October 2014 Legal Briefs

• Military lending changes proposed
• Correcting direct deposits
• A lesson for mortgage servicers
• Trust your vendor, but verify
• Costly lender errors
• Exemption threshold going up
• Unclaimed property

Military lending changes proposed

By Andy Zavoina

You may not have worried about the old Military Lending Act (MLA), but there is a new proposal which would expand the MLA covered loan types, and with the regulatory emphasis on servicemember protections, this will affect your bank.

For starters, this is not the Servicemembers Civil Relief Act (SCRA). The Military Lending Act is separate and is targeted at preventing abusive loans to servicemembers and their dependents. The MLA was enacted in 2007. Remember all the banks in unison saying “we don’t make those loans so it doesn’t apply to us,” only to search the portfolio and discover that some of these loans were being made?

As a recap, the MLA currently covers three loan product types:

1. Payday loans – 91 days or less and not more than $2,000
2. Vehicle title loans – Terms less than 182 days excluding purchase money (this is often the “gotcha”)
3. Tax refund anticipation loans

There are exceptions and certainly more detail than the above descriptions, but it was easy to look at these products and avoid the MLA altogether. If the proposal is adopted as written, however, that will change.

Under the proposal the definition of covered loans will include the three above and expand to also include:

4. Deposit advance loans
5. Installment loans
6. Unsecured open-end lines of credit, and
7. Credit cards

These are all Reg Z loans and an overdraft line of credit under Reg Z would also be covered. Under the proposal it is the exclusion list that is limited instead of the few loan products that are covered. Exclusions under the proposal will be limited to real estate loans secured by the borrower’s dwelling and purchase-money loans. The reach of product types now means you likely do make MLA covered loans.

Servicemembers and their dependents are afforded many additional protections under the MLA, including:

• Limiting interest to 36 percent
• Prohibiting arbitration and prepayment penalties, and
• Requiring delivery of special disclosures before consummation.

These include oral disclosure requirements.

The definition of “dependent” changed in 2013. While it was generally similar to IRS rules on providing more than half a person’s support, the current definition is the same used by the military to determine eligibility for medical and dental care. This expanded who was covered to include unremarried widows and widowers and certain unremarried former spouses of servicemembers. You can’t think it only applies to a spouse of someone in the military. Again, with the expansion of covered loans, risk is increased far beyond what you initially faced.

In 2013 there were changes made to the MLA that expanded enforcement risk. The 2013 Defense Authorization Bill added a civil liability provision that allows private actions for MLA violations to be filed in federal court. While the bill provides for actual damages, it could be read to require payment of at least $500 in damages even if the actual damages sustained were less. Still, with limited loan product applicability bankers were not losing sleep over it. But with the expansion of product types, risk increases. Also, factor in the MLA penalties that already exist. In addition to criminal and civil penalties if creditors violate the rule, consumer credit contracts that are not in compliance will be deemed void from inception.

So we know this is not your 2007 MLA. The group of individuals being protected has already expanded and it is not obvious who those persons are without investigation. Covered product types will expand under the proposal to essentially loans covered by Reg Z with just a few exceptions. Litigation risk has and will increase as a result of these changes.

The proposed MLA replaces a variety of requirements and restrictions on lenders including:

1. Determining if the borrower is a “covered borrower.” This means knowing if any of your borrowers is a servicemember or a dependent of one. This can be accomplished in any of several ways, including a 3-step process outlined in the MLA which involves screening the borrower against the Department of Defense database. This is the same database you use for SCRA checks and emphasis is increasing on the use of this in today’s enforcement environment. Use of the database would be required to obtain a safe harbor. This is an extra step and procedurally would require more work. Credit bureaus may offer this check as an add-on to credit reports in the future, but it isn’t a current option. Today the loan applicants complete a form, a “covered borrower identification statement,” but it was found they occasionally complete the form incorrectly and lose protections as a result. The burden will now shift more on the lender. Even if the database check is not positive, if the lender knows the applicant is covered, they must rely on what they know and not the database for safe harbor protections.
2. Providing specific oral and written disclosures prior to consummation. These must be made for applicable loan products which will be greatly expanded.
3. Limiting the interest rate to be charged to 36%. This is not what qualifies a loan to be MLA applicable, it is what is prohibited if it is. As with the current MLA you calculate a Military Annual Percentage Rate (MAPR), which is calculated differently than the APR under Reg Z, for the purposes of the rate cap. Many fees excluded from the finance charge under Reg Z are included in the MAPR so that ceiling rate is more easily attained. Don’t focus solely on the interest rate charged on the loan.
4. And the proposal would continue to prohibit arbitration and prepayment penalties.

The proposed rule will implement several provisions added by the 2013 amendments. Enforcement authority will be held by the agencies that enforce TILA. The Consumer Financial Protection Bureau will have primary MLA enforcement authority over large banks and shares enforcement authority with the Federal Trade Commission on nonbank lenders.

Consider how the expansions that have been made and are proposed will impact your loan application process. Comment on the proposal. There is more detail in the proposal on why the DoD felt these changes were necessary. Banks are typically not the offenders, but the victims of unintended consequences. Perhaps enough thoughtful comment letters can make these changes more likeable. Your comments are due by November 28, 2014.

Correcting direct deposits

By John S. Burnett

In the waning days of September, Federal Reserve Bank Services broadcast at least two emails for Treasury’s Fiscal Service Bureau to alert banks about payroll processing errors that would (or should) cause direct deposits of federal employees’ pay to reject. Deposits to savings accounts carried checking credit transaction codes and deposits to checking accounts carried transaction codes for savings credits. Most processing systems would reject such items for manual handling or return. The Fiscal Service asked receiving depository financial institutions (RDFIs) to manually credit the rejected items to the designated accounts to help the federal employees (and bank customers) avoid problems that would be caused if the deposits were sent back (which an RDFI would have the right to do).

I imagine that most banks receiving such an alert and a few rejected items fitting that description would go ahead and post the items manually. It would have been the right thing to do for the bank’s customer and it presented minimal, if any, risk to the bank. Many banks receiving the cross-coded items would have proactively checked for overdrafts that might have resulted from a one-day posting delay, and ensured they were paid and, yes, probably reversed any fees, too.

If those direct deposits had instead been direct debits, similarly “cross-coded” savings for checking, what would have been the right course to take? In many banks, allowing the items to reject and manually posting them the next business day could create problems if one of the items still failed to post, leaving no time for a timely return. It would be more prudent to check before manually reentering such an item to ensure that it will post, and return it (rather than attempting to post it) in time to meet the ACH returns deadline.

A lesson for mortgage servicers

By John S. Burnett

Attention mortgage servicers! If your bank services residential mortgage loans for itself or for other lenders, there’s a loud and clear message from the CFPB in the news that Troy, Michigan-based Flagstar Bank has been hit with the CFPB’s first enforcement action for violations of the new servicing rules in subpart C of the Bureau’s Regulation X (12 CFR Part 1024). The CFPB action, announced on September 29, directs Flagstar to stop violating the regulations, pay $27.5 million to consumers damaged by the illegal activities, and pay a $10 million fine.

Flagstar services loans owned by other lenders or investors. In that position, Flagstar is required to administer foreclosure relief (loan mitigation) programs provided by the loan owners. But the Bureau’s statement indicates that from 2011 to the present (the loan servicing regulatory requirements became effective in January of this year), Flagstar failed to provide the resources (adequately trained and supported staff) required to properly administer those programs. The Bureau provides an example of the bank’s staffing in 2011, in the depths of the mortgage meltown: Flagstar had 13,000 active loss mitigation applications with only 25 full-time employees and a third-party vendor in India to review them. It took as long as nine months to review some of those applications. The bank’s loss mitigation call center was working with call wait times averaging 25 minutes, with an unsurprising call abandonment rate of almost 50 percent. Mitigation applications expired due to the bank’s dithering.

Once the servicing regulations took effect in January, the bank regularly missed regulatory deadlines for evaluating mitigation applications; failed to timely notify borrowers of incomplete mitigation applications; miscalculated borrower income and wrongfully denied requests for loan modifications; failed to provide the reason for denying modification applications; misrepresented or failed to provide notice of appeal rights; and imposed overly long trial periods for modifications.

Of the $27.5 million to be paid out to injured borrowers, the Bureau estimates that at least $20 million will be paid to about 2,000 borrowers whose loans were foreclosed. None of the borrowers who were injured will be barred from seeking additional damages resulting from Flagstar’s conduct. And Flagstar has been barred from acquiring servicing business for default loan portfolios until it has demonstrated its ability to comply with loss mitigation requirements protecting consumers. And just to drive the point home, Flagstar must also engage in outreach to injured borrowers who were not foreclosed on, offering mitigation options and halting foreclosure processes affecting those consumers during the outreach effort.

The lesson for any of your banks who service consumer mortgage loans is clear – to stay in the business of servicing loans, you must devote adequate staff and other resources to comply with the servicing requirements and provide the consumer protections in subpart C of Regulation X. Small servicers need to comply with subpart C, too, although they aren’t held to the standards for general servicing policies, early intervention, continuity of contact and loss mitigation (except for section 1024.41(j)) in sections .38 through .41. And it’s important to remember that the requirements apply to all consumer mortgage loans being serviced, not just those added since the rules became effective.

Trust your vendor, but verify

By John S. Burnett

As banking and all that goes with it gets more and more complex, it’s not surprising to see more bankers reaching out for vendor solutions. It’s obviously important that a bank be able to trust its vendor’s work, but before they place trust in vendor products or services, it’s critical that the bank verify the accuracy of the vendor’s work and the compliance of the vendor’s product or service with regulatory requirements. With or without a guarantee from the vendor, the bank is responsible for compliance and for any problems the service or product may cause.

That’s a lesson to be learned from the FDIC’s August enforcement action against a Georgia bank, which was ordered to pay a $10,000 civil money penalty for multiple UDAP violations over two years under section 5 of the Federal Trade Commission, in connection with the publication and utilization of certain advertising and marketing materials that were prepared by an independent third-party contractor under the direction and supervision of the Bank.

Costly lender errors

By John S. Burnett

There were a couple of significant cases reporting in the last month that resulted from individual lender actions that got regulatory scrutiny and resulted in penalties. HUD announced that a Jackson, Tennessee, mortgage lender will pay a $35,000 settlement for Fair Housing Act violations resulting from a denial of a mortgage loan to a couple, one of whom was discovered to be on maternity leave. The loan had been approved, but the lender “pulled the plug” and notified the couple of its reversal within 24 hours of the scheduled closing.

In another case, HUD announced a settlement under which a bank, its subsidiary and one of the bank’s loan officers have agreed to pay off a Belcourt, North Dakota, Native American couple’s $11,000+ credit card balance with the bank and approve a home mortgage refinance at terms applied for, after allegedly refusing to refinance the couple’s mortgage because the property is located on a reservation.

Neither of these settlements is substantial in relation to the assets of the lenders involved, but each of these cases (and the inevitable negative press that accompanies it) could have been avoided with appropriate individual training in Fair Housing Act compliance. They also present strong arguments for a “second look” procedure under which any denial (or withdrawal of approval) gets reviewed by a seasoned lender before it’s communicated to an applicant.

Exemption threshold going up

By John S. Burnett

On January 1, 2015, the Regulation Z exemption threshold will increase from $53,500 to $54,600. Consumer credit – except for loans secured by real estate or by personal property used or expected to be used as the consumer’s principal dwelling and private education loans – in excess of the threshold amount is exempt from Regulation Z. The exemption threshold is subject to change each year based on year-to-year Consumer Price Index changes measured as of June 1 of the preceding year. The threshold amounts in effect since the amount began to be indexed in 2011 can be found in comment 3(b)-1 to Regulation Z.

Unclaimed property

By Pauli D. Loeffler

We’ve had many emails and calls regarding unclaimed property, a subject last covered in depth 14 years ago in the OBA Legal Briefs. There have been several changes since 1997, so it seemed time to revisit the topic.

Where do I find the Oklahoma statutes, rules/regulations, and forms for unclaimed property? The Oklahoma version of the Uniform Unclaimed Property Act (“UPA”) is found in Title 60 (Property Code) of the Oklahoma statutes §§ 651-688 which can be accessed by going to www.oscn.net, clicking on the Legal Research tab at the top of the page, selecting “Oklahoma Statutes Citationized” and then scrolling down to Title 60, clicking “expand” and scrolling down to the specific statutes. The rules/regs are found in Title 735 (State Treasurer) in Chapter 80. You can access through the Secretary of State’s website https://www.sos.ok.gov/. Forms and instructions for reporting mentioned here are found on the Oklahoma State Treasurer’s website (http://www.ok.gov/treasurer/) by choosing the “Holder Information” option under “Unclaimed Property.”

What is the purpose of the UPA? All states have unclaimed property laws. The UPA represents a final effort to contact the owners (by newspaper publication and the State Treasurer’s website) so that missing owners can reclaim their property. A large percentage of owners, however, never make a claim. What all unclaimed property laws have in common is that any unclaimed property defaults to ownership by the state after a certain time (unless the true owner later shows up). “Finders keepers” has no application: nothing held for a “lost owner” will ever become owned by the temporary holder (i.e., a bank, an insurance company, the purchaser of oil and gas, etc.) based on the passage of time. Undeniably, one purpose of unclaimed property laws is to benefit the state financially by allowing it to keep and spend the assets of lost owners who fail to claim their property. When cash is turned over to the State Treasurer, or after non-cash property is turned over, sold and converted to cash, it does not continue to earn income for the missing owner. The owner’s claim is “frozen” at the amount remitted or at the net proceeds obtained from sale of any non-cash property. Just as an insurance company has a reserve account to pay claims based on actuarial tables or historical claims, the State Treasurer, is charged with establishing a reserve fund sufficient to pay all anticipated claims promptly. (§§ 670-671) Since a percentage of owners never make a claim, the rest of the funds as well as interest earned on the reserve fund belong to the state and go into Oklahoma’s General Fund. (§ 672)

The fact that the state has a financial stake in unclaimed property explains why it is such a “big deal” in Oklahoma. Title 60 O.S. § 680 contains provisions for interest, civil penalties, and in extreme case, fines and imprisonment if unclaimed property is not reported and turned over on a timely basis. The State Treasurer can also conduct an on-site examination (with the cost to be paid by the holder of unclaimed property) if there is reason to believe that a holder has failed to report unclaimed property. (§ 678)

When do holders have to report unclaimed property? Most holders are required to file an unclaimed property report with the Oklahoma State Treasurer prior to November 1st each year unless the holder has requested and been granted permission for late filing. (§ 661) Unless the holder is reporting fewer than 15 properties, the report must be sent electronically. The report must contain safe deposit box inventory detail. Unclaimed property, other than the contents of a safe deposit box, must be remitted with the report. The Treasurer will contact the bank regarding the contents of the safe deposit box it requires to be remitted.

Property that must be included in the annual report is any property meeting the required time period of abandonment as of June 30th of the year reported.

When is property presumed to be abandoned? This depends on property. Generally speaking, the presumption of abandonment requires two things: lack of activity and loss of contact with the customer.

Deposit accounts. Demand, savings, or matured time deposit accounts are presumed to be abandoned unless within five years, the owner has increased or decreased the amount of the deposit, presented the passbook for the crediting of interest or has communicated in writing with the bank concerning the property or otherwise indicated an interest in the property as evidenced by a memo on file prepared by an employee of the bank. (§ 652 A.)

If more than one person has a legal or equitable interest in property, the property will not be presumed abandoned unless it has remained unclaimed by ALL its owners. If your institution maintains contact with just a single joint account owner, the account is saved from having to be turned over to the State Treasurer.

If the bank has sent a statement or other business communication concerning the account or property to the owner by first-class mail, and the statement or communication has not been returned for inability to make delivery to the addressee, the property shall not be presumed to be abandoned. The five-year period begins to run at the later of when the business communication to the owner has been returned as undeliverable or on the last date the owner has communicated with the bank. (§ 652 A. 5. b.) This leads to issues if all business communications are electronic or the bank does not send mail with ancillary service endorsements (e.g., “Address Service Requested”). For instance, I moved into my current residence more than 9 years ago, and 401k statements for one of the former owners still come to my address. This can also happen when the customer is deceased. When the bank knows the customer is deceased, and no one steps forward to claim the property, using the date of death as the date for presumption of abandonment may be reasonable.

Automatically renewable time deposits. § 652 D. has special provisions with regard to automatically renewable time deposits. The period of presumed abandonment is 15 years after the expiration of the initial time period of the time deposit. After that period of time, the property is deemed to be unclaimed property unless, within the 15 years, the owner has either increased or decreased the amount of the deposit, communicated in writing with the bank concerning the deposit, otherwise indicated an interest in the property as evidenced by a memorandum or other record on file prepared by an employee of the bank, or had another relationship with the bank and either communicated in writing with the bank about that relationship or otherwise indicated an interest in it, as evidenced by a memo or other record on file prepared by an employee of the bank.

The primary difference in the treatment of automatically renewable time deposits and other deposit accounts is that after the property is presumed abandoned, the financial institution must REPORT these to the Treasurer but has the OPTION to remit these OR retain them! This provision recognizes the unique nature of automatically renewable time deposits (the intention of the customer that the funds remain undisturbed), while allowing the State Treasurer to achieve its objective of collecting and providing information about funds that may have been forgotten.

Service charges under § 652. If you wish to impose a dormancy or inactivity charge or to cease payment of interest on an account due to dormancy or inactivity or under Title 6 O.S. § 901 B. 9., you must adhere to the following guidelines:

• You must give reasonable notice to the owner of the property that you may impose the charge or cease payment of interest either:
  • at the time the account is opened; or
  • through a schedule of charges sent to the owner of the property; or
  • through a statement in the rules, regulations, or bylaws of the holder that the holder may impose the charge or cease payment of interest.
• You must be consistent with the practice. In other words, you must regularly impose the charge or cease payment of interest under the circumstances. You cannot do so on a piecemeal basis.
• If you regularly reverse or otherwise cancel such charge or retroactively credit interest for a reason other than an error or omission by the holder, then in proportion to the extent you do so with respect to other deposits, you must likewise reverse or otherwise cancel charges or retroactively credit interest with respect to property that is reported to the State Treasurer as unclaimed property. This provision is required to guard against situations where the bank has a policy of reversing charges or crediting interest retroactively for inactive customers who become active again but don’t do the same for accounts which remain unclaimed. All inactive accounts must be treated the same insofar as service charges and interest are concerned.

Keep in mind that if the account is a consumer account, you cannot cease payment of interest due to dormancy without proper disclosure or redisclosure under Reg DD.

C.D.s held in an IRA. The general abandonment period described above for C.D.s will not apply to a C.D. held in an individual retirement account (IRA) or self-employment plan (SEP). For these accounts, abandonment cannot occur earlier than seven years after the date when distribution of all or part of the funds becomes mandatory. For a regular IRA, distribution must begin after the individual turns 70 ½. On this basis, abandonment with respect to a C.D. in a regular IRA could not occur before age 77 ½, or some months later. For a Roth IRA there is no mandatory distribution date provided the individual is still alive, so funds held in a Roth IRA apparently will not become unclaimed property until seven years after the death of the owner.

Travelers’ checks and money orders other than third-party bank checks. The presumption of abandonment commences under § 652.1(a) for travelers’ checks when they have been outstanding for more than 15 years after their issuance and the owner has not communicated in writing with the issuer about them, or otherwise indicated an interest in the property as evidenced by a memorandum or other record on file prepared by an employee of the issuer. If the “holder” (a term defined in § 651 7. as “a person who is in possession of property belonging to another, a trustee or indebted to another on an obligation”) has sent a statement or other business communication concerning the account or property to the owner by first-class mail, and the statement or communication has not been returned for inability to make delivery to the addressee, the property shall not be presumed to be abandoned. A holder of the unclaimed money order may not deduct a charge from the instrument for failure to present unless there is a valid, written agreement which allows the charge.

Money orders that are signed by the bank as well as those signed by the purchaser are deemed abandoned after they have been outstanding for more than seven years after its issuance unless the owner, within seven years, has communicated in writing with the issuer concerning it or otherwise indicated an interest as evidenced by a memorandum or other record on file. (§ 652.1 (b))

The holder of a travelers’ check or money order covered by §652.1 cannot deduct any charge imposed by reason of failure to present the instrument unless there is a valid written agreement between the issuer and the owner to do this AND the issuer regularly imposes such charges and does not regularly reverse or otherwise cancel them.

Money orders and checks. § 651.2 provides the period of abandonment on a check, certified check, cashier’s check, draft or other similar instrument (not covered by § 652.1), is five years. Time begins to run when the item is payable or from issuance if payable on demand. To presume abandonment, the owner must not have communicated in writing with the financial organization concerning it within five years or indicated an interest as evidenced by a memo or other record on file prepared by an employee of the institution.

Safe Deposit Boxes. Five years after the lease expires, property held in a SDB that is unclaimed by the owner is presumed to be abandoned. The Treasurer may decline to receive reported unclaimed property it considers to have a value less than the expense of giving notice and holding sale.