When implementing and creating processes for the 1071 Small Business LAR Rule, determining when the institution will be subject to the collection and reporting requirements is vital.
The CFPB’s tiered implementation means we must first undertake a count to determine when the institution is subject to the collection and reporting of the covered data. The count is an important first step.
Article 1 in our series for 1071 implementation covers those reporting tiers.
The count is an important first step to implementation. The final rule provides three methods to determine if a Small Business loan should be counted; however, before making that determination, we need to first understand what is considered a “Small Business.”
What is a Small Business?
The final rule’s definition of “Small Business” incorporates, in part, the Small Business Administration’s (SBA) definition of “Small Business concern.” A “Small Business” is one that had $5 million or less in gross annual revenue for its preceding fiscal year. Thus, if a business had more than $5 million in gross annual revenue for its preceding fiscal year, it is not a Small Business.
The definition also states that a business concern may take several legal forms, including a trust, sole proprietorship (including individuals), partnership, limited liability company, corporation, joint venture, or cooperative. However, if a joint venture with more than 49 percent participation by foreign business entities it would not be considered a Small Business under the 1071 Rule.
Furthermore, financial institutions are not required to collect and report data for not-for-profit applicants, because they are not “organized for profit” and are thus not a “business concern.”
Additionally, the CFPB anticipates applications from foreign businesses will fall outside the scope of the rule’s data collection and reporting requirements unless they have a place of business located in the United States and they either operate primarily within the United States or they make a significant contribution to the U.S. economy through payment of taxes or use of American products, materials, or labor.
What is a covered transaction?
A covered origination is a credit transaction that the financial institution originated to a Small Business. Refinancing can be a covered origination; however, extensions, renewals, and other amendments of existing transactions are not considered covered originations unless the transaction includes an increase in the amount of credit extended.
Financial institutions must understand the difference between a refinance and renewal and may have to adjust their processes. The CFPB’s Final Rule states that a refinance occurs when “an existing obligation is satisfied and replaced by a new obligation undertaken by the same borrower.” Remember, when we speak of the “obligation” we are referring to the Note.
The Final Rule also states that refinances or applications for a refinance must be assigned a different identifier than the transaction that is being refinanced.
What transactions are excluded?
The following transactions are excluded from the count as they are not considered covered credit transactions under the Final Rule even if they satisfy Regulation B’s definition of business credit:
- HMDA-reportable transactions.
- Trade credit, a financing arrangement wherein a business acquires goods or services from another business without making immediate payment in full to the business providing the goods or services.
- Insurance premium financing is generally a financing arrangement wherein a business agrees to repay a financial institution the proceeds advanced to an insurer for payment of the premium on the business’s insurance contract and wherein the business assigns to the financial institution certain rights, obligations, and/or considerations in its insurance contract to secure repayment of the advanced proceeds.
- Public utilities credit as defined in Regulation, 12 CFR 1002.3(a)(1)
- Securities credit as defined in Regulation B, 12 CFR 1002.3(b)(1)
- Incidental credit as defined in Regulation B, 12 CFR 1002.3(c)(1), but without regard to whether the credit is consumer credit, is extended by a creditor, or is extended to a consumer.
- Factoring and leasing.
- Consumer-designated credit used for business or agricultural purposes.
- Loans to government entities and non-profits.
- Purchases of a credit transaction, purchases of an interest in a pool of credit transactions, and
- Purchases of a partial interest in a credit transaction (such as through a loan participation agreement).
How should you count Covered Transactions?
The CFPB’s Final Rule on 1071 Small Business data collection provides three methods for determining your Small Business count for each year. Below are the methods.
Method One
The use of a financial institution’s loan origination system (LOS), which may already record the revenue amount and other internal loan codes and may provide reports to quickly identify covered transactions towards the final count for each year.
In addition, many CRA LAR reporters can assess their count based on the volume reported on the CRA LAR. You may also be able to include an entities gross annual revenue if your CRA-LAR software contains the fields and the data is captured.
But what do smaller financial institutions do if revenue or any other key information is not readily available to isolate the covered transactions in their LOS. TCA recommends utilizing the CALL Report codes, since every Bank must submit a quarterly report and utilize any internal loan codes to identify the business loans.
There are various business purpose CALL Report codes such as 1.a2, 1.b, 1.e.1, 1.e.2, 3, and 4. However, it will be the Bank’s responsibility to read the loan approvals to validate the loan qualifies as a covered transaction and to ensure the accuracy of their CALL report.
The Financial Institution must also identify business purpose closed-end residential mortgage loans that are not HMDA reportable. These Small Business loans can be identified by the CALL Report codes of 1.c.2.a and 1.c.2.b and 1.d, along with the Bank’s core system codes for purpose, class, and other identifying lending codes.
The loan approval document may provide detailed information on how the loan proceeds were used. The financial institution may also create a report with the CALL Report codes and the appliable core system fields with filters to identify business purpose loans secured by residential dwellings.
Lastly, the CALL Report codes, and core system codes can help identify consumer credit designated loans. CALL Report codes for consumer lending products are HELOC, 1.c.1 and 6a, 6b, 6c and 6d, which identify these products as personal, family, or household purposes. The Financial Institution can create a report to identify these loans that are to be excluded.
Method Two
If the financial institution does not collect sufficient information to determine which borrowers are Small Businesses pursuant to the Final Rule, it can determine the number of covered originations for 2022 and/or 2023 by using the methodology provided by the CFPB.
Such institutions may count covered originations for the last quarter of the calendar year 2023 (October 1 through December 31). This loan count would then be quadrupled (multiplied by four) to annualize the number. This annualized number will then be utilized as the loan count for 2023 and 2022 to determine institutional coverage.
Method Three
The third method is to assume that all the covered credit transactions originated during a calendar year were made to a Small Business to determine institutional coverage. The financial institution would adhere to the compliance date tier pursuant to the final rule.
What are best practices for Compliance Officers?
Once a financial institution has determined the volume for 2022 and 2023, document the process and methodology you utilized to identify the Small Business loans. The results will identify the rationale for whether the financial institution will be a reporter.
This information should be provided to the Compliance Committee so the process and methodology can be memorialized in the Compliance Committee minutes. Documentation should also include required next action steps.
The steps should include annual monitoring, especially for those yet to reach the threshold as of 2023. Additionally, the results Small Business loan volume should be reported to all Stakeholders to inform them when the threshold and the requirement for starting the data collection process has been realized.
Although outside of the Compliance Officers realm, consider having the appropriate individual(s) review or validate your CALL Report to ensure that loans are coded accurately.
As always, we are here to help! TCA is “A Better Way” to help you comply with the Small Business LAR.
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