Adverse Action... What's the Reason?
Recently, my colleague published a compliance blog post discussing when to send an adverse action notice. You can read that blog here. As such, I thought it may be helpful to discuss the content of the notice. The Compliance Team here at America’s Credit Unions often gets questions regarding what reason(s) should be used on an adverse action notice. First, it’s important to note that, while we cannot provide legal advice or advise credit unions on the specific reason(s) they should use in particular circumstances (credit unions may want to consult with legal counsel), this blog’s purpose is to provide a helpful starting point.
To start, section 1002.9(a)(2) of Regulation B outlines the required content of adverse action notices:
“(2) Content of notification when adverse action is taken. A notification given to an applicant when adverse action is taken shall be in writing and shall contain a statement of the action taken; the name and address of the creditor; a statement of the provisions of section 701(a) of the Act; the name and address of the Federal agency that administers compliance with respect to the creditor; and either:
(i) A statement of specific reasons for the action taken; or
(ii) A disclosure of the applicant's right to a statement of specific reasons within 30 days, if the statement is requested within 60 days of the creditor's notification. The disclosure shall include the name, address, and telephone number of the person or office from which the statement of reasons can be obtained. If the creditor chooses to provide the reasons orally, the creditor shall also disclose the applicant's right to have them confirmed in writing within 30 days of receiving the applicant's written request for confirmation.” (Emphasis added).
Under the above, a credit union is permitted to provide either a statement of specific reasons or they can provide a disclosure that the applicant has the right to a statement of specific reasons. Paragraph (b)(2) addresses the statement of specific reasons requirement:
“(2) Statement of specific reasons. The statement of reasons for adverse action required by paragraph (a)(2)(i) of this section must be specific and indicate the principal reason(s) for the adverse action. Statements that the adverse action was based on the creditor's internal standards or policies or that the applicant, joint applicant, or similar party failed to achieve a qualifying score on the creditor's credit scoring system are insufficient.”
As you can see, the statement of reasons must be specific and must indicate the principal reason(s) for the adverse action. Furthermore, the statement of specific reason(s) cannot be that it was based on the credit union’s internal standards or policies, as this would be insufficient under the rule. Additionally, the commentary to this section further clarifies that “a creditor need not describe how or why a factor adversely affected an application. For example, the notice may say ‘length of residence’ rather than ‘too short a period of residence.’”
It may also be helpful to review Appendix C to Part 1002. Specifically, Form C-1 contains a sample list of principal reasons for credit denial, termination, or other action taken concerning credit that may be helpful. Below is an excerpt of Form C-1 with examples of principal reasons for adverse action:
“Part I—Principal Reason(s) for Credit Denial, Termination, or Other Action Taken Concerning Credit
This section must be completed in all instances.
____Credit application incomplete
____Insufficient number of credit references provided
____Unacceptable type of credit references provided
____Unable to verify credit references
____Temporary or irregular employment
____Unable to verify employment
____Length of employment
____Income insufficient for amount of credit requested
____Excessive obligations in relation to income
____Unable to verify income
____Length of residence
____Temporary residence
____Unable to verify residence
____No credit file
____Limited credit experience
____Poor credit performance with us
____Delinquent past or present credit obligations with others
____Collection action or judgment
____Garnishment or attachment
____Foreclosure or repossession
____Bankruptcy
____Number of recent inquiries on credit bureau report
____Value or type of collateral not sufficient
____Other, specify: ______”
Credit unions should note that, if the credit union checks a reason in the above list, the reason must be accurate for the individual consumer’s situation. Comment 4 to Appendix C states, in part, that:
“If the reasons listed on the forms are not the factors actually used, a creditor will not satisfy the notice requirement by simply checking the closest identifiable factor listed. For example, some creditors consider only references from banks or other depository institutions and disregard finance company references altogether; their statement of reasons should disclose “insufficient bank references,” not “insufficient credit references.” Similarly, a creditor that considers bank references and other credit references as distinct factors should treat the two factors separately and disclose them as appropriate. The creditor should either add such other factors to the form or check “other” and include the appropriate explanation.”
Credit unions that use “AI” in their decision making should especially take note of the requirement for specificity. This CFPB Circular discusses adverse action notices when AI or complex algorithms are involved. The Circular notes that, even if a credit union uses a complex or “black-box” algorithm, the credit union must provide clear and accurate reasons for the denial regardless of whether it understands the algorithm.
Alternatively, as previously mentioned, credit unions can provide a notice without specific reasons if they include a statement about the member’s right to request the specific reasons, as well as the process for doing so. Form C-5 is a sample notice of disclosure of the right to request specific reasons for credit denial.
Ultimately, credit unions may need to make risk-based decisions, based on the specific facts at hand, regarding the statement of specific reasons for an adverse action.
The Compliance team has released the compliance calendar, a member benefit resource, which includes important compliance dates for regulatory rulemaking. The calendar includes dates, brief summaries, and compliance resources for outstanding rulemakings that are in progress as well as a list of pending regulations.
