The Consumer Financial Protection Bureau (CFPB) issued a compliance guide for small entities that are to be subject to the Section 1071 small-business lending rule. The guide provides a detailed summary of the final rule’s requirements and provides details and examples when necessary to clarify the different components and requirements of the final rule.
Who is a covered entity?
The guide clarifies that whether a financial institution is a covered entity under the rule will be an annual determination each financial institution must make based on the number of covered originations it originated in each of the two immediately preceding calendar years. It is possible for a financial institution to be a covered entity for a particular calendar year, even if it was not a covered entity the year before, or for it to be a covered entity for a particular year, but not the next.
If a financial institution does not meet the threshold to be a covered entity in a particular calendar year, it is permitted to voluntarily compile data in certain circumstances. Because the collection of such data may be a violation of the Equal Credit Opportunity Act (ECOA) and Regulation B, the final rule grants provisions for entities that are not covered in a particular year to still voluntarily collect demographic information for covered applications.
One such provision permits any entity that was a covered entity in the previous five years, but is not for a particular year, to engage in such voluntary collection of information.
Another such provision allows for entities that have made the threshold in the previous year to voluntarily collect required data in the second year of the two-year threshold period. The financial institution in this situation may only collect demographic information for covered applications from small businesses, and it must comply with the otherwise applicable requirements of the final rule.
Otherwise, a non-covered entity may engage in voluntary collection of data, but if it decides to do so, it must report that data to the CFPB as if it were a covered entity.
Reporting requirements and mergers
In cases of mergers or acquisitions, the surviving or newly formed financial institution is a covered entity under Section 1071 if it meets the threshold when considering the combined lending activity of the surviving or new institution and the merged or acquired institution(s) in each of the two preceding calendar years.
However, if two institutions that are both not covered entities in the calendar year of the merger form a financial institution that meets the threshold to become a covered financial institution for that same calendar year, the surviving or newly formed financial institution is not required to compile, maintain, or report data for the calendar year that the merger is effective.
If a covered entity and an entity that is not a covered financial institution merge and the new or surviving institution is a covered entity, for the calendar year of the merger, the new or surviving covered financial institution must compile, maintain, and report data for covered applications from the previously covered financial institution. However, compiling, maintaining, and reporting data is optional for covered applications from the financial institution that was not covered prior to the merger or acquisition.
Covered credit transactions
To determine whether it is a covered entity, a financial institution must count certain covered credit transactions it originated in the preceding two calendar years. Specifically, a financial institution must count the covered credit transactions that it originated to small businesses, except those otherwise-covered credit transactions that extend, renew, or otherwise amend an existing transaction.
The final rule specifically excluded certain extensions of business credit from the definition of covered credit transactions. These exclusions include:
- Trade credits: A financing arrangement wherein one business acquires goods or services from another business without making immediate payment in full to the business providing the goods or services is not a covered credit transaction.
- Home Mortgage Disclosure Act (HMDA)-reportable transactions: A transaction that is a covered loan for purposes of HMDA (as defined by Regulation C, 12 CFR 1003.2(e)).
- Insurance premium financing: A financing arrangement wherein a business: (i) agrees to pay to a financial institution, in installments, the principal amount advanced by the financial institution to an insurer or insurance producer in payment of premium on the business’s insurance contract or contracts plus charges, and (ii) as security for repayment, assigns to the financial institution certain rights, obligations, and/or considerations in its insurance contract or contracts.
- Public utilities credit: extensions of credit that involve public utility services provided through pipe, wire, or other connected facilities, or radio or similar transmission (including extensions of such facilities), if the charges for service, delayed payment, and any discount for prompt payment are filed with or regulated by a government unit.
- Securities credit: extensions of credit subject to regulation under Section 7 of the Securities Exchange Act of 1934 or extensions of credit by a broker or dealer subject to regulation as a broker or dealer under the Securities Exchange Act of 1934.
- Incidental credit: extensions of credit that are neither public utilities credit or securities credit that are not made pursuant to the terms of a credit card account, not subject to a finance charge, and not payable by agreement in more than four installments.
Instances of refinancing an existing credit obligation is considered a covered application that a covered entity must report if the new obligation would be a covered credit transaction and the request is made in accordance with procedures used by the covered entity for the type of credit requested.
If a small business makes a request for two or more covered credit transactions at the same time, a covered entity must report each request that satisfies the definition of covered application as a separate reportable application. If, however, the small business is only requesting a single covered credit transaction, but is considering multiple credit products, the financial institution reports the request as a single reportable application.
In a situation where a covered entity initially determined that a covered application is from a small business based on available information and collects demographic information pursuant to the final rule, but later concludes that the applicant is not a small business, the financial institution does not violate ECOA or Regulation B if it meets the requirements for the safe harbor.
To qualify for this safe harbor, a financial institution must have had a reasonable basis at the time it collected the data for believing the application was a reportable application. The financial institution does not report the application to the CFPB on its small-business lending application register.
This is part one in a series analyzing and breaking down this guidance from the CFPB on the Section 1071 rule. More will be available in coming weeks.