Think the new Department of Defense regulations don’t apply to your bank? A closer look might surprise you

 

A U.S. military service member finds himself or herself in a financial crisis. There’s too much debt, or a family emergency arises.

So the service member turns to short-term solutions, such as payday loans or titled vehicle loans, to get through the current situation. But what happens next is often the beginning of a recurring cycle of very costly debt that compounds on itself and becomes harder and harder to dig out of. The stress caused by the quagmire of debt has become a problem for many military families, and thus for the military itself.

The military has implemented programs to help. These range from financial education to making predatory lenders off-limits to military personnel. They include military aid societies that provide financial assistance to affected individuals.

Beyond those measures, part of the response to this problem is new legislation and regulation. The John Warner National Defense Authorization Act for fiscal 2007 was passed on Oct. 17, 2006, and implementing regulations were issued by the Department of Defense (DOD) in August 2007. The DOD Limitations on Terms of Consumer Credit Extended to Service Members and Dependents Regulation became effective on Oct. 1, 2007.

The act and implementing regulations require additional disclosures for and place certain limitations on loans within the defined categories of payday loans; titled vehicle loans; and tax refund anticipation loans to service members and their dependents. Any creditor that makes any of these to a regular or reserve member of the armed forces (Army, Navy, Air Force, Marines, or Coast Guard) on active duty, or their dependents, must provide additional loan disclosures and adhere to certain limitations on rate, prepayment penalties, and related factors.

A bank should not choose to completely ignore the DOD regulation. Civil money penalties can be assessed by regulators. In addition, the law provides that a contract containing any prohibited term is voided.

Risk assessment process
Every bank should take the time to determine what, if any, risk it may have in connection with the new requirements. The first step in the risk assessment process is to identify any products and services that could be covered by the regulations.

Some will be apparent on their face, but others won’t be so obvious. They could include sub-categories and pricing variations of broader product categories. Many banks have initially assumed that they are not subject to the DOD regulation, but upon closer examination have found that indeed they are covered in some way. One bank, for example, discovered that a single branch out of its whole network, one located in a rural area, makes a handful of vehicle title loans each year, while the rest of its branches never make any loans that would be covered by the regulation.

If a bank does not offer any covered consumer credit transactions, the compliance risk is low. However, even if the risk is low, because the bank does not offer such a product, there is always the potential for a creative lender to depart from the norm and tailor a loan to a borrower (and possibly a “covered borrower,” as defined further on) that could bring the bank under the regulation.

DOD, credit regulator?
All types of creditors fall under the new DOD regulation, not just payday lenders and predatory lenders, even though the types of credit targeted by the legislation and regulation are not typically found at insured depository institutions supervised by the federal banking regulatory authorities. If a creditor is a “creditor” as defined by Regulation Z (Truth in Lending Act), the creditor is a creditor under the DOD regulation, too. In addition, if a person is an assignee of a covered type of consumer credit transaction, that person is also subject to the DOD regulation, even if the person did not make the original loan. Thus, a bank that buys instalment paper from third parties needs to be aware that the assignment could bring it under the coverage of the DOD regulation, depending on the type of credit involved.

Banks have been very nervous over the past year or so,  anticipating how the DOD would perform as credit regulator. While no new reg is enjoyable, there is at least some comfort in knowing from whence the ill wind blows, so to speak, in terms of rules from usual regulators.

The DOD took a long time to publish  the new regulation. It consulted with the federal financial regulators (FDIC, OCC, Treasury Department, Federal Reserve Board, OTS, NCUA, and FTC) to draft a regulation that provides some consistency with existing credit regulations like Regulation Z. There are references in the DOD regulation to definitions in Regulation Z and the DOD regulation incorporates familiar APR calculation methodology from Regulation Z into the requirements for the new Military Annual Percentage Rate (MAPR).

Coverage issues
Banks naturally have spent much time studying the coverage of the regulation. If a bank is not making any of the types of loans included in the definition of “consumer credit transaction,” the DOD regulation does not apply to them.

A consumer credit transaction is defined as closed-end credit to a covered borrower primarily for personal, family, or household purposes that meets the definition of a payday loan, tax refund anticipation loan, or a vehicle title loan. Each of these types of specialized loan products has specific criteria that apply.

 

Payday loans covered by the reg are those that have a term of 91 days or fewer and amount financed of $2,000 or less.

Vehicle title loans covered by the regulation are only loans with a term of 181 days or less, and that are secured by the title to a motor vehicle that are not used to purchase the vehicle.

Tax refund anticipation loans covered are limited to loans in which the borrower expressly grants the creditor the right to receive all or part of the borrower’s income tax refund, or expressly agrees to repay the loan with the proceeds of the borrower’s refund.

For banks that are concerned that such loans could include any loan that is made to a borrower who plans to repay the loan with a future tax refund, explanatory information issued with the final regulation says that the intent of the regulation is to cover credit products that are designed to expressly use tax refunds as collateral for the loan and not cover loans where borrowers merely note that a tax refund may be used to repay.

The other key definition limiting coverage is “covered borrower.” That is, the regulation only applies if a creditor makes a covered loan to a covered borrower. A covered borrower is a regular or reserve member of the armed forces serving on active duty and the member’s spouse, children, or other dependent.

To determine if a borrower is a covered borrower, a creditor can use the model Covered Borrower Identification Statement provided in the regulation, which puts the burden on potential borrowers to self-identify, allowing the creditor to rely on the borrower’s declaration of coverage or noncoverage.

Although the regulation is narrow in scope, an important caveat must be considered: Congress gave the DOD the authority to broaden its coverage if necessary. Thus, if the DOD discovers that creditors are using different methods of providing similar types of short-term, high-cost credit to service members and their families that result in abuses, it can expand the regulation.

Credit limits and disclosure additions
If a covered loan is made to a covered borrower, the regulation contains limitations on terms of the credit, including:

• Maximum Military Annual Percentage Rate (MAPR) of 36%, which is calculated differently than the normal APR for consumer loans.

• Prohibition against renewals, refinances, or consolidations of any consumer credit transaction by the same creditor to the same covered borrower that does not result in more favorable terms to the covered party.

• Prohibition against requiring covered borrowers to waive their rights to legal recourse under any other applicable statute, including the Servicemembers Civil Relief Act

• Prohibition against requiring covered borrowers to submit to arbitration or more onerous legal notice provisions in the case of a dispute.

• Prohibition against unreasonable notice from covered borrowers as a condition for legal action by the covered borrower

• Prohibition against requiring covered borrowers to establish an allotment to repay the debt.

• Prohibition against charging a prepayment penalty, or not allowing prepayment of the debt in full or in part.

• Required new disclosures before the loan is consummated including the MAPR, and a statement of the service members’ rights under the DOD Regulation. (Of course, the usual Regulation Z disclosures still apply, too. However, the DOD disclosures must be made separately, both in writing and orally.)

Choices to make
If a bank has covered products, there are five basic roads to choose from, in regard to these DOD regulations:

• Discontinue products that fall within the scope of the rules altogether.

• Discontinue offering such products to covered service members and their dependents, but continue to offer them to other borrowers.

• Redesign covered products for everyone so that they do not meet the coverage criteria of the regulation.

• Redesign covered products for identified covered borrowers only and continue to offer existing products to others.

• Continue to offer existing covered products with the new limitations and disclosures required. BJ

 

The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0208/index.php?startid=56

 

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