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Appeal of Determination That Appraisal Function Lacks Independence (Third Quarter 1994)


A bank appealed its examiner's determination that its commercial real estate appraisal function lacks independence because of the reporting lines within the organization. The unit reports to a vice chairman who also has responsibility for the credit extension, collection, and lending policy functions. The bank's appeal to the supervisory office was decided in favor of the examiner.


The function in question reports administratively to a senior vice president responsible for collateral appraisal and control. That individual reports to an executive vice president with responsibility for credit policy, commercial credit training, portfolio analysis, and reporting. The executive vice president reports to the vice chairman responsible for credit risk management.

The examiner's decision was determined as follows:

Both 12 CFR 34.45 and Banking Circular 225 (dated December 21, 1987) required that appraisers be independent of the lending, investment, and collection functions and not involved, except as an appraiser, in federally related transactions. The September 28, 1992 revised issuance of BC-225 expands on this standard by stating, "In order to avoid potential conflicts of interest, staff appraisers should not be supervised by loan underwriters, loan officers or collection officers." The regulation and circulars note that in some instances it may be necessary to use a qualified individual who is not independent of the lending function to perform an appraisal, but this exception is primarily intended for cases where the bank is small and lacks the resources to retain qualified, in-house independent appraisers. The examiner decided this bank was large enough and sophisticated enough to afford qualified in-house appraisers, reinforcing the need for independence.

Although the vice chairman is not actively involved in the daily credit approval and appraisal activities of the bank, he is ultimately responsible for credit policy, the credit approval process, and collection and appraisal functions. It is through his authority that the potential for a conflict of interest could occur.

The bank based its appeal on the following points:

  1. No one in this reporting chain has any lending or revenue generation responsibilities. No staff appraiser is supervised, controlled, or influenced by anyone who has direct loan underwriting, account management, or collection responsibilities.

Line appraisers and reviewers are insulated from potential negative influences by reporting to a regional manager who, in turn, reports to a chief appraiser. The chief appraisers report directly to the unit head. Independence is further supported by two senior positions strategically placed in the unit's organization: the managers of compliance and training, and quality assurance and audit. This is in strict compliance with BC-225 (REV) which stipulates that "staff appraisers should not be supervised by loan underwriters, loan officers, or collection officers."

  1. As a diversified financial services provider, the credit function of this bank encompasses the strategic management or risk beyond the more traditional narrow confines of "credit risk" relating to loans. Transactional credit approval is totally separated from the credit policy, portfolio management, problem loan workout, and derivative and trading products administration activities within this credit risk management function.
  2. Direct management and experienced senior level oversight of the appraisal function has a necessary and logical place within the bank's strategic credit risk management group. This arrangement ensures the unit's independence from line management, which is challenged and given incentives to produce volume and expand market share, and from transaction approvers, who, hypothetically, could succumb to direct or indirect pressure to influence the appraisal process.
  3. There has never been any indication or suggestion that actual or implied pressure or influence has ever been exerted on the unit in question. A different reporting channel simply to avoid the "credit" sphere would negate the protective features mentioned above and the efficient service the bank has been providing through this arrangement.


The current structure of the bank's real estate appraisal function fulfills the mandate for independence as required by the regulation and banking circulars. Nothing was discovered to arouse concern that appraisal independence was compromised or threatened. Further, the independence of the process as currently structured is not unduly dependent on the persons presently performing those duties. Assuming competent replacements are chosen, independence should not be adversely affected by personnel changes.

Note: This decision is unique to the specific facts and circumstances of the case decided. As such, it should not be viewed as precedential. The issue of independence is currently being reassessed, and more specific guidance will be provided.

Appeal of CRA Rating (Third Quarter 1994)


A bank filed a second-tier appeal of the rating and findings of OCC's Community Reinvestment Act examination report. The bank's CRA performance was rated "Needs to Improve Record of Meeting Community Credit Needs" based upon alleged substantive violations of the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA). The bank claims that OCC criticism rests on an incomplete and inaccurate understanding of what actually occurred at the bank. Further, apart from the fair lending violations, the examiners found the bank's CRA performance to be equal to or better than the performance that had been rated "Satisfactory" at the previous CRA examination. At their exit meeting with the board of directors, the examiners specifically confirmed that the bank would have received a "Satisfactory" CRA rating had it not been for the fair lending violations.

Examiners identified three instances of single women who applied for loans reported under the Home Mortgage Disclosure Act (HMDA) in which "protected income" was not taken into account by the bank. Two of the applications were for home improvement and the third was for money to purchase a house. The protected income involved child support, social security benefits received on behalf of a dependent child, and part-time wages. All three applications were denied. The examiners also identified a case in which the protected income of the primary applicant, Veterans Administration disability, was taken into consideration by the bank when it made the credit decision. That application was approved.

The bank responded that only one of the three instances appeared to contain an error under the ECOA and this error was due to the lending officer's honest misunderstanding of a nuance in the protected income rules. The loan officer believed that social security income of the applicant's dependent son had to be excluded from consideration, analogous to the mandatory exclusion of the income of non-applicant spouse. In the other two cases, the bank claimed there was no Regulation B error. One of the applicants was disqualified on the basis of a previous bankruptcy filing, without respect to income. The other applicant's protected income had been considered, but had not been properly recorded on the internal HMDA reporting form.

At the examiner's request, the bank conducted its own file search for the 24-month period prior to the date of examination to identify all applicants affected by the practice. Of the 156 approved and denied individual female applicants, management uncovered six instances (including the three cases identified above) in which protected income was not taken into account in the loan applications of single women. These applications were either not approved or were approved for a lesser amount than that requested. Seven additional approved loans were identified in which the applicant(s) had protected income that was not included in the HMDA register and therefore was not taken into account when making the credit decision. The bank also took affidavits from each of the loan officers who made the 13 loans noted above.


The ECOA states that " [i]t shall be unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction. on the basis of race, color, religion, national origin, sex or marital status or age (provided the applicant has the capacity to contract)." 15 U.S.C. 1961 (a).

The FHA further provides that "[i]t shall be unlawful for any person or other entity whose business includes engaging in residential real estate-related transactions to discriminate against any persons in making available such a transaction, because of race, color, religion, sex, handicap, familial status, or national origin." 42 U.S.C. 3605

Regulation B, 12 CFR 202.6(b)(5), states that "[A] creditor shall not discount or exclude from consideration the income of an applicant or the spouse of an applicant because of a prohibited basis or because the income is derived from part-time employment or is any annuity, pension, or other retirement benefit. When an applicant relies on alimony, child support, or separate maintenance payments in applying for credit, the creditor shall consider such payments as income to the extent that they are likely to be consistently made."

A violation or 12 CFR 202.6 does not automatically result in discrimination that would violate ECOA. However, the failure to take a protected class of income into account can result in a pattern of loan denials that would demonstrate a pattern of discrimination, in violation of ECOA.

The facts in this case do not support a discrimination case based on overt discrimination, as there is no instance of overt refusal to lend to a woman or an unmarried person. At issue is whether the facts support a finding of disparate treatment. In the fair housing context, the presence of any one individual of a protected class who is treated differently from any one, similarly situated member of the control class is sufficient to establish a disparate treatment case.


The referenced violations of ECOA did occur. The documentation was not sufficient to support the claim that the instances identified were simply the result of HMDA reporting errors. After conducting its own file search, the bank initiated corrective action by sending letters to certain applicants re-soliciting credit applications. These letters include the statement. "A review of our files indicates that we did not take the child support (or social security benefits) listed on your application into consideration when making our credit decision." Based on these letters to the affected applicants, the bank's assertion that HMDA record-keeping and reporting errors created the appearance of infractions of ECOA appears contradictory. Also, there was not supporting information bolstering the loan officers' recollections (as reflected in the affidavits included with the appeal) that protected income was considered in their credit underwriting and decision-making process for the referenced sample of loans.

However, despite the fair lending violations, a rating of "Satisfactory Record of Meeting Community Credit Needs" was assigned by the Ombudsman's Office. The quality of all other aspects of the bank's overall CRA performance justified this rating.

Note: A bank's fair lending performance materially affects its assigned CRA rating. All such decisions are unique to the facts and circumstances of each case and must be decided on an individual, case-by-case basis.

Appeal of Examiner's Direction to Defer Recognition of Gains (Third Quarter 1994)


A bank appealed its examiner's direction to defer recognition of all gains on the sale of Small Business Administration (SBA) loans for 90 days. A provision in the sales agreement provides for recourse if the borrower fails to make the first three payments after sale of the loan.

The bank claims its accounting practices are in accordance with generally accepted accounting principles (GAAP EITF 88-11). The bank's accounting firm takes the position that the risk of returning a premium is minimal, which has been proven through historical experience. Further, OCC confirmed by letter that there is no question these transactions should be reported as sales, not financings. The bank believes that Instructions for the Consolidated Report of Condition and Income (call report) state clearly that if the transaction is a sale, the gain or loss must be recorded immediately. Finally, the bank states that there is no published rule or regulation specifically requiring that gains on sales of SBA loans be deferred. The principle is discussed in unpublished interpretations and opinions. The bank believes that reliance upon the case-by-case implementation of unpublished rules results in inequities and material inconsistency in the reporting of financial results among peer banks.

The effects of complying with the examiner's direction are as follows:

  • The bank will fall below the "well-capitalized" level
  • The bank will find itself in noncompliance with the capital requirements of its formal agreement.
  • The bank will have to recognize expenses incurred in the current quarter and will be unable to recognize the related income.


Although the accounting and reporting treatment required for regulatory reporting is generally consistent with GAAP, there are exceptions where the agencies have concluded a more stringent policy is necessary for supervisory reasons. The policy on assets transferred with recourse is one such area. The call report instructions state that the general rule for reporting transfers ("sales") of assets is for purposes of reporting to the bank supervisory agencies and agency determination of capital adequacy; it is not intended to establish presumptions about the legal or contractual rights of the parties to the transfer.

Transactions involving the "sale" of assets are reported either as financing or sales transactions. The general rule is that a transfer of loans, securities, receivables, or other assets is to be reported as sale of the transferred assets by the reporting selling institution and as a purchase of the transferred assets by the reporting purchasing institution only if the transferring institution:


  • default on principal or interest by the obligor of the underlying instrument or from any other deficiencies in the obligor's performance;
  • changes in the market value of the assets after they have been transferred;
  • any contractual relationship between the seller and purchaser incident to the transfer that, by its term, could continue even after final payment; or
  • any other cause

According to the instructions to the call report, "If risk of loss or obligation for payment of principal or interest is retained by, or may fall back upon, the seller, the transaction must be reported by the seller as a borrowing from the purchaser and by the purchaser as a loan to the seller."

However, in recognition of the unique structure of SBA loans, the staffs of the banking agencies concluded that the optional repurchase provision contained in the loan agreements would not prohibit sales treatment, provided the refundable premium on the sale is deferred until the refund provision expires. This modification is consistent with the accounting for loan securitization sales transactions involving the use of an escrow or spread account to absorb losses. In other words, by deferring the premium income until it becomes nonrefundable, a bank recognizes a sale for regulatory purposes.


The bank must defer SBA premium income for 90 days according to the interagency guidelines. The temporary change in capital categories resulting from this treatment cannot be avoided. Capital adequacy encompasses many other qualitative factors in addition to Prompt Corrective Action (PCA) capital category (i.e., earnings, credit risk, funding risk, growth, management, and board supervision, etc.). The district will emphasize, as the bank should, the bank's overall capital adequacy and capital planning efforts versus a temporary change in capital categories. The supervisory office agreed to give consideration to the amount of SBA premium income that will become available for earnings during the upcoming quarter in their qualitative assessment of the bank's overall level of capital sufficiency. This does not relieve the legal requirement that the bank has to comply with the mandates imposed by the PCA section of the Federal Deposit Insurance Corporation Improvement Act and the capital levels specified in the bank's formal agreement.

The agencies recognize that this policy on recourse needs to be reviewed. Currently, an interagency working group, under the auspices of the Federal Financial Institutions Examination Council, is studying the entire recourse issue in great detail. The group has already solicited public comment on the issue and expects some proposals for change in the near future.

Due to the immateriality of the bank's packaging fees in relation to total income, the bank need not amortize loan packaging fees over the life of the loan.

Appeal of Violation (Third Quarter 1994)


The Office of the Ombudsman received an appeal letter on behalf of a bank that was cited for a violation of 12 CFR 9.12 and Opinion 9.3900. The bank invested trust funds into two mutual funds that are advised by an investment advisory firm in which a bank director, who also serves on the bank's trust committee, holds a 5.23 percent interest. Neither fund nor the investment advisory firm is affiliated with the bank. The funds were invested without obtaining prior written authorization.

First, the bank does not believe that the relationship between the bank and the minority investment by the bank director constitutes an affiliation sufficient to create a problem under 12 CFR 9. None of the interests delineated in Section 9.12(a) are affected in this case:

  1. The trust funds are not invested in stock or obligations of the advisor. The fund may terminate its relationship with the advisor upon 60 days notice without penalty at any time.
  2. No property is acquired from affiliates of the bank or their directors, officers, or employees. The adviser does not sell fund shares; such shares are distributed directly by the funds.
  3. The bank receives no advantages from the sale of the funds nor does the advisor.

The bank does not believe that the bank director's minority interest of 5.23 percent is sufficient to create a conflict of interest or a sufficient interest to fall within the prohibitions of Section 9.12. The bank is not purchasing services of the advisor, it is purchasing shares of the funds, which are unaffiliated with the bank and in which no bank director has an interest. Neither does the bank believe that the bank director's service on the bank's trust committee should weigh heavily in the decision. Even if a director has a conflict of interest, traditional corporate practice, which is recognized by OCC, holds that by abstaining from any participation in the discussion of, or vote upon, a matter in which such director has an interest, such director may thereby avoid an impermissible conflict of interest under applicable law. The bank cites Alabama Code, Section 10-2A-63, 12 CFR 215.4(b) (i), Section 7.5217(a) and Alabama Code, Section 10-2A-21(d).

Second, the bank believes that the provisions of the local law, in this case the Alabama Code, were expressly intended to permit a bank to rely on such provisions in order to invest trust funds in mutual funds that are advised by the bank or its affiliates. Alabama Code, Section 19-3-120.1, expressly governs trust investments in mutual funds, and expressly authorizes investments in mutual funds advised by bank affiliates. In the bank's view, 19-3-120.1 is more than sufficient for purposes of 12 CFR 9.12(a). The absence of any "affiliation" between the bank and the funds raises a question in the bank's mind as to whether reliance on the statutory authorization is even necessary. Although the terms "connection" and "interest" from Section 9.12(a) are broad, the bank believes that with respect to trust mutual fund investments by a trust department, the connection or interest must be an "affiliation" in order to even need the protection provided by 19-3-120.1 for purposes of 12 CFR 9.12.

Finally, the bank believes that recent OCC decisions allowing the bank acquisitions of companies that act as advisers to mutual funds expressly recognized that investment companies (mutual funds) are separate and distinct from their advisers (decision to charter J.& W. Seligman Trust Company, N.A. and decision to charter Dreyfus National Bank & Trust Company). The bank also cites First Union's acquisition of Lieber Asset Management Corporation (93-ML-08-023) and Mellon Bank's acquisition of The Dreyfus Corporation (93-NE-08-043 and 93-NE-08-044).


The legal issue raised by this appeal involves the conflict of interest that may exist given the investment of trust assets in mutual funds advised by a company in which a bank director owns stock. In pertinent part, Section 9.12(a) provides:

  • (a) Unless lawfully authorized by the instrument creating the relationship, or by court order or by local law, funds held by a national bank as fiduciary shall not be invested in stock or obligations of, or property acquired from, the bank or its directors, officers or employees, or individuals with whom there exists such a connection, or organizations in which there exists such an interest, as might affect the exercise of the best judgment of the bank in acquiring the property, or in stock or obligations of, or property acquired from, affiliates of the bank or their directors, officers or employees.

The OCC's regulation is intended to reflect and require for national banks the duty of undivided loyalty, a basic principle of trust law followed throughout the United States. Lending commentators on trust law emphasize the importance of the duty of loyalty and the expected adherence to the high standard. The focus of the duty of loyalty is to deter fiduciaries from entering into positions involving conflicts of interest.

In the present situation, although another company is investment advisor to the mutual funds and not the bank, the relationship of the bank director to the advisory company falls under the circumstance proscribed by the language of 12 CFR 9.12. Here, at least one bank director has some type of ownership in or control over the advisory company. The fees received by the investment advisor depend in part on the assets invested in the mutual funds. As such, the owners of the advisor have an interest in the investments in the mutual funds. As directors of the bank, this individual is responsible for directing and reviewing the fiduciary powers of the bank. Accordingly, in the ombudsman's view this situation falls within the scope of the 12 CFR 9.12 prohibition regarding the investment of funds in stock or obligations of organizations in which there exists such an interest as might influence the best judgment of the bank.

As provided by the language of 12 CFR 9.12(a), a self-dealing transaction generally is permissible only when specifically authorized by the trust instrument creating the relationship, where a court order authorized the specific transaction, or where local law allows the otherwise prohibited practice. In this bank's situation, it is not argued that the trust instruments specifically authorize the investment of trust assets in mutual funds that are advised by a company owned in part by directors of the bank. Nor is there any court order authorizing the transactions in question. While the Ombudsman's Office is not aware of any Alabama statute that expressly states that a bank may invest trust monies in mutual funds that are advised by a company owned in part by directors of the bank, Alabama Code, Section 19-3-120.1 (1993), does authorize banks acting as fiduciaries to invest in mutual funds that the bank or an affiliate advises or provides other services:

The fact that such fiduciary or any affiliate thereof is providing services to the investment company or investment trust as an investment advisor,. custodian, transfer agent, registrar or otherwise, and is receiving reasonable remuneration for such services, shall not preclude such fiduciary from investing in the securities of such investment company or investment trust; provided, however that which respect to any fiduciary account to which fees are charged for such services, the fiduciary shall disclose (by prospectus, account statement or otherwise) to the current income beneficiaries of such account or to any third party directing investments the basis (expressed as a percentage of asset value or otherwise) upon which the fee is calculated.

Arguably, this section thereby authorizes investment in the mutual funds where a greater conflict exists than that in the bank's situation. Since the Alabama legislature specifically authorized investment in mutual funds where the bank or an affiliate acts as investment advisor or provides other services, it is at least arguable that the statute may include the situation where bank directors own shares in the advisor even though not enough shares to be an affiliate. If the directors owned a greater percentage of the stock (creating an even more direct conflict), and such ownership triggered affiliation between the bank and the advisor, then the conduct would be expressly authorized by the language of the statute. However, we are not aware of any cases interpreting the meaning of the statute and there is no official legislative history.


Because this is a question of law without any precedential or official legislative history, the Ombudsman's Office chose not to render an immediate decision. The bank was asked to seek a formal opinion from the Alabama attorney general regarding the meaning and intent of the statue. Although not binding for this Office, under the rules of statutory construction, the formal opinions of state attorneys general are normally given considerable deference. While waiting for receipt of that opinion, the bank was advised not to make any more investments in the mutual funds in question and to notify the ombudsman of the attorney general's opinion.

For reasons unique to the State of Alabama, the bank requested as an alternative, and the ombudsman agreed to accept, a similar ruling from the Alabama superintendent of banks. Kenneth R. McCartha, superintendent of banks for the State of Alabama, confirmed the bank's position in a letter dated August 12, 1994, providing his official opinion regarding the meaning and intent of the Alabama statue. In light of the history of the legislation and the language of Alabama Code, Section 19-3-120.1, Superintendent McCartha concluded that banks located in Alabama, in the exercise of their fiduciary or trust powers, are specifically authorized by 19-3-120.1 to invest in mutual funds where such banks, or their respective officers, directors, or shareholders have an affiliation or lesser interest in a mutual fund, or investment advisor, or other service providers to a mutual fund.

Therefore, the ombudsman concluded, after careful consideration of all the facts, that the most reasonable interpretation of Part 9 provides an exception for the conflict in question. This decision is unique to the facts and circumstances of this situation and local law. This in no way establishes OCC precedent regarding conflicts of interest. Notwithstanding this conclusion, the Alabama statue requires the fiduciary to provide disclosure to the current income beneficiaries and/or any third parties directing investment of the basis on which any investment advisory fee or other fee is calculated. The bank did not make these disclosures and therefore the cited violations must stand. Although the bank may continue investing fiduciary monies in the mutual funds in question, the appropriate disclosures must be made in accordance with the local law.

Appeal of CRA Rating (Third Quarter 1994)


A formal appeal was received concerning a bank's Community Reinvestment Act (CRA) rating of "Needs to Improve Record of Meeting Community Credit Needs." Approximately 80 percent of the bank's business is in the trust/fiduciary area with the remainder in commercial banking. The bank's only office is located in a large downtown metropolitan area.

The appeal states that the fundamental flaw of the performance evaluation (PE) is captured in the following comment:

There are no legal or financial impediments that inhibit the bank's ability to meet the credit needs of its community. The bank has made a modest response to help meet the credit needs of the community. There is a strong need for affordable housing and small business loans within the bank's delineated community. Considering this, management and the board actions designed to meet these needs have thus far been fairly narrow in scope. The bank has not sufficiently pursued alternative means by which it can help meet the community's credit needs.

The appeal then states the preceding is manifestly inaccurate as the bank has made more than a modest response to ascertain and to help meet the credit needs of its local community and has pursued many alternatives means by which it could help meet the community's credit needs. The bank states that the needs of the local community are of such an obvious nature that the credit needs and demographics within a two-mile radius surrounding the downtown area have been well identified by the bank and steps have been taken to help address these needs, within the limits of the expertise and resources of the bank.

The appeal goes on to state that although only approximately 20 percent of the bank's loans are made within its delineated community, this does not prove that the bank in any way fails to address its CRA responsibilities. The bank is heavily involved in outreach programs of various sorts. Many such involvements will lead (and are leading) to extensions of credit in the local community, as has been shown through association with two organizations. Because the bank conducts private banking business, it is natural that the extensions of credit it is willing to make available would mostly fall within geographic areas that are not low- to moderate-income. This is not due to avoidance of CRA responsibilities. At the same time, as the PE discussed, the board and management are looking for credit needs and are open to additional extensions of credit to creditworthy borrowers within the bank's local community. This is proven in that the bank is making such loans as the opportunities arise.

The appeal states the bank feels that the rating is based upon the following conclusionary statements in the performance evaluation

  • The bank's contact with community groups is inadequate.
  • The board's involvement in the CRA oversight process is inadequate.
  • The bank has no written marketing or advertising programs.
  • The bank has made limited efforts to extend loans for small businesses, home improvement, and housing rehabilitation throughout its community.

The appeal lists several reasons why the bank does not feel that these are accurate statements. These reasons are summarized below:

  • Prior to the start of the examination, one of the bank's officers had been invited to be on the board of directors of an organization that was helping an area within the bank's delineated community rebuild. After the examination, another officer became a senior advisor to this organization.
  • An officer and director of the bank joined the board of a home for children and identified the need for a loan, which the bank made after the examination.
  • The bank gave a donation and a large working crew to a nationwide organization that rehabilitates homes of a low- or no- income residents, including those in the bank's local community.
  • An officer has established a relationship with a real estate developer to develop a financing proposal term sheet to be used to obtain financing to develop low- and moderate-income housing in a low- and moderate-income area within the bank's delineated community. The bank feels that this effort will result in a large loan in which the bank would possibly participate in addition to giving ongoing consulting.
  • Members of the board of directors have been working with a minority-owned bank regarding the establishment of a trust capability for the bank with this bank acting as the "back office" for the other bank.
  • Bank officers and directors are working with a group in developing and proposing a structure for a syndicated credit facility to be used by a fund established to lend to small businesses in a low- and moderate-income area.
  • The board has been involved in the establishment of policy for the CRA area and has met all of the technical requirements of the act. The majority of board members are officers at the bank. On an informal basis, the officers/directors constantly discuss with one another the activities that each is undertaking, including activities for CRA. The appeal states that it is unfair to say that such involvement is inadequate because of the fact that the directors/officers are intimately involved in the process on a daily basis. Due to the small size of the staff (five commercial bank officers), each of the officers knows what the others are dong with respect to CRA and they discuss these matters on a continuous basis.
  • The bank has not spent heavily for written marketing or advertising programs. However, recently the bank has funded the placement of its name on an assistance van that tours regularly through the bank's local community, disseminating financial, legal and regulatory information to small business owners. (Although this advertising was implemented after the examination, negotiations for such advertising were being conducted prior to the writing of the PE). The board of directors does not feel that it would be prudent from a safety and soundness aspect for a bank that allocates only 20 percent of its business to commercial banking to spend large amounts of money on advertising.
  • As pointed out in the PE, prior to the examination, the bank made some home purchase loans in its CRA delineated community and joined a referral program comprised of five local banks and one savings and loan association. In addition, the bank purchased several SBA-guaranteed loans, approximately a third of which are in the city where the bank is located. Since the examination, the bank purchased an additional pool of direct SBA loans, all assisting businesses within the city in which the bank is located.
  • Before the examination began, the bank joined with other financial institutions with a mission of making loans for multiple-unit buildings in its CRA community. Subsequent to the examination this resulted in the bank committing funds for 30- year loans for three low-income multifamily projects.

The appeal concludes by pointing out that the PE observes that the bank's credit products and services are suited to the bank's market niche. The bank feels this is appropriate, as the bank specializes in trust services and is designed to conduct private banking which constitutes 80 percent of the bank's business and reflects the expertise of the bank's personnel. Since only 20 percent of the overall business is dedicated to commercial banking and the bank cannot be all things to all people in its local community, the bank feels it has chosen credit products and services with which the bank has expertise and from which the community benefits. The appeal states that nowhere in the statute or regulation of CRA does it require that the bank make loans within its local community for which it has no expertise, even if there is such a need in the community, as long as the bank is helping to fulfill other community credit needs for which it does have expertise. The appeal emphasizes that the bank has geared its CRA-related credit products and services to meet the credit needs of the low- and moderate-income areas by, among other things, lending to financial intermediaries and participating in loan consortia or pools that lend directly to low- and moderate-income areas.


Although some institutions may be subject to statutory or regulatory constraints that prevent them from operating as a "full service" bank, other banks may choose to voluntarily limit or specialize their services to target particular markets. This is fine; however, such banks have the same continuing and affirmative obligations as a "full service" institution to help meet the credit needs of the entire local community consistent with safe and sound operations. A bank's self-imposed service or market limitations may not be used as justification for a failure to define its local community or to help, directly or indirectly, in meeting the credit needs within that community, including low- and moderate-income neighborhoods.

Whether or not a bank operates as a "full service" entity is not a determining factor in evaluating its CRA performance. Every bank should be able to demonstrate that it is fulfilling its CRA responsibilities, either within the context of its chosen service specialties or in other ways. The final measure of CRA performance is in the credit benefits accruing to the bank's local community as a result of that bank's activities, irrespective of the vehicle by which those credit benefits are provided.

Question 29 in the January 1993 OCC book An Examiner's Guide to Consumer Compliance discusses the Federal Financial Institutions Examination Council's (FFIEC) view on what, in addition to traditional direct lending activities, an institution can consider in meeting obligations and responsibilities under the CRA. Examples of nontraditional activities that banks may consider to help meet their responsibilities are described, including debt investments, equity investments, and other services and activities.


Review of CRA in a bank such as this, which has a niche market in a specialty area, must be carefully analyzed to ensure that all aspects of the bank's CRA performance are evaluated properly. There are two objectives that must be achieved through a bank's CRA program. The first is that results must be apparent, and the second is that these results must come from the bank's delineated community. The bank must find products that both meet the credit needs of low- and moderate-income individuals and fit into the servicing abilities of the bank's staff.

It is reasonable that this bank would not have a significant amount of direct lending to low- and moderate-income individuals, because the bank's niche services (private banking) are traditionally targeted at high-income individuals. This bank should not be expected to develop expertise that does not pertain to the needs of 80 percent of its business. However, the institution must find other ways to meet its obligations under the CRA. This bank had attempted to do this through the purchase of SBA pools and developing relationships with groups, leading to the financing of projects that will help meet the needs of the individuals within the bank's delineated community. Although the bank had instituted several programs that should improve its performance under CRA, sufficient time had not transpired for the results of these programs to be evident. Based on the information included in the bank's appeal package, coupled with a review of the examination work papers, and discussions with an examiner experienced in CRA activities in niche market banks, it was concluded that the appropriate ratings as of the date of the PE remains "Needs to Improve." It was also evident that since the writing of the PE, some of the bank's efforts were resulting in a tangible benefit to the bank's delineated community. For this reason, the scheduling of the bank's next CRA review was moved up approximately three months.

Postscript: Examiners assigned to the district where the bank is located recently completed a CRA examination of the bank, which resulted in a rating of "Satisfactory Record of Meeting Community Credit Needs."

Appeal of Decision Concerning Retroactive Application of Accounting Requirements (Third Quarter 1994)


A bank appealed a decision issued by the Office of the Chief Accountant in conjunction with the bank's supervisory office concerning retroactive application of two accounting and record-keeping requirements for mortgage banking activities. First, the bank seeks to avoid application of an initial inherent rate of return as the discount rate for existing purchased servicing. Second, it is attempting to avert exclusion of cash flows from existing originated mortgages in the impairment analysis of purchased mortgage servicing rights (PMSR).

On the fist issue (discount rate), the bank does not want to comply with OCC and GAAP guidelines on a retroactive basis because of the extreme amount of effort involved in calculating the initial inherent rates for servicing purchased in previous years. The bank states that in mid-1992, with the concurrence of the local examiners, it began using a pricing model (run monthly for each product line) to ensure that prices paid for servicing did not exceed the present value limitation established by SFAS No. 65. At the end of each quarter, the cash flow stream for each pool is discounted using an effective long-term rate based on an adjusted Treasury rate. With this control in place, the bank capitalizes PMSR for each mortgage at the amount paid. As the pricing model is only run on a product-level basis the bank does not have a record of the initial rates of return for the PMSR of each mortgage. Further, the prepayment and revenue assumptions that would have been used for products purchased prior to use of the pricing model are not documented.

Management requests that the bank be allowed to implement this change on a prospective basis with the initial inherent rates used as the discount rate for all servicing rights purchased after March 31, 1994. For previously purchased servicing, the bank would utilize an internally developed discount rate matrix that indicates an "add-on spread" for converting the Treasury rate to an appropriate discount. The spreads were determined based upon information obtained from the bank's external auditors and other independent sources.

On the second issue (separation of cash flows), the bank claims it would require many hours of data entry and programming to re-work their model to a loan-level methodology to exclude the cash flows from originated mortgages. Certain loan-level data has not been maintained since late 1992. While management believes that the amount of these cash flows would not result in a material difference in amortization and impairment, the bank has been unable to substantiate the exact amount of the impact to examiners without reprogramming the model. Further, the bank notes that the Financial Accounting Standards Board (FASB) is reconsidering the accounting treatment presented by SFAS No.65 specifically in regards to the treatment of originated servicing rights. According to the bank, it appears certain that by the end of 1994, GAAP will make no distinction between servicing rights from an originated mortgage and a purchased mortgage. Therefore, the bank requests that the exclusion of cash flows from originated mortgages be implemented on a prospective basis only, with cash flows from retail products excluded for all pools sold after March 31, 1994


The instructions to the Consolidated Report of Conditions and Income (call report) state that PMSR "shall be carried at a book value that does not exceed the discounted amount of estimated future net cash flows. Management of the institution shall review the carrying value at least quarterly, adequately document this review, and adjust the book value as necessary. The discount rate used for this book value calculation shall not be less than the original discount rate inherent in the intangible asset at the time of its acquisition, based upon the estimated future net cash flows and price paid at the time of purchase."

Further, the call report instructions state the following: "In order for a bank to report such mortgage servicing rights as intangible asset the rights must: (1) represent the bank's obligation to service mortgage loans owned by others, (2) have been purchased or otherwise acquired in a bona fide transaction, and (3) provide for the receipt of future servicing revenue which is expected to exceed the anticipated costs of providing the servicing. The right to service a bank's own loans (whether originated directly or purchased) shall not be reported as an asset."


  1. The bank's proposal is acceptable. Using an estimated discount rate based upon a realistic spread over Treasury securities at the time of purchase is reasonable, given the lack of bank records supporting the true inherent discount rate. The matrix provided by bank management is reasonable, and may be used for establishing discount rates for exiting PMSR. The assigned discount rates should remain constant for the remainder of these assets' lives. For all servicing rights purchased in the future, the bank should use a discount rate not less than the original discount rate inherent in the intangible asset at the time of its acquisition. This is consistent with the way OCC has treated other banks in the same situation.
  2. Bank management needs to address this issue to ensure that cash flows from originated mortgages are not included in the valuation and impairment testing process for PMSR. The latter are a separate asset and must not be commingled with retail production cash flows. Neither GAAP nor RAP permit unrelated revenue sources to support the value of PMSR.

As the bank notes, FASB is considering a revision to SFAS No. 65 to make the accounting for originated mortgage servicing rights more like that for PMSR. The revision would provide, in certain circumstances, for servicing from originated mortgages to be capitalized. However, the initiative is only a pre-exposure draft at this time. Further, its provisions would only be applied prospectively, with retroactive application prohibited.

The Ombudsman's Office believes a reasonable alternative, based upon available bank information, is the utilization of the original mortgage pool percentage as a means of determining the portion of mortgage pools with retail originations. While the current mortgage pool percentages may be somewhat different form the original percentages due to prepayments, defaults, etc., this alternative provides a reasonable estimation preferred to the bank's present approach.

Appeal of Violation of Regulation Z


A formal appeal was received concerning several violations of Regulation Z that resulted from the implementation of a secured credit card program. These violations included open-ended and closed-end credit transactions.

Nine months before a routine examination, a 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 on 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 the partial guarantee of the loan broker on the underlying obligations 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

A pool was set up at the bank that would function as follows:

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 form 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

A partial guarantee was set up in addition to the pool account. This guarantee functioned as follows:

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 individual would offer cash collateral in the amount of the credit line desired. In addition, the individual 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

All customers had the following three options for securing their credit cards:

  • Provide cash collateral to the loan broker
  • Provide an existing line insurance policy with a sufficient cash surrender value to the loan broker; or
  • 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 that 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, the 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 amount. In some instances, the loan broker promised to return the portion of the installment loan that 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 loan to the individual. The loan broker extended its limited guarantee to both the installment loan and the credit card loan.

Recap of Program

These programs ran in tandem with the bank's own pre-existing credit card program; however, the bank offered guarantee 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 Conclusion

The examination report listed nine violations of Regulation Z that occurred in connection with the bank's program to issue guaranteed or secured credit cards. Under the program, the loan broker would guarantee borrower's loans with the bank. The bank offered guaranteed credit cards only to borrowers who applied through the loan broker.

The loan broker prepared the credit card applications on behalf of these borrowers and forwarded them to the bank for approval. For its services, the loan broker charged the customer various fees. The loan broker required borrowers to provide one of three forms of collateral as detailed above to get its guarantee.

Based on these facts, which are not disputed by the bank, the supervisory office cited the bank for violations of Regulation Z, including failure to disclose the proper finance charges and annual percentage rates (APRs) for various extensions of credit. The bank has appealed all violations on two general grounds:

  1. The bank did not believe that the loan broker should be treated as a creditor but as a third-party broker, therefore allowing the fees paid to a third-party broker not to be considered finance charges under the Truth in Lending Act (TILA) and Regulation Z.
  2. The bank did not believe the Office of the Comptroller of the Currency (OCC) correctly calculated the amount of the finance charges.

Treatment of Creditors and Fees Paid to Third Parties

TILA and Regulation Z require lenders to disclose the cost of credit to borrowers, including all finance charges associated with the loan. See 15 U.S.C. 1637, 1637a, 1638(a), and 12 CFR 226.6, and 226.18. Regulation Z states:

The finance charge is the cost of consumer credit as a dollar amount. It included any charge payable directly or indirectly by the consumer and imposed directly by the creditor as an incident to or a condition of the extension of credit. It does not include any charge of a type payable in a comparable cash transaction.

The loan broker imposed various fees on borrowers who sought guaranteed credit cards from the bank. The OCC determined the bank was required to disclose those costs as finance charges. The bank contends that these fees were charged by the loan broker for the loan broker's benefit and, therefore, the bank is not required to include the third-party fees in the finance charges for the bank's loans.

The Official Site Commentary on Regulatory Z (226.4(a) Definition, note 3) explains how charges by persons other than the creditor are treated. It states the following:

Charges by third parties. Charges imposed on the consumer by someone other than the creditor for service not required by the creditor are not finance charges, as long as the creditor does not retain the charges. For example:

  • A fee charged by a loan broker to a consumer, provided the creditor does not require the use of a broker (even if the creditor knows of the loan broker's involvement or compensates the loan broker);.

In contrast, charges imposed on the consumer by someone other than the creditor are finance charges (unless otherwise excluded) if the creditor requires the service of the third party. For example:

  • A fee charged by a loan broker if the consumer cannot obtain the same credit terms from the creditor without using a broker.

The appeal contends that the supervisory office is treating the loan broker as a creditor under Regulation Z by attributing the fees charged by the loan broker to the bank. However, this miss-characterizes the basis for the violations. The OCC is viewing the loan broker as a third party that the bank required customers to use if they wanted, or needed, guaranteed credit cards. Because borrowers could obtain guaranteed credit cards from the bank only by applying through the loan broker, the bank was required to include the loan broker's fees in the finance charges for those extensions of credit.

The appeal also discusses that customers were not required to use the loan broker to obtain credit cards for the bank. The law is clear that a broker's fees need not be included in the finance charge if the borrower can obtain the same credit terms from the lender without using the broker. In this bank's case upon the bank's own admission the loan broker borrowers could not receive the same credit terms directly from the bank. Moreover, the bank required the loan broker customers to obtain the loan broker's guarantee in order to receive a credit card.

Amount of Finance Charges

The loan broker offered to guarantee a customer's credit card debt under the three different programs described above. It was immaterial to the bank which program a customer used since the loan broker provided the same guarantee and collateral to the bank under each program. However, different costs were associated with each program; consequently, the amount of the finance charges for each loan was affected by how the customer met the bank's requirement that the loan broker guarantee the customer's loan.

The bank argues that certain fees imposed by the loan broker in connection with the insurance card and installment loan card should not be included in the finance charge under Regulation Z. The thrust of the argument is that the bank did not require customers to obtain insurance or take out an installment loan to obtain a guaranteed credit card because customers had the option of meeting the loan broker's collateral requirements by providing cash collateral. Although this is true, it is the purpose of Regulation Z to assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him or her and avoid the uninformed use of credit. Regulation Z requires the bank to disclose the finance charge for the particular option chosen by each customer, otherwise the borrower would have no way of comparing the cost of the different finance options, a condition that the Truth in Lending Act intended to remedy.

The bank will be required to reimburse affected customers. Because of the variety of different options that were offered, the appropriate OCC District Office will provide guidance on which charges should be included in the finance charges for each of the various options. The District Office will also review the bank's calculations for accuracy before any reimbursements are made.