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Documentation: Necessary For Everything
Loan documentation has been a rallying cry in the arena of fair lending for some time. The Department of Justice has taken the position, when there are questions about lender decisions in a loan file, that "if you didn't document it, you didn't do it." Alternatively, if you didn't document to prove you did it right, you did it wrong.
Predatory lending is often defined as making loans to borrowers who lack the resources to repay the loan - and failing to note that fact. Safety and soundness concerns about sub-prime lending are raised when the examiner is unable to determine the applicant's ability to repay from the information in the loan file.
And when it comes to complying with the Bank Secrecy Act, the lender should know what use will be made of the loan proceeds.
The common denominator to these and other concerns is poor documentation. The solution to all of these issues is careful and accurate documentation of loans. The challenge for financial institutions is establishing a standard of regular or minimum loan documentation and then maintaining that standard.
What should be documented?
In addition to the borrower's name and the loan type, the most important information to document in a loan file is the borrower's income. The file should show the amount of income and include some indication of how income was verified.
Income documentation is critical for a variety of purposes. The basic, of course, is safety and soundness. Without evaluating how a loan will be repaid, how can the lender assure the institution that the loan is safe and sound?
Income evaluation is also significant in fair lending. The borrower's income and other core credit qualifications is what the lender should be considering. Documentation of income is one way to demonstrate that the evaluation was fair and non-discriminatory. It can also demonstrate technical compliance with Regulation B's income treatment rules. When a loan file shows consideration of pertinent credit qualifications, an investigator or examiner has a comfort level that the lender looked at and considered pertinent elements of creditworthiness rather than prohibited bases.
Similar concerns arise from predatory lending allegations. The single definition of predatory lending on which everyone agrees is that if the borrower lacks the income to repay the loan, it is a predatory loan. The very documentation that enables a lender to survive a fair lending examination also provides the lender with the information needed to respond to a charge of predatory lending.
Closely related to predatory lending are the concerns of examiners when an institution makes sub-prime loans. Loans to sub-prime borrowers are, by their very nature, riskier than loans to prime borrowers. Examiners want to see that the lending decisions were made carefully and based on solid information.
Next, the file should indicate an analysis of the borrower's obligations. The key to non-predatory lending is making loans within the ability of the borrower to repay. Income and obligations are both essential to evaluate the ability to repay. Other information used to evaluate the application, including credit reports and follow-up on any questions raised in the report or the application, should be present and explained in the file.
Finally, there should be a statement, however brief, of the loan purpose. This means that the file should contain a statement of what the borrower intends to do with the loan proceeds. This information is relevant to safety and soundness considerations, but it is essential information for compliance with the Bank Secrecy Act. Lenders should have knowledge of where money is going and how it will be used when it leaves the institution.
Tools for documentation
Documentation does not need to be fancy. The information can be concise. A simple form will do the trick - as long as the lenders fill out the form.
Loan officer worksheets are familiar to all lenders. Most institutions have some form of lender worksheet. Most of the worksheets have the information needed for compliance documentation. The problem is that lenders don't use them. If you use worksheets to document loan underwriting, be sure to maintain the clear expectation that a "good loan" is one with proper documentation.
More advanced techniques include use of software such as Excel. These can be developed in a shell form and provided to lenders. Using a software form can have the advantage of doubling as a loan committee memo. Serving this double purpose is a way of minimizing what is perceived as "extra" work for compliance while providing the institution with consistent documentation.
Automated underwriting systems may create the documentation. As underwriters enter the information into the system, the documentation system is created. However, this system is dependent on collecting the information first. And there are also situations when a "notes" box should contain information.
Whatever system you use, lenders should not be allowed to skip steps or make assumptions. When that happens, you have documentation deficiencies that will haunt you. The compliance bottom line should be the loan officer's bottom line. Poorly documented loans should count against the loan officer's performance evaluation.
ACTION STEPS
- Review a sample of loan files and compare the amount and placement of documentation in each file. Give special attention to differences in documentation.
- Look through the existing forms and worksheets that lenders do (or should) already use. Consider how these worksheets could be revised (if needed) to provide adequate and consistent loan documentation.
- Meet with lenders to discuss documentation methods. Explain the purpose of documentation and get their views on methods that will work.
- Consider how many compliance requirements can be met with one worksheet. For example, HMDA and CRA information can be gathered on a lender's worksheet.
Copyright © 2002 Compliance Action. Originally appeared in Compliance Action, Vol. 7, No. 12, 10/02
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