Special Considerations for Freezing or Reducing HELOCs
During the worst part of the great recession, one of the things
that many of our clients did to reduce risk was to freeze or reduce credit
lines on open-ended credit. Many credit providers too this unpopular stand as a
risk avoidance strategy. More and more, consumers were shocked to find that
their credit lines were reduced to an amount that was close to the outstanding
balance even though the credit is in good standing.
Home Equity Loans (HELOCs) are traditionally some of the
largest open-end credits and, unfortunately, some of the most dramatically
affected by market conditions. As the market values of homes all over the
country continued to fall, many banks took the stand that the most prudent thing
to do was to reduce credit lines to reflect the new, lower value of the home that
is being used as collateral for the loan.
While establishing a program for reducing or freezing HELOCs
may be a prudent business practice, banks should closely consider the Fair
Lending and CRA implications of such a program, before aggressively pursuing
it. This is especially true in light of
the ongoing emphasis that is being placed on Fair Lending in in 2013 and
beyond.
Regulatory Considerations
While the trend of reducing credit is highly un-popular,
banks are well within their rights to pursue this action. For example,
Regulation Z allows a bank to alter a home equity loan program when the
underlying property has experienced a “significant decrease in value”[1].
The regulation details the rules for determining whether a significant decrease
in collateral value has occurred and specifies the means for reinstating credit
once the collateral value returns.
On the other hand, banks need to be careful to be aware that
the decisions that they make may trigger further disclosures. For example,
Regulation B requires that when an unfavorable change in an account occurs that
does not affect an entire class of customers, an adverse action has occurred. [2]
In other words, the decision to reduce or freeze individual accounts due to a
reduction in collateral value is an adverse action and triggers a Regulation B
adverse action notice.
However, the places where foreclosures are taking place and
where real estate values are declining can often be in places where large
concentrations of protected groups reside. [3]
In addition, the decision to reduce HELOCs can have a disproportionate impact
on a certain segment of the customer base.
For example, suppose a bank’s HELOC marketing program had
been targeted at its woman owned business or the Hispanic segment of its customer
base. A decision to reduce or freeze
these HELOCs could result in a large protected class of the customer base
disproportionately impacted. This is the type of situation that was at the root
of a lawsuit filed by the city of Baltimore, Maryland against Wells Fargo Bank
where two thirds of the foreclosures in that city were in census tracts where
African Americans represented 60 percent or more of the population.[4]
It is also current a cause celebre in the current case of the city of Richmond,
California, where the city is using the powers of imminent domain to take
houses from the banks that are attempting to foreclose. Regardless of the outcome of these cases, the
overall reputation of the banks that are involved will be greatly
diminished.
It is critically important that the bank consider the
consumer protection implications of a program to freeze or cancel products. Fair lending is one of the areas of
regulation where mere compliance with the letter of the law does not necessary
reduce risk. The impact of policies and
procedures are widely considered as part of a comprehensive fair lending
examination. As a result, the impact that
business decisions have on traditionally underserved communities can, and will
be considered. The business or economic reasons
for the decision to proceed with or cease products should be well documented to
protect against accusations of unfair or illegal lending practices.
Conclusion Tough economic times often call for unusual measures. It is in these times that the goals of safety and soundness run headlong into consumer protections. While programs to reduce or freeze HELOCs can make perfect economic sense, the potential for reputation and or legal risk to the bank can outweigh the benefits.
[1] [1]
Defined as 50% of the equity of the underlying property at Staff Commentary of
Regulation Z at 226.5b(f)(3)vi
[2] [2]This
revision emphasized that the exception applies only when the creditor’s action
is not based on the individual credit characteristics of the affected
accountholders. For example, the exception would apply where a creditor
terminates all secured credit accounts because it no longer offers that type of
credit. Federal Register / Vol. 68, No. 52 / Tuesday, March 18, 2003 /
Rules and Regulations
[3] Declining Market Policies Have Disparate Impact
On Minorities, Lower Income Neighborhoods, Reuters Apr 1, 2008 6:30am EDT
[4] [4][4]
Everyone's Feeling Economic Pain, But
It's Hitting Minorities Worst of All. By Valeria Fernandez , ColorLines January 19, 2009
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