In response to an increasing number of questions from loan servicers as the Making Home Affordable Modification Program ("HAMP") has ramped up, the Board of Governors of the Federal Reserve System has issued guidance to address the question of whether a denial of a loan modification with respect to borrowers not in default constitutes an "adverse action" for purposes of Regulation B (Equal Credit Opportunity). Regulation B makes clear that such notice requirements are inapplicable to borrowers in default (Reg. B, § 202.(c)(2)(ii)); however, see the discussion below for a major caveat in that regard.

The Federal Reserve letter outlines the following four-part procedure for analyzing whether the declination of a HAMP or other loan modification constitutes an adverse action:

First, is there an extension of credit? Under a HAMP trial period plan or modification, the servicer extends the right to defer payment of a debt by capitalizing accrued interest and certain escrow advances, reducing the interest rate, extending the loan term, and/or providing for principal forbearance. According to the FRB, these actions constitute an extension of credit. See, 12 C.F.R. § 202.2(q).

Second, is there an application? Under Regulation B, an "application" means "an oral or written request for an extension of credit that is made in accordance with procedures used by a creditor for the type of credit requested." 12 C.F.R. § 202.2(f). Utilizing this definition, the FRB has concluded that if a borrower has submitted sufficient information for the mortgage loan to be evaluated under HAMP guidelines, then the borrower has submitted an "application" for an extension of credit.

Third, was the application for extension of credit declined? Under Regulation B, an "adverse action" includes "a refusal to grant credit in substantially the amount or on substantially the terms requested in an application." 12 C.F.R. § 202.2(c)(1)(i). Evaluation of a borrower's information according to HAMP guidelines and declination of the request constitutes an adverse action and the decision must be communicated to the borrower pursuant to Regulation B's adverse action notice requirements at 12 C.F.R § 202.9.

Fourth, was the borrower currently delinquent or in default ? Under Regulation B, a creditor is NOT required to provide an adverse action notice to a borrower whose account is currently delinquent or in default. 12 C.F.R. § 202.2(c)(2)(ii). However, although Regulation B may not require the adverse action notice be sent to such a borrower, the HAMP does require a Borrower Notice to be sent to every borrower that has been evaluated for HAMP but not offered a loan modification, according to directives issued by the Treasury Department in connection with HAMP. The most recent of these directives is Supplemental Directive 09-08, effective January 1, 2010, which states: "A servicer must send a Borrower Notice to every borrower that has been evaluated for HAMP but is not offered a Trial Period Plan, is not offered an official HAMP modification, or is at risk of losing eligibility for HAMP because they have failed to provide required financial documentation. The written notices must comply with all laws, rules and regulations including but not limited to, the Equal Credit Opportunity Act, when applicable to the transaction." (Emphasis added.)

In short, notwithstanding that Regulation B does not require adverse action notices be delivered to borrowers already in default, servicers in HAMP must give the appropriate notice, irrespective of whether the borrower is in default or not. Failure by a HAMP servicer to provide such a notice could result in a loss of eligibility for that servicer to participate in HAMP.