June 2016 Legal Briefs

• Is it a refi?
• U3C: No change in late fee, dollar amounts
• Operational Odds and Ends
• Updated plans from the Bureau
• Sudden Overtime Changes

Is it a Refi?

By Pauli D. Loeffler

You have a closed-end mortgage loan on your books that the borrower wishes to modify and/or the note is maturing. If the modification is a refinance under §1026.20 of Reg Z, all new disclosures will be required and §1026.32 (HCML), §1026.35 (HPML) and §1026.43 (QM/ATR) will be triggered, so it is important to know what is and isn’t a refi. Note that §1026.20 applies only to refinancings undertaken by the original creditor, or the holder or servicer of the original obligation. A “refinancing” by any other person is a new transaction under the regulation and will always require new disclosures. This article will not address the disclosure provisions for assumptions under §1026.20(b), subsequent disclosures for ARMs under (c) and (d) or escrow cancellation under (e).

What is a refinance? Let’s say the bank has a 5-year fixed-rate balloon loan secured by a mortgage on the principal residence that it wants to renew for an additional 5 years at a fixed rate (either the same or an increased rate). Will this be a refinance requiring new disclosures and triggering HCML, HPML and ATR or not? We look first at § 1026.20(a) for the general definition of a refi and the first exception:

(a) Refinancings. A refinancing occurs when an existing obligation that was subject to this subpart is satisfied and replaced by a new obligation undertaken by the same consumer. A refinancing is a new transaction requiring new disclosures to the consumer. The new finance charge shall include any unearned portion of the old finance charge that is not credited to the existing obligation. 

The Official Interpretation provides:

20(a) Refinancings

1. Definition. A refinancing is a new transaction requiring a complete new set of disclosures. Whether a refinancing has occurred is determined by reference to whether the original obligation has been satisfied or extinguished and replaced by a new obligation, based on the parties’ contract and applicable law. The refinancing may involve the consolidation of several existing obligations, disbursement of new money to the consumer or on the consumer’s behalf, or the rescheduling of payments under an existing obligation. In any form, the new obligation must completely replace the prior one.

i. Changes in the terms of an existing obligation, such as the deferral of individual installments, will not constitute a refinancing unless accomplished by the cancellation of that obligation and the substitution of a new obligation.

ii. A substitution of agreements that meets the refinancing definition will require new disclosures, even if the substitution does not substantially alter the prior credit terms.

2. Exceptions. A transaction is subject to §1026.20(a) only if it meets the general definition of a refinancing.

If the current obligation is not wholly satisfied and replaced by a new obligation, the subsequent loan will not constitute a refinance, BUT there can be absolutely NO new money out (e.g., no origination fee, recording or other fee can be added to the loan). Further, the bank cannot add a variable rate feature where no variable rate has been previously disclosed:

Official Interpretation

20(a) Refinancings

3. Variable-rate. i. If a variable-rate feature was properly disclosed under the regulation, a rate change in accord with those disclosures is not a refinancing. For example, no new disclosures are required when the variable-rate feature is invoked on a renewable balloon-payment mortgage that was previously disclosed as a variable-rate transaction.

ii. Even if it is not accomplished by the cancellation of the old obligation and substitution of a new one, a new transaction subject to new disclosures results if the creditor either:

A. Increases the rate based on a variable-rate feature that was not previously disclosed; or

B. Adds a variable-rate feature to the obligation. A creditor does not add a variable-rate feature by changing the index of a variable-rate transaction to a comparable index, whether the change replaces the existing index or substitutes an index for one that no longer exists.

iii. If either of the events in paragraph 20(a)–3.ii.A or ii.B occurs in a transaction secured by a principal dwelling with a term longer than one year, the disclosures required under §1026.19(b) also must be given at that time.

Despite these two restrictions, the bank CAN increase the fixed rate without it being a refinance based on the following language found in the Examination Manuals/Handbooks of all the bank regulators (CFPB, FDIC, Federal Reserve, OCC):

“If, at the time a loan is renewed, the rate is increased, the increase is not considered a variable rate feature. It is the cost of renewal, similar to a flat fee, as long as the new rate remains fixed during the remaining life of the loan. If the original debt is not canceled in connection with such a renewal, the regulation does not require new disclosures. Also, changing the index of a variable rate transaction to a comparable index is not considered adding a variable rate feature to the obligation.”

Even when the transaction does wholly satisfy the prior obligation replacing it with a new obligation, §1026.20(a) provides five exceptions when the transaction will not be treated as a refi. The first is a renewal of a single payment obligation with no change in the original terms. This exception applies both to obligations with a single payment of principal and interest and to obligations with periodic payments of interest and a final payment of principal. In determining whether a new obligation replacing an old one is a renewal of the original terms or a refinancing, the bank may consider it a renewal even if accrued unpaid interest is added to the principal balance, changes are made in the terms of renewal resulting from the factors listed in §1026.17(c)(3), or the principal at renewal is reduced by a curtailment of the obligation.

The other four exceptions for a transaction that wholly satisfies the prior obligation replacing it with a new obligation are:

1. Reduction in the annual percentage rate with a corresponding change in the payment schedule. If the annual percentage rate is subsequently increased (even though it remains below its original level), if the increase is effected in such a way that the old obligation is satisfied and replaced (i.e., the general definition of a refi), new disclosures must be made. Change in the payment schedule to implement a lower annual percentage rate would be shortening of the maturity, or a reduction in the payment amount or the number of payments of an obligation. The exception does not apply if the maturity is lengthened, or if the payment amount or number of payments is increased beyond that remaining on the existing transaction.

2. An agreement involving a court proceeding. These agreements include reaffirmations of debts discharged in bankruptcy, settlement agreements, and post-judgment agreements.

3. A change in the payment schedule or a change in collateral requirements as a result of the consumer’s default or delinquency, UNLESS either a) the rate is increased, or b) the new amount financed exceeds the unpaid balance plus earned finance charge and premiums for continuation of insurance of the types described in §1026.4(d) (i.e., no new money). This is considered a work-out.

4. The renewal of optional insurance purchased by the consumer and added to an existing transaction, if disclosures relating to the initial purchase were provided.

The note has matured and the balloon is due. This situation generally occurs when the bank is waiting on the borrower to provide updated financial information, and there has been a delay in providing it, although sometimes the upcoming maturity date of the note somehow just “falls through the cracks.” There are conflicting statements in the BankersOnline Forums (Bankers Threads) on whether or not it is possible to modify a matured note on a closed-end loan without it being a refinance. My position is “Yes, this is possible.” Arguably, it is could be seen as a work-out since nonpayment of the balloon is a delinquency or default, although quite often the borrower continues to make installment payments in the same amount he has been making.

Whether or not the borrower has been making installment payments after the balloon payment is due, the bank still has an existing obligation that may be modified provided there is no new money out and a variable rate feature is not added that was not previously disclosed. Under Oklahoma case law the balloon is an installment which may be deferred, and if deferred, it could be modified. The OK U3C statute covering deferrals when viewed along with Reg Z commentary regarding what is and isn’t a refi allows for modification/renewal/extension of the loan instead of a refinance. I must acknowledge the fact most real estate loans are only subject to the U3C’s disclosure and remedy provisions. Reg Z does not go into much detail regarding deferrals, but the OK U3C is more explanatory.

Title 14A O.S. 3-204 provides:

(1) With respect to any consumer loan, refinancing, or consolidation, the parties before or after default may agree in writing to a deferral of all or part of one or more unpaid installments.

(2) With respect to a consumer loan, refinancing, or consolidation, which is not precomputed, at the time of deferral the debtor may agree in writing to a deferral charge that the lender may make and collect…

The balloon is an installment, and may be deferred before or after maturity (default). The bank and the customer can agree in writing to defer the payment of the installment (balloon) even though the note has matured. The deferral agreement should not be back dated but should express the agreement of the parties to defer the payment from not later than the due date of the balloon through the anticipated date of the modification.

Admittedly, it is always better if the deferral agreement was executed prior to the due date to extend the maturity date, however a deferral is still available after default. Of course, there are safety and soundness concerns, and there will be raised eyebrows if you have several months and/or multiple deferral agreements where the borrower is not even paying accrued interest. This would be true whether it is a consumer or a commercial loan which has no particular disclosure requirements.

U3C: No change in late fee, dollar amounts

By Pauli D. Loeffler

Under the statutory authority established pursuant to Tit. 14A O.S. Section 1-106, the Admistrator of the Department of Consumer Credit adjusts certain dollar amounts effective as of July 1st each year to provide for inflation. These dollar amounts are found in various sections of Oklahoma’s Uniform Consumer Credit Code (U3C) and include late fees. For the second consecutive year, there is no increase in any of the dollar amounts. The amounts in effect as of July 1, 2014 and July 1, 2015 remain the same, as does the late fee amount (the greater of 5% of the unpaid installment or $24.50). Note that the tiered rates for Sec. 3-508A, which are not subject to annual adjustment (see the July 2014 OBA Legal Briefs), will remain unchanged unless altered by enacted legislation. You may access the chart directly with regard to amounts on the Oklahoma Department of Consumer Credit website: https://www.ok.gov/okdocc/documents/2016%20dollar%20changes%20FINAL.pdf

A frequently asked question is “What is the maximum late fee for consumer loans and dealer paper?” Since July 1, 2014, the maximum permitted late fee has been the greater of $24.50 or 5% of the past-due payment.

Some banks’ loan documents have specifically pegged the “dollar amount” portion of their late fee formula at whatever amount was in effect when the loan was made. If the late fee is disclosed in this manner, the bank cannot raise the late fee if the amount authorized under the Oklahoma U3C increases UNLESS the loan is refinance, modified, renewed or a payment is deferred by written agreement and the borrower signs an agreement consenting to imposition of an increased late fee. Other banks have used an adjustable formula in the late-fee provision of their loans, allowing for "the greater of 5% of the unpaid amount of the installment payment or the maximum dollar amount established by rule of the Consumer Credit Administrator from time to time." Banks using a formula that specifically allows for this type of inflation adjustment can re-set their existing loans to charge a new, higher late fee when the same is determined by the Consumer Credit Administrator.

Operational Odds and Ends

By John S. Burnett

Same Day ACH

NACHA’s Same Day ACH rule will be effective in just over three months from the deadline for this edition of Legal Briefs, on September 23, 2016. Federal Reserve Payment Services have made their changes to enable the new offering, and banks across the country will start seeing its impact immediately when the “switch” is activated.

Any ACH payment, including both debits and credits (international transactions (IATs) and high-value transactions over $25,000 won’t be eligible) can be submitted as a same-day entry. As a Receiving Depository Financial Institution (RDFI), you will have new file delivery schedules and new procedures to follow. But you will rely on the Settlement Date provided by your ACH Operator, so you won’t have to review Effective Entry Dates or other indicators. During the first phase of implementation, only credit entries will be eligible for same-day treatment. You will be required to provide end of day funds availability for these items (by Phase 3, availability will be required by 5 p.m. local time).

If you also act as an Originating Depository Financial Institution (ODFI), you will also have new file submission and delivery schedules and changes in procedure to discuss with your ACH Operator. You’ll also need to determine the business model for offering Same Day ACH (it may or may not be something your Originators want or need). Pricing adjustments with your Originators will also need to be finalized, since there is a 5.2 cent fee (subject to periodic review and change) passed from the ODFI to the RDFI for each same-day transaction processed.

Because entries with current and past dates in the Effective Entry Date field will be expedited through the ACH as same-day entries, ODFIs will need to work with Originators to ensure they know the effect of errors in this critical field.

Testing

Federal Reserve Financial Services (FRFS) is opening a testing period running from June 28 through September 2. If your institution is interested in testing, contact FRFS and submit a rest request form at least a week in advance of the test window you want to work with.

Modified mid-day FedForward deposit options

Beginning July 1, Federal Reserve Financial Services (FRFS) will modify the structure of its mid-day FedForward deposit options. The changes are designed to limit instances of the Reserve Banks offering same-day credit for items that cannot be collected that same day, thereby reducing the associated cost that must ultimately be recovered by the Reserve Banks. For details on the changes, read the June 1, 2016, FRFS notice, at
https://www.frbservices.org/communications/customer_communications.html#check

Changes to FDIC’s Summary of Deposits survey

If your institution has any branch offices, it has to respond to the FDIC’s annual Summary of Deposits (SOD) survey, which reports branch office deposits as of June 30 each year. The FDIC’s recent FIL-36-2016, issued on May 31, includes important information about a change in filing procedure. Starting with this year’s survey, which is due by July 31, submissions are made via the Federal Financial Institutions Examination Council’s (FFIEC) Central Data Repository (CDR). The use of FDICconnect to submit the survey has been discontinued.

Whoever is responsible for submitting the SOD has to have an account established with the CDR. If your bank’s SOD will be submitted by the same individual who submits its Call Report to the CDR, a separate CDR account is not needed. Instructions for registering for a new CDR account are on page 2 of the FIL. You can find SOD reporting instructions, worksheets and additional details on the FDIC’s Bank Financial Reports webpage at
https://www.fdic.gov/regulations/required/

Updated plans from the Bureau

By John S. Burnett

The CFPB rolled out its Spring 2016 rulemaking agenda as May was drawing to a close. The first two items on the list – (1) Arbitration and (2) Payday, auto title and similar lending products – have already resulted in proposed rules. The proposed Arbitration rule (actually announced before the notice on the Spring agenda was released) would restrict the use of mandatory arbitration agreements, and outlaw such agreements in conjunction with waivers of class action rights in contracts for consumer financial products or services. Comments on the this proposal are due by August 22, 2016.

As expected, the CFPB announced its proposed rule on Payday, Vehicle Title, and Certain High-Cost Installment Loans on June 2 in a media event during its Kansas City field hearing on the topic. The 1334 pages detail a complex rule that will mostly affect non-bank lenders who make the loans in question. Comments on this proposal will close September 14, 2016.

We have a better idea on tentative delivery dates for other rules from the Bureau, although none of them can be considered “set in stone.” The farther out the date, the more likely it is to be missed.

Coming this summer

The Bureau suggested it would offer a proposal by “late July” to “make small clarifications and further regulatory guidance” on the TRID rules that were effective in October 2015. We don’t know what will be covered other than vague statements that the proposals will address areas of concern that have arisen since last October. Most residential mortgage lenders have long “wish lists” of things they want to see clarified, explained or otherwise “fixed.”

The final rule amending a proposal published in December 2014 on mortgage servicing requirements is also planned for sometime this summer. The proposal addressed enhanced loss mitigation requirements and compliance with servicing rules when a successor in interest or bankruptcy is involved. We will have to see what comes out in the final rule.

Also expected this summer is a final rule on prepaid financial products. The proposal was issued in November 2014, and it’s anticipated that the Bureau’s rule will create a “comprehensive set of consumer protections” for these products.

Over the horizon

Finally, the Bureau said it is still in the “pre-rule” stage in its study of overdraft services on consumer checking accounts, debt collection practices, and the Dodd-Frank Act requirement for data collection on loans to women-owned, minority-owned and small business lending.

Sudden Overtime Changes

By Andy Zavoina

Overview:

The good news is that the final overtime rule has been published. We’ve had calls and emails on this as bankers anticipated the final rule and wanted to prepare. It is here!

The new rule is like interest rates. When asked if interest rates are “good” right now, the answer depends on whether you are a depositor or a borrower. The overtime rule is similar in that from an employee perspective you may find that you will work fewer hours, get overtime or get a raise, but from the bank’s perspective there may be more costs on the salary entry for your labor costs.

I recall when we had a new staffer in the loan area and he was told he had to clock in and out. He hated it. He wanted the “prestige” that we lenders had. Yes, those of us working 60 hours a week told him he was crazy because he could either get overtime, or his own time to do what he wanted because he had to leave for the day. We didn’t have that privilege as we worked until we were done. We had the 7 am meetings and stayed late preparing reports and evaluating loan applications. Many employees are basically in the same boat today but the tests have not been updated on who is exempt from overtime requirements and who is not. These changes came about because it was believed that many workers put in well over 40 hours a week, for no additional compensation. Now the numbers used in the exemption tests are changing and this change will impact the bank’s bottom line by increasing labor costs. In just a few months 2017 budgets will be in the works and this increase in costs (or decrease in staff hours) must be allowed for.

Overtime Basics:

Let’s explore the basics on the new rule and the changes you must prepare for, as well as some decisions to make now which may influence your upcoming procedures. The final rule amends the regulations under the Fair Labor Standards Act (FSLA). The final rule was published on May 18, 2016, by the Department of Labor and it is effective December 1, 2016. The copy I have is 508 pages so while the deep detailed analysis may be enjoyed by those in Human Resources, others in the bank need to be familiar with the basics. If you manage a department, you may find that your budget constraints will require changes in salary levels, hours worked by staff, and work allocated to employees. As a department manager you need to understand what is happening and how it impacts your change management. Human Resource specialists will dig further into the rules and exceptions than we need to go.

There are two categories of staff, exempt and nonexempt. The former do not get overtime while the latter do. The exempt category is reserved for employees who perform high-level executive or professional work, outside sales employees, and a few other narrowly defined categories. Exempt employees must also must earn at least $23,660 a year to be considered exempt under the current rules. That income trigger is the major change in the new rule.

The revisions in the new rule are intended to make those tests easier to follow and to bring them current to today’s workplace. Currently one test is having a weekly income of $455 or $23,660 annually. It’s not difficult to surpass that minimum and be exempt, but those numbers were set in 2004! The new rule will raise the income test to $913 a week or $47,476 annually. This amount will be adjusted every three years. It is believed this income test will provide a measure of equality for many women and minorities, as they are believed to be a majority of those in the gap between the old and new income amounts.

The main exemptions are income based and these exempt persons are referred to as Executive, Administrative and Professional (EAP) employees and certain computer professionals as well as outside sales employees. To qualify the Department of Labor outlines three criteria:

1. The employee must be salaried, meaning that they are paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed;

2. The employee is paid more than a specified weekly salary level, which is $913 per week; and

3. The employee primarily performs executive, administrative, or professional duties, as defined in the "duties test."

Certain employees are not subject to either the salary basis or salary level tests (for example, doctors, teachers, and lawyers). The Department of Labor’s regulations also provide an exemption for certain highly compensated employees ("HCE") who earn above a higher total annual compensation level to be set at $134,004 under the new rule and satisfy a minimal duties test.

If your salary package includes a bonus there are some rules on that and how it relates to the salary amount that qualifies for the EAP exemption threshold. Nondiscretionary incentive bonuses (such as commissions) tied to productivity or profitability may be paid, however, the amount attributable toward the EAP standard salary level is capped at 10 percent of the required salary amount.

This is in contrast to discretionary bonuses which are paid at the bank’s sole discretion and not in accordance with any predefined standards.

Overtime Options:

As it relates to bank staff there will be four options to address the overtime in general.

1. Pay nonexempt employees time and a half for working over 40 hours per week.

2. Limit the hours worked to no more than 40 per week.

3. Provide pay raises to exceed the threshold to be set at $47,476 annually/$913 weekly.

4. Any combination of the above.

Of the key three options, only limiting the hours worked will not increase salary expenses. But limiting the hours to 40 per week of someone currently working 50 means that 10 hours per week will need to be shifted to others. Another potential option to reduce full-time staff with part timers. Some banks prefer this for staffing flexibility and saving on benefits while others see more work involved in more people for scheduling, training, etc., and feel the increase in the workforce can damage the corporate culture as seen by customers. Some banks simply don’t have the workforce available.

Change Management:

The bank, and perhaps each department to start with, will need to inventory the staff and determine under the new rule which may be in a position to be nonexempt. This starts with salary reviews and eliminates those EAPs earning over $47,476.

Next, determine who may work over 40 hours per week. Employees may clock in, keep a log, swipe a badge, or anything else that accurately tracks time. A constant log of “8am – 12pm, 1pm – 5pm” could trigger audit questions. Time on the clock could include the time an employee spends texting other staff about official business, reviewing and responding to bank email before going into work, and other job related duties. Start having potentially affected staff keep hours now and also allow for periodic special tasks such as quarterly meetings, morning meetings, HMDA and CRA scrubs, training for new and changed regulations, etc. But by getting an accurate idea of time on the clock now, the bank will be in a better position to evaluate each employee. With the new rule, expect more scrutiny and potentially more complaints. The accuracy of the time logs will be critical.

After accuracy of the logs, to ensure that work related activity is reported as required, or not done outside of prescribed times, you should have an audit trail that shows who reports, when and how, so that the bank is satisfied with the results.

Once you know how many employees will be impacted, the bank can decide what options will be used to address any overtime costs. As the bank makes its choices, it may decide to discuss the options with staff. Some may appreciate fewer hours or the option of earning overtime pay or a higher salary. If work is to be reassigned to others, will compensation be needed for that? Can other staff realistically absorb the additional work, or can the tasks themselves be reduced? There is a lot that needs to be resolved.
Remember, while the rule definitely impacts your 2017 calendar year, it actually begins December 1, 2016.