Declaration of Homestead with the Registry of Deeds in order to increase that protection up to $500,000 in a primary dwelling. The Act expanded on protections for the elderly and allow for homes held in trust to benefit from homestead protections.

How the Protection Works: The homestead protection protects equity built up in the home against some creditors. The protection is subordinate to mortgages and certain liens on the property though, such federal, state, and local taxes and liens. A creditor who tries to make an attachment to a home (such as by court order) in violation of the homestead can get that attachment avoided.

It also offers substantial protection in bankruptcy, and is often what enables bankruptcy debtors to stay in their home. A bankrupcty debtor who has built up equity in his or her home but has a lot of unsecured debt can keep up to $500,000 of their home’s equity out of the bankruptcy estate if they file a Declaration of Homestead properly (and up to $125,000 automatically under the new law).

Qualifications:  A Declaration of Homestead may be filed by 1 or more owners who occupy or intend to occupy a home as a primary residence. It ONLY applies to primary residences. The homestead protection applies to the owners and family members who occupy a home as a primary residence. A homestead is terminated if the home is conveyed to a non-family member though, so even if a Declaration of Homestead was previously filed on the property, the new owner will still need to file a new declaration.

It’s optional whether or not a borrower will elect to file one though, so it can be difficult for a lender or broker issuing the Loan Estimate to determine whether to disclose the recording fee for the homestead. The recording fee for a Declaration of Homestead is $35 (https://www.sec.state.ma.us/rod/rodfees.htm), so my $5 out of tolerance example is not a remote possibility. But the cost is so minimal compared to the potentially $375,000 extra protection it offers, that you could probably assume that an applicant who qualifies for filing the Declaration will do so at closing. However, there is no requirement that the Declaration be filed at closing, though there is a disclosure requirement about the homestead the settlement agent needs to provide. Thus if you have a reason to believe the borrower will opt out of filing the Declaration, then that’s fine. But if you are unsure at the LE stage, it is better to include it than not.

 

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com

The Right of Rescission and Purchasing New Interests

The right of rescission gives consumers the right to rescind, or cancel, certain transactions involving a consumer’s principal dwelling. The rule is nuanced and detailed though, which can make it confusing to apply in some situations.

Here’s a scenario to look at the right of rescission rules: Tenant A owns 50% of a property, and Tenant B owns the other 50%. Tenant A dies, and now Tenant B wishes to purchase the other 50% interest in the property from Tenant A’s estate, and at the same time refinance the original existing mortgage. How does the right of rescission apply to this transaction?

The right of rescission applies in a credit transaction where the consumer acquires or retains a security interest in a principal dwelling, subject to some exemptions. Generally, the right of rescission doesn’t apply to the initial purchase of the property. (The rule exempts “residential mortgage transactions” which is defined as the financing of the “acquisition or initial construction” of a dwelling.)

However, the right of rescission applies to “the addition to an existing obligation of a security interest in a consumer’s principal dwelling,” but it is limited to “only the addition of the security interest and not the existing obligation.” This applies here, where the borrower already has an existing interest in the property and is looking to just add to that interest. Therefore the right of rescission applies to the new credit to acquire the new 50% interest.

But it’s not just the purchase of the other half interest that is involved here; the borrower also wants to refinance the existing loan. How does the right of rescission rule affect that part?

One exemption to the right of rescission rules goes to the refinancing or consolidation of credit already extended by the same creditor and already secured by the consumer’s principal dwelling. But this only applies to the extent it covers the outstanding principal balance, and it doesn’t cover any new credit extended beyond the outstanding balance. Or, in other words, the portion of the loan that is being refinanced is not subject to the right of rescission rule, but the new credit being extended to purchase the new interest in the property is subject to the right of rescission.

So if Tenant B’s remaining balance on his loan to secure his 50% property interest was $150,000, and he now wants a $350,000 loan to purchase the other 50% interest for $200,000 and refinance his $150,000 loan, then the right of rescission applies to the $200,000 new credit and not the $150,000 loan. Note this exemption only applies if the borrower is attempting to refinance with the original creditor though. If the borrower is getting a loan from a new creditor which would pay off the existing obligation, then the whole loan is subject to the right of rescission rule again.

What are the effects of a consumer exercising their rescission rights? The full effects could take their own post, but one thing to remember is that the right of rescission rules focus heavily on the security interest a creditor takes in property and the creditor’s ability to encumber a consumer’s interest in property.

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com

 

Brief Overview of the Military Lending Act

Well, it’s been 2 month’s since the Military Lending Act took effect. If you’re institution hasn’t determined whether you’re ready and compliant yet, contact me because you’ve got some catching up to do. At least the credit card provisions haven’t kicked in yet, so if you offer credit cards you still have time for those.

It’s overdue then to give a brief overview of the act, including what I think are some helpful ways of identifying products that might fall under its umbrella.

One Sentence Summary

“A lending institution cannot impose a Military Annual Percentage Rate (MAPR) above 36 percent on any non-exempt consumer credit extended to a Covered Borrower.”

This is my one sentence summary that breaks down the big three elements that most institutions should be primarily focused on.

Non-Exempt Consumer Credit

Consumer credit must comply with MLA guidelines if: 1) it charges a finance charge (as defined under TILA), or 2) it is payable in installment payments of more than 4 installments, and 3) is not an exempt transaction.

Exempt transactions are:

  1. Those not covered under TILA (12 CFR § 1026.3) or state law;
  2. Purchase-money financing for vehicles;
  3. Purchase-money financing for personal property;
  4. Residential mortgage credit transactions, including purchases, refinances, construction loans, HELOCS, HE Loans, and reverse mortgages;

Technically the regulation mentions a fifth, which is any transaction not involving a covered borrower identified through the safe harbor method. But that logic is a bit too circular for me, so I consider the question of if a consumer is a covered borrower as its own separate step.

Cover Borrowers, Defined and Identified

A “covered borrower” under the MLA is a full-time active duty Service member (Armed Forces, Coast Guard, National Guard, and Reserve) who are under a call or order to serve for more than 30 days. It also includes the service member’s dependents, defined as a spouse, child under 21, parents or in-laws residing with and depending on the Service member for support, and unmarried people who the Service member has custody.

A covered borrower is only a covered borrower at the time of the transaction, and only remains a covered borrower during the service period.

Creditors are free to determine whether a consumer is a covered borrower however they wish. BUT there are two safe harbor methods of verifying a consumer’s status as a covered borrower:

  1. Through the Department of Defense’s database, located here: https://mla.dmdc.osd.mil/
  2. Through the credit reporting agencies, who have all updated their reports to reflect whether or not an applicant is an active service member.

Using one of those two methods, and documenting the result, “conclusively determines” the issue of whether an applicant is a covered borrower under the MLA.

Military Annual Percentage Rate (MAPR)

The MLA also adds new fees to be considered finance charges when calculating the MAPR. These fees include:

  1. Premiums or fees for credit insurance;
  2. Fees for a debt cancellation contract or debt suspension agreement;
  3. Fees for a credit-related ancillary product sold in connection to the credit transaction or account;
  4. Application fees (with some exceptions);
  5. Participation fees;

When you have a non-exempt transaction to a covered borrower, then you need to calculate the MAPR to include the new finance charges with the standard TILA finance charges also. The MLA then caps the rate you can charge a covered member at 36%. If calculating the MAPR with all the fees, new and old, results in a MAPR above 36%, then the creditor has the option of waiving fees and charges above that limit to comply with the MLA cap.

That’s just a brief overview of the basic elements of the MLA. It does not include disclosure requirements, limited terms in agreements, penalties, or other aspects of the MLA. The MLA is already in effect though, so if you’re not sure if you’re compliant with it yet then there is no time to waste.

 

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com

Curing Defects on Closing Disclosures

Mistakes happen. Things change. Life is unpredictable.

Sometimes after closing things happen that make the CD the borrower received to be no longer accurate, or you’ll notice a mistake was made and the borrower paid a higher fee than he or she should have.

Here’s how to fix those mistakes.

Change Due to Events Occurring after Consummation

This is probably the more well-known rule. If an event occurs in connection with a settlement within 30-days after closing, and the event causes the consumer to actually pay a different amount than what is disclosed on the CD, then the creditor needs to place in the mail corrected CDs no later than 30-days after discovering the event occurred.

But if the event causes the consumer to pay an amount above tolerance, then see the 60-day refund rule.

Changes Due to Clerical Errors

Non-numeric clerical errors can be cured by placing corrected CDs in the mail no later than 60 days after closing.

60-Day Refund Rule

If, within 60 days after closing, it is discovered that the consumer actually paid more than what was disclosed on the LE, or more than what was allowed under the tolerance rules, then the creditor must refund the excess amount with a revised closing disclosure.

So, for example, if the consumer pays an extra $30, $25, $25, and $10 over the disclosed LE fees on four itemized services subject to 0% tolerance, then the excess $90 must be refunded within 60 days of the closing. If the consumer also pays $1,190 on a service the LE estimated at $1,000 subject to 10% tolerance,* then the creditor must refund the excess $90 there as well (for a total of $180) no later than 60 days after the closing.

Don’t forget to take advantage of these rules to fix any mistakes discovered. The costs of fixing and refunding will be much less than if you are forced to do it by a regulator.

* The 10% tolerance means the consumer can pay up to $1,100 on a fee estimated at $1,000 on the LE. Thus, the extra $90.

 

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com

Understanding Intent to Proceed

Here’s a short cheat sheet on intent to proceed information:

Q:           Can a borrower give intent to proceed before receiving an LE?

A:            No. Section 1026.19(e)(2)(i)(A) requires the borrower to receive the disclosures before indicating an intent to proceed “with the transaction described by those disclosures.” Only after those events occurred in that order can a fee be imposed (with one exception listed below).

 

Q:           What fees can be imposed or received before a creditor receives an intent to proceed?

A:            Section 1026.19(e)(2)(i)(B) allows for a bona fide fee to obtain a consumer’s credit report before the consumer received the LE.

 

Q:           Is signing the LE considered to be intent to proceed?

A:            No. The signature lines on an LE are optional, and are only for confirming receipt of the disclosure.

 

Q:           What if we close the loan without ever receiving intent to proceed, isn’t intent to proceed implied?

A:            No, it must be expressly given. Comment 2 to § 1026.19(e)(2)(i)(A) states “a consumer’s silence is not indicative of intent because it cannot be documented to satisfy the requirements of § 1026.25.”

 

Q:           How may a consumer indicate intent to proceed?

A:            Section 1026.19(e)(2)(i)(A) lets the consumer indicate an intent to proceed in any way the consumer chooses, unless the creditor requires a particular manner. The creditor must document the intent to proceed to satisfy the documentation requirements of § 1026.25.

 

Q:           Do you always need intent to proceed, even if you aren’t charging up front fees?

A:            Yes, Comment 5 to § 1026.19(e)(2)(i)(A) states “a fee is ‘imposed by’ a person if the person requires a consumer to provide a method for payment, even if the payment is not made at that time.”

 

Q:           Do you need a new intent to proceed with every new LE?

A:            No, only the initial LE.

 

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com

 

Are Discharge Tracking Fees a Finance Charge?

When a mortgage is paid off, a discharge needs to be filed in the registry where the mortgage was recorded. The registry of deeds exists and its records are public to give notice to any subsequent creditor that a lien exists on a piece of property, so that the creditor isn’t making a loan on something that is already encumbered by another lien. It’s a notice system, and so when a mortgage is paid off a discharge is filed to let other creditors know that the previous obligation and security interest no longer exists. Without a discharge being recorded, creditors assume the obligation is still outstanding on the mortgage.

Sometimes things fall through the crack and discharges aren’t filed though, even when the loan is paid off. Some attorneys and other third-parties will sometimes charge a “discharge tracking fee” on a loan. This is to “track, obtain, and record” discharges. If a creditor is making a loan to purchase or refinance a mortgage, it wants to make sure it gets first-lien priority by ensuring any previous mortgages have a discharge recorded with them.

Is this a finance charge though? There are arguments for and against considering it a finance charge.

Arguments for:

A finance charge is the cost of consumer credit. The regulation says finance charges “includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.” It also does not include any “charge of a type payable in a comparable cash transaction.” Or, in other words, if it was being bought with cash instead of through a loan, what charges would still need to be paid? Things like taxes, recording fees, etc.

Mandatory third-party fees also count towards finance charges, even if the consumer can choose the third party.

Discharge tracking fees are mandatory third-party fees that would not be incurred in a comparable cash transaction. In addition, a bankruptcy case in Massachusetts, In re Acevedo, 476 B.R. 360 (2012) assumes that a discharge tracking fee is a finance charge, but does not go into a substantive discussion about whether it truly is a finance charge.

Arguments Against:

On the other hand, 12 CFR § 1026.4(c)(7) excludes from finance charges (i) “Fees for title examination, abstract of title, title insurance, property survey, and similar purposes,” and (ii) “Fees for preparing loan-related documents, such as deeds, mortgages, and reconveyance or settlement documents.” An unrecorded discharge can certainly have an effect on the title to property, so option (i) is plausible as a “similar purpose.” More convincing, in my opinion, is that a fee to “obtain, track, and record” discharges is a “fee for preparing loan related documents” as a discharge indicated the termination of a loan obligation.

Really, either argument can be made in good faith, and not all fees are created equal. In my humble opinion though, the safe approach if you have the choice is to include the discharge tracking fee as a finance charge.

 

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com

Getting Priorities Straight

Solar panels are hot right now (pun intended), and they are likely to get even hotter as costs go down and financing options become more readily available to homeowners looking to reduce their energy bills. In fact, thanks to Fannie Mae’s new HomeStyle Energy program the installation of solar panels may be getting even easier and cheaper. You can read more about the program here.

Currently though banks are giving loans, and installers are giving leases, to homeowners looking to upgrade their homes with solar panels. And in order to protect themselves and their loans they are filing UCC Financing Statements, otherwise known as UCC-1s or simply Financing Statements. While there is generally nothing wrong with doing so, it rightly has some Register of Deeds’ concerned because the filing of a UCC-1 can lead to some complicated results that can affect both buyers and mortgage lenders.

A comprehensive analysis of those results and the many situations that could lead to them are a bit too complicated for me to get into here though. For now, let’s stick to the basics.

What is a UCC-1?

A UCC-1 is a simple form which is filed with a state to inform the “world” (that is, inform other potential creditors) about another creditor having a security interest in a particular item. There are many items that can be covered by a UCC-1, such as consumer goods in a home, inventory in a store, equipment in a factory, fixtures in (or on) a home, and even timber and other resources on land, to name just a few. A UCC-1 is a way of making sure a creditor who takes a security interest in a particular item get priority over a competing creditor’s interest in that property. The general rule is the first to file the UCC-1 is the first in line to be paid back, though that general rule comes with many exceptions.

They are very basic forms though. They generally only require 3 things to be valid:

  1. Debtor’s name and address
  2. Creditor’s name and address
  3. A description of the collateral

That’s it. The forms can be found online, and completed online, and filling them out should be quick and easy. For example, in Massachusetts they can be found here: http://www.sec.state.ma.us/cor/corpdf/ucc1.pdf.

What does this have to do with solar panels, and what’s the problem?

I snuck it in above in the middle of a list, but remember I said it covers fixtures in or on a home? While it’s very difficult to say what is and is not a fixture until a court rules that something is a fixture, there is a very strong argument that solar panels would be fixtures. After all, they are literally affixed to a home. This also likely increases the value of the property, which means that potentially a bank holding a mortgage to the real property is now competing with a creditor holding a security interest in the solar panels that are attached to the real property. Generally, the mortgage wins this battle of priority.

But not always!

If a bank gives a loan to a borrower for the purpose of installing solar panels, the bank will likely be deemed to have a special kind of interest called a purchase-money security interest. If that bank also properly files a UCC-1 fixture filing (which just requires an addendum to the UCC-1), then the bank can take priority even over a mortgage. This is called a super-priority purchase-money security interest.

This can be a problem for the bank holding the mortgage, and for the homeowner when it comes time to sell or refinance the home, because now there is a senior lien on the property. Unfortunately, whether it is even a problem is something that is determined on a case-by-case basis, which is especially true when it’s an installer with a lease on the panels.

My goal here though was to spread awareness about some potential pitfalls to watch out for when lending to install solar panels. And of course I’m not trying to discourage the making of the loans or installation of solar panels, but in compliance we are in the business of making sure it’s done right. My inkling is that new programs and products like the Fannie Mae one will emerge that will make these concerns a relic of the past, but for now I just want everyone to make sure they have their priorities in line (again, pun intended).

Bryan T. Noonan, Esq.
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)

Reporting Gross Annual Revenue for CRA Purposes

This is going to start off looking like my post about reporting income on the HMDA/LAR. That’s because the standard for what gross annual revenue institutions rely on when reporting for CRA purposes is similar to reporting gross annual income for HMDA. That is, in making its determination of whether a business meets the $1 million or less standard, “an institution should rely on the revenues that it considered in making its credit decision.” (See A Guide to CRA Data Collection and Reporting, page 13.) But that’s about the extent of the similarity, and there are some wrinkles that can make GAR reporting tricky.

Before starting though, it should be noted that institutions are not required to consider or gather revenue information when making a loan. If revenue information is not collected or considered when making a loan, then GAR information should be coded for “revenues not known” when reporting.

If, however, revenue information is gathered and/or relied upon, then the calculation for reporting goes as follows, regardless of how it was regarded internally.

Definition of Gross Annual Revenue

“Gross annual revenue” is the total yearly income from all sources before deductions, exemptions, costs, reductions, or other adjustments. It’s typically listed on the Profit & Loss Statement on the first or second line, with a name like Gross Revenue, Total Revenue, Gross Sales, Total Sales, Gross Income, Total Income, etc. Only the actual revenue counts for CRA purposes; projected, pro forma, or other expected income should not be used for determining the $1 million threshold. This means that a start-up business with no annual sales yet would have gross annual revenues of $0, which is completely allowed.

GAR does not need to be verified, and institutions can rely on the borrower’s reporting of GAR.

GAR Used in Making the Credit Decision

The CRA reporting guide says that only the revenues that an institution considered when making its credit decision should be used to determine whether a small business or farm had gross annual revenues of $1 million or less. Practically speaking, this means that the revenues of the entities the institution considered in making its credit decision.

This most commonly comes up in loans to subsidiaries. If the institution relies solely on the subsidiary to make a credit decision on the loan, then only the subsidiary’s GAR is used for reporting. If, however, the credit decision is based on the parent company’s revenues also, then the two combined companies’ revenue is what’s considered.

Say ABC, Inc., with gross annual revenues of $15 million, creates a subsidiary, X Corp, with gross annual revenues of $0. A bank making a loan to X Corp, knowing X Corp’s ability to repay it is based on ABC, Inc.’s revenue, can’t claim that loan was made to a small business and must report revenues over $1 million. But if X Corp’s revenue is high enough (or not considered) so that the bank makes its credit decision based on X Corp’s performance alone, then only X Corp’s GAR information is considered when reporting.

Exceptions

First, the easy exception, personal income isn’t reported as GAR. If a business applies for a loan that is guaranteed or cosigned by an individual personally, and the decision to make the loan considers the individual’s salary (maybe from another job), that salary is not considered as GAR. If John, a salaried employee, decides to start a side business, J Corp, and J Corp then applies for a loan which John personally cosigns or guarantees, then John’s salary is not included in the GAR calculation even if the bank considers this income when making the credit decision.

The second exception is with unaffiliated cosigners or guarantors. Unaffiliated cosigners or guarantors do not count towards the GAR calculation. “Affiliated” businesses are generally ones which have a direct or indirect ownership interest or control. So if John’s brother-in-law’s business, M Corp, is a guarantor on J Corp’s loan but has no ownership interest or control of J Corp, then M Corp’s revenue is not included in the GAR calculation because M Corp is unaffiliated.

The analysis is very fact-driving, and can vary on a case-by-case basis. It’s important to know the rules, just as it’s important to know your customers.

 

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com

Reporting Income on the HMDA/LAR

There can be a lot of confusion about what income or revenue to report on the HMDA/LAR. Most of this confusion can be because the income to be reported on the LAR is not always what was used to underwrite the loan. So how do you determine what to report for income on the LAR?

Definition of Income and Revenue

First thing to keep in mind: there is no set, standard definition of “income” for HMDA. The FFIEC glossary definition of “gross annual income” is “[t]he income reported is the total gross annual income an institution relied upon in making the credit decision.” (The government has no problem with using a word in the definition of the word.) This is consistent with the regulatory comments on income reporting, which says “[a]n institution reports the gross annual income relied on in evaluating the creditworthiness of applicants.” (12 CFR § 1003.4(a)(10)- Comment 6.) This includes cosigners, co-applicants, and co-borrowers, if their income is used to make the credit decision (i.e., qualify for the loan).

Primary vs. Secondary Liability Test

This isn’t stated clearly in the regulations, but it should be: income is only reported on those primarily liable under the loan, if their income is used to make the credit decision.

Cosigners, co-applicants, and co-borrowers are generally presumed to be primarily liable on the loan, meaning they have the primary obligation to repay the loan. Guarantors are often secondarily liable, meaning they only become liable for the debt after those primarily liable fail to repay the loan. It’s not always as simple as that in practice, but for our purposes guarantors = secondarily liable.

An institution may make a credit decision on a borrower’s application based on the commitment of a guarantor. They may consider the income of a guarantor, and based on that income combined with the borrower’s income, agree to make the loan.

In this case, the credit decision is being made based on the income of the borrower and the guarantor. But only the borrower’s income should be reported on the LAR. That is because “an institution does not include the income of a guarantor who is only secondarily liable.” (See Comment 6, above; see also HMDA Guide to Reporting, Appendix D-10, Paragraph 6.)

So the second part of the reporting test looks at who is primarily liable on the loan.

Example

Here’s a concrete example taken right from the Fannie Mae HomeReady Non-Borrower Household Income Flexibility worksheet:

“A single woman with children is looking to buy a larger home, so her father can move in with her. Her father has monthly income and, although he will not pay rent to his daughter, he may contribute to household expenses periodically. The father’s income is not considered as qualifying income; therefore, there is no change to the borrower’s DTI ratio of 47%. The existence of the father’s income, however, is considered the compensating factor that allows the borrower to have a DTI ratio greater than 45%.”

The father’s income in this case is not reported on the LAR, because the father (presumably) will not be primarily liable on the loan. This is despite the fact that if you are an institution underwriting to the HomeReady standards, the credit decision is made based on his income.

Note though that if the father is a cosigner on the loan, meaning he shares primary liability, then both the woman and the father’s income would both be reported together.

 

Bryan T. Noonan, Esq.
Regulatory Compliance Consultant
SPILLANE CONSULTING ASSOCIATES, INC.
501 John Mahar Highway, Suite 101
Braintree, MA  02184
781-356-2772
781-356-2837 (fax)
www.scapartnering.com