Commercial Lending – Compliance Doesn’t Apply, Right?
As a former compliance officer, I used to hear, “I’m a commercial lender, I don’t need to worry about compliance.” While most federal regulations are geared toward consumer lending, there are regulations that apply to commercial loans. Therefore, it is important for banks to ensure commercial lenders are aware of the federal regulations that do apply to them.
Regulation B – Equal Credit Opportunity Act (ECOA)
The purpose of this regulation is to promote the availability of credit to all creditworthy applicants without regard to race, color, religion, national origin, sex, marital status, or age (provided the applicant has the capacity to contract) and prohibit discrimination against any applicant because all or part of the applicant’s income comes from a public assistance program or the applicant has in good faith exercised any right under the Consumer Credit Protection Act. The regulation prohibits creditor practices that discriminate based on any of these factors and applies to all credit, commercial as well as consumer.
In addition to promoting the availability of credit to all creditworthy applicants, the regulation also requires creditors to notify applicants of the action taken on their applications. All applicants must be notified of the action taken within 30 days of a completed application. The notice required for commercial loans depends on the size of the business. If the business has revenues equal to or less than $1 million, notice may be given orally provided the ECOA rights are disclosed at the time of application. Applicants must be informed of their right to receive a written notice with a statement of reasons of adverse action, and upon request, a written notice with a statement of the reasons must be provided. If the ECOA rights are not given at the time of application, a written notice of adverse action must be provided. For businesses with revenues greater than $1 million, adverse action may be given orally; however, if an applicant requests a written statement of reasons within 60 days, it must be provided.
Creditors are also required to provide applicants with copies of appraisal reports used in connection with credit transactions if the loan is secured by a first lien on a one- to four-family dwelling. In addition, creditors are required to provide applicants a written notice of the applicant’s right to receive a copy of written appraisals developed in connection with the application within three days of application. It is important to note the regulation does not include an exemption for denied loans, even if denied within three business days.
The regulation prohibits creditors from requiring a spouse to cosign or guarantee a commercial loan unless the spouse has an interest in the entity borrowing the money. To prevent such situations, the regulation requires applicants to affirmatively indicate their intent to apply for joint credit. The intent must be stated at application either in written form if the application is received in person or verbally if the application was taken over the telephone. Signatures on joint financial statements attesting to the accuracy of the form are not sufficient to evidence the intent to apply for joint credit.
A guarantee on an extension of credit is part of the credit transaction and is subject to Regulation B. A creditor may require the personal guarantee of the partners, directors, or officers of a business and the shareholders of closely held corporations even if the business or corporation is creditworthy and independently meets the creditor’s lending standards for the amount and terms requested. This requirement must be based on the guarantor’s relationship with the business and not on a prohibited basis. For example, creditors may not require guarantees only for women-owned or minority-owned businesses. Similarly, a creditor may not require guarantees only from the married officers of a business or the married shareholders of a closely held corporation.
Regulation C – Home Mortgage Disclosure Act (HMDA)
The purpose of Regulation C is to provide the public with loan data that can be used to 1) help determine whether banks are serving the housing needs of their communities, 2) assist public officials in distributing public-sector investment to attract private investment to areas where it is needed, and 3) assist in identifying possible discriminatory lending patterns and enforcing antidiscrimination statutes.
Commercial loans secured by a dwelling may be HMDA reportable, depending on the loan purpose. Loans primarily for a business or commercial purpose are reportable if the purpose is a home purchase, home improvement, or a refinance. Alternatively, loans secured by a dwelling for a business or commercial purpose, but not a home purchase, home improvement, or a refinancing, are not HMDA reportable.
Flood Disaster Protection Act
Flood rules apply to all loans secured by a walled and roofed structure, including loans with collateral taken as an abundance of caution. They apply whenever a loan is made, increased, renewed, or extended. While most commercial lenders remember to determine the flood status and notify the borrower that a property is in a flood plain when a loan is first originated, checking the status for loan modifications, renewals, and extensions and notifying the borrower are often overlooked. In addition to the structure, contents located inside the building are also subject to the rules if they are also taken as collateral.
There is an exemption for structures detached from the primary residential structure. This exemption applies to consumer loans as well as loans made for business, commercial, or agricultural purposes, provided the loan is secured by a residential property. To qualify for the exemption, the structure must be detached, not be used for commercial or agricultural purposes, and not serve as a residence. For example, an outbuilding that is not attached to the primary structure and is used as a workshop for a hobby car collector is exempt; however, if the same workshop is used to fix up and sell cars, the transaction would not be exempt.
Regulation BB – Community Reinvestment Act (CRA)
The underlying purpose of the CRA is to encourage banks to meet the credit needs of local communities where they are chartered. Banks are assessed on their ability to meet these needs depending on their size. The lending test of the CRA for large and intermediate-small banks evaluates their record of helping to meet the credit needs of their assessment areas through lending activities by considering home mortgage, small business, small farm, and community development lending. Large banks (those with $1.284 billion or more in assets) are required to collect and report certain data for their small business and small farm lending activity. The data is to be reported in accordance with Call Report instructions.
Fair Credit Reporting Act (FCRA)
While the FCRA is primarily for consumer purposes, it also applies to obtaining a consumer’s credit report as part of underwriting a business loan. However, creditors must have a permissible purpose before obtaining a credit report. Determining whether a creditor has a permissible purpose for obtaining a credit report of a guarantor of a commercial loan is not always clear cut. A consumer’s written authorization to obtain a credit report is always a permissible purpose. If a creditor is not sure if it has a permissible purpose to obtain a credit report when the consumer is a guarantor or co-obligor, it is acceptable practice to obtain authorization to access the consumer’s credit report in the credit application or separate document.
Servicemembers Civil Relief Act (SCRA)
The SCRA protects servicemembers’ financial and legal affairs during periods of active military service. It requires creditors to provide certain relief from debt that was incurred before servicemembers entered active duty. The main benefit of the SCRA is interest rate cap protection. Servicemembers eligible for SCRA benefits are to receive a reduced interest rate of 6% and required payments are to be reduced to reflect the lower interest rate. The reduced interest rate is only for loans incurred prior to entering active duty and applies to all loan types including loans for business purposes.
Regulation Z – Truth in Lending (TIL)
While Regulation Z is a consumer protection regulation, there are two components of the credit card provisions applicable to business, commercial, and agricultural purposes. The first is that no credit card may be issued to any person except 1) in response to an oral or written request or application for the card, or 2) as a renewal of, or substitute for, an accepted credit card.
The second component relates to the liability of unauthorized use of cards issued for business purposes. Employees are provided protections for unauthorized use of a business credit card where the card issuer provides 10 or more credit cards for use by the employees of the organization.
Fair Lending
Commercial lenders should also be concerned with fair lending risks. Traditionally, regulators focused on mortgage and indirect lending for fair lending concerns. The focus has shifted somewhat to include commercial or business lending due to concerns that lending needs of women- and minority-owned small businesses are not being met. Creditors should evaluate their policies and procedures related to pricing, underwriting, referrals, compensation, marketing, and other lending operations to identify potential fair lending risks. This should include a comparison of denied applications for minority- and women-owned businesses to businesses owned by non-protected classes.
Conclusion
While the majority of federal consumer protection regulations apply just to consumer loans, some commercial loans are subject to the same requirements. Banks should review these regulations and ensure they have implemented policies and procedures to comply with the regulations that do apply.
