Proposed Community Reinvestment Act Regulations

December 1994
FINANCIAL SERVICES NEWSLETTER

Conduct described in two recent developments as proper compliance with certain federal banking regulations may result in a violation of other regulations, thus creating an inherent "Catch 22" situation for both commercial lenders and originators of residential mortgages. The two developments, and our view of the potential problems, are described below.

PROPOSED COMMUNITY REINVESTMENT ACT REGULATIONS: Collection of Race and Gender Data of Loan Applicants

The four federal banking regulatory agencies have issued a proposed revised regulation under the Community Reinvestment Act. While much of the revised CRA regulation addresses enforcement and compliance with CRA, the rule also requires for the first time that banks collect and report race and gender data on applications for business loans of $1,000,000 or less (and with respect to farm loans of $500,000 or less). The regulation applies to banks and holding company affiliates with $250,000,000 or more in consolidated assets. The regulators have provided a form to set out the percentage of interest in the proposed borrower that is minority-owned and the percentage that is female-owned. Periodic CRA reports will include a summary of the number and dollar amount of loans in both categories.

Setting aside the increased regulatory burden of the proposed rules, our concern is the conflict between the required collection of race and gender data and the provisions of Regulation B and the Equal Credit Opportunity Act, which prohibit any inquiry or consideration of race or gender. Although collecting such data will no longer in and of itself be a violation of ECOA, since it is required under CRA, plaintiffs' lawyers (can't you see this coming) trying to make a discrimination case under ECOA should have a field day if they are able to obtain the CRA data and compare loan approvals and denials directly with the race or gender information (Does the term "Class Action Lawsuit" sound applicable here?).

The comment period for the proposed rules expired on November 21, and a substantial number of negative comments were received by the regulatory agencies. If approved, the rules will be effective July 1, 1996. On a related note, the Small Business Administration has adopted the CRA reporting requirements for all SBA lenders, which we assume will become effective if and when the revised CRA rules finally are adopted.

TRUTH-IN-LENDING DISCLOSURE STATEMENT: You Had Better Prepare It Yourself.

The decision of a federal court in Pennsylvania earlier this year in effect mandates that residential mortgage lenders not permit the closing attorney to prepare the Truth-in-Lending disclosure statement. The closing attorney in Brodo v. Bankers Trust Co., Trustee, CIV A 93-1858, U.S. Dist. Ct., E.D. Pa., Mar 25, 1994, charged a fee of $450.00 for all of his closing services, which included preparation of the TIL disclosure statement. The fee was not broken down and allocated among the various services provided.

Under the Truth in Lending Act and its implementing regulation, Reg. Z, certain fees are expressly excluded from the definition of "finance charge." Most other fees and charges relating to the loan are to be disclosed and included in the calculation of the finance charge. Unfortunately for the lender in the Brodo case, fees for preparation of the TIL disclosure statement are not considered an excluded item. In fact, the commentary to Reg. Z states specifically that such fees are to be included in the calculation of the finance charge. Because a portion of the attorney's fee was not allocated to preparation of the TIL disclosure statement, and because the court determined that the attorney obviously would not have prepared the statement free of charge (we won't comment on the reasonableness of that assumption), the borrower was permitted to rescind the transaction long after the normal three-day right of rescission had expired.

The trap set by the Brodo court is the assumption that lenders may allocate a portion of the closing fee to preparation of the TIL disclosure statement and thus avoid the problem faced by the lender in Brodo. The facts giving rise to the Brodo decision arose prior to March 1994, when HUD issued final revised rules under the Real Estate Settlement Procedures Act extending the applicability of RESPA to second mortgage transactions. RESPA always has prohibited the collection of a fee for preparing a TIL disclosure statement, thus allocating a portion of a closing attorney's fee to preparation of the TIL disclosure statement for a second mortgage transaction now violates RESPA. The safest course for lenders, which we understand is the common practice in this area, is for the lender to prepare the TIL disclosure statement, rather than the closing attorney, and not to assess a charge for that service.

ONE MORE RESPA RULE: Application to Certain Business Loans.

The new RESPA rules described in the preceding paragraphs also extended the coverage of RESPA to certain business loans secured by a mortgage on residential property. As initially published in February 1994, the proposed rules were quite ambiguous and appeared to apply to all business loans if one-to four-family residential real estate was offered as collateral. As a result, the common transaction in which the principal of a closely-held business offers a second mortgage on his or her residence as collateral for a loan to the business would be covered by

RESPA. Several industry publications summarized the new rules and gave often conflicting accounts.

As a result of the confusion, HUD issued a "corrected" rule on March 31 of this year, which became effective on August 9. The new rule clarified that most business loans are exempt from RESPA and its implementing regulation, Reg. X, unless the loan is made to an individual for the purpose of acquiring, refinancing, improving or maintaining one-to four-family residential real estate for rental purposes. Unless a business loan fits into the narrow category described in the previous sentence, the business loan exemption that we always have been accustomed to is still available and RESPA disclosures are not required. This is a frequently asked question and is understandably confusing because of HUD's flip-flop on the issue. We hope this clarification is helpful.