The old adage is that there is more than one way to skin a cat. I have never skinned a cat and never had the desire to do so. However, with compliance, sometimes there is an easier way. Here are some examples.
Many financial institutions give their employees a discounted rate on their loans during the period the person is an employee. Let’s say that the normal rate on a loan is 6%. If an employee applies for the loan, the rate is discounted to 5 1/2% so long as the person is an employee in good standing. There are two ways to document the rate. One way is to write the loan at a 5 1/2% rate and have a provision in the note that if the person leaves the employment of the institution, the rate increases to 6%. The second and better way is to write the loan at a 6% interest rate and then have a rider to the note that says that so long as the person is employed by the institution, the rate will be 5 1/2% and the payments will be reduced accordingly. Under the first circumstance, the loan has a variable rate, and the circumstances in which the rate may increase must be disclosed. If the loan is secured by residential real estate, it is an ARM loan, and the institution must create an ARM disclosure. Using the second method, the loan does not have a variable rate and is not an ARM (under the Regulation Z definitions) because the rate cannot increase over the rate initially disclosed.
While we are talking about preferential rates, remember that the Federal Reserve Act prohibits a regulated financial institution from paying an employee a preferential rate on deposits. There can be other advantages to an employee account but not the rate.
Under Regulation Z, a refinancing generally occurs when an existing obligation is satisfied and replaced by a new obligation undertaken by the same consumer. In other words, the consumer has an existing loan with you, and you and the consumer want to change the terms of the loan. To do so, you have the consumer sign a new note replacing the old one. Also, anytime you advance new money on an existing loan or change the rate from a fixed to a variable rate that is a refinancing. If your transaction is a refinancing, you must provide the consumer all new disclosures. On the other hand, if you want to make changes to the terms of the loan, the changes do not involve advancing new money or changing the rate from a fixed to a variable rate and you implement the change without having the customer sign a new note, for example, by signing a loan modification agreement, that is not a refinancing and no new disclosures are required.
You can use a loan modification agreement to shorten or extend the term of a loan, increase or decrease the interest rate or monthly payment, or modify any other term of the loan other than increasing the loan amount or changing from a fixed to a variable interest rate and thereby avoid the disclosure requirements. For example, assume you have a five-year balloon note at a fixed rate that is maturing and you want to extend the term for an additional five years either at the same or a different fixed rate. You can implement those changes with a loan modification agreement modifying the original note and you are not required to provide any disclosures.
If you have a properly disclosed variable rate plan, a refinancing is not triggered if the rate change is in accordance with those disclosures. A refinancing requiring all new disclosures is required under a variable rate plan, even if it is not accomplished by the cancellation of the old obligation and substitution of a new one, if you increase the rate based on a variable-rate feature that was not previously disclosed.
Loans to Executive Officers.
Regulation O has a provision that if a covered financial institution makes a loan to one of its executive officers, the loan must have a provision that it is callable at the institution’s discretion if the executive officer should become obligated to other financial institutions in an amount greater than his or her institution could lend. Some institutions put the executive officer call language in the note itself. Do not do that. Instead, put the call language in a rider to the note. By doing it that way, if the institution ever sells the loan, it may remove the rider, and the call provision does not follow the note to the institution that purchases the loan. For example, you may make an executive officer a residential mortgage loan that you plan to sell in the secondary market. During the period, however short, that the institution owns the loan, you must have the call provision, but you do not want that provision continued to the secondary market buyer. The issue is solved by putting the call provision in a rider that does not go forward.
These are some of the tricks of the compliance trade. If you have discovered other ways to lessen the compliance burden, let us know and we will try to pass them on.