The final rule has expanded the scope of covered products how does this impact your business?

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1 January 2016 Military Lending Act It s time to get prepared The final rule has expanded the scope of covered products how does this impact your business? Overview A joint point of view by PwC s Consumer Finance Group and Financial Services Regulatory Practice Protecting the financial interests of servicemembers and their families is a spotlight issue for both the prudential regulatory agencies and the Consumer Financial Protection Bureau (CFPB). In 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) established the Office of Servicemember Affairs (OSA) within the CFPB for the purpose of developing and implementing initiatives to educate and empower servicemembers to make better informed decisions regarding financial products and services. The OSA also monitors servicemember complaints regarding financial products and services and coordinates the efforts of federal and state agencies to improve consumer protection measures for military families. Since then, there have been a number of supervisory and enforcement actions taken against lenders for MLA impacts more products and covers more lenders MLA requires more items to be included in the MAPR calculation MLA provides for additional disclosure requirements MLA provides for additional consequences and safe harbors MLA covers consummated transactions on or after October 3, 2016 (October 3, 2017 for credit card transactions) MLA covers active military members, their spouses and/or covered dependents violations of consumer financial protection laws and regulations that caused harm to servicemembers, including harm arising from violations of the Servicemembers Civil Relief Act (SCRA). In a continuation of the theme of protecting servicemembers from financial harm, on July 21, 2015 the Department of Defense (DoD) issued the final rule amending the regulations implementing the Military Lending Act (MLA).

2 2 The MLA provides specific protections for servicemembers covered consumer credit products. Such protections include a limit on the annual cost of credit on the extension of credit to a 36 percent Military Annual Percentage Rate or MAPR. The MAPR includes additional items than the Annual Percentage Rate (APR) disclosed under Regulation Z (discussed further below). The MLA requires creditors to provide military-specific disclosures and prohibits creditors from: Requiring a servicemember to submit to arbitration in the event of a dispute; Requiring a servicemember to waive their rights under the Servicemembers Civil Relief Act; extended to active-duty servicemembers or their dependents, as long as the credit: Is subject to a finance charge; or Is payable by written agreement in more than four installments. That means that the amended rule applies the protections of the MLA to all forms of payday loans, vehicle title loans, refund anticipation loans, deposit advance loans, installment loans, unsecured open-end lines of credit, and credit cards. However, the change in the definition of consumer credit excludes loans secured by real estate and purchase-money loans, including a loan to finance the purchase of a vehicle for the purposes of the MLA. Requiring a servicemember to provide a payroll allotment as a condition of obtaining credit; Charging a prepayment penalty; Permitting refinance of a payday loan; Permitting a credit to be secured using a post-dated check; or The MLA rule amendments became effective October 1, 2015 for covered credit transactions consummated on or after October 3, 2016, excluding credit card transactions. Credit card products must conform to the rule by October 3, Considerations for noncompliance Requiring the use of the title of a vehicle as security for a consumer credit obligation (provided that the lender is not a chartered or licensed bank, savings association, or credit union). As originally implemented by the DoD in 2007, the MLA protections applied only to three narrowly-defined consumer credit products: closed-end payday loans for no more than $2,000 and with a term of 91 days or fewer; closed-end auto title loans with a term of 181 days or fewer; and closed-end tax refund anticipation loans. In contrast, the DoD s current amendments to the MLA rules now expand the range of covered transactions by more closely aligning the definition of consumer credit with the broader, traditional definition of consumer credit covered by Regulation Z. As a result, the amended rule generally covers consumer credit offered or Penalties The consequences for failing to comply with the provisions of the MLA can be severe. For example, where a transaction violates the MLA, the note or credit becomes void from inception, which could require a lender to identify and refund all fees and interest paid by the affected borrower. Moreover, each instance of knowingly violating the MLA constitutes a misdemeanor and is subject to criminal penalties, which may include fines and imprisonment. Additionally, the MLA authorizes private lawsuits by affected borrowers and statutory damages of not less than $500 per violation plus the potential for punitive damages and reasonable attorneys fees. Violations of Regulation Z (e.g., failure to provide Truth in Lending disclosures) may also be considered violations of MLA and may subject lenders to penalties under both

3 3 Regulation Z and MLA. Lenders should be aware that such violations may also be considered violations of Unfair, Deceptive, or Abusive Acts or Practices Act (UDAAP) which could result in additional penalties and supervisory actions. Additional considerations In addition to the statutory penalties described above, lenders should be aware of the reputational risks associated with noncompliance with MLA. The treatment of servicemembers, their spouses and covered dependents is a sensitive and highly visible topic with regulators and non-compliance with the new regulation could attract heightened regulatory scrutiny, as well as costly remediation. But my institution has an SCRA compliance program. We re covered for MLA too, right? While financial institutions may already be familiar with the SCRA, a law that is similarly aimed to protect active duty military servicemembers, the MLA differs greatly from the SCRA in terms of coverage, timing of coverage, disclosure requirements, and interest rate calculation and caps. We will explore the key differences between the two rules below. Coverage The SCRA protects servicemembers and their dependents on pre-service debts when they subsequently become active duty after opening an account. By contrast, the MLA protects servicemembers and their dependents at the time of origination if they are on active duty at that time. Thus, if a servicemember opens an account with a financial institution and subsequently becomes active duty, SCRA applies; however, if the servicemember is on active duty status when the servicemember or dependent becomes obligated on the debt, then the MLA applies. The MLA ceases to apply to a credit transaction if or when the consumer ceases to be on active duty. Disclosure requirements The MLA requires unique disclosures that are not applicable to SCRA. There is only one set of circumstances that triggers SCRA disclosures: Department of Housing and Urban Development (HUD) requires that SCRA disclosures be provided by mortgage servicers on mortgages at 45 days of delinquency. On the other hand, to comply with the MLA, financial institutions must provide certain disclosures both orally and in writing in a format in which the borrower can keep. Disclosures include: MAPR Statement, which must describe the charges that the creditor may impose in terms of the MAPR; A clear description of the payment obligation, such as a payment schedule for closed-end consumer credit; and Account opening disclosure (as mandated by Regulation Z) for open-ended consumer credit. The MLA disclosures must be provided either at the time the borrower becomes obligated for the transaction or at the time the account was established. Further, the MLA disclosures can be provided at one time and by one creditor in the case of multiple creditors. To fulfil the requirement to provide these disclosures orally, the rule expressly permits the use of a toll-free number that may be disclosed on an application or written disclosure statement. Interest rate calculation and caps The SCRA caps interest rate charges, including fees, at 6 percent. The interest rate cap for purposes of the SCRA represents the typical finance charge calculation as prescribed by Regulation Z. The MLA, on the other hand, caps interest and fees at 36 percent MAPR and requires the effective MAPR to be calculated each month for open-ended credit. The MAPR is not the interest rate on the loan, nor is it the same as the APR disclosed under Regulation Z. Rather, it

4 4 may include more fees and charges that the APR including: Any fee or premium for credit insurance, including single premium credit insurance, for debt cancellation or for debt suspension, regardless of whether such fees or premiums are voluntary; Any fee for a credit-related ancillary product sold in connection with the credit (however, there is currently little guidance on what products are deemed credit-related ancillary products sold in connection with a transaction); and Application and/or participation fees (e.g., credit card annual fees), with exception for once per 12 month period application fees imposed by Federal credit unions or insured depository institutions on short-term, small amount loans. Bona fide fees on credit cards are not included, provided they are reasonable and customary. We discuss this further below. Operational implications The amended MLA rules create operational challenges to comply with the rule by the effective dates. Specifically, creditors will need to define a process to independently identify servicemembers and their covered dependents, as creditors can no longer rely on statements from applicants regarding military status. The amended rule gives creditors latitude to define the process for identifying servicemembers, but also provides a safe harbor where the creditor relies on the DoD s MLA Database or active duty notifications provided by consumer reporting agencies on the consumer s credit bureau report. As banks and other financial institutions already know, there are limitations on the DoD s MLA database, including the timing of updates and failure to include servicemembers spouses and covered dependents. These known deficiencies with the DoD s MLA database may require creditors to establish additional supplemental methods to identify covered borrowers. To address this complexity, institutions should consider including multiple status checks in their process, such as at application and at closing. In addition, creditors may consider developing processes to centralize customer records to capture any record or documentation to evidence a borrower s military status. Institutions should also consider processes for verifying military identification of spouses and dependents, until they are included in the DoD s MLA database. Disclosure requirements arising under the amended rules also create operational challenges. Disclosures must be provided both orally and in a written format that the borrower can keep. Therefore, creditors will need to devise processes to ensure that consumers are provided these disclosures as prescribed. The amended MLA rules provide model notices for written disclosure, and it expressly permits the use of a toll-free number to provide the oral disclosures, provided the phone number is disclosed to consumers. Institutions should consider whether to staff a toll-free phone line with live people or to provide a recording of the disclosures. In either case, steps must be taken to ensure the disclosures remain current and consistent with practices and applicable law. Calculation of MAPR will likely be one of the most challenging operations for creditors. The ambiguity of what fees should be included in the MAPR within the current rule, will likely pose risks and operational issues. For closed-end credit, the MAPR will be a one-time calculation made at the time the loan is made. However, for open-end credit transactions, the MAPR must be calculated for each covered billing cycle to determine whether a creditor is compliant with the 36 percent MAPR limitation. A distinct set of complex rules has been created to determine what fees must be included in the MAPR for credit cards, which we cover in more detail below. Creditors should evaluate their fee tables to determine which fees may be included in MAPR and if such fees can be flagged as MAPR eligible to facilitate consistency in computation. Additionally, creditors will have to

5 5 develop calculators or other means to compute MAPR, both at inception and monthly during the life of the loan for open-end credit. Special considerations for credit cards Initially, credit cards were not covered by the protections of the MLA. However, under the amended rule, credit cards are now a covered product. Recognizing the complexities involved in applying MLA protections to credit card products, the DoD extended the implementation date for credit cards to October 3, Among the complexities involved in applying the MLA to credit card transactions is the fact that credit cards are not necessarily offered in the same manner as other credit products. For example, credit cards may be offered outside of the financial institution s direct control, such as at a point of sale. As a result, creditors will need to work with their retail partners to determine how servicemembers and their spouses and covered dependents will be identified at account opening, and how they can provide all disclosures required under MLA. Another area of complexity in the application of the amended MLA rule to credit cards is the determination of whether fees are bona fide fees. If a creditor imposes any fee that is not a bona fide fee and imposes a finance charge, the total amount of those fees, including any bona fide fees and other finance charges, must be included in the MAPR. A MAPR in excess of 36 percent will require curing by waiving excess fees. Bona fide fees that are reasonable may be excluded from the MAPR calculation (except for credit insurance premiums and fees for creditrelated ancillary products). For a bona fide fee to be considered reasonable, it must be compared to fees typically imposed by other creditors for the same or substantially similar product or service. The rule provides an example based on the like-kind principle. When assessing a bona fide cash advance fee, it must be compared to fees charged by other creditors for transactions in which consumers receive extensions of credit in the form of cash or its equivalent. Alternatively, when assessing a foreign transaction fee, it may not be compared to a cash advance fee because the foreign transaction fee compensates for the service of exchanging the consumer's currency, and does not provide for an extension of credit to the consumer. A bona fide fee is reasonable if it is less than or equal to an average amount of a fee for the same or a substantially similar product or service (as discussed above) charged by five or more creditors with at least $3 billion in outstanding loans on U.S. credit card accounts at any time during the three-year period preceding the average computation. A fee higher than the average may be reasonable depending on other factors relating to the credit card account. For example, many credit card accounts, especially cards with rewards programs, as well as high value, high cost cards (e.g., airline lounge cards), may have bona fide fees that exceed the average fees charged by other creditors. In these cases, the creditor will need to evidence the value to the consumer supporting the higher cost, such as access to a significantly higher credit limit or additional services or other benefits are offered. If a fee is not confirmed as bona fide and reasonable, it must be included in the MAPR. To address these complexities, creditors will need to build processes to routinely monitor such fees and evaluate new fees prior to implementation to understand their potential inclusion in MAPR. In addition, creditors will need to devise processes to compare their fee tables to determine that they meet the reasonableness standard under the rule.

6 6 What are the primary differences between the SCRA and the MLA? SCRA MLA Coverage Servicemembers (and their spouses and dependents) on pre-service debts when they subsequently become active duty Servicemembers (and their spouses and dependents) that are on active duty at the time of indebtedness Interest rate cap & calculation Interest including fees, such as late fees or other transactions fees, capped at 6% Interest including fees capped at 36% MAPR MAPR calculation Includes interest and fees plus the following additional charges (if applicable to the transaction): o Credit insurance premiums/fees o Debt cancellation contract fees o Debt suspension agreement fees o Fees associated with ancillary products o Application and/or participation fees (with exception for once per 12 month period application fees imposed by Federal credit unions or insured depository institutions on short-term, small dollar loans) Closed-end credit follows the Regulation Z APR calculation but includes the applicable charges Open-end credit follows the Regulation Z effective APR calculation but includes the applicable charges (No fees or charges may be imposed on zero balance accounts unless it is a covered participation fee) Disclosures required Disclosure is only required on mortgage loans after 45 days of delinquency (HUD SCRA disclosure) Written format only Either at the time the account is established or when the borrower becomes obligated for the transaction, the following disclosures are required: MAPR statement Payment obligation descriptions Other applicable Regulation Z disclosures Disclosures are required both orally and in a written format the borrower can keep

7 7 Things you should consider doing now Reconsider your strategy Financial institutions need to assess their strategies on how to comply with the requirements and provisions of the MLA. If you are a creditor that directs products and services to members of the military and their families, you should consider including as part of your compliance with the MLA, a plan to identify products and services that would bring value to members of the military while maintaining compliance with the MLA and MAPR requirements. A leading practice for larger financial institutions is to establish an Office of Military or Servicemember Affairs to promote fair and consistent treatment of servicemembers and their families. Product offerings While at first look, the MLA appears to limit the scope of products that can be offered to a servicemember, it still allows for opportunities to improve a creditor s position and capitalize on this defined market by refining its strategy and evaluating what types of products best meet the unique needs of those serving in the military. This approach can be used to mitigate the MLA compliance risk of having available only standard products that may have elements that would exceed the MAPR if utilized by the borrower. Adapt your operations Each lender should consider making enhancements and changes to their business practices and account processing to comply with amended MLA. Origination decisioning will need to account for an assessment of military status, the servicing systems will need to be enhanced to include monthly calculation of MAPR for openend credit, and the required disclosures will need to be incorporated into the processing of the extension of credit. Systems Many lenders use automated underwriting processes, especially for low-balance and unsecured transactions, that rely on complex algorithms to determine credit eligibility, product types and credit limits. These underwriting systems may need to be updated and enhanced to accept and process data relating to the military service status of applicants, including spouses and covered dependents. Compliance with this will be critical to ensure adherence with the safe harbor provided by the MLA. These system updates should be a top priority for lenders as they are often complex and time-consuming to update. In addition, servicing systems may need to be enhanced to accommodate the need to calculate MAPR on a monthly basis and have the flexibility to make necessary adjustments on a timely basis. Often servicers rely on manual processor intervention, which could lead to errors in computation and non-compliance. Making these updates as part of the strategic plan to comply with MLA may pay dividends in the future. Review of contracts Contracts, including notes and credit agreements, should be reviewed by legal counsel to ensure that prohibited terms are not embedded in loan agreements with military borrowers. This key step can help provide assurance that the contracts remain enforceable under MLA. Training, policies and procedures Spreading awareness of the new provisions and ensuring understanding across the organization is important to overall compliance with MLA. To ensure that the right individuals are ready to comply with the amended MLA rule, lenders and servicers should assess who in their organizations will be impacted by the MLA and ensure they have the proper training and tools including updated policies and procedures and applicable job aids.

8 8 To prepare for internal and external audits, lenders should have a robust process for maintaining evidence of compliance with MLA. For example, as part of the roll-out, lenders should consider including guidelines and a process for formalizing document retention. Formalize compliance monitoring and testing Integration with SCRA programs While the differences between MLA and SCRA have been highlighted, integration of the two programs may be advisable to create a center of excellence in military lending. This strategic approach could help a lender or servicer provide consistent and reliable service to members of the military as well as share institutional knowledge. As with any regulation or rule change, lenders must incorporate the amended requirements into their compliance monitoring and testing universe. This will be necessary both to ensure timely and accurate implementation of the new rule and to promote go-forward identification of risks and control deficiencies that may arise from the MLA and associated processes.

9 9 Additional information Consumer Finance Group Financial Services Regulatory Practice Jonathan Odom Partner Anthony Ricko Principal Scott Lutz Senior Manager Nicole Anderson Director Sara Van Zuilen Manager Brandi Morales-Espinal Manager Additional contributor to this piece: Brittany Taylor Follow us on 2016 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. PwC US helps organizations and individuals create the value they re looking for. We re a member of the PwC network of firms in 158 countries with more than 180,000 people. We re committed to delivering quality in assurance, tax and advisory services. Tell us what matters to you and find out more by visiting us at

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