Regulation B: The More It Changes, The More It Stays The Same

The Federal Reserve has completed its review of Regulation B and published the final results. The final version has two significant changes relating to data collection for self-testing and retention of information relating to pre-solicitations. There are other, more subtle changes. But don't underestimate them. Most of these changes really amount to an intensification of the same message: Don't discriminate against any credit applicants.

The substantive changes are not really a change but a stronger statement of the prohibitions that have always existed. Similarly, the considerations of the Board in deciding not to lift the general prohibition of collecting information on race and sex of applicants (except for loans subject to special monitoring data requirements) illustrates that the Board understands that its role is not only to prohibit discrimination but also to make it difficult to discriminate.

We Mean Business!
The "no surprise" surprise is the emphasis the Board placed on signature violations. Examiners for the Federal Reserve and other agencies continue to report finding spousal signatures on the note or on guarantees when there is no explanation in the file of how or why the signature is there.

Requiring a signature simply because the individual is married to the applicant amounts to substantive discrimination. The harm done affects both the applicant, who was unable to obtain individual credit, and the spouse who was required to sign and thus incur liability on the debt.

The Official Staff Commentary already contains the advice that submission of a joint financial statement may not be used to presume the application is for joint credit. Now the Board has revised the Regulation itself to say the same thing - just in case the commercial lenders weren't getting the point.

To further make this point, the Board strongly recommends that a lender have documentation of any additional signatures. The signature itself, such as a spousal signature on a note or a guarantee, may not be considered evidence of the borrower's intent. The Board does not specify what would constitute sufficient documentation. None, however, is clearly not enough.

Documentation methods could include multiple signatures on the application, correspondence from the loan officer explaining that additional assets are needed to support the loan (without specifying what assets), or notes concerning conversations with the applicant about additional support for the loan. With this further clarification of the signature rules, the need for better documentation in commercial loans is apparent. Although the regulation does not require the use of an application form, doing so - at least in simplified form - is a good practice to follow. Even without an application form, loan officers should keep log sheets on which they record the gist of conversations with the applicant about the loan application.

The Commentary now also advises that the creditor may not assume that the borrower will transfer title to property as a means of removing the property from the reach of collectors. The message - delivered directly to commercial lenders - is that using spousal guarantees to shore up a loan is not an acceptable way to underwrite business credit. In fact, good safety and soundness considerations dictate taking a security interest in property needed to support the loan rather than getting guarantees that amount to no more than a moral commitment in bankruptcy court.

Income From One Or Both
Another clarification in the revised regulation is that income of co-applicants must be treated in the same way, whether or not the co-applicants are married to each other. The creditor may either consider the income of each applicant separately or combine the income of both applicants. However, the creditor must follow the same method for all applications, regardless of the relationship of applicants to each other.

Many lenders like to distinguish between "co-applicants" and "co-signers." For co-applicants, they combine income while for co-signers they consider income of each separately. If your lenders are telling you they do this, investigate further. You may find a pattern that co-applicants are applicants who are married to each other while co-signers are not. This is not a legal way to make the distinction.

Lenders also cannot look to the Regulation AA cosigner rule to define who is or is not a co-signer. Instead, lenders should look to how the applicants came through the door. If they came in together, they are co-applicants. If one person applied, was evaluated, and did not qualify without additional support, then the person that applicant brings in is a co-signer.

Record Retention
There are some additions to the record retention rules, but no significant changes. The Board had considered whether to expand record keeping for business purpose loans, but concluded that the additional burden of such record retention was not justified by the benefit to enforcement. Thus, the rules for business loan retention remain unchanged.

New, however, is a set of record retention rules for credit solicitations. When a creditor solicits credit applications, the solicitation activity is subject to record retention for a period of 25 months. The creditor must keep records relating to the solicitation for 25 months from the date of solicitation. Records to be kept include the solicitation criteria and any lists. In addition, the creditor must keep records of any consumer complaints relating to the solicitation. These do not have to be kept together, simply be retained somewhere so that examiners can review them.

When is an applicant an applicant?
The pre-solicitation record keeping requirement grew out of several concerns. Predatory marketing practices caused consumer advocates to lobby the Board to take action to protect consumers. The Board noted that credit solicitations can discriminate, targeting customers based on age or another prohibited basis. Some of the predatory lending practices that have been identified used geography to target market costly products, a.k.a. "redlining."

For purposes of drafting Regulation B, the question is whether ECOA and the regulation protect consumers who have not yet applied for credit. The regulation has long prohibited discouragement of applicants. The Federal Reserve has been reluctant to reach aggressively into regulating practices that may lead to applications, such as solicitation. The approach has been to advise that such marketing practices may violate the ECOA if they result in a pool of borrowers that is discriminatory.

In this revision, the Federal Reserve has taken a clear but cautious step toward including solicitation practices. The new requirement for recordkeeping is designed to enable examiners to evaluate the design and demographic impact of a solicitation. Creditors must now retain information used to select targets for the solicitation and any consumer complaints. Examiners will evaluate these for evidence of unequal treatment.

The Federal Reserve will continue to look at prescreening and solicitation practices. The Board will be asking examiners whether the information they review should be augmented to be made more useful. This requirement is step one of what could become a more expansive reach by Regulation B into marketing practices.

Other Clarifications
The definition of creditor is revised to clarify that when multiple parties are involved in a single credit application, anyone participating in making the decision or in setting the terms of the credit is a creditor. A broker that brings in a loan with negotiated terms is a creditor by virtue of having set the terms of credit.

ACTION STEPS

Review your loan procedures for consistency with the revisions to Regulation B.
Audit a sample of loan files to evaluate how unmarried co-applicants are treated. Give particular attention to applications referred from dealers.
Audit the adverse action notices for accuracy and completeness. Note whether there is a need for new reason options.
Schedule training to cover any changes that will affect your institution.