Fair Lending- A Silent Killer?  - Part Two- A Proactive Approach. 

There’s No getting around it!  

In our previous post we discussed the idea that certain aspects of fair lending laws and obligations will apply to your bank no matter the size or the character of the products offered.  Even if your bank focuses almost entirely on commercial lending and is a small community bank, fair lending must be a consideration for your management.   This is true because the Equal Credit Opportunity Act, the Community Reinvestment Act and the Flood Insurance rules apply to all banks.  In addition, we noted that regulators are expanding the purview of the Unfair Deceptive Acts or Practices Act.  Finally we noted that HMDA often applies to commercial banks through their apartment lending activity.  The point is that fair lending cannot and should not be ignored.  

We further established that now is the time to start getting ready for the significant changes that are coming to the way data is collected.   We believe that section 1071 of Regulation B will represent a significant change in the way that data is collected and reported for community banks.  While this change in the way the information is recorded will be the future, it is also clear that influential regulators such as the CFPB look upon this section of the regulation favorable and will eventually implement this regulation.  

Change Creates Opportunity 

Even though the changes that are coming will require significant alteration of the loan application processes, we see an opportunity.  First, the type of information that will be required can be useful for planning and marketing purposes.  

 The list of information that we know will be required includes the following: 

I.                    ‘(1) IN GENERAL.—each financial institution shall compile and maintain, in accordance with regulations of the Bureau, a record of the information provided by any loan applicant pursuant to a request under subsection (b).

‘‘(2) ITEMIZATION.—Information compiled and maintained under paragraph (1) shall be itemized in order to clearly and conspicuously disclose—

‘‘(A) the number of the application and the date on which the application was received;

‘‘(B) the type and purpose of the loan or other credit being applied for;

‘‘(C) the amount of the credit or credit limit applied for, and the amount of the credit transaction or the credit limit approved for such applicant;

‘‘(D) the type of action taken with respect to such application, and the date of such action;

‘‘(E) the census tract in which is located the principal place of business of the women-owned, minority-owned, or small business loan applicant;

‘‘(F) the gross annual revenue of the business in the last fiscal year of the women-owned, minority-owned, or small business loan applicant preceding the date of the application;

‘‘(G) the race, sex, and ethnicity of the principal owners of the business; and

‘‘(H) any additional data that the Bureau determines would aid in fulfilling the purposes of this section.

‘‘(3) NO PERSONALLY IDENTIFIABLE INFORMATION.—In compiling and maintaining any record of information under this section, a financial institution may not include in such record the name, specific address (other than the census tract required under paragraph (1)(E)), telephone number, electronic mail address, or any other personally identifiable information concerning any individual who is, or is connected with, the women owned, minority-owned, or small business loan applicant.[1]

 As you can see, the type of information that will be required is extensive.  It is also worth noting that this information could go a long way toward helping your bank completely analyze how it is meeting the credit needs of the community and to plan accordingly.  

A Proactive Approach

When considering both the omnipresent nature and the impending growth of fair lending, we believe that a proactive approach is the best manner to proceed.  Such an approach can start immediately and can be enhanced incrementally without significant drain on current resources.   The starting point is an assessment.  

The fair lending risk assessment of your banks should be comprehensive and multi-dimensional; fair lending reviews touch several areas of your bank.   A thorough fair lending risk assessment can and probably should, include information from other areas such as:

·         The compliance risk assessment

·         The strategic plan

·         Enterprise wide risk assessment

·         Community Reinvestment Act   assessment

For fair lending, the focus of the assessment should be on how all of the operating areas of the bank impact the surrounding community.  For example, it is important to consider how the lending program meets the needs of the community.   Simultaneously, one should consider how deposit products that are being offered meet those same needs.  Has there been outreach to the local community to determine whether the products being offered by the bank are a good fit for the entire bank’s population?  The fair lending assessment should be completed at least annually.  For many banks, the overall resources available to the compliance department are limited.  Performing a comprehensive review of fair lending may seem like a low priority item.  However, by leveraging the information form other assessments and reviews that are regularly performed, this task can be completed seamlessly.  

Who Are You? 

For many banks, the question “how do you meet the credit needs of your community”? - can be a real stumper!  Most can answer in very general terms, but if pressed by a regulator, specifics would be difficult to present.   In the near future, this will be a significant question that must be answered with details.  A proactive approach to fair lending would include ongoing and dynamic research into the credit needs of the community.  There is significant public information available about the economic conditions in your local community.  Maintaining an active file that details statistics such as the median income and house price in your assessment area is critical.   Moreover, using this information to develop a set of answers to the question of meeting credit needs will serve your bank well. 

How are You Doing? 

There has been an increasing amount of attention on consumer complaints.   A best practice is to keep a complete records of complaints and how they were resolved and to report these results to the Board on a regular basis.  Regulators expect that complaints form customers will be taken seriously and addressed as a part of an overall fair lending effort.  Along these lines, the use of “mystery shoppers” to test the overall customer experiences is an excellent proactive approach.  

The Cutting Edge

The law already allows a bank to conduct a self-assessment of it compliance with the Equal Credit Opportunity Act (Reg. B.).  Specifically, 202.15 allows for the fact that a self-test for compliance is both encouraged and privileged information.   Put another way, by using the self-testing provision of Regulation B, you bank can start collecting all of the above information now.  Information about who your commercial borrowers are and what characteristics they do and don’t have is invaluable information.  It is also information that will eventually be required, so why not start today? 

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[1] 5 U.S. Code § 1691c-2

 

Fair Lending- A silent Killer?    A Two Part Series

Over the last few years, compliance has become the center of attention for management of community banks.   Currently there is a great deal of attention being placed upon the upcoming changes to the RESPA-TILA forms while areas such as proper HMDA reporting, BSA/AML management and flood insurance remain constant areas of concern for compliance professionals.   While all of these areas continue to receive attention and resources, there are several areas of compliance that often get overlooked.  Chief among these is fair lending compliance.   

One of the reasons that this area is often overlooked is because fair lending compliance is very difficult to gauge.   There is no one fair lending law and managing compliance in this area requires considering the manner in which several regulations come together.   Fair lending reviews borrow information from Regulation B (the Equal credit Opportunity Act), the Community Reinvestment Act (“CRA”), Unfair Deceptive Abusive Acts or Practices Act (“UDAAP”), the Fair Housing Act, and to some extent the Home Mortgage Disclosure Act (“HMDA”).   The interplay between these regulations are considered when determining the level of fair lending compliance at a bank.  For many Compliance Officers reviewing compliance with each if these regulations takes significant time and resources and there simply isn’t much time left to review for fair lending.  

Another reason fair lending gets overlooked is that often, its applicability is misunderstood; this is especially true at community banks that do majority commercial lending.  The thought is that since there are very few consumer loans, the risk of a fair lending problem, is low.  However there are several reasons why this thinking is dangerous.  Fair lending laws apply in commercial settings and violations can cause significant enforcement actions.   In addition, the passage of Dodd Frank will greatly expand this area for commercial banks.    Now is the time to check things out to make sure that this potentially silent killer is not lurking at your bank.  

Fair Lending Laws ALWAYS Apply

Remember the heart of fair lending laws is the Equal Credit Opportunity Act, which is implemented by Regulation B.   This is the one consumer regulation that does not have an exemption for non-consumer loans.   Reg. B applies to all credit!  The reasons for this are myriad and are the results of a long and sordid history of bad behavior.   The basic reason for Reg. B’s existence is to ensure that that credit opportunities are available for all and to ensure that education about those opportunities is widespread.  Regulation B always applies. 

Another fair lending component that applies in all situations is the Community Reinvestment Act (“CRA”).   The CRA was designed to encourage banks to meet the credit needs of the communities in which they operate.   All banks are required to by the regulation to make an effort to make loans that will ultimately benefit the immediate surrounding area of the bank, called the assessment area.   Regardless of whether or not the loans being made are largely commercial, the expectation is that the majority of loans are made to people or business within the assessment area and that are being originated meet some part of the credit needs of the community. 

The Unfair, Deceptive Abusive Acts or Practices Act (“UDAAP”) has also been applied to all banks whether or not they are primarily commercial.   Because this act covers the practices of a bank, its reach is expansive.    Moreover, UDAAP has the ability to expand a consumer regulation into the commercial area.   This has happened most recently in the area of overdrafts.  There have been several enforcement actions at banks that relate directly to overdraft programs.  For many of these enforcements actions, consumer accounts that were being used for business purposes were included.    

The end result is that whether your bank is largely a commercial lender or not, fair lending compliance is a necessity.   

 Regulators will review Fair Lending for Commercial Portfolios

The fair lending examination procedures of the regulators all include a section for reviewing consumer and commercial loans.   Although the primary focus of the procedures is on consumer loans, it is clear that commercial loans should be included:  

Where an institution does a substantial amount of lending in the commercial lending market, most notably small business lending and the product has not recently been examined or the underwriting standards have changed since the last examination of the product, the examiner should consider conducting a risk factor review similar to that performed for residential lending products[1]

There are several factors that an examiner will review when performing the commercial loan portfolio fair lending review, these include: 

·         The manner in which loan staff interacts with clients

·         Pricing Disparity- are people in protected classless asked to pay higher fees and rates that similarly situated people in no protected classes?   

·         Pricing Exception- are exceptions to pricing policy being allowed in a fair and equal manner

·         Underwriting Disparity- Do all customers have a similar underwriting experience or are people in protected classes asked for more extensive information.  Is the underwriting time period generally the same for all borrowers? 

·         Underwriting Exceptions- Are exceptions to policy made is a fair and equal manner? 

·         Assessment Area Diversity- Do the banks products and services meet the credit needs of the community? 

In the past, the amount of information that could be used for these reviews was limited.  Commercial lending is generally an art for in that each loan is unique and it is difficult to compare the outcomes because several factors are considered in making a commercial credit decision. 

A BIG Change is Coming!

One of the most significant of the future regulations is section 1071 of the Dodd Frank Act.  This section amends the equal credit opportunity Act (AKA as Reg. B) to require banks to gather information about applicants for commercial loans.   The information that will be gathered is very similar to information that is currently required by the Home mortgage Disclosure Act (HMDA).

The reason that this section of the Act was enacted is clear. 

“The purpose of this section is to facilitate enforcement of fair lending laws and enable communities, governmental entities, and creditors to identify business and community development needs and opportunities of women-owned, minority owned, and small businesses” ^[2]

Put another way, the purpose of the collection of this information will be to allow the banks, economists and regulators to more completely and accurately determine the types of loans that are being requested by minority and women owned business.  Presumably, the collected data will be used to provide regulators with tools to craft legislation that will expand fair lending laws and rules to the commercial lending area

There are some unique features to the requirements of this law.  In particular, the lending staff member who is doing the underwriting is NOT ALLOWED to ask the questions required by the law;

Where feasible, no loan underwriter or other officer or employee of a financial institution, or any affiliate of a financial institution, involved in making any determination concerning an application for credit shall have access to any information provided by the applicant pursuant to a request under subsection (b) in connection with such application.^[3]

The idea here is that this information must not be part of any credit decision, and the bank is under an obligation to present evidence that this information has been segregated from the credit decision.  Therefore even in cases where there are too few staff members to totally segregate the collection of the information from the loan staff, a protective wall still must be created. 

If a financial institution determines that a loan underwriter or other officer or employee of a financial institution, or any affiliate of a financial institution, involved in making any determination concerning an application for credit should have access to any information provided by the applicant pursuant to a request under subsection (b), the financial institution shall provide notice to the applicant of the access of the underwriter to such information, along with notice that the financial institution may not discriminate on the basis of such information^[4]

The time is coming when this information must be collected and the Bank must make sure that once it is collected, that the information has no impact on the credit decision.

Not only is fair lending an issue of great importance today, this is an area that will continue to grow in the compliance firmament.  Now is the time to take proactive measures to develop your fair lending compliance area.   In part two of this blog we will discuss proactive measures for fair lending.   

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[1] FDIC compliance Manual 2014

[2] Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act

[3] Ibid

[4] Ibid