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BirdsEye View

fair lending or fair banking

Compliance has always been part of the requirements of our license to operate is more important than ever. If we want to be a bank we must be compliant, pay FDIC insurance, etc. Fighting "city-hall" doesn't make much sense in most instances at this point. The order of the day is to find out what it takes to comply, and do it with the least cost and disruption to the customer experience and daily operations.

With that in mind, the article below outlines the recent shifts in the importance and expectations of Fair Lending Compliance, and what you can do to prepare for your next Fair Lending exam. The firm of Buckley Sandler has produced the materials underlying this article, and is an expert on this subject.

Fair Lending enforcement is now a stated priority of AG Holder and his assistant for Civil Rights Perez. Department of Justice (DOJ) is the principal federal law enforcement agency who is responsible for enforcing EQOA (Equal Credit Opportunity Act) and Fair Housing Act (FHA).

DOJ has established a Fair Lending Unit, staffed with twenty attorneys, economists and a statistician. It has established a new position -- Special Counsel for Fair Lending, and continues to build capacity to address Fair Lending issues. The scope of the activities has been broadened to include consumer lending, auto lending (including indirect auto) and credit cards. In instances where the bank relied on third party activities, such as indirect auto or credit bureau reporting, the bank is held accountable for any discriminatory results of such activities.

As of 6/1/11 DOJ has 60 open matters and more than fifteen ongoing investigations involving allegations of discriminatory lending in several areas:

  • Discretionary pricing
  • Redlining in either marketing and lending
  • Reverse redlining in either marketing and lending
  • Steering of minority borrowers to less favorable loans
  • Marital status/gender/age lending discrimination

In today's brave new world, regulators are required to refer matters to DOJ when they have reason to believe or suspect (but not necessarily firm evidence) there is a pattern or practice of discrimination. As a result, DOJ's Civil Rights Division received more referrals on this subject in 2010 from the regulatory agencies than in the last twenty years. In addition, a Financial Fraud Enforcement Task Force has been formed to facilitate cross-agency collaboration and ensure aggressive, coordinated enforcement, as per Mr. Perez.

Most DOJ investigations follow FDIC referrals. Altogether the agencies referred 49 cases to DOJ in 2010; 26 involved race of national origin discrimination claims, vs. 30 such referrals for the 8 years 2000-2008. The prosecution criteria they use are:

  • The discrimination practice could cause serious financial or emotional harm to members of protected classes
  • The practice is unlikely to cease without court action
  • Full compensation is unlikely without court action
  • The case might set an example for the entire industry through punitive damages that will deter lenders from treating restitution as a cost of doing business or address and important issue
  • Not all referrals result in DOJ action. Some referrals are returned because the practice has ceased and there is little chance it will be repeated, or because the practice was accidental in the first place. For example, in 2010 DOJ returned 28 of the 47 bank regulatory agency referrals.

The DOJ process is lengthy and thorough. Once a referral is received, they typically ask for more information, giving the bank an opportunity to be an advocate and explain. Once the response is reviewed, the referral is either returned to the regulator or a letter "authorizing to sue" is issued. If that letter is received, you can still negotiate a settlement of the claim, but it will become a public consent decree settlement with the filed lawsuit.

There are currently seven cases with authorizations to be filed against financial institutions in a pre-suit negotiation. Confidentiality agreements are signed pre-negotiations to ensure DOJ methodology and their analyses is remain confidential.

DOJ is using one overreaching legal theory to prosecute their cases: There is disparate impact under FHA and ECOA. This applies even to policy or practice that is, on its face, neutral, but somehow results in disparate impact on protected classes. It also applies in situations where there appears to be no reasonable business purpose for the policy or practice.

In cases of discriminatory pricing (which might result even from risk-based pricing and credit scoring), DOJ prepared regression analysis of the pricing differential between allegedly similarly situated white borrowers and minority borrowers. They select the pairings and then conduct the analysis, using the disparate impact theory. There is zero tolerance here, no acceptable "threshold" of disparity, even though regression analysis can't capture all factors relevant in discretionary pricing systems. Ultimately, this is an attack on the exercise of discretion in mortgage pricing or pricing of other consumer and small business loans.

In cases of redlining, the cases are built on the location and nature of the bank's marketing or branching efforts, claiming they are insufficient in minority neighborhoods. The disparate impact theory here compares the bank's results to "peer group: analysis and HMDA data market penetration analysis. Additional allegations pertain to CRA Assessment Areas that allegedly are drawn deliberately to exclude minority neighborhoods. DOJ disregards the CRA ratings when making decisions on these issues.

Two cases were filed and settled simultaneously in 2010. Both alleged that African-American borrowers were charged higher prices for wholesale loans in violation of ECOA and FHA, asserting disparate impact theory. AIG settled for $6.1 million to the borrowers. It was the first time a bank was held liable for broker activity and for failure to supervise wholesale brokers.

A more recent settlement with Nixon State Bank to resolve allegations that the bank violated ECOA by charging higher prices on unsecured consumer loans made to Hispanic borrowers from 2006-2009. DOJ alleged that the bank didn't maintain written loan pricing guidelines for these loans until mid-2009, and that the bank's loan officers were granted broad discretion in handling all aspects of the unsecured consumer loans, which resulted in disparate impact.

The bank agreed to:

  • Revised its pricing policies
  • Monitor loans for potential disparities based on national origin
  • Pay approximately $100,000 in restitution
  • Train all employees on ECOA

Nixon State Bank has $71 million in assets and is the seventh oldest state-chartered bank in Texas. There are similar stories, but one will suffice...

Since Dodd-Frank and the CFPB, new expectations have been set for banks over $10B. I believe these expectations will be eventually applied to all banks. HUD continues to enforce FHA, but the Bureau might conduct joint investigations with HUD and DOJ on Fair Lending matters.

As we look forward, some of the emerging risks that banks need to be thoughtful about include:

  • Effect of consumer lending contraction and higher lending standards on minority access to credit
  • Significantly increased federal regulatory and enforcement focus on all lending activities
  • Merger of discrimination issues with "unfairness" issues. Regulators now define "unfairness" very broadly. UDAP enforcement actions are rising, and the emphasis is on "A" (Abusive), which is a judgment call. Dodd-Frank does spell out anew "abusive" practices standard which goes well beyond disclosure compliance, but your regulator might go further still.
  • Fair Lending examinations are expanding:
    • They are longer and more extensive
    • They include all types of lending
    • They evolved from traditional areas of focus such as judgmental underwriting and discretionary pricing to include the ENTIRE LOAN LIFECYCLE (including servicing and collections)
    • They include liability for third party originators and servicers
    • Regulators are probing issues relative to unfair and deceptive servicing practices in examinations
    • Foreclosures and bankruptcy filings are being challenged by various entities
    • State AGs are very active in litigation and investigation of mortgage servicers
    • Examinations focus especially on workout procedures and other foreclosure prevention measures; they evaluate fairness with respect to protected class borrowers that are pushed into foreclosure too quickly

I know this is disheartening, but suggest this is the environment within which we operate today. It will change in the future, but not in the coming couple of years. The best medicine here is an ounce (or pound) of prevention. Monitor and enhance your policies and procedures in areas that are most likely to be subject to regulatory scrutiny:

  • Pricing and credit risk policies
  • Any discretion in loan origination decisioning and pricing must be carefully managed through appropriate controls
  • Loss mitigation policies must be carefully written and discretion tightly managed
  • Documentation needs to be robust and complete, particularly when exceptions are involved.
  • Assign Fair Lending responsibility within each line of business
  • Conduct thorough fair lending risk assessment at least annually
  • Utilize statistical techniques to develop your own pairings and ensure no unintended disparate impact result
  • Provide clear guidance and training expectations for third parties; review then for compliance carefully and frequently
  • Prioritize procedural and Fair Lending compliance training for all personnel, given the new emphasis on loan life cycle; utilize attorney-client privilege for identified risks going forward
  • Analyze HMDA data at least annually and understand it
  • Monitor all consumer complaints, no matter how frivolous, and handle with care; analyze trends and handle issues timely
  • Conduct self-assessment on loan modification data to ensure no disparate impact by race, national origin and other protected bases; analysis should include a range of workout possibilities
  • Document thoroughly