Signatures: Love 'Em But Leave Them Off Of Loanst

Signatures: Love 'Em But Leave Them Off Of Loans

FDIC has published guidance on the spousal signature rules of Regulation B. FIL-9-2002, February 4, 2002. There is nothing new here. The reason for the publication is that violations continue - even more than a quarter century after the rules went into effect.

If you don't think the FDIC is on track (it is) then consider the fact that the Federal Reserve Bank of Philadelphia has issued a similar warning. The FRB-Philly's publication is shorter and in plainer English but communicates the same message: a signature that is not supported by the application and underwriting is a violation of law. It is legal liability; not security or safety.

Signature violations remain the most dangerous and costly violations of Regulation B. Problems with adverse action notices and monitoring data may occur more often, but those violations do not have the high risk of lawsuits and damages that goes with signature violations.

FIL-9-2002 summarizes the signature rules, including the co-signer and guarantor rules. The FRB-Philly's document includes a flow chart to guide the lender in thinking through when and whether to require signatures. These summaries may be useful for training materials and in procedures manuals.

The more revealing part of the FDIC document discusses lending practices that are affected by the signature rules. The specific practices are discussed because they are problem areas found by examiners.

Common Violation
The most common violation of the signature rules is requiring a signature when the signature is not permitted. This usually happens because the lender making the decision believes that it is reasonable and appropriate to require the signature.

Lenders require extra signatures, such as spousal signatures, because they believe that the loan is better or safer with the spouse's signature. Long-standing lender lore instills the belief that more signatures make the loan safer and sounder.

The lender's adherence to this lore ignores the fact that the Equal Credit Opportunity Act was passed to stop this very practice. Signature requirements that used to make the loan safer and sounder are now illegal. Those very signature requirements create legal liability rather than safety.

In the context of signatures, ECOA has two primary purposes. First, the act guarantees a person's right to individual credit if the person qualifies. This means that creditors may not request additional signatures to make the loan "safer."

Second, it means that a person, such as a spouse of an applicant, cannot be coerced into becoming liable on a note by signing it when that person is not a credit applicant. This purpose also means that a non-applicant cannot be required to sign the note and incur individual liability for credit that is really extended to someone else.

Reasonable Belief
Regulation B provides a standard for deciding when requiring an additional signature could be appropriate. The lender requiring the signature should have a reasonable belief that the signature is necessary to create a valid note and/or a valid lien on the property securing the loan.

Guidance provided by Regulation B uses the term "reasonable belief." This is generally understood to mean reliance on a well-reasoned attorney's opinion. In FIL-9-2002, FDIC sets a higher standard. When requiring a signature that will impose personal liability to provide access to jointly owned property, FDIC advises that the lender rely on an opinion of the state attorney general. This opinion should be obtained by the creditor prior to requiring the signature.

By advising creditors to rely on an opinion of the state attorney general, the FDIC sets a standard that is higher than merely maintaining an attorney's opinion on file. Using an attorney general's opinion means that the creditor has no influence on the work of the attorney. In addition, the attorney general is the ultimate authority on the legal issues of state property law short of taking the issue to court.

Guarantees
The FIL reminds us that Regulation B protections apply to guarantors of a loan as well as to the applicants. A lender can neither require a guarantor's signature because of considerations prohibited by Regulation B nor impose requirements on guarantors that it could not impose on applicants.

FIL-9-2002 discusses several concerns often raised by commercial lenders. One is the fear that, without the spouse's signature, the borrower may transfer title of property to the spouse, leaving the creditor without a remedy. The FIL explicitly states that creditors may not make this assumption. "The possibility of subsequent changes in the form of ownership (for example, by transfer or divorce) may not be considered." Creditors may only consider the actual form of property ownership before or at consummation.

Guarantee requirements should be based on a clear and consistent policy. Lenders may require that all owners or principals of a company, such as officers, partners or principal stockholders, guarantee the loan. Any such requirement must be based on the guarantor's relationship with the business - not with one of the business owners.

Lenders may not automatically require spouses of shareholders or principals to guarantee the loan even if the loan is supported by jointly-owned property. The decision to lend and the determination of what signatures should go on what documents must be based on the ownership of the business and the ownership of the property; not the personal relationships of the parties.

FIL-9-2002 also reminds creditors that they may not subvert these signature rules by using a combined note and security instrument. Signatures on any such instrument should be clearly marked or placed to limit the personal liability of the property owner providing only access to the property.

Diagnostics and Corrections
It is easy to look at the issues discussed in FIL-9-2002 and figure out where the problems are. It is a simple matter of considering the practices and participants in the process. Clearly, commercial lenders are a key part of the problems the FDIC sees. Each element of the FIL specifically mentions commercial lending practices.

Examiners are now looking at commercial loans. They look for compliance with Flood Hazard Insurance and Regulation B requirements. It doesn't take Sherlock Holmes to deduce that this FIL is issued because of the number of problems that examiners are finding and reporting. The FIL specifically recommends that all loan officers, both consumer and commercial, should be familiar with Regulation B's signature rules.

The FIL outlines a plan of action to design a compliance program without signature violations. The memo outlines a three-prong approach: review and revision of loan policies, periodic training, and monitoring and auditing.

The Three-Pronged Program
Policies and procedures underlay any compliance program. FDIC recommends a thorough review of loan policies and procedures, looking specifically for any policies that call for loan guarantees by spouses of the partners, officers, directors or shareholders of a closely held corporation.

This review should also look for and delete any policies that call for or assume that a joint financial statement justifies a request for the spouse's signature. Finally, the policies should give clear guidance on how to consider and take security in jointly owned assets that are offered as collateral.

Policies and procedures contain the guidance for lenders. The procedures should include information on state law regarding property ownership. The procedures should also provide guidance on when and how to obtain any signatures to perfect security. FDIC recommends reflecting these rules in loan checklists.

For the second prong, FDIC looks at training. This should be on two levels. First, staff new to lending should have training on ECOA. Second, there should also be refresher training for experienced staff. Refresher training may also be triggered by changes in markets, products, and demographics.

Finally, the monitoring and auditing programs should give careful attention to signatures and other ECOA provisions.

ACTION STEPS

Review your loan files, comparing signatures on loan applications with the signatures on the loan documents.
If you find extra signatures on loan documents, find out how they got there.
Review and compare the documentation of loans with regard to the signatures that appear on the note.
If documentation does not explain the presence of signatures, initiate a review of loan underwriting procedures. Build in minimum documentation standards.
Review the policies and procedures. Look for instructions on when to obtain and when to avoid spousal guarantees.
Review and update lending checklists to include reminders about signature rules.
Schedule training. Include discussion of signature rules and loan documentation.