Appeal of Violation of 12 U.S.C 161 (First Quarter 1995)
The bank felt this appeal was necessary for the following three reasons.
- Management believes the ALLL was adequate as originally reported as of December 31, 1993. The bank re-filed its call reports to comply with its internal ALLL policies and because of the previous violation of 12 U.S.C. 161 with associated civil money penalties and reprimands. The bank did not re-file because it had determined the ALLL was inadequate.
This dispute over ALLL adequacy centers around a certain large loan relationship and a proviso in the bank's ALLL policy requiring a minimum ALLL balance equal to 50 percent of nonaccrual loans. The bank claimed in its appeal letter that, through an oversight, the senior loan officer had inadvertently failed to include the large relationship in the calculation of the required minimum ALLL balance. When the bank's external accountant discovered the omission, the bank immediately corrected the problem by first visiting the OCC supervisory office to explain the matter and then re-filing the December 31, 1993 call report. Documentation obtained through our review of this appeal demonstrates that the minimum coverage calculation for nonaccrual loans was included in the December 31, 1993 ALLL analysis and the board made a conscious decision not to make the associated ALLL adjustment. Not withstanding this discrepancy, the question remains whether a violation actually occurred.
- The bank is concerned about the threat of future civil money penalties.
The bank claims that the examiner-in-charge of its next examination told bank officials he did not believe the cited violation would be significant and was not going to refer it for civil money penalties. The error should have been caught, but the bank immediately corrected the situation upon discovery. Despite this assurance, the bank felt that the circumstances warranted an appeal to a neutral third party to assess the seriousness of the alleged violation.
- The bank perceives OCC hostility stemming from an alleged ethical conflict concerning a former OCC employee.
The bank is convinced that this situation created an unfavorable relationship with the supervisory office. The board of directors is concerned that every violation of any kind will be vigorously pursued because of the bank's less than friendly relationship with the supervisory office. The bank believes that all possible violations of law, no matter how minor, have now become major issues, causing great anxiety among the management and directors of the bank.
12 U.S.C. 161(a) requires national banks to file accurate reports of condition and income to the Comptroller of the Currency in accordance with the Federal Deposit Insurance Act. Each report of condition shall contain a declaration by the president, a vice president, the cashier, or by any other officer designated by the board of directors of the bank to make such declaration, that the report is true and correct.
The ALLL must be maintained at a level that is adequate to absorb all estimated inherent losses in the bank's loan and lease portfolio. The Instructions for Preparation of the Consolidated Reports of Condition and Income state the following: "At the end of each quarter, or more frequently if warranted, the management of each bank must evaluate, subject to examiner review, the collectability of the loan and lease financing receivable portfolios, including any accrued and unpaid interest, and make appropriate entries to bring the balance of the allowance for loan and lease losses (allowance) on the balance sheet to a level adequate to absorb anticipated losses. Management must maintain reasonable records in support of their evaluations and entries."
SFAS No. 5 is the primary, authoritative accounting document concerning the accrual of the ALLL. It defines an inherent loss (loss contingencies) as an existing condition, situation, or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. The conditions associated with most loans involve some degree of uncertainty about collectability. However, a provision to the ALLL for an inherent loss (loss contingency) associated with loans should be made only if both of the following conditions of SFAS No. 5 are met:
- Information available as of the evaluation date indicated that it is probable that the value of the loan had been impaired. (One or more future events must be likely to occur and confirm the fact of the loss.)
- The amount of loss can be reasonably estimated. (Under Financial Accounting Standards Board Interpretation No. 14, the ability to estimate a range of loss is sufficient to satisfy this condition.)
The timing of certain events in the sequence of this case is central to the question as to whether a violation of law occurred. The bank placed a portion of the large relationship on nonaccrual in November 1993, with the balance placed on nonaccrual in December. At year end 1993, the entire relationship was internally classified substandard/nonaccrual. The bank was involved in active negotiations with the managing partners of the project. Based on the strong financial capacity of the guarantors, the bank did not expect any loss on this relationship. The bank filed its December 31, 1993 call report on January 25, 1994. The bank's external CPA confirmed that the ALLL balance was adequate based on the information available to the bank at the time.
However, the large relationship deteriorated during the month of February, in the midst of the external CPA's annual audit of the bank. The bank's president decided to initiate litigation against the guarantors and charged off the loan on February 28, 1994. At that point, the CPA became uncomfortable with the ALLL balance. Since his FYE audit was still in progress, he recommended an additional provision adjustment to the December 31, 1993 ALLL balance based upon his own analysis. To make the bank's RAP book consistent with its GAAP book, the CPA's additional provision adjustment was made retroactive and the bank refiled its initial call reports. The charge-off and the accompanying provision of equal amount were both treated as first quarter events.
The Ombudsman's office decided that there is not conclusive evidence that a violation of 12 U.S.C. 161 occurred. The fact that the bank did not comply with its policy for calculating the allowance does not, in and of itself, constitute a violation of law. It is extremely difficult to pinpoint the exact date a loss should have been recognized in prior periods. We found no justification that the large relationship was improperly graded at December 31, 1993, nor were we able to corroborate that the ALLL balance was inadequate as originally filed in the bank's initial December 31, 1993 call report.
Further, the tone of the supervisory officer's letter to the bank was inappropriate. The bank immediately brought the alleged violation to OCC's attention, made appropriate adjusting entries, and refiled the affected call report. The supervisory office agreed to take the following actions:
- Reiterate to the bank that OCC acknowledges the bank' forthrightness in bringing this matter to OCC's attention upon discovery by the bank. No violation of law will be cited and no civil money penalties or other administrative action contemplated.
- Send a revised version of the supervisory office's letter to the bank eliminating any inappropriate language. References to past reprimands and penalties will be deleted.
The alleged ethical conflict involving the former OCC employee was referred to the OCC'S ethics counsel. Subsequently, this matter was referred to the Department of the Treasury Office of the Inspector General for appropriate investigation.
Appeal of Requirement on Physical Separation of Loan Underwriting and Credit Origination (First Quarter 1995)
A bank requested that the Ombudsman's Office reconsider OCC's requirement that the mortgage loan underwriters of the bank's mortgage company subsidiary be located in separate buildings from the credit origination function. At the time of the bank's acquisition of the mortgage company, the bank agreed to separate the functions, pursuant to OCC interpretations of the branching rules, in order to receive a speedy approval of the application for the acquisition. The bank's appeal is motivated by the competitive disadvantage these restrictions create. Physical separation of underwriters causes the mortgage company to incur additional expense, creates employee morale issues, and is contrary to industry practice.
Under the McFadden Act, any bank office that performs certain "core" banking activities, including accepting deposits, paying checks, and lending money, is a branch and thus subject to location restrictions (12 U.S.C. 36(f), 12 U.S.C. 81). Interpretative Ruling 7.7380 permits national banks to originate loans at locations other than the main office or a branch office of the bank provided that the loans are approved and made at the main office or a branch office of the bank or at an office of the subsidiary located on the premises of or contiguous to, the main office or branch office of the bank.
A letter signed by Eric Thompson, director of OCC's Bank Activities and Structure Division, dated October 13, 1994, states that it is permissible to maintain loan approval offices in the same buildings as loan production offices (LPO) of a mortgage company subsidiary of a national bank. The locations in question are not branches of the bank. The loan approval office would be located on a different floor than the LPO; be in an area not identified by any mortgage company signs; have a different entrance to the building than the LPO; be in an area that is not accessible to the public, including customers of the mortgage company; and have a staff that is separate and independent from the loan origination personnel. In no case will loan proceeds be disbursed at either an LPO or a loan approval office.
Similar conclusions are communicated in a letter signed by Frank Maguire, Senior Deputy Comptroller for Corporate Activities and, Policy Analysis, dated October 12, 1994. This letter approves the acquisition of a mortgage company by a national bank subject to certain conditions. In this case, credit underwriting offices are located in the same buildings as LPO's, but are either located on different floors of a multi-story building, or in separate areas on the same floor. There is no public access to the underwriting offices and no customers visit these offices. Each underwriting office will be staffed separately from the LPO, and underwriting personnel will operate independently of the LPO.
Both letters conclude that, under the given circumstances, locations where LPO's and credit underwriting offices are maintained in separate areas of the same building should not be considered branches for purposes of 12 U.S.C. 36. A nonpublic office that only performs credit underwriting functions is not a branch and situating it in the same building as an LPO does not change the non-branch character of either office.
The Ombudsman's Office decided that the interpretive letters provide the mortgage company an avenue to locate underwriting and origination functions in the same building. Consistent with the facts and circumstances contained in these letters, the mortgage company subsidiary no longer needs to maintain the mortgage loan underwriters in separate buildings from the credit origination function.
Appeal of Conditions for Approval of Licensing Application (First Quarter 1995)
A bank appealed two conditions imposed in OCC's approval of a corporate licensing application. The bank sought approval for a proposed reorganization by the bank's parent company (BHC) of its credit card business among two of its subsidiary banks ("Bank A" and "Bank B"). The reorganization would be effected, in part, through a sale of Bank A's credit card portfolio to Bank B, which is engaged exclusively in credit card and related activities.
The transaction would be structured as follows. Bank A would sell to Bank B its credit card business, including the existing receivables and billed accounts as well as certain limited unsecured lines of credit and related fixtures, equipment, and personal property. The transaction would exclude any receivables that are low-quality assets. Simultaneous with the transfer to Bank B of its credit card business, Bank A would make a combined dividend to and stock repurchase from and distribution to the BHC. The dividend component would be sized to equal income realized by Bank A through reversal of card related loan loss reserves less write down of low-quality assets to current market value. The dividend would be paid by Bank A in cash and the stock repurchase and distribution paid first in-kind with low-quality assets and the remainder in cash. The BHC estimates that the current market value of the low-quality assets equals approximately 50 percent of the outstanding balances. The BHC would contribute as common equity capital to Bank B all dividend and stock purchase proceeds received from Bank A. The BHC would also purchase a certain amount of tier 2 capital qualifying subordinated debt from Bank B.
OCC placed the following conditions on the proposed transaction:
- The portion of the transfer to be structured as direct sale from Bank A to Bank B must be accounted for at fair value.
- The accounting for the Bank A common stock repurchase must include a proportional deduction from undivided profits of any amount paid in excess of the issue price of the shares retired.
The Instructions for the Preparation of the Consolidated Reports of Condition and Income specifically prohibit accounting for such transactions at cost. Under the glossary entry for property dividends, the instructions state that "the transfer of securities of other companies, real property, or any other asset owned by the reporting bank to a stockholder or related party is to be recorded at the fair value of the asset on the declaration date of the dividend." Also, Topic 11-A of the Bank Accounting Advisory Series states that "the transfer of assets between a bank and a related party should be accounted for on the basis of the asset's fair value." The agencies base this long-standing position on the necessity of maintaining consistency of accounting policy regarding transactions involving affiliated and nonaffiliated institutions. They believe that otherwise the reliability of call reports would be diminished when comparing an independent bank to one owned by a holding company.
The accounting for retirement of treasury stock has varied treatment under GAAP. OCC has generally required use of the pro rata approach (via undivided profits) rather than deducting the entire amount from capital surplus. The intent of this approach is that capital surplus should not be reduced by more than the amount applicable to shares retired. Accounting Principles Board Opinion No. 6 which governs the accounting for such transaction designated the method required by OCC as an acceptable method. However, GAAP would allow other methods. Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins, states in Paragraphs 7 and 8 Chapter 1B that there is "general agreement that the difference between the purchase price and the stated value of a corporation's common stock purchased and retired should be reflected in capital surplus, while the net asset value of the shares of common stock outstanding in the hands of the public may be increased or decreased by such purchase and retirement, such transactions relate to the capital of the corporation and do not give rise to corporate profits or losses. "The Current Text of Accounting Standards published by the Financial Accounting Standards Board states the following in Section C23, Paragraph 102: "If an enterprise's [capital] stock is retired, or purchased for constructive retirement (with or without an intention to retire the stock formally in accordance with applicable laws):.b. An excess of par or stated value over purchase price shall be credited to additional paid-in capital. [APB6, Pl2a]."
The bank's appeal was granted. The ombudsman decided that the most practical approach, looking at the substance and intent of the bank's proposal, was to grant an exception to OCC's long-standing regulatory accounting requirement that asset transfers among affiliated institutions be accounted for at fair value. The bank may disregard the conditions imposed by the supervisory office. The direct sale of credit card assets from Bank A to Bank B may be accounted for at the GAAP alternative of lower of market value or book value. Further, the Bank A common stock repurchase need not include a proportional deduction from undivided profits.
This exception is exclusively applicable to the unique facts and circumstances associated with this transaction. Nothing in this decision undermines or compromises OCC's consistent preference for fair value accounting in the transfer of assets between legal entities. The Ombudsman' Office fundamentally agrees that it is inappropriate to allow appreciated assets to be transferred out of a bank at less than fair value. Such transactions may obscure the true value of transferred assets and allow banks to shift assets in order to distort the earnings of affiliates. Also, they could be used to circumvent regulatory dividend rules when an institution is otherwise unable to pay dividends.
Central to this decision is the fact that, in substance, it is a one-time reorganization of the BHC's credit card business to achieve operational efficiencies. The bank would not initiate this transaction with an unrelated party because it is not "selling assets," per se. The ombudsman also recognizes that the affiliate banks in transaction could have reached similar regulatory capital results had the transaction been accounted for at fair value. The transaction is consistent with generally accepted accounting principles. There is no concern that this transaction involves a dissipation of assets or capital. Neither is it viewed as an attempt to circumvent any legal requirements such as dividend limitations.
There are no other safety and soundness concerns associated with the transaction.
Likewise, because the accounting for common stock repurchases is not clear under GAAP, the ombudsman has no supervisory concerns regarding the accounting
methodology proposed by the bank.
Appeal of Required Accounting Treatment for Sale Residential Mortgage and Servicing (First Quarter 1995)
A bank appealed to the Ombudsman's Office for reconsideration of the accounting treatment required by OCC regarding the sale of residential mortgages and servicing. The bank originates first mortgage loans, most of which are FHA-insured or VA-guaranteed, and sells them without recourse along with the servicing rights to large institutional buyers who package and sell them in the secondary market. The buyers of the servicing rights require the bank to bear the servicing costs of defaulted mortgages which become delinquent by more than 60 days during the first six months after origination. The bank must either reimburse the servicing entity for its foreclosure costs, or repurchase the loan from the servicing entity and initiate foreclosure procedures itself.
First, the bank claims OCC is requiring of it a more stringent application than that afforded other national banks on this issue. Second, the bank believes it is illogical for OCC to allow sales treatment for mortgages sold when the servicing rights are retained but require financing treatment for mortgages sold when the servicing rights are sold. The bank maintains that it has no more recourse exposure by selling the servicing rights than it would if it retained them. Finally, the bank believes OCC policy favors the larger institutions that can afford to retain large servicing portfolios.
The bank would like OCC to allow sales rather than financing treatment for these loans. The bank would establish a reserve account, calculated in a manner satisfactory to OCC, that would account for and offset all expected future costs and losses relating to any recourse risks retained in the sale of these loans.
Regulatory policy generally requires that the sale of assets with recourse be accounted for as borrowings during the period of time the recourse provisions apply. Capital is held against the entire amount of loans involved in the arrangement.
The glossary entry for sales of assets in the Instructions for the Preparation of the Consolidated Report of Condition and Income states the general rule that transfers of assets are reported as sales by the selling institution only if the transferring institution retains no risk of loss from the assets transferred resulting from any cause and has no obligation to any party for the payment of principal or interest on the asset transferred for any cause. For any given transfer, the determination of whether risk is retained by the transferring institution is to be based upon the substance of the transfer agreement.
Footnote 14 in Appendix A of 12 CFR 3 states that, for risk-based capital purposes, the definition of the, sale of assets with recourse, including one- to four-family residential mortgages, is generally the same as the definition contained in the call report instructions. Capital is held against the entire amount of assets sold in transactions in which the bank retains risk in a manner constituting recourse under the call report instructions, but which are not reported on the bank's statement of condition.
Banks may service loans for investors with or without recourse. Government National Mortgage Association (GNMA) servicing is generally without contractual recourse. Under the Veterans Administration (VA) "no bid" program, however, the service has exposure for principal loss in the event of mortgagor default, and exposure for interest loss on FHA loans. This exposure does not preclude sales treatment under regulatory accounting principles. GNMA, Federal National Mortgage Association (FNMA), and Federal Home Loan Mortgage Corporation (FHLMC) services all incur non-reimbursable expenses as part of the collection process for defaulted mortgages. These costs are considered normal requirements incidental to servicing mortgages and are not considered recourse.
The FNMA program provides two options for services: "regular," or "special." For regular servicing, the bank retains all default risk of loss. There is no recourse associated with special servicing other than the normal representations and warranties. FHLMC servicing options are similar to those under FNMA. The exposure associated with GNMA servicing is not subjected to a capital charge. Therefore, when a bank sells FHA or VA mortgages into GNMA pools and retains the servicing rights, the transaction is granted sales treatment and no capital is required against the mortgages sold. Mortgages sold under FNMA and FHLMC non recourse programs are also granted sales treatment and no capital is required against the mortgages sold.
The ombudsman concurs with the bank's concern that regulatory accounting policy is inconsistent for mortgage sales where servicing rights are retained versus sold. Accordingly, the Ombudsman's Office granted sales treatment for the portion of the sales related to mortgage loans on which the bank's exposure is limited to reimbursement of the services foreclosure costs. Further, consistent with the treatment afforded banks that package and sell loans into GNMA pools, under FNMA's "special" programs, and FHLMC non recourse programs and retain the servicing, the bank need not hold capital against mortgages which qualify for sales treatment. In order to qualify for sales treatment, the bank must not take back or substitute any loans. Financing treatment is required for all loans sold under recourse arrangements with the exception of FNMA and FHLMC programs. FNMA and FHLMC loans sold under recourse programs must be included as assets when determining risk-based capital.
The mortgage loans and the servicing will be accounted for as separate components. The bank must continue to defer recognition of the sale of the servicing until the recourse period expires. Accordingly, the sales proceeds must be allocated between the sale of the mortgages and the sale of the servicing. All income related to the sale of the servicing, including the servicing release fees, must be deferred until the recourse period expires. Should the expected loss exposure exceed the amount of the deferred income, a reserve must be established through a charge to operations.
An interagency working group, operating under the auspices of the Federal Financial Institutions Examination Council, is currently studying the entire recourse issue in great detail. OCC policies in this area may be revised as a result of this interagency effort.
Appeal of Report of Examination (First Quarter 1995)
A formal appeal was received concerning two aspects of a Report of Examination (ROE). The bank had previously appealed several violations of Regulation Z that resulted from the implementation of a secured credit card program. This subsequent appeal dealt with two specific issues of the secured credit card program. The first involved a citing of a Regulation Z violation, and the other dealt with the method in which the examiners determined the classified portion of the pool of secured credit card loans.
Nine months before a routine examination, the bank entered into a business relationship with a loan broker. The agreement was that the loan broker would solicit credit card applications from individuals and would require these applicants to pledge collateral (either cash or the cash value of a life insurance policy) in favor of the loan broker. In exchange, the loan broker would present the applications to the bank and offer the bank partial guarantee of the loan broker on the underlying obligation of the customers. The loan broker charged the applicants fees for its services. At the time the bank entered into the relationship with the loan broker, the programs were limited to "cash cards" and "insurance cards" Four months later the insurance card program was no longer offered. At that time, a derivation of the cash cards called "installment loan cards" became available. In addition to offering the above, the bank purchased existing credit card accounts receivables from another bank. The other bank previously had a relationship with this loan broker. The highlights of the agreement are detailed below.
Establishment and Maintenance of Pool. The loan broker agreed to deposit to the pool an amount equal to approximately 50 percent of the approved line for each credit application accepted by the bank. In addition to the above, funds in a similar pool were transferred from the bank in which the receivables were purchased. If a customer of the loan broker defaulted on his or her obligation to the bank and the default remained uncured for three billing cycles from the date of default, the default in the credit was cured by payment in full from the funds in the pool. The loan broker agreed that at all times at least 30 percent of the dollar amount of the aggregate approved credit card lines would be maintained in the pool.
Loan Broker's Guarantee. The partial guarantee covered all amounts due to the bank in connection with the cards of the loan broker customers to the extent such amounts were incurred or charged within four years after the issuance date of the credit card. The guarantee was limited to $1MM after the bank's receipt and application of the pool and the bank's receipt and application of all collateral under a pledge and security agreement of the same date.
Cash Cards. An applicant would offer cash collateral in the amount of the credit line desired. In addition, the applicant would pay the loan broker a participation fee.
In exchange, the loan broker would agree to submit the credit card application to the bank and to support the application with its own partial guarantee, which it collateralized with the pool account. The loan broker agreed to return the collateral to the individual upon cancellation of the card and repayment of all indebtedness there under.
Insurance Cards. Each customer had the following three options that could be used to secure a credit card:
(a) Provide cash collateral to the loan broker;
(b) Provide an existing life insurance policy with a sufficient cash surrender value to the loan broker;
(c) Purchase life insurance with sufficient cash value through the loan broker and then pledge that insurance to the loan broker.
Once sufficient collateral was pledged to the loan broker, the loan broker would present the application to the bank. If the application was approved, the loan broker would extend a partial guarantee on the customer's indebtedness for four years. The loan broker supported the guarantee with the deposit account described above. The pledge of the insurance to the loan broker remained in effect only as long as the credit card remained outstanding. Once the credit card was cancelled the customer would own the insurance policy free of any assignment. The insurance was universal life insurance or whole life insurance, not credit insurance. Neither the bank, loan broker, nor any loan account was ever listed as a beneficiary on any of these policies. Each insured was at liberty to list his or her own designated beneficiary. The bank had no knowledge of how much insurance each customer purchased. These cards were only offered for four months.
Installment Loan Card. When the bank and the loan broker stopped offering insurance cards, the bank began to offer the installment loan card. This program was a derivation of the cash card program, designed for persons who did not have sufficient cash to meet the loan broker collateral requirements. Under this program the loan broker would arrange a 24-month installment loan from the bank for the borrower. The borrower would instruct the bank in writing to disburse all of the proceeds to the loan broker. The loan broker would keep one portion of the loan proceeds as its fee. The loan broker would place the remainder of the proceeds in the pool account. In some instances, the loan broker promised to return the portion of the installment loan which it placed in its reserve account, less a fee. In other situations, the loan broker made no such promise.
Once the individual made two installments on the 24-month note (the first payment being taken at the time of the application), the bank would extend a credit card line to the individual. The loan broker extended its limited guarantee to both the installment loan and the credit card line.
Summary of Programs. These programs ran in tandem with the bank's own preexisting credit card program; however, the bank offered guaranteed credit cards only to borrowers who applied through the loan broker. The interest rates and fees earned by the bank on its own cards versus those generated by the loan broker were somewhat different, although the bank did not feel they were significantly different.
Discussion and Conclusions
Each of the two issues will be discussed separately.
Violation of Law Resulting in Relationship between Closed-End and Open-End Credit
A violation of 12 CFR 226.5 General Disclosure Requirements (Open-End Credit) was cited in the ROE. This section of the regulations states:
(c) Basis of disclosures and use of estimates. Disclosures shall reflect the terms of the legal obligation between the parties. If any information necessary for accurate disclosure is unknown to the creditor, it shall make the disclosure based on the best information reasonably available and shall state clearly that the disclosure is an estimate.
In addition, a violation of 12 CFR 226.6(a) Initial Disclosure Statement was cited. This section states:
The creditor shall disclose to the consumer, in terminology consistent with that to be used on the periodic statement, each of the following items, to the extent applicable:
(a) Finance charge. The circumstances under which a finance charge will be imposed and an explanation of how it will be determined, as follows:
(4) An explanation of how the amount of any finance charge will be determined, including a description of how any finance charge other than the periodic rate will be determined. In the ROE these violations stated that for open-end credit in the installment loan version of the program, the finance charge must also include the principal amount of the installment loan required to obtain the credit card, less the membership dues.
The bank's appeal states that the bank disclosed the closed-end transactions and the open-end transactions as if they were unrelated to one another. The appeal goes on to state that the bank does not believe the OCC has a legal justification to take a position that the closed-end and the open-end transactions should have reflected one another. The bank summarizes its arguments as follows:
"There is no law directly on point. Neither the statute, regulation, case law nor the commentary directly addresses the issue. However, with respect to credit sales, the commentary does address related transactions stating as follows:
16. Number of transactions. Creditors have flexibility in handling credit extensions that may be viewed as multiple transactions. For example:
- When a creditor finances the credit sale of a radio and a television on the same day, the creditor may disclose the sales as either one or two credit transactions;
- When a creditor finances a loan along with a credit sale of health insurance, the creditor may disclose in one of several ways: a single credit sale transaction, a single loan transaction, or a loan and a credit sale transaction.
- The separate financing of a down payment in a credit sale transaction may, but need not, be disclosed as two transactions (a credit sale and a separate transaction for the financing of a down payment).
We continue to believe that this is the best law on the subject of related transactions. If a creditor in a credit sale transaction is afforded the flexibility to separately structure related transactions, we cannot see why the OCC is refusing to allow the bank similar consideration in related loan transactions."
The Office of the Ombudsman found that the violations of law should remain in the ROE. As acknowledged in the bank's letter, none of the above examples (from Section 16 of 12 CFR Part 226.17(c)(1) of the Official Staff Commentary) specifically match the situation at the bank. The example closest to the bank's situation is the third example; however, it does not specifically address the situation where closed-end and open-end transactions are directly linked by a bank, but instead deal with two closed-end transactions. More significantly, it does not appear that the credit sale borrowers in the example were required to finance the down payment at the same institution. The closed-end transactions in the example could legitimately be considered separate for disclosure purposes. In contrast, if a customer did not choose to secure his or her credit card by cash or the cash value on a life insurance policy, then the customer was required to obtain the closed-end credit as a pre-condition for the open-end credit. If the customer chose the installment loan plan, he or she had no choice but to obtain a closed-end credit from the bank. Therefore, the bank's consumers were undertaking essentially one transaction.
The three examples say nothing about the content of the disclosures, only that they may be done separately. The ombudsman agrees that the bank's decision to make separate disclosures was not a violation. The violations were cited because the content of the disclosure on the open-end credit was incorrect. It did not include the closed-end credit as a finance charge for the open-end credit. The violation did not depend on whether the two transactions were disclosed separately or together, but whether the disclosures accurately reflected the substance of the transaction.
The underlying purpose of the Truth in Lending Act (TILA) is to help consumers make informed credit decisions by guaranteeing accurate and meaningful disclosure of the costs of credit. The finding that the bank imposed the closed-end transaction as a requirement for the open-end credit, it follows that the closed-end credit costs would have to be disclosed as part of the open-end credit cost in order to "reflect the terms of the legal obligation."
The Assets Subject to Criticism page in the ROE classified the balance outstanding on all the secured credit cards as substandard. The bank did not appeal the classification but included in its appeal the following:
We are unable to understand the OCC's thought process in classifying the secured credit card related loan classifications. In our view, the loan classifications by the examiners were unnecessarily inflated. A major change in the credit card related credits occurred in December 1993, when the bank rescinded the loans in progress and debited the pool account. The examiners were well aware of this fact.
Although the bank did not disagree with the substandard classification, the manner in which the classification figures were determined was not understood.
The manner in which the examiners arrived at the classified portion of the program is tied to their determination of the "passed" portion of the program representing cash collateral. The examiners determined the entire credit card program (outstanding extensions of credit and contingent liabilities) to be a substandard bank asset and criticized it as such. The difference between the amount classified as substandard and the size of the program consisted of the portion of the credit card deposit account that provided partial security for the program. This portion was excluded from the classification because the security was in the form of cash. The bank was given credit for 30 percent of the total amount in the credit card program (including outstandings and unfunded amounts on issued credit card and installment loans). The "passed" amount was split proportionately between the outstanding installment loan portfolio (58 percent) and credit card portfolio (42 percent). The "passed" amount was split proportionately instead of applying it all against one portfolio because the examiners did not want to appear to be classifying one portfolio and not the other. There was no conscious effort to classify contingency credit more severely than outstanding credit. The examiners' intent was to reflect that a portion of the whole program was not subject to criticism because of the cash in the pool account.
The ombudsman concluded that the ROE overstated the classified amounts of the extensions of credit related to the credit card program. Although examiners typically use financial information as of the examination date, if material events occur (either positive or negative) while the examiners are in the bank, the numbers are adjusted. Because the rescissions took place after the examination team left the bank, the level of credit-card- program-related classified assets was not adjusted. Because these rescissions were completed and all refunds made before the ROE was mailed, the ombudsman felt the classification numbers should have reflected these actions.
The appropriate supervisory office provided the bank with an amended Assets Subject to Criticism and Summary of Assets Subject to Criticism report pages to reflect the above changes.