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Appeal of Legal Lending Limit Violation (Third Quarter 1995)

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.

  1. (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).