Show Me the Numbers: A Guide to California’s New Financial Disclosure Laws
by Paul Bent Monitor 101 2021
Paul Bent of The Alta Group provides a somewhat snarky explainer on new and expanding financial disclosure regulations in the state of California and what they’ll mean for the equipment finance and leasing industry at large.
Paul Bent, Senior Managing Director, The Alta Group
There is no doubt you’re aware that California, the bastion of financial rules and regulations (and my home state), has once again enacted legislation affecting equipment leasing and finance. And because it is the country’s most populous state and largest economy, what is happening in California is already having an impact across the U.S.
The new California legislation requires various consumer-friendly financial disclosures to be included in writing and separately signed for most non-bank commercial financings of personal property up to $500,000 with borrowers or lessees whose business is principally directed or managed from California. However, although this legislation was passed in 2018 and codified in new Division 9.5, §22800-22804, of the California Financial Code, it has yet to be actually put into effect. That’s because the state agency responsible for enforcing the law, California’s newly renamed Department of Financial Protection and Innovation, or DFPI, is still working out the rules and regulations it will use.
Interestingly, the legislation itself (California Senate Bill 1235 — a number that has become somewhat notorious in the leasing world) is only about four pages long, but the most recent version of the related proposed regulations, version No. 5, runs to about 50 pages of very detailed rules, instructions and requirements that must be followed by lenders and most lessors, who are variously called “providers” or “financers” under the regulations.
Now, there is a section of the regulations specifically addressing “lease financing,” and you may think that financial disclosures here would be pretty straightforward, especially for basic conditional sales, dollar-out leases or EFAs — the kinds of “loans” that most of us are used to in the equipment leasing industry. In these kinds of “loans,” there is an amount of money to be advanced for the purchase of the asset being financed, there’s a period of time over which the money must be repaid, there’s a rate of return or interest (call it a yield if you prefer) on the money and there’s a resulting payment to be due every month. We’ve all done that calculation a thousand times, so it must be pretty simple to “disclose” that information to a lessee, right? You might think so, but don’t be too hasty. The California DFPI doesn’t quite see it that way. Under the currently proposed regulations, which are close to being finalized, the documentation for any capitalized lease deal or loan that falls into this category in California will have to include a whole lot of things you’re most likely not used to including.
Let’s start with the basics. The first should be “the total amount of funds provided,” as stated in the law itself, but something else actually must come first. According to the proposed regulations, “at the top of the disclosure, centered on the page or other display medium [I guess that must mean a website, although that’s not defined in the 50 pages of rules], the provider shall print ‘OFFER SUMMARY FOR’ followed by a one- to five-word description of the type of product offered, which may include the financer’s branding terminology.”
Now that we have that cleared up, what about the actual information you are supposed to disclose? Well, we need to deal with more formatting requirements next. For lease financings, the disclosures have to be presented in a table “consisting of eight rows and three columns.” (Keep in mind that this format is only for lease financings. There are pages of regulations for other types of deals, including closed-end financing, factoring, open-end credit plans, sales-based financings and more.)
Now, what about the actual disclosures? Well, just hold on a minute. Before that, you need to know the term or estimated term of the transaction. If it is more than one year, it must be stated in “units of years and months, with any remaining days expressed as a portion of a month to the nearing two decimal points.” The prior version of these regulations provided a helpful example, in case this is too hard to follow, stating that a term of 400 days “would be disclosed as ‘1 year, 1.33 months,’” but for some reason, this example has now been removed. Frankly, I didn’t find it very helpful anyway; I can’t remember ever doing a deal with a term of 400 days, but you never know. In addition, I don’t know about you, but I’ve done lots of deals in which I’ve had to negotiate down to the last basis point of rate but never one that involved a fraction of a day.
Anyway, back to the important stuff — the rows and columns. It seems that only the second (middle) column of the required eight rows by three columns table actually includes the information you must disclose. Essentially, all the other boxes in the table are names and directions and details dictated pretty much verbatim by the regulations themselves.
For example, the first column in the first row for leases (and remember, this may be different for other types of financing) must contain the words “Funding Provided.” That seems pretty clear, although there’s another section of the regulations that defines “Amount Financed” with respect to closed-end transactions or sales-based financings as “the amount of funds to be provided by the financer to the recipient,” which sounds very similar to me. In any case, it seems as though this is what most of us would call OEC or original equipment cost.
In row two, you must write in column one, “Annual Percentage Rate (APR)” and the corresponding rate must go into column two. This is what you’ve been waiting for. The regulations provide the following helpful language to define the APR you must enter:
The annual percentage rate is a measure of the cost of credit, expressed as a yearly rate, that relates the amount and timing of value received by the recipient to the amount and timing of payments made to the provider.
In case this seemingly lucid definition is not sufficient for understanding what actual number you must put in the column, the regulations refer you to Appendix J of Part 1026 of Chapter 12 of the U.S. Code of Federal Regulations. And that, in case you didn’t recognize it by its official part and chapter numbers, is Regulation Z or the federal Truth in Lending Act. There you will find the joy of learning about both the actuarial method and the United States rule method of computing APR (either of which is apparently acceptable in the state of California).
Of course, if your lease has no “finance charges” in addition to regular monthly rent or lease payments, the APR should be the same as the interest rate you are used to calculating for every deal. But if your lessee is obligated to pay additional amounts, such as administrative fees, set-up fees, documentation fees, origination fees, interim rent, pre-commencement interest and/or hold-over rent, then the APR will not simply be equal to the running rate or basic yield on the deal. In such instances, you may need to find another method for calculating APR or perhaps learn how to add such charges into your trusty HP 12-C or 17-B.
And what about column three of row two? Well, there you must state the following specific language:
“APR is the cost of your financing expressed as a yearly rate. APR incorporates the amount and timing of the funding you receive, fees you pay, the periodic payments you make and the anticipated cost for you to acquire the property at the end of the lease term.
“Your APR is not an interest rate.”
I’m sure you’ve seen such explanations and disclaimers in consumer-oriented documents or contracts. As many of us have predicted for a long time, the consumer financing world has at last truly begun to collide with our equipment leasing and financing paradise.
Now that you’ve disclosed the funding amount and the APR, I’m sure you’re wondering what must go into rows three through eight of the table required by the new California regulations-in-waiting. Row three requires a statement of the “Finance Charge” on the deal, together (in column three) with your own “calculation” of the finance charge, “with the amount and description of each expense included in the finance charge.” This is where you will have to list all of the fees, costs and additional charges the lessee is or will be required to pay in addition to regular monthly payments of principal and interest or “rent.”
In row four you will have to state the “Total Payments” on the deal, meaning the “total amount of payments the [lessee] will make during the term of the contract (including the cost of the purchase option).” That amount includes the total payments the lessee is expected to make during the term “if the [lessee] makes minimum required payments and exercises the purchase option under the agreement.” Of course, the cost of such things as interim rent payments and possible purchase options at different points in time may not yet be known — remember, this disclosure table must be filled out and signed by the lessee before the transaction is executed, but the regulators seem to be leaving that detail for you and your lawyer to work out.
Row five must show the periodic lease payments, and there is a lot of writing in the proposed regulations addressing what to do about variable payments, purchase options and other issues that may make this more complicated than it seems at first glance.
The term of the transaction goes in the sixth row, which actually only requires two columns, the first saying “Term” and the second showing, you guessed it, the term. In prior versions, the regulations did require a third column, which had to say, “This is how long you will make lease payments under the contract,” but the regulators must have realized that borrowers and lessees could probably figure that out for themselves.
Finally, rows seven and eight deal with prepayments — row seven with notification that accrued and unpaid interest that may be charged and row eight with notification that additional finance charges may be due in such an event.
Oh, and the newest regulations also provide for the possibility that periodic payments may not always be monthly. If that is the case in your deal, then a new row has to be inserted between row four and row five showing the words “Average Monthly Cost” in column one, the actual average monthly cost in column two and the following specific language in column three: “Although you do not make payments on a monthly basis, this is our calculation of your average monthly cost based upon the payment amounts disclosed below.”
As I hope you can tell, I have treated this subject rather lightly in hopes of keeping you awake while you read about California’s new financial disclosure regulations. But in reality, they do need to be taken seriously. Although they are not expected to become effective any sooner than early 2022, they are definitely on their way and will certainly be taken seriously by the regulatory authorities in the most populous state in the U.S. Similar disclosure rules and regulations are also being considered and, in some cases, already adopted in other states, so you should keep aware of developments in this changing aspect of equipment leasing.
Treating commercial leases and loan transactions as consumer financing has been coming down the pike for several years, and these “new” SB 1235 regulations are just a further manifestation of that continuing change in our industry.
Editor’s Note: Following the writing of this article in June 2021, yet another draft “modification” of the proposed California SB 1235 commercial financial disclosure regulations was released (dated Aug. 9, 2021). Although these modifications appear not to impact significantly the details outlined in this article, the reader must note that these regulations are subject to change at any time prior to their final codification. For further information and updates, please visit thealtagroup.com/blog.
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