Automated Loan Underwriting System - Segregation of Duties for Loan Officers

June 16, 2020

Rick Wargo, COO
Compliance 4 Credit Unions LLC
449 Eisenhower Boulevard
Harrisburg, PA 17111

RE: Automated Loan Underwriting System - Segregation of Duties for Loan Officers

Dear Mr. Wargo:

You have asked if § 1761c(b) of the Federal Credit Union Act (FCU Act)¹ prohibits a member service representative (MSR) of a federal credit union (FCU) from inputting data into an FCU’s automated loan underwriting system (ALUS) and then disbursing the funds if the ALUS approves the loan. As discussed in more detail below, § 1761c(b) of the FCU Act does not prohibit such a scenario, provided appropriate controls and safeguards are in place to comply with the purpose of this provision of the FCU Act.

FCU Act Section 1761c(b)

Section 1761c(b) of the FCU Act provides, in relevant part, that “No individual shall have authority to disburse funds of the Federal Credit Union with respect to any loan or line of credit for which the application has been approved by him in his capacity as a loan officer (emphasis added).”² NCUA’s long held interpretation is that the purpose of this provision is to segregate loan approval and disbursement duties of the loan officer to decrease the incidence of fraud, embezzlement, and errors. We continue to interpret § 1761c(b) of the FCU Act in this way.

Automated Loan Underwriting System

An ALUS is a technology-driven platform that enables lenders to obtain a computer generated loan decision based on the lender’s own underwriting criteria. These types of systems are becoming increasingly common and are an efficient way to help lenders stay competitive regarding all types of loans. Generally, someone must input data into the system in order for it to generate a decision.

Background

You have informed us that an FCU that you are assisting received an exam finding indicating that the FCU’s use of an ALUS was impermissible under § 1761c(b) of the FCU Act. The exam finding cited NCUA Legal Opinions from 2002 and 2010³ to support this finding. The same FCU MSR that would input a member’s data/information into the ALUS was also disbursing the funds to the member if the ALUS generated an approval of the loan.

NCUA Legal Opinions

The 2002 NCUA legal opinion concluded that it was a violation of § 1761c(b) for an FCU employee who inputs an applicant’s data into an ALUS to disburse approved loan funds. Specifically, the opinion stated that “an employee entering data into an automated underwriting system is responsible for the accuracy of the data and proper use of the system and, as such, the employee is acting as a loan officer and may not disburse the loan.”⁴ The legal opinion reasoned that the potential for fraud or error exists in the use of an ALUS because the result depends on the correct entry of data about a loan applicant. As such, this 2002 opinion concluded that an FCU employee using an ALUS is “functioning as a loan officer and may not disburse a loan the employee has approved.”⁵

The 2010 legal opinion concluded that it is permissible for an FCU to use a fully automated loan underwriting system but reiterated that it is a violation of the FCU Act for an FCU employee to be both the person inputting the applicant’s data into the ALUS and the person who disburses the loan funds.⁶

These opinions conclude that if an FCU employee inputs data into an ALUS and then disburses funds after the ALUS generates a loan decision, then that renders that employee a loan officer. With advances in technology and the ever evolving ways that FCUs operate in today’s modern marketplace, we do not believe that those conclusions continue to be true in all instances.

Analysis

You have indicated that with advances in technology, ALUS programs have evolved since 2002 and 2010. You have represented that with respect to the subject FCU, the MSR entering data into the ALUS is not exercising the analytical or discretionary functions traditionally performed by a typical loan officer.  Rather, you describe the MSR’s duties as simple data processing and an administrative task. Further, you have stated that while the MSR may input the data about the applicant into the ALUS, it is the ALUS, which is based on the underwriting criteria established by the FCU, which applies the underwriting criteria and renders a loan decision. In fact, some MSRs inputting data may not even know what the FCU’s underwriting standards are.

You have asserted that the MSR serves as an administrative functionary only, not as what the FCU Act contemplates as a loan officer. The FCU Bylaws provide the following description of a loan officer’s duties, including his or her duties with respect to an ALUS:

Section 2. Loan officer duties. For each loan, the loan officer must review the character and financial condition of the applicant and their surety, if any. The loan officer will ascertain the applicant's ability to fully and promptly repay the loan. The credit union may use an automated loan processing system to conduct this review, subject to the conditions set forth in Section 3, below. Where appropriate, the loan officer should provide, or refer applicants to, financial counseling assistance.

Section 3. Unapproved loans prohibited. The loan officer must approve all loans. Loan terms and rates must comply with applicable law and regulations. If the credit union uses an automated lending system, the loan officer must review all loan applications the system has denied, and review at least a sample of approved loans to screen for fraud and ensure the automated system is functioning within the lending policies the board has established.⁷

As noted above, a loan officer is responsible for reviewing the character and financial condition of an applicant and ascertaining that person’s ability to fully and promptly repay the loan. The loan officer must also take the discretionary action to provide to or refer an applicant to obtain elsewhere financial counseling assistance. Further, the loan officer is responsible for having the skills and knowledge to: 1) make certain that loan terms and rates comply with applicable law and regulations; and 2) screen for fraud and ensure the ALUS is functioning within the FCU’s established loan policies by reviewing all loans denied by the ALUS and reviewing a sample of loans approved by the ALUS. In your scenario, you have represented that the MSR is conducting data entry and disbursement functions only, but not performing any of the loan officer duties described in the FCU Bylaws.

We cannot confirm that your assertions would be true in all situations. However, we believe that the subject scenario you articulate could comply with the purpose of § 1761c(b) of the FCU Act to prevent fraud and errors in the loan processing context by separating the loan approval and disbursement functions if certain safeguards were in place to assure that the MSR is not functioning as a “loan officer.”

Such safeguards could include, but would not be limited to, establishing internal controls and official procedures that: 1) strictly limit the MSR’s duties in the ALUS context to data processing and other necessary administrative functions that are separate and distinguishable from loan officer duties; 2) develop internal procedures to maintain a segregation of duties between the MSR and the loan officer outside of the ALUS function so there is no confusion about what duties each performs; 3) establish internal checks and balances to: a) effectively monitor that MSRs are correctly inputting data into the ALUS and correctly disbursing funds based on ALUS credit decisions; and b) detect any instances of fraud or embezzlement; and 4) exclude MSRs from any involvement with the ALUS other than effectuating accurate data input and proper disbursements.

Please contact us if you have any further questions.