Pub. 9 2014-2015 Issue 3

September | October 2014 23 Extraordinary Service for Extraordinary Members. D OES YOUR BANK HAVE A POLICY OF ADDING THE BALANCE of a charged-off deposit account to the principal of a loan the customer has at your bank? If so, you’re not alone; however, this course of action could easily cause your bank many regulatory headaches. A policy such as this presents a minefield of issues that must be addressed, including contractual language; unfair, deceptive, or abusive acts or practices (UDAAP); safety and soundness issues; and compliance issues (disclosures). Below we highlight just a few issues presented by this policy in light of the continued regulatory focus on overdraft programs. 1. With respect to overdrafts, banks need to follow Gen- erally Accepted Accounting Principles (GAAP) and the Call Report guidelines, and should be reporting 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 Federal Financial Institutions Examination Council (FFIEC) requires that an overdraft be charged off against the current year’s income when the account is overdrawn for 60 days, as stated in the FFIEC guidance on over- drafts. Paying off an overdraft by adding principal to an exist- ing loan effectively 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 capitalizing 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 its counsel to determine its rights and remedies with respect to the specific loan. Often, banks assume there is a provision in the loan agree- ment permitting this. Rather than assuming, the bank should carefully read the loan agreement to determine if this is accurate. Keep inmind, this action would not be considered in the same category as force placement of insurance. 3. A question also exists of whether disclosures are nec- essary under Reg Z prior to converting the balance of the overdraft to a loan that accrues interest. As a Don’t Let a Charged-Off Checking Account Become a Minefield Darlia Fogarty, Director of Compliance, Compliance Alliance  Minefield — continued on page 24