Background
A formal appeal was received
in April 1995 requesting a review of a legal lending limit violation
cited in a February 1994 report of examination (ROE).
In July 1993 the bank made a
$1.4 million loan to a limited partnership for the purpose of
purchasing a strip shopping center. In August 1993 the bank
purchased a $1 million participation in a loan to a separate limited
partnership. Proceeds were used to buy a different shopping center.
One corporation is the general partner for both limited
partnerships. In October 1993 the bank made a $105,000 loan to the
general partner secured by a money market account at the bank. In
December 1993 the bank approved a $1.25 million line of credit to
the general partner but no funds had been advanced.
During the next examination,
the two separate limited partnership loans were combined for legal
lending limit purposes. A violation of 12 U.S.C 84 was cited and the
examiner used the rule under 12 CFR 32.5(c)(1) as the reason for
attributing the loans to the general partner. The individual loans
to the general partner were either not funded or secured with funds
held at the bank and were not used to calculate the excessive
portion of the total combined debts.
The banker states that a
violation of 12 CFR 32.5(c)(1) should not have been cited. He agrees
that a general partner is liable for the debt of the partnership. He
does not agree that the debts of two separate limited partnerships
should be combined merely because they have a common general
partner, even though the "common enterprise" tests are not met. He
explains that the two limited partnerships subsequently formed two
separate corporations; they borrowed the same amount of funds, used
the same collateral, and had the same sources of repayment. The new
debts were not combinable under the regulation even though the
previous general partner guaranteed both new debts. The only thing
that changed was the legal borrowing entity. The supervisory office
agreed that the above corporate borrowing structure would not result
in a legal lending limit violation.
The banks interpretation of
the rule is that items 1, 2, and 3 of section C of 32.5 are related
and should not be isolated for combination purposes; the paragraph 2
"common enterprises" criteria must be met before debts of the
partnership can be combined for lending limit purposes. The banker
opined that the regulation is intended to limit the risk to the bank
and not to determine the liability of a borrower, guarantor, or
partner. In the above corporate borrowing situation, the risks to
the bank in dollar amount have remained the same but a violation
would not be cited. He asked the ombudsman if violations of the
legal lending limit would be cited in the future, if the same
limited partnership situation occurred again.
Discussion
The law violated was 12
U.S.C 84 ---Lending Limits. The regulation, 12 CFR 32.5, details
when loans to different borrowers should be combined when
calculating the limit. Paragraph (c) (1) of the regulation refers to
(general) partnerships, joint ventures, and associations and
explains that a credit to a partnership will be attributed to each
member of the partnership. Consequently, if the general partner has
a separate debt, that debt would be combined with the partner's
liability under the partnership's debt. Or, as in this bank's case,
if the general partner is a general partner in two or more
partnerships, because the general partner is liable for debts of
each partnership, the debts of the partnerships are combined with
each other and with any individual debt of that general partner for
lending purposes.
Paragraph (c)(2) of the
regulation refers to (general) partnerships and details when a loan
or an extension of credit to members of a partnership will be
attributed to the partnership or to other members of the partnership
if the general rules under paragraph (a) are met.
Paragraph (c)(3) simply
recognizes that there are limited partnership agreements that
specifically state that limited partners will not be held liable for
the debts of the limited partnership. If there is an exclusionary
comment in the limited partnership agreement, the debts of the
limited partnership will not be attributable to each member of the
limited partnership, unless the rules in paragraph (a) of this
section are met.
The law (12 U.S.C. 84) is
intended to prevent one individual, or a relatively small group,
from borrowing an unduly large amount of the bank's funds. The
regulation (12 CFR 32.5) implements the law and is used to determine
when the liabilities of a borrower, guarantor, or partner are to be
combined for legal lending purposes.
Under OCC Bulletin 95-11,
issued February 16, 1995, the OCC transmitted the final rule
revising 12 CFR 32. The revised regulation, effective March 17,
1995, amends section 32.5 (c) and the special rules for partnerships
are now included under 32.5 (e). The revision combines the previous
paragraphs (1) and (3).
Conclusion
The ombudsman agreed with
the supervisory office that a violation of the legal lending limit
had occurred and that under 12 CFR 32.5(c)(1) the loans in question
should be attributed to the general partner and combined for the
purposes of the lending limit. The ombudsman also stated that under
similar situations, future violations of the law would be
cited.
APPEAL OF VIOLATION OF REGULATION Z (Third
Quarter 1995)
Background
A formal appeal was received
from three separate banks regarding a violation of Regulation Z. The
violation was based upon each institution's failure to disclose an
accurate annual percentage rate (APR) to credit card customers when
a cash advance fee was charged. The banks properly informed the
customers of the cash advance fees on the applications and the
cardholder agreements. The cited errors relate to APRs disclosed on
credit card periodic statements prepared for each bank by the same
credit card service company.
None of the three banks
disputed that the violation occurred. Each bank believed that the
errors were caused by a faulty computer program that correctly
included cash advance fees in the finance charge but failed to
include these fees in the APRs. Therefore, they believe that this
violation present in all banks serviced by this credit card service
company. The basis of each of the appeals is a statement in banking
circular 272 (National Bank Appeals Process): ".it is the OCC's
policy to maintain open and on-going communication with the
institutions it supervises and to foster the fair and equitable
administration of the supervisory process." The appeal letters ask
that the three banks not be required to provide restitution to each
of their customers, because all financial institutions are not being
treated fairly and equitably.
Discussion
The three banks were each
cited for a violation of 12 CFR 226.14(a), which states:
Determination of annual percentage rate.
(a) General Rule.
The annual percentage rate is a measure of the cost of credit,
expressed as a yearly rate. An annual percentage rate shall be
considered accurate if it is not more than 1/8 of 1 percentage point
above or below the annual percentage rate determined in accordance
with this section.
Footnote 31a states the
following: An error in disclosure of the annual percentage
rate or finance charge shall not, in itself, be considered a
violation of this regulation if:
(1) The error resulted from a corresponding error in a
calculation tool used in good faith by the creditor;
and
(2)
Upon discovery of the error, the creditor promptly discontinues use
of that calculation tool for disclosure purposes, and notifies the
Board in writing of the error in the calculation tool.
In addition, the official
staff commentary on regulation z---truth in lending states the
following:
226.14(a) 5-Good faith reliance on faulty
calculation tools. Footnote 31a absolves a creditor of liability for
an error in the annual percentage rate or finance charge that
resulted form a corresponding error in a calculation tool used in
good faith by the creditor. Whether or not the creditor's use of the
tool was in good faith must be determined on a case-by-case basis,
but the creditor must in any case have taken reasonable steps to
verify the accuracy of the tool, including any instructions, before
using it. Generally, the footnote is available only for errors
directly attributable to the calculation tool itself, including
software programs; it is not intended to absolve a creditor of
liability for its own errors, or for errors arising form improper
use of the tool, from incorrect data entry, or from misapplication
of the law.
Each bank was contacted to
discuss what types of steps had been taken to verify the accuracy of
the bank's APRs disclosed on credit card accounts. Although the
banks had hired legal counsel to review the accuracy of the
disclosures, no independent testing of the accuracy of the APRs and
finance charges was conducted by any of the three institutions. Once
the banks were notified by the OCC of the possible problem, each
bank did contact the credit card service company to direct it to
cease charging the fees.
Although it was each bank's
responsibility to verify the accuracy of its own APRs and finance
charges, the Ombudsman's Office did contact the credit card service
company to inquire about the testing that the company had performed
on the program. The credit card service company contracts with a
larger credit card processor for certain operational services,
including customer statement preparation. The credit card service
company did have a law firm review the program for proper Regulation
Z disclosures; however, accuracy of individual APRs was not
tested.
Even if adequate testing had
been performed, it would have been necessary to determine if the
errors were directly attributable to the faulty computer program or
if there had been a mismatch between the forms and the computer
program.
Conclusion
Based on the bank's lack of
testing, the provisions in the footnote discussed above are not
applicable, and each of the banks will be required to reimburse the
affected customers. Each bank was instructed to conduct a file
search for the two-year period prior to the examination that cited
the violation of law. Before the banks make reimbursements, the
appropriate OCC district office will review the following:
- Samples of each bank's adjustment
calculation.
- Documentation of the method of conducting file
searches.
Once the submitted
information has been reviewed by the appropriate district office,
each bank will be notified when to reimburse the affected customers.
Another concern expressed in
each of the appeal letters dealt with each bank's belief that the
alleged violation was a system wide problem for many financial
institutions served through the credit card processor or the credit
card service company. Each bank stated that if nationally chartered
banks are going to be required to reimburse customers for this
violation, all other financial institutions -state-chartered banks,
credit unions, savings and loans, institutions governed by the
Federal Reserve---should receive equitable treatment and also be
required to reimburse affected customers.
The ombudsman ensured that
the position taken by the OCC during the appeal review was in
accordance with the Regulation Z requirements. Although the OCC does
not have jurisdiction over any institutions other than national
banks, the other relevant regulatory agencies are aware of the
miscalculated APRs and have expressed their intention to handle the
situation in a living manner consistent with the OCC's
approach.
APPEAL OF RESPONSIBILITY FOR REIMBURSEMENT
RESULTING FROM VIOLATION OF REGULATION Z (Third Quarter
1995)
Background
A bank appealed its
reimbursement responsibilities resulting from Regulation Z
violations which were cited in its most recent report of
examination. The violations involved improper disclosure of funding
fees paid to the Veteran's Administration (VA) for loans originated
by the bank and sold into the secondary market. The bank incorrectly
treated the fee as a settlement charge rather than a prepaid finance
charge. The examination report concluded that the bank had a pattern
of inaccurate disclosure of the VA funding fee in each of 11 loans
that were reviewed. As a result, the bank's disclosures overstated
the amount financed (12 CFR 226.18 (b)) and understated the finance
charge (12 CFR 226.18(d)). In 10 of these loans, the bank's
disclosures understated the annual percentage rate (12 CFR 226.22
(a)(2)). The disclosure errors exceed the tolerance for inaccuracies
provided in 12 CFR 226.18(d)n.41 and 226.22(a)(2).
The disclosure errors were
not caused by faulty calculation tools. The bank directly input the
VA fees as nonfinance charges. The bank found similar violations on
loans consummated prior to the implementation of the present
software program in March 1994. The examiners asked the bank to
review its files to find all VA loans originated since the last
consumer compliance examination in September 1991 and to make any
required reimbursements.
The bank's appeal does not
contest the existence of the violations or the need for
reimbursement. However, bank management believes that the purchasers
of the loans share some responsibility for the reimbursements. The
purchaser preapproved the loans, each of which was extended in
accordance with the purchaser's underwriting standards. Because the
bank sold all of the loans in question, its files on these loans are
incomplete. The bank does not know the current balance of the loans
or if the loans have paid off. The appeal letter states that it is a
monumental task trying to track down all of the information so the
bank can calculate the reimbursement amounts. Bank management
estimates that the amount of potential reimbursements needed to
cover the period since the last compliance examination exceeds
$25,000.
Discussion
A VA "funding fee" is
imposed, pursuant to the rules of the Department of Veterans
Affairs, for the VA guarantee on the loan. It is
similar to a fee paid to a private mortgage insurer to protect a
creditor against default on a loan. Charges for guarantees against
default or other credit loss are expressly included in the
definition of a finance charge under Section 106 of the Truth in
Lending Act (15 U.S.C. 1605(a)(5)). The transactions in
question meet the "pattern or practice" standard of the law.
Therefore, reimbursement is required by 15 U.S.C.
1607(e)(2). The Policy Guide for
Administrative Enforcement of the TILA provides that restitution
must be ordered for those loans with an understated annual
percentage rate (APR) or finance charge that were originated in the
period between the current examination and the immediately preceding
consumer compliance examination (45 Fed. Reg. 48712, July 21,
1980).
Covered loans that have been fully repaid during that time
are subject to restitution orders only if they were consummated in
the two years prior to the date of the current examination.
The OCC's authority to
enforce the TILA under Section 8 of the Federal Deposit Insurance
Act is limited to national banks, federal branches and agencies of
foreign banks and institution-affiliated parties (12 U.S.C. 1818, 15
U.S>C. 1607(a)(1)(A)). The bank sold the VA loans in
question to mortgage companies, not national banks, federal branches
and agencies, or institution-affiliated parties.
Further, the OCC's formal TILA enforcement policy generally
limits OCC authority to order restitution for TILA violations to
original creditors (See OCC's An Examiner's Guide to Consumer
Compliance, January 1993, "Questions and Answers on Reimbursement,"
p. 122, Q2).
Conclusion
The Ombudsman concluded that
the OCC has no enforcement jurisdiction over the purchasers of the
loans.
However, nothing in the TILA would prevent an assignee and
creditor from voluntarily sharing responsibility to make
restitution. Bank management should review the
terms of the loan sale agreements between the bank and the
assignees. The agreements may limit the
ability of the bank to seek the participation of the assignees in
reimbursing the borrowers (i.e., if the bank agreed to indemnify the
assignees in the event the loans are determined not to have been
originated to compliance with applicable laws).