Regulatory Intelligence Briefing A New Era of Fair Lending

Transcription

1 Regulatory Intelligence Briefing A New Era of Fair Lending August 26, 2015 August 12, 2015 CENTER OF REGULATORY INTELLIGENCE

2 Table of Contents A. Editorial Note from the Managing Director, Center of Regulatory Intelligence... 3 B. Biweekly Washington D.C. Regulatory Roundup... 4 C. Featured Regulatory Intelligence Briefing A New Era of Fair Lending... 6 D. Did You Know? E. About FIS Center of Regulatory Intelligence

3 A. Editorial Note from the Managing Director, Center of Regulatory Intelligence Introduction Fair lending claims can be unpredictable and relentless. This Regulatory Intelligence Briefing (RIB) is geared towards providing lenders with a forecast of what is on the fair lending horizon and equipping lenders with the intelligence needed to survive an unpredictable regulatory landscape. In this RIB, we will address the risks of noncompliance, the Consumer Financial Protection Bureau s (CFPB s) approach to fair lending issues and the recent Supreme Court Case of Texas Department of Housing and Community Affairs. We will also review high profile actions in 2015, along with the lessons learned from those actions, how to put those lessons into action and enforcement trends to come. Banks and financial institutions know that fair lending is not an easy concept; it is an inherently complex and constantly evolving area of risk. It is back in the forefront a much higher risk component that deserves more of an institution s time and resources. The CFPB, now in its fourth year of existence, along with its Office of Fair Lending and Equal Opportunity, continues the effort to ensure that all borrowers receive equal access to credit and credit protections. The Office of Fair Lending, which strives to ensure fair, equitable and nondiscriminatory access to credit for all Americans, has been working hard to meet this goal. This is evidenced by the supervisory and public enforcement actions that provided approximately $224 million in monetary relief to about 303,000 consumers in 2014 alone (the most recent year for which yearly data is available). Fair Lending can cause strategic implications for all business areas. Financial institutions may think that they do not have a fair lending concern with the products or services that they offer until such time as they are informed that the regulators have identified an issue. When the regulators identify an issue, they may make a referral to the Department of Justice (DOJ), and then the financial institution is looking at the possibility of a much larger, more time-intensive and more costly problem. We want to be your strategic and trusted business partner and assist you in navigating evolving examiner expectations with regard to fair lending. We hope that by reading this RIB, you will increase your awareness of recent developments and activities with regard to fair lending so you can evaluate your institution s practices and take action if necessary. In our next RIB, we will focus on Unfair, Deceptive or Abusive Acts or Practices (UDAAP), with a particular focus on emerging risks, the latest enforcement action trends and regulatory examination high-risk focal points. Peter D. Dugas Managing Director, Center of Regulatory Intelligence Peter has over 16 years of government and consulting experience in advising clients on supervisory matters before the U.S. Government and in the implementation of enterprise risk management programs. He is a thought leader in government affairs and regulatory strategies in support of banks and financial institutions compliance with the Dodd- Frank Act and Basel Accords. Prior to joining FIS, he served as a Director of Government Relations at Clark Hill and in senior government positions, including serving as a Deputy Assistant Secretary at the U.S. Department of the Treasury. 3

4 B. Biweekly Washington, D.C. Regulatory Roundup Regulatory and Compliance Alerts CFPB Bulletin on Cancellation of Private Mortgage Insurance On August 4, 2015, in a Bulletin, the CFPB provided guidance to mortgage servicers regarding the cancellation and termination of private mortgage insurance (PMI). PMI protects the lender if the borrower stops making payments on a loan. Lenders generally require consumers with a down payment of less than 20% to purchase PMI. The PMI premiums are added to the borrower s monthly mortgage payment. The Homeowners Protection Act of 1998 requires lenders to cancel PMI when the level of borrower equity in a home increases. The Bureau has identified substantial industry confusion over the implementation of PMI cancellation and termination requirements. The purpose of the Bulletin is to clarify the existing PMI cancellation rules; it does not impose new requirements. OCC Guidance on Risk Management of Financial Derivatives On August 4, 2015, in a Bulletin ( ), the Office of the Comptroller of the Currency (OCC) clarified its expectations regarding the extent to which national banks and federal branches or agencies of a foreign bank may make or take delivery of a physical commodity to hedge commodity derivative transactions. Specifically, the Bulletin provides calculation guidance for determining whether physical hedging activities are a nominal portion of risk management activities. OCC considers physical hedging positions of a bank to be nominal only when they are no more than 5 percent of the notional value of the derivatives that are in that same particular commodity and allow for physical settlement within 30 days. This Bulletin supplements Banking Circular 277 (BC-277), "Risk Management of Financial Derivatives" (October 27, 1993). As described in BC-277, a bank that satisfies certain conditions may engage in physical commodity transactions (for example, by buying or selling title to a commodity via a warehouse receipt or bill of lading) to manage the risks of commodity derivatives. One condition is that the physical commodity transactions constitute a nominal percentage of the bank s risk management activities. BC-277 does not, however, detail what percentage of risk management activities is "nominal," nor does it provide a calculation methodology for this condition. This bulletin provides that supplemental information. The OCC expects a bank that plans to engage in such activity to present a detailed plan and to obtain prior written nonobjection from OCC supervisory staff before proceeding. OCC Guidance on Tax Refund Products On August 4, 2015, in a Bulletin ( ), the OCC issued guidance outlining safety and soundness measures that national banks and federal savings associations should follow when offering tax refund-related products. This guidance replaces OCC Bulletin (February 18, 2010), which transmitted "OCC Policy Statement on Tax Refund-Related Products." This guidance outlines safety and soundness measures for OCC-supervised banks that offer tax refund-related products. The measures include: Ensuring that the board of directors maintains sound risk management policies, procedures and practices to oversee all tax refund-related products 4

5 Implementing effective internal controls and review standards for advertising and solicitations Providing appropriate disclosures that explain material aspects of the products to consumers Implementing appropriate due diligence and adequate procedures to ensure that tax refund-related products provided by third parties comply with applicable guidance Ensuring that Bank Secrecy Act (BSA) compliance risk management systems cover tax refund-related products Providing training programs (including certification processes) that address regulatory requirements, internal policies and procedures and responsibilities for maintaining an effective compliance program Maintaining adequate capital and liquidity levels Developing timely and accurate management information systems for tax refund-related products Ensuring compliance with all applicable laws and regulations, including those involving consumer protection Agencies Provide Additional Guidance on Resolution Plans On July 28, 2015, in a joint press release, the Federal Reserve Board (FRB) and the Federal Deposit Insurance Corporation (FDIC) published guidance for 119 firms that will be filing updated resolution plans on or before December 31, Based on a review of plans submitted late last year, the agencies are tailoring the requirements for the final submissions. Some firms will receive individual feedback on areas for improvement. Bank holding companies with total consolidated assets of $50 billion or more and nonbank financial companies designated by the Financial Stability Oversight Council as systemically important must periodically submit resolution plans to the regulators. Each firm must submit a plan for rapid and orderly resolution in the event of material financial distress or failure of the company. One hundred fifteen U.S. bank holding companies with less than $100 billion in total nonbank assets and foreign-based firms with less than $100 billion in U.S. nonbank assets were required to file a second resolution plan with the agencies in December 2014, and four foreign-based firms were required to file an initial resolution plan. Legislative Activity Congress will return on September 8,

6 C. Featured Regulatory Intelligence Briefing A New Era of Fair Lending Introduction This year, we have seen fair lending thrust back into the spotlight by a highly publicized U.S. Supreme Court case, as well as several high profile enforcement actions and trends in examination findings. In this briefing, we recap what are the strategic impacts if fair lending risks are not managed, provide analysis on the U.S. Supreme Court case and highlight the risks emerging from recent enforcement actions and regulatory examinations. We conclude with what are risk management best practices to stay ahead of the curve given the recent developments. Fair Lending s Strategic Implications Illegal Lending Discrimination Fair lending claims stem from a number of federal and state laws, most notably the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA), which prohibit lenders from discriminating against credit applicants based on race, color, religion, national origin, sex, marital status, familial status, handicap, age, income from public assistance and the exercise of rights under the Consumer Credit Protection Act ( prohibited bases ). The courts have recognized three methods of proof of lending discrimination under ECOA and FHA: Overt discrimination, when a lender blatantly discriminates on a prohibited basis. Disparate treatment, when a lender treats applicants differently based on one of the prohibited bases. Disparate impact, when a lender applies a practice uniformly to all applicants, but the practice has a discriminatory effect on a prohibited basis and is not justified by business necessity. Implications of Fair Lending Violations If a federal regulatory agency (i.e., FDIC, FRB, OCC, NCUA or CFPB) identifies a reason to believe that a lender has engaged in a pattern or practice of discrimination in violation of ECOA or FHA, the agency must refer the ECOA violations to the DOJ and the FHA violations to HUD. The DOJ will then decide whether to investigate and prosecute or return the referral back to the agency for administrative resolution. HUD will also investigate and decide whether to prosecute. Any pattern or practice of discrimination will result in downgrade in compliance and CRA ratings (for banks), possible assessment of civil money penalties and restitution to affected credit applicants or borrowers. Downgrade of CRA rating for a bank will result in delay or denial of corporate application for approval for merger, acquisition, launch of new line of business or other strategic growth initiative. Negative publicity or community activist group protests may lead to adverse impact to the lender s reputation and loss of business. 6

7 DOJ Referrals Leading the charge in fair lending enforcement is the CFPB and its Office of Fair Lending and Equal Opportunity, which is designed to collaborate with divisions and offices across the agency to ensure that there is fair, equitable and nondiscriminatory access to credit for all consumers. In 2012, the CFPB entered into a memorandum of understanding (MOU) with the DOJ regarding fair lending referrals. Under the MOU and ECOA, the CFPB must refer matters to the DOJ when the CFPB has reason to believe there is a pattern or practice of lending discrimination under ECOA. CFPB Director Richard Cordray recently reaffirmed the agency s commitment to eradicating discriminatory lending practices: We will continue to root out illegal discriminatory lending practices in the marketplace. I look forward to working closely with our partners at the Department of Justice to ensure consumers are treated fairly. CFPB Press Release, May 28, Lending Referrals to DOJ by Agency Source: The U.S. Attorney General s 2014 Annual Report to Congress Pursuant to the Equal Credit Opportunity Act Amendments of 1976 A report recently issued by the U.S. Attorney General s Office highlights that the CFPB referred five times more fair lending cases to the DOJ in 2014 than the FDIC (2014 Annual Report to Congress Pursuant to the Equal Credit Opportunity Act Amendments of 1976, April 2015). At the end of 2014, the DOJ had 25 open fair lending investigations. In nine of those investigations, the parties were engaged in pre-suit negotiations. Nonbank Risk CFPB referrals are not only limited to banks. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the CFPB has the authority to supervise any nonbank that it has reasonable cause to believe has engaged or is engaging in conduct that poses risks to consumers. The CFPB also has 7

8 authority under the Dodd-Frank Act to supervise certain specified types of nonbanks, regardless of size. These include: mortgage companies (originators, brokers, and servicers, including loan modification or foreclosure relief services), payday lenders and private education lenders. The enforcement examples below highlight that the CFPB is indeed exercising this authority. In fact, nonbanks have been a large focus of CFPB attention this year. Banking Agency Enforcement Actions Banking agencies have also stepped up their focus on fair lending examinations and are uncovering patterns or practices of illegal discrimination, beyond technical violations. In 2014, examinations identified primarily technical ECOA or FHA violations, while in 2015 year-to-date, examinations have uncovered illegal patterns or practices leading to referrals to the DOJ. Most of the referrals have been returned by the DOJ for administrative action, including downgrade of CRA ratings and enforcement actions: 8

9 U.S. Supreme Court Case In addition to the risk of regulatory enforcement, creditors face the risk of litigation. If the case makes it to a federal court, the borrower could receive actual damages, punitive damages, attorney s fees and court costs, which can be monumental. The court can also mandate equitable or declaratory relief, such as ordering the creditor to cease or modify its policies and practices. Texas Department of Housing and Community Affairs v. Inclusive Communities Properties, Inc. The recent, highly publicized U.S. Supreme Court out of Texas made a noteworthy impact on the fair lending landscape as we know it. Let s take a quick look at the case and some key takeaways from the decision. Overview of the Facts The Inclusive Communities Projects (ICP), a nonprofit corporation that helps low-income families obtain affordable housing, brought an action under the FHA against the Texas Department of Housing and Community Affairs (Department). ICP alleged that the Department was supporting segregation by allocating too many tax credits in predominantly black communities and too few tax credits in predominantly white suburban neighborhoods. ICP claimed there was a disparate impact. Unlike disparate treatment, where ICP would have to show that the Department had a discriminatory intent or motive, under disparate impact theory, ICP only had to prove that a seemingly neutral policy had a disproportionately adverse effect on minorities. The Department argued that the FHA itself does not contain the language to support this theory of law. It drew support for its argument from two other laws: Title VII of the Civil Rights Act of 1964 (Title VII) and the Age Discrimination in Employment Act (ADEA). Both of these laws have effects language, which refers to the consequences of an action rather than the mindset or motive of the actor. It is based on this language that the Supreme Court has ruled in the past that both Title VII and the ADEA allow for a disparate impact theory of liability. FHA does not contain effects language, and the Department argued that this rendered a disparate impact theory inapplicable. This argument by the Department failed. The Court s Decision The court held that the effects language was in fact present in the FHA. The FHA provides that it is illegal to refuse to sell or rent or otherwise make unavailable or deny, a dwelling to a person because of race. In a 5 4 decision, the majority held that the otherwise make unavailable language refers to the effects of an action rather than the actor s intent, so actions done without any discriminatory intent are illegal if they have discriminatory results. In other words, as long as a policy results in a disproportionate adverse impact based on a prohibited basis, it is irrelevant whether or not the creditor had a discriminatory intent. Implications for Creditors The question of whether the fair lending laws support the theory of disparate impact was finally resolved. The regulators have been given the green light to investigate and prosecute disparate impact claims. So, lenders need to review their current lending practices, with particular emphasis on underwriting; conduct an analysis to determine if any of the lending practices result in a disparate impact on a prohibited basis; and then review 9

10 these to determine whether there is a legitimate business necessity for these practices and there are no less discriminatory alternative practices. Recent Fair Lending Actions and Trends The CFPB has certain factors it takes into account in identifying and rooting out fair lending risks. It uses a riskbased prioritization approach to consider many qualitative and quantitative factors at the institution, product and market levels to determine what, where and how fair lending risks to consumers should be addressed. These factors include: Complaints and Tips Supervisory and Enforcement History Quality of Compliance Management Systems Data Analysis Market Insight (Fair Lending Report of the Consumer Financial Protection Bureau, April 2015) The CFPB compiled data from agencies under the Federal Financial Institutions Enforcement Council (FFIEC) and identified the most frequently cited violations under Regulation B, the implementing regulation for ECOA, in The top five ECOA violations cited by the major federal banking regulators in 2014 were: Source: Fair Lending Report of the Consumer Financial Protection Bureau, April

11 Key Enforcement Actions An understanding of enforcement actions is good way for lenders to become acquainted with some of the elements that could turn into a fair lending problem. In 2014, the main type of referral to the DOJ was discrimination based on race or national origin. This represented double the number of referrals for all other types of protected classes combined. Enforcement data during the first part of 2015 seem to indicate that race remains a predominant theme. While you should not neglect to analyze your practices for their potential impact on all protected classes, you should pay particular attention to race. As illustrated by these numbers, the examiners are certainly paying close attention to it. How the Home Mortgage Disclosure Act Comes into Play The Home Mortgage Disclosure Act (HMDA) Loan Application Register (LAR) is one of the primary tools that examiners use to detect illegal discrimination and predatory lending. The LAR contains a vast amount of information related to race, age and other protected class information for mortgage loans. HMDA data can assist with identifying and managing disparities in lending to prohibited basis groups, majority/minority census tracts, redlining, pricing, denial and withdrawal rates, and even more fair lending issues. Self-identifying a fair lending issue can make a world of difference when it comes to enforcement. Without an accurate HMDA LAR, you cannot adequately self-assess to stay one step ahead of examiners. In addition, our field consultants are seeing quite a bit of examiner attention citing LAR errors. Verify that you have adequate controls in place surrounding your HMDA LAR to ensure compliance and data integrity, which will in turn facilitate your self-identification of fair lending issues. HMDA Changes on the Horizon It is important to note that the CFPB has issued a proposal for new HMDA fields. The proposed fields include property value, loan terms, total point and fees, duration of any introductory rate and the applicant s or borrower s age and credit score. Aside from the challenge of ensuring accuracy of all of these additional fields, the obvious fair lending questions bubble to the surface: Are there discrepancies in credit scores among prohibited basis borrowers versus non-prohibited basis borrowers? Are protected classes paying higher points and fees? Are protected classes getting shorter term loans? Are protected classes receiving shorter introductory rate periods? A proactive lender may want to begin to collect and analyze this data now to try to ensure that there are no fair lending risks or issues. 11

12 CFPB s BISG Methodology While analyzing mortgage loan files for fair lending compliance is relatively easy thanks to data collection requirements, nonmortgage credit lacks such requirements. When it comes to nonbank lending, there are many categories of loans that are on examiners radar. How, then, can these loan files be assessed for potential fair lending issues, such as discrimination on a prohibited basis like race? In those cases, the CFPB uses substitute, or proxy, information to fill in data about consumers demographic information. The CFPB accomplishes this by relying on the Bayesian Improved Surname Geocoding (BISG) method. In 2014, the CFPB issued a paper entitled Using publicly available information to proxy for unidentified race and ethnicity: A methodology and assessment to educate the industry on its use of the BISG method. The [BISG] method involves constructing a probability of assignment to race and ethnicity based on demographic information associated with surname and then updating this probability using the demographic characteristic of the census block group associated with place of residence. Using publicly available information to proxy for unidentified race and ethnicity: A methodology and assessment, Summer 2014 Traditionally, practitioners relied on a geography-only or surname-only proxy method. However, the CFPB declares in its paper that the BISG method is a more accurate method of determining proxies. The CFPB goes on to explain that lenders do not have to utilize the BISG method. However, given that this is what the examiners are using, following suit is a prudent choice. Failing to do so would only result in a disparity between the information your auditors are using and the information that the CFPB uses to examine fair lending compliance. A prime example of this can be seen in a high-profile 2014 enforcement action against an indirect auto lender that allowed dealers to charge interest in a manner that resulted in a finding of discriminatory pricing affecting African Americans, Hispanics, Asians and Pacific Islanders. This action took place prior to the CFPB s issuance of its paper on the BISG method. Had the lender had the benefit of conducting an audit or self-evaluation using the BISG method, it would have had a better chance of identifying the issue itself before examiners did. Let s take a look at what we can learn from two specific race-related enforcement actions that were issued in

13 Indirect Auto Lending: July 2015 Allegations: Lender s policies relating to pricing discretion and compensation led to minority borrowers paying higher interest rates than nonminority borrowers with comparable loans and without regard to creditworthiness. Roots of problem: 1. Discretion: The lender provided the dealership with a risk-based rate, but then allowed the dealer to increase the rate by as much as 2.25%. 2. Compensation: These dealer mark ups could generate money for the dealers, thereby incentivizing the dealers to increase the rate. Principal victims: African Americans, Hispanics, Asians and Pacific Islanders Consequences for lender: Remediation: Substantially reduce or entirely eliminate the dealer s discretion to mark up rates Damages: Pay $24 million in damages to a settlement fund to compensate the victims, and administer the fund and distribute the funds to the victims. This enforcement action is another prime example of how early detection, early remediation and self-reporting could have saved this lender millions. Unfortunately, the violations were discovered because of an investigation conducted by the CFPB. Had the lender discovered the violations, it could have capped its damages and initiated corrective action much earlier on. Wholesale Mortgage Lending May 2015 Allegations: Nationwide wholesale mortgage lender with business nationwide in 25 states established a base or par rate for each of the loan products it offered based on specific loan terms for an applicant with specified credit characteristics, but discretion led to higher rates and fees charged to minority borrowers. Roots of problem: 1. Discretion: Mortgage brokers had unguided discretion in setting total broker s fees charged without regard to borrower s credit risk characteristics or the loan product features. Brokers also had discretion to charge higher rates without objective criteria. 2. Compensation: Fees paid to brokers were a combination of increased interest revenue and fees paid directly by borrower. Principal victims: African Americans and Hispanics Consequences for lender: Damages: Pay $9 million in damages to a settlement fund to compensate the victims, and hire a third party to administer the fund and distribute the funds to the victims. 13

14 This action underscores several points: 1. Nonbank lenders remain a priority for CFPB enforcement. 2. Race-based discrimination is a commonly recurring theme. 3. Lender discretion and incentive compensation heighten fair lending risk. Third-Party Risk In both of the above cases, the CFPB brought enforcement actions against lending institutions because their third party partners were committing fair lending violations. Those lending institutions were not found to be intentionally engaging in fair lending violations. We are often asked, If our third party lending partner is violating fair lending laws, can we be held liable? As illustrated by the above actions, the answer is a resounding YES. In both of those actions, the third-party dealership and brokers were accused of committing the violations, yet the lender was held liable. Some lenders may dismiss the relevance of the enforcement actions just discussed because the actions were brought with regard to products, services or third-party arrangements that they do not think apply to them. This is where everyone should pause and give some thought to the lessons that can be taken from these parties unfortunate mistakes. Does your institution have any third-party vendors that assist in any part of the lending process, such as underwriting, servicing or perhaps collections? The CFPB s enforcement actions remind institutions to ensure you have conducted thorough due diligence and have adequate oversight and controls in place. If these two enforcement actions have taught us anything, it is that the actions of third-party partners and vendors will be imputed to the lending institution. Emerging Risk Areas Recent examinations by the agencies indicate fair lending issues emerging in these four areas: Mortgage lending Indirect auto lending Credit cards Small business lending Remember that ECOA applies to all of the above credit types, so your fair lending program for business lending should be as comprehensive as the one for consumer lending. In particular, problematic patterns or practices are being identified in examinations related to: Redlining Access to credit for limited English proficiency (LEP) consumers Pricing discrimination Social Security disability We will look at each of these in turn now. How Strategic Decisions Can Unintentionally Become Redlining Redlining occurs when a lender does not offer credit to minority-heavy neighborhoods. These may tend to be lower income neighborhoods that lenders may be hesitant to service due to a perceived higher level of risk 14

15 involved. Accordingly, it is important for lenders to scrutinize any practices they have in place that cause them to focus on or exclude certain neighborhoods. While redlining is generally intentional (e.g., we will not lend south of the railroad tracks) there are also some practices that might unintentionally lead to redlining as well. Some of these practices may not be evident. For example, a lender s policy not to extend loans on single family residences valued at less than $50,000 or residences with less than 1,000 square feet may not on its face exclude lower income neighborhoods. However, when this policy is applied, redlining may occur, because lower income neighborhoods will be more likely to have dwellings valued at less than $50,000 and/or fewer than 1,000 square feet. While the lender s intent may be completely innocent, the effect of these practices is that few or no real estate loans will be granted in the high-minority areas within the lender s assessment area. Thus, it appears that this would be a fair lending issue and may be considered redlining. Reverse Redlining Still on the Radar Reverse redlining occurs when a lender targets minority consumers, not to deny them loans, but to charge them more than could be charged to a comparable nonminority consumer whose business is considered more desirable. In fact, in the 2000s, some financial institutions were accused of focusing on heavily African-American communities for subprime mortgages, flipping and higher fees. Here are some additional examples of predatory practices seen in reverse redlining: Balloon payments that require borrowers to pay off the entire balance of a loan by making a substantial payment after a period of time during which they have been making regular monthly payments Required single premium credit life insurance, where the borrower must pay the entire annual premium at the beginning of the policy period rather than in monthly or quarterly payments (With this cost folded into the loan, the total costs, including interest payments, are higher throughout the life of the loan.) Homeowners insurance where the lender requires the borrower to pay for a policy selected by the lender High prepayment penalties that trap borrowers in loans Fees for services that may or may not actually be provided Loans based on the value of the property with no regard for the borrower s ability to make payments Loan flipping, whereby lenders use deceptive and high-pressure tactics that result in the frequent refinancing of loans with additional fees added each time Negatively amortized loans and loans for more than the value of the home, which result in borrowers owing more money at the end of the loan period than when they started making payments Lenders involved in reverse redlining have claimed that their practices do not violate ECOA or the FHA because they are making credit available to minorities rather than denying it. However, this argument does not satisfy regulators. The DOJ has been involved in a number of reverse redlining cases over the past decade. In the DOJ s view, making credit available in a way that harms borrowers is discriminatory if the creditor targets borrowers on a prohibited basis. Access to Credit for Limited English Proficiency Consumers The CFPB s 2015 Fair Lending Report also addressed the issue of limited English proficiency (LEP). The CFPB intends to consider the challenges to LEP consumers when trying to access credit. The CFPB encourages lenders to assist LEP consumers in order to increase access to credit and to reach out to the CFPB for ideas on how to facilitate access to credit. Lenders should look at their current customer base and ensure that they can 15

16 accommodate consumers who cannot speak or read English. We expect to see this on the CFPB s agenda very soon. Pricing Discrimination Another practice that is very risky relates to pricing. Inconsistency in pricing will lead to a fair lending claim. As illustrated by the enforcement actions covered in this analysis, allowing loan originators the discretion to vary pricing can be near-fatal to the lender. The best practice according to the lessons from these enforcement actions is to not give any discretion. The second best practice is to limit discretion to very specific scenarios and to track closely how exceptions are used and who benefits from those exceptions in order to make sure that a pattern doesn t emerge under which protected classes receive less favorable pricing as a result of the limited pricing discretion. Social Security Disability The CFPB Report reminded lenders of the November 18, 2014, CFPB Bulletin cautioning lenders not to require unnecessary documentation from consumers who receive Social Security disability income. This is a fair lending issue that the CFPB continues to monitor, and proactive lenders would be well served to review the bulletin in detail to ensure that they do not have any policies or procedures in place that contradict the guidance. Income from Public Assistance Another noteworthy issue raised in the CFPB s Summer 2015 Supervisory Highlights (Highlights) relates to the Section 8 Housing Choice Voucher (HCV) Homeownership Program, which is a program that is aimed at assisting low-income, first time home buyers. In the Highlights, the CFPB cautioned lenders not to deny or discourage borrowers who received HCV assistance. The CFPB reminds lenders that under the ECOA a lender cannot deny credit because all or part of the applicant s income derives from any public assistance. Accordingly, the CFPB declared that lenders cannot have a blanket policy to deny borrowers who receive HCV assistance. Loan Servicing Practices The specter of fair lending compliance looms large over all aspects of lending, from advertising of loan products, to evaluation of loan applicants, to the pricing and features granted to borrowers, to the servicing of loans once closed. Servicing practices have the potential to become fair lending nightmares if practices are not applied fairly and equally. So, what kind of servicing problems could arise with fair lending implications? Treating a borrower differently in servicing a loan by waiving penalties or other charges, taking a different approach to invoking default remedies or using different standards for pooling or packaging a loan in the secondary market can all have fair lending implications. A finding of disparate treatment can arise when there are substantial disparities among loss mitigation servicing options; decision processing times; or the completion of foreclosure, collateral repossession and similar legal actions that may be taken to protect and to liquidate loan collateral on delinquent accounts. Other potential fair lending pitfalls in servicing can come from lack of clear loan file documentation for servicing or loss mitigation decisions, granting policy exceptions or granting fee waivers. As in much of the lending process, a servicer may sometimes try to help out a borrower by waiving fees or penalties, but well intended practices may turn into fair lending violations if negative patterns emerge over time 16

17 with protected classes benefitting less frequently from these attempts to assist troubled borrowers. Even workout loans can be deemed discriminatory if you do not afford all your borrowers the same opportunity. As a servicer, you must be as consistent, fair and circumspect as possible with your servicing policies and practices to ensure that you do not fall into the fair lending pit. Many lenders think fair lending concerns are over once the obligation goes to collection. They are incorrect. In fact, loan collection standards that vary geographically can also cause fair lending violations if, for instance, delinquent auto loans resulted in repossession in a shorter time period for loans made to borrowers in certain neighborhoods or geographical areas. What Are Your Peers Hearing from Their Examiners? While public cases and documents offer useful guidance, it is always beneficial to know what points examiners are raising in the field, as it provides additional key insight on the direction the examiners are going and what to tune up in advance of your next exam. Based on reports we ve received from our field consultants, we have compiled a list of top issues in examinations: Inadequate tracking of exceptions to policies and procedures Discretionary pricing practices with no monitoring controls in place Lack of adequate fair lending supervision of third party partners and vendors Insufficient fair lending policies and procedures Inconsistent practices in relation to grossing up non-taxable income Failure to perform a separate fair lending risk assessment for mortgage subsidiaries Lack of integrity of HMDA data Action Steps to Address Fair Lending Risks So what action steps should we take in response to the intelligence gathered from the Supreme Court case, recent enforcement actions, and the CFPB s report and our experts in the field? Knowledge is the first step. The second is to putting that knowledge into action. Let s explore how we can put these lessons learned into action based on recent headlines. 17

18 Tackling Fair Lending Trouble Spots Based on our analysis of the most recent intelligence, we recommend that you take a deeper dive into trouble spots by implementing these best practice based recommendations: Analyze disparate impact risk Review compensation practices Evaluate discretion and exceptions Compile and analyze data Mystery shop for a closer look Pay attention to headlines Apply the above to third-party service providers Let s take a closer look at each of these. DISPARATE IMPACT With the uncertainty of the future of disparate impact claims being challenged in the Supreme Court, regulators may have been hesitant to bring disparate impact claims. Those days are over, and it is possible that we may now see an influx of these cases. Recall that the disparate impact theory does not require intent to discriminate, only that there is a discriminatory effect. This is a daunting proposition for creditors. The recent Supreme Court case significantly heightens risk in this area by opening up an entire potential body of litigation. So where do you start when it comes to mitigating this dicey risk? 1. Review Documentation. Review all policies and procedures that place conditions or limitations on access to credit, with particular attention to your underwriting policies and procedures. This is where you will probably find the most issues relating to disparate impact. Consider how criteria for products and terms were set and what potential unintended impacts could result. Is there a business necessity? (For example, charging a higher rate to those with lower credit scores because of X or Y). Thorough documentation of business necessity is critical. Be sure to keep notes of any meetings in which the business justification for a policy is discussed, along with notes of who was present and what information was reviewed. Gather any internal financial analyses, market studies or statistics that support your decision. When the board votes on the policy, make sure it is documented in board minutes that explain the business necessity for the policy. After the policy has been in place for some time, review the performance of existing loans to evaluate whether the policy is having its intended effect. If possible, compare loans from before and after implementation of the policy, with special attention to prohibited basis characteristics, especially race. 2. Compile and Analyze Data. Accumulate and review data from your own files if possible. For non-mortgage products, try your hand at the CFPB s BISG method. Pull census information as well as income information (if available) to get a good idea of who your mortgage customers are and to make sure that your borrowers reflect your population. For example, it is particularly helpful to show an examiner that 11 percent of your population is Hispanic based on the most recent census and 12 percent of your mortgage borrowers are Hispanic. This type of analysis and documentation will help you determine if minorities are being declined 18

19 for credit in greater numbers or are receiving less favorable terms. If this is occurring, see if it can be tied back to a policy or procedure. If your statistical analysis reveals a disparate impact against minorities, question why the policy exists in the first place. The answer had better not be, Because that is the way we have always done it, or It is common industry practice. Neither of these responses goes over well with examiners. You will need a justifiable business necessity backed up by statistics or some other evidence to justify your decisions. 3. Consider Alternatives. Determine if there is an alternate policy that will have no impact or less of an impact on minorities. This determination can be accomplished by using the same analysis used in determining your business necessity. Chances are you can find some alternative that is less impactful. It is better that you find it and implement it yourself, rather than having an examiner or a plaintiff point one out to you. COMPENSATION As illustrated by recent enforcement, compensation is a hot area for examiner attention. A clear and objective compensation policy is the best way to stay in the clear. Does your institution pay commission or any other incentive type of compensation? If so, expect examiners to scrutinize it closely. Consider hiring a third party to assess your compensation program, and interview personnel with incentive compensation plans to uncover any potential trouble areas. When assessing your own and your third parties compensation practices for compliance with applicable requirements, such as the Loan Originator Compensation Rules, be sure to also investigate for possible fair lending concerns. Some trouble areas on which to focus include: Home equity lines of credit (HELOCs) Auto loans (particularly dealer loans) Uncollateralized consumer loans Business loans DISCRETION AND EXCEPTIONS It goes without saying that you should review lending policies, procedures and practices, but applying what we have learned, pay special attention to policies, procedures and practices that relate to discretion that can be applied during any part of the lending process. Does your institution allow lenders to modify pricing or fees at their discretion? If so, ensure that there are clear and objective criteria and parameters to follow when discretion is exercised. Exceptions are a close cousin that may overlap with discretion. Even in the presence of clear, objective lending policies, oftentimes personnel and third parties are permitted to make exceptions from established policies. Do lenders make exceptions or deviate from policies, procedures and practices in order to remain competitive? If so, are they required to clearly document the objective rationale and legitimate business reasons for the exception in the loan file? Ensure that monitoring includes reviews of such notes to ensure that exceptions are well documented and the reasoning does not raise fair lending concerns. The best way to mitigate risk in this area is to prohibit pricing and underwriting discretion or exceptions, but if your business chooses to allow these, clear and objective policies, procedures and documentation can often effectively mitigate risk. MYSTERY SHOP A great way to identify compliance issues is to have qualified professionals pose undercover as customers seeking to do business at your branches. This enables compliance to get an objective picture of what a consumer experiences when going to your institution. This is also a great way to check in on your third parties 19

20 practices. By taking mystery shopping an extra step and strategically sending mystery shoppers of different races, genders or ages fair lending concerns that would not otherwise surface may be discovered. Pay, particular attention to how the shoppers are treated, what products and terms they are offered and whether they are discouraged intentionally or unintentionally from applying. Be strategic about control groups versus prohibited basis groups, the branches to which they are sent and the products or services for which they shop. All mystery shoppers should have the same basic fabricated background and seek the same products or services to ensure the most objective approach possible. Any potential issues that come to light can be further investigated through more direct reviews and interviews with staff. THIRD-PARTY RELATIONSHIPS All of the above lessons apply with equal force to your third-party service providers or vendors that are involved in any part of the credit process. Ensure that vendor contracts appropriately address assignment of liability and the third party s commitment to complying with fair lending laws. Contracts should also include provisions granting your company access to and cooperation from the third party should a claim arise. In addition to verifying that they have an appropriate compliance program in place, ensure that the vendor s policies and procedures are in line with your company s risk appetite, paying particular attention to areas with elevated risk, such as compensation practices, discretion, exceptions and day-to-day treatment of consumers. Continue to monitor your third party partners and vendors to ensure that they continuously uphold policies, procedures and practices related to fair lending. All of the above action items are not a one-time event; you should plan for annual to semiannual monitoring of all of the above action items. HEADLINES You can stay in the know about what examiners are focusing on by paying close attention to enforcement actions and lawsuits such as those we ve just discussed. Ensure that you integrate the key takeaways into your periodic staff training. This will enable you to educate your staff on the highest risk areas and best practices. Conclusion We hope you will use the intelligence in this briefing to take a closer look at your institution s lending practices and uncover any potential trouble areas. There is no guarantee that a lender can completely prevent fair lending claims, but at least lenders can take certain steps to minimize the risk and demonstrate good faith efforts to comply. Cristina Equi, Esq. Assistant Director, Regulatory Advisory Services Cristina brings more than 10 years legal experience in the areas of commercial and contract litigation, as well as age, sex, race, disability, religious and national origin discrimination. Cristina has litigated cases involving the Fair Housing Act and the Unfair, Deceptive, or Abusive Acts or Practices Act (UDAAP), and advised clients on the Fair Credit Reporting Act and their obligations under that act. Currently she serves as assistant director of regulatory advisory services and assists clients by responding to inquiries regarding federal compliance questions, monitoring upcoming changes to the Federal Regulations, and drafting articles and guidance on federal compliance issues. Cristina received her Juris Doctor from the University of Miami in Cristina has also been a member of the Florida Bar since 1998 and also member of the Northern, Middle and Southern Districts of the Florida Bar. 20

21 D. DID YOU KNOW? FIS Fair Lending Review and Proxy Analyzer Tool FIS Fair Lending Proxy Analyzer Tool (FLPA) Utilizes CFPB s BISG Proxy Methodology for use in nonmortgage-related fair lending statistical analyses. FIS staff of fair lending experts, comprised of former regulators, examiners, compliance officers and attorneys, provide various fair lending review services, and utilize the FLPA Tool FLPA Tool analyzes all nonmortgage-related credit products Simulates CFPB review and identifies fair lending risks 21

22 Fair Lending Regulatory University Courses Regulatory University is the financial services industry's most comprehensive, authoritative, cost-effective, Web-based regulatory training solution. Regulatory University contains a library of more than 250 courses covering safety and soundness and consumer protection laws and regulations, high and emerging risk issues, products and services, and other topics of relevance to multiple lines of business. Suite of video-based fair lending courses that incorporate latest cases Enhanced Curriculum Management Assign courses by regions, branches, groups and job function. Custom Content Manager Our easyto-use Custom Lesson Manager allows you to customize existing Fair Lending courses by incorporating your policies and procedures or create a new course from scratch. Learn more about our Fair Lending compliance services: sign-up for a demo or visit 22