Pub. 5 2014 Issue 3

fall 2014 27 West Virginia Banker We’ve recently been made aware of a process that quite a few banks have been doing for many years that could very easily cause the bank many issues with the regulatory agencies. H ere is the scenario — banks have made it a policy to add the balance of a charged-off deposit account to the principal of a loan the customer has at the bank. This policy presents a minefield of issues that must be addressed, including contractual language, UDAAP, safety and soundness and compliance issues (disclo- sures). This memo highlights some of the issues presented by this policy in light of the continued regulatory focus on over- draft programs. By Darlia Fogarty, Director of Compliance, Compliance Alliance Just a few of the issues presented, by adopting this practice, in light of the continued regulatory focus on overdraft programs are: 1. With respect to overdrafts, banks need to follow GAAP and the Call Report guidelines and should be re- porting these charged-off accounts as such. This, in a nutshell, means that these losses come out of the bank’s bottom line income. In an issuance from 2005, the FFIEC requires that an overdraft be charged off against cur- rent year’s income when the account is overdrawn for 60 days, as stated in the FFIEC guidance on overdrafts. Paying off an overdraft by adding principal to an existing loan effective- ly sidesteps the rule and masks the loss of income. This presents a safety and soundness issue because the bank may be over reporting income because the loss will no longer be reflected on the books. In essence, you are capi- talizing a past due loan and calling it income. Additionally, the existing loan that has had the overdraft tacked onto the principal balance could well be considered as impaired since now the borrower has demonstrated that they do not have the ability to remain current on their debt obligations. 2. Whether this practice is even permissible would be governed by the agreement between the borrower and the lender. Since each loan is unique, the bank will have to consult their counsel to determine their rights and remedies with respect to the specific loan. Often, banks assume that there is a provision in the loan agreement permitting this. Rather than assuming, the bank should carefully read the loan agreement to determine if this is accu- rate. Keep in mind, this action would not be considered in the same category as force placement of insurance. 3. There is also a question of whether disclosures are necessary under Reg Z prior to converting the balance of the overdraft to a loan that accrues in- terest. As a reminder, Reg Z and Reg DD, of course, would only apply to consumer loans/accounts. With that being said, any fee for overdrafting an account must be disclosed per Reg How Does a Charged-off Checking Account Become a Minefield of Issues?  Minefield of Issues — continued on page 29