Are you Aware that the FFIEC has proposed Standards for Diversity in Hiring and Procurement? 

 

It is understandable that with a number of regulations that have started to impact the banking industry that some guidance might “fall through the cracks”.  We note that one such area is the joint agency guidance on diversity.  

 

On Oct. 25, 2013, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corp., National Credit Union Administration, Consumer Financial Protection Bureau, and Securities and Exchange Commission (SEC)  which is collectively known as the FFIEC,  issued a proposed interagency policy statement on diversity. The Dodd-Frank Act requires these agencies to develop standards for regulated entities to assess diversity. Comments on the proposal have been extended until Feb. 7, 2014. 

 

While we await the final guidance, it is our recommendation that financial institutions begin to prepare for the changes that this guidance will bring. 

 First Things First-What is this all About? 

 

One of the things that the Dodd Frank addresses is the effort being made by financial institutions in the area of inclusion of women and minorities in the overall hiring and procurement processes.  The legislative discussion of Section 342 of the Dodd Frank act helps to describe what it is that this section of the law is designed to do. 

 

The Agencies believe that a goal of section 342 is to promote transparency and awareness of diversity policies and practices within the entities regulated by the Agencies. The establishment of standards will provide guidance to the regulated entities and the public for assessing the diversity policies and practices of regulated entities. In addition, by facilitating greater awareness and transparency of the diversity policies and practices of regulated entities, the standards will provide the public a greater ability to assess diversity policies and practices of

regulated entities. The Agencies recognize that greater diversity and inclusion promotes stronger, more effective, and more innovative businesses, as well as opportunities to serve a wider range of customers.[1]

 

Put another way, Dodd Frank is trying to get financial institutions to get to know their entire assessment area not only as customers, but as potential employees and contractors.   We believe that this fits in with a larger direction to financial institutions that they should get to know the credit and financial needs of the communities they serve.   Much like the Community Reinvestment Act, there is nothing in the law or the guidance that directs institutions to lower standards or to set quotas.  Instead, the idea here is to make sure that the employment and procurement processes are inclusive.   The fact is that there are many “diamonds in the rough” that go overlooked and as a result are unbanked or underemployed. 

 

Will This Require a Whole new Reporting Process?

 

The fact is that the guidance has not been finalized, so it is difficult to say with complete accuracy what the guidance will require.  However, based upon the standards in the proposed rule, it is not likely that a whole new data collection regime will be required.  Instead, it will be the duty of the Board and senior management to include diversity considerations in the strategic plan and ongoing monitoring of performance.  

 

According to the proposed guidance, the expectation will be that institutions will

·         Include diversity and inclusion considerations in the strategic plan

·         Will have a diversity and inclusion plan that is reviewed and approved by the Board

·         Will have regular reports to the Board on progress

·         Will provide training to all affected staff

·         Will designate a senior officer as the person responsible for overseeing and implementing the plan

 

While this may seem like a long list of new requirements, in our opinion that is not the case at all.  When developing a strategic plan and assessing the credit needs of the community, the idea of diversity should be part and parcel of the basic considerations and projections.  It is clear that regulators will increasingly focus on financial institutions ability to identify the financial needs of the communities they serve and to match how the banks activities meet those needs.  In addition, we believe that examiners will ask financial institutions to document the reasons why they are not able to offer certain products.  The same will be true in the area of hiring and procurement.  Financial institutions will need to be able to document diversity efforts and to have a good explanation for the lack of diversity.  

 

It is important at this point to emphasize that we do not believe that this guidance is leading towards hiring or procurement quotas.  Instead, the requirement will be for complete and clear documentation of the efforts made to ensure that diverse candidates are being considered. 

 

Why is this a Good Thing? 

 

The fact of the matter is that diversity has been and will always be strength.  Of course a diverse loan portfolio is one that can absorb fluctuations in various industries without much turmoil.   Diverse ideas and experiences have always lead to innovation.  In point of fact, there has been a history of exclusion of several communities of potential customers by financial intuitions for some time.  The whole point of the Community Reinvestment Act was to get financial institutions to look at all communities for potential clients. 

 

Earvin “Magic” Johnson has developed a multi-Billion dollar business based upon the idea that diversity is strength.  His companies have invested in neighborhoods that were traditionally under banked and lacked access to funding.  The success of this company proves that there are many opportunities that are available in communities that often get overlooked.  

 

Self-Assessment

 

One of the more controversial points of the regulations is that it appears to rely on self-assessments.  There are no examinations standards that are mentioned in the guidance.  While some commenters decried the idea that self-policing is too vague; It appears that the expectation is that financial institutions will develop a policy, monitor compliance with that policy and make the results available to the public. 

  

We have always counseled that self–assessment is both an opportunity and a curse.  The opportunity exists for an institution to self-define itself.  By setting standards that are based on a comprehensive understanding of the community vis-à-vis the capabilities of the bank, an institution has the opportunity to create a strong impression with regulators.  The institutions that accomplishes that feat will create be able to show that is has considered its community versus what it can do and has developed a plan that reflects the sum total of these considerations. At the end of the day this is what regulators will willingly accept and applaud. 

 

Implications

 

While it is too early to tell what the final guidance will look like, it is obvious that there will be an emphasis on diversity planning and programs for financial institutions. We suggest that the approach should be part of the overall strategic planning process

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[1] Federal Register Vol. 78 No. 207

Changes in Community Reinvestment Act Questions and Answers May bring Some Welcome News  

One of the more difficult tasks that our clients must accomplish is to try to meet the community development and community service tests in the Community reinvestment Act (“CRA”).  For many community banks the opportunities to do community service that qualifies under the requirements of the CRA are very limited.  The same is true with opportunities to conduct community development activities while staying within ones assessment area.    In many cases, the service opportunities have been limited to teaching classes at organizations that serve community needs.  Lending and investment opportunities are often “gobble up” by the large banks in the assessment area, leaving the community banks to scramble to try and comply with the requirements of the regulation.     

In November of 2013, the FFIEC announced changes to the Community Reinvestment Act  Q & A that have the potential to greatly expand a bank’s ability to meet the tests of CRA while doing CRA activities outside of the assessment area.  [1] In addition the ability to perform community service has also been expanded.  Just remember along with new powers come additional responsibilities and therefore additional risks!  

The Changes

There are actual several changes that were adopted in November, 2013.  We are only discussing a few that we believe directly impact compliance with the community development tests for small intermediate banks.  Large Banks are encouraged to read the full text of the changes. 

In the past there was wording that suggested that banks could do community development activities outside of the assessment area, the caveat for how these activities might qualify for credit to the bank performing them was unclear.     The original Q & A stated the following:

 Q&A §     .12(h) – 6 had stated that examiners would consider such activities if an institution, considering its performance context, had adequately addressed the community development needs of its assessment area(s).

In particular, the language created doubt that activities outside of a defined assessment area would be given credit at all.  The agencies first proposed new language that indicated that as long as these activities were performed in a safe and sound manner and weren’t done in lieu of activities within the assessment area, they would be okay.  However, because many comments were received [2] the language was changed.  The adopted new language says:

§    .12(h) – 6 states, with respect to community development activities that are conducted in the broader statewide or regional area that includes the institution’s assessment area(s), that “examiners will consider these activities even if they will not benefit the institution’s assessment area(s), as long as the institution has been responsive to community development needs and opportunities in its assessment area(s).”

The definition of what a broader statewide of regional area was left fairly open to a common sense application.  There are not specific guidelines for defining these.   It is safe to say that a definition that includes contiguous counties or economic zones that cross state lines (Lake Tahoe in California and Nevada for example) would be an acceptable definition.  

 Another significant change is the service that can qualify as community service on the part of bank employees.   The current Q & A stated that service to a community group was defined as

  §     .12(i) – 3 stated that providing technical assistance to organizations that engage in community development activities (as defined by the regulation) is considered a community development service

 

For many of our clients this language has been taken to limit the things that bank employees may do to get credit for the community service.  The FFIEC clearly wanted to expand that definition and in particular wanted to add that serving on the Board of community service organization can indeed count as community service 

§     .12(i) – 3 to clarify that service on the board of directors of a community development organization is an explicit example of a technical assistance activity that could be provided to community development organizations that would receive consideration as a community development service

The idea here is that the service on the Board of these organizations must be active and not symbolic.  In what looked almost like a throw away, the FFIEC also added the following: 

In addition, in response to commenters’ suggestions, the Agencies are adding the following example of a technical assistance activity that might be provided to community development organizations: providing services reflecting financial institution employees’ areas of expertise at the institution, such as human resources, information technology, and legal services.

 

Of course this language greatly expands the sort of services that a bank may provide to community development organizations while meeting the service requirements of the CRA. 

Broader Implications

Simply put, the more work you do upfront, the more leeway you get!   For example, being able to prove that there is broader region that you serve outside of your assessment area and that this region is legitimately economically connected is an important step in being able to perform community development activities out of the assessment area.   The second step is being able to show that the plan for activities allows the bank to serve the needs of the immediately assessment area while expanding.    

We believe that for a plan to expand to activities beyond the assessment are must be well thought out, and there must be documentation to show that the plan does not ignore low to moderate income groups within the assessment area.  However, for banks that do not have these populations directly within the established assessment area, this is a significant opportunity to expand and reach new levels of community development that had heretofore been unattainable.  

The key to a successful expansion is being able to document the idea that the Bank understands the credit needs of the people within the established assessment area.   In conjunction with understanding those needs the bank must be able to show how their activities meet those needs.   

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[1] For the full text of the changes see http://www.federalreserve.gov/newsevents/press/bcreg/20130318a.htm

[2] We continue to remind our clients that the agencies do read and consider comments they receive!

What is the new Higher Priced Mortgage appraisal Rule and How is it different from the Reg. B Valuations Rule?    

Introduction

2014 marks the beginning of several changes to regulations affecting banks and other financial institutions.   Two similar new regulations that will start having impact in 2014 are the appraisal rule (Reg. Z)  and the Valuations Rule (Reg. B).    Both of these regulations deal directly with the need to give applicants for loans a copy of the appraisal or valuation that is used to evaluate the property being pledged as collateral for a loan.  Both of these changes require that the appraisal/valuation be done quickly and a copy of the results should be delivered to the applicant immediately thereafter.   [1]

Different Applications

When considering these two rules there are  few differences to keep in mind.   The rules  for Regulation Z (appraisal rule) apply for Higher priced Mortgages (“HPML”).  A loan is a higher priced loan if it:

·         It is a first-lien mortgage (other than a jumbo loan) with an annual percentage rate (APR) that exceeds the Average Prime Offer Rate (APOR) published by the Bureau at the time the APR is set by 1.5 percentage points or more. 

·         It is a first-lien jumbo loan with an APR that exceeds the APOR at the time the APR is set by 2.5 percentage points or more. A loan is a jumbo loan when the principal balance exceeds the limit in effect as of the date the transaction’s rate is set for the maximum principal obligation eligible for purchase by Freddie Mac. (Comment 35(a)(1)-3)

·         It is a subordinate-lien with an APR that exceeds the APOR at the time the APR is set by 3.5 percentage points or more.[2]

 

On the other hand, Regulation B applies to ALL transactions that involve a lien on a dwelling for whatever purpose (although the valuations rule applies only to first liens) .  Remember, Regulation B covers ALL lending so even if the loan is for a commercial purpose, such as a small business loan with the borrower pledging her home as collateral, regulation B applies and the valuations rule applies.     

The CFPB’s Small Entity Compliance Guide describes the biggest difference between the regulations as follows:

·         First, while the ECOA Valuations Rule does not apply to subordinate liens, the HPML Appraisal Rule does apply to subordinate liens.

·         Second, while the ECOA Valuations Rule covers any transactions secured by a dwelling for any purpose, the HPML Appraisal Rule applies only when the covered loan is for a consumer purpose and is secured by a principal dwelling.

·         Third, while the ECOA Valuations Rule does not exempt any types of transactions secured by a first lien on a dwelling, the HPML Appraisal Rule exempts several types of transactions.

From our point of view, if an  application will include a first lien on a dwelling, then loan staff should prepare to deliver a copy of the appraisal or valuation to the applicant. 

Requirements of the regulation. 

Each of the regulations has specific requirements for notification to customers.  However, the requirements for the type of valuation that must be done is somewhat different.   Under Regulation Z, when a loan is considered a HPML, then very specific requirements for the appraisal kick in.  Included in the requirements are the need for a site inspection by the appraiser.   Remember, this requirement will apply to HPML whether they are first or subordinate lines.    The specific requirements of the regulation are as follows: 

·         Disclose to consumers within three business days after receiving the consumers’ applications that they are entitled to a free copy of any appraisal the creditor orders and also can hire their own appraiser at their own expense for their own use. (§ 1026.35(c)(5))

·         Obtain a written appraisal performed by a certified or licensed appraiser in conformity with the USPAP and Title XI of FIRREA and its implementing regulations. (§§ 1026.35(c)(1)(i) and 35(c)(3)(i))

·         Have the appraiser visit the interior of the property and provide a written report (§ 1026.35(c)(3))

·         Deliver copies of appraisals to applicants no later than three business days before consummation (§ 1026.35(c)(6)(ii))

 

 

Under the Regulation B valuations regulation, the requirements are similar:

 

·         When you receive an applicant’s application, you have three business days to notify the applicant of the right to receive a copy of appraisals.

·         You must promptly share copies of appraisals and other written valuations with the applicant.

·         Promptly means promptly upon completion, or at least three business days before consummation (for closed-end credit) or account opening (for open-end credit), whichever is earlier.

·         The applicant can waive the right to receive copies of the appraisal or other written valuations in advance of the closing, but in those cases, you must still deliver the copies at or prior to consummation or account opening [3]

Reg. B does not detail the type of appraisal that is needed.  However, there is a comment in the guidance that points out that if a financial institutions uses the appraisal standard set out in Regulation z, they will meet the standards in Regulation B.   therefore, as a practical matter, setting the standards at the Regulation Z level would appear to be the most prudent course of action.  

 

Why are they doing this?

As with all regulations that appear to significantly impact, the mode or method doing business, our clients tend to ask – “why are they (the regulators”) doing this to us” ?   The answer as with almost all consumer regulations is that they are designed to correct some past bad behavior.   There is little doubt that  inaccurate and in some cases, downright fraudulent valuations and appraisals of property were significant contributors to the financial crisis.  In the case of regulation B, these changes reflect the traditional twin goals of the Equal credit opportunity Act; to increase credit opportunity for protected classes and to increase borrower education. 

The idea here is to give the applicant clear and concise information about the value of the property that they will be using as collateral.  Further, it is an opportunity to ensure that property valuation is not impacted by illegal discrimination or fraud.  

What’s Next

Although there are some exceptions to each of these rules, we suggest that they represent the best practices standard that the regulatory agencies will use going forward.   Therefore, even if there are some exceptions that might get you “off the hook” today, the time is now to start implementing practices that include giving copies of the valuations to applicants.   Going above and beyond the requirements of the regulations will never be viewed as a bad thing by regulators. 

The following chart was developed after a cursory review of the regulations and is for information purposes only.  You should always consult with your compliance professional before taking action.   VCM assumes no liability for the accuracy of the chart.

 

Loan Type	Purpose	HPML	Reg. Z	Regulation B
Purchase  Mortgage	Consumer	Yes	Yes	Yes
Purchase  Mortgage	Commercial	No	No	Yes
Refinancing	Consumer	Yes	Yes	Yes
Refinancing	Commercial	No	No	No
Secondary Lien	Consumer	Yes	Yes	No
Secondary Lien	Commercial	No	Yes	No
HELOC –First Lien	Consumer	No	No	Yes
HELOC –First Lien	Commercial	No	No	Yes

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[1] The assumption in this article is that the financial institution will issue on qualified mortgages. 

[2] You can find an online APOR rate spread calculator, which automatically imports the applicable APOR to compare with APR, at http://www.ffiec.gov/ratespread/newcalc.aspx.

[3] The Official Interpretations of the regulation provide examples for guidance. (See “When must copies of valuations be provided to applicants?” on page 17 on the CFPB guidance)