Addressing Upcoming Changes in HMDA Directed by the Dodd Frank Act-A Two Part Series

This is an update to a blog we posted earlier this year.  

Part One: The “Known-Knowns”  

In August of 2014, the CFPB released it proposed changes to the Home Mortgage Disclosure Act (“HMDA”) (Regulation C).  The comment period for these changes ended in October of 2014 and the final rule is scheduled for July of 2015.   Of course it is impossible to predict exactly what the changes will be, but to paraphrase a speech from Donald Rumsfeld, there are some known-knowns when it comes to these changes.     

A Quick Bit of Background

Remember that HMDA is designed to help develop information on the lending practices of banks.  In its original form, HMDA was designed to make banks disclose where they were lending to help stop “red-lining”.   Red-lining is the  practice of specifically refusing to make loans in areas or neighborhoods.  In the past there were lenders who would literally take a map of a city and draw a red line around neighborhoods in which they refused to lend.  

As the mortgage industry grew and changed, HMDA also changed.  The focus of the information being collected moved from disclosure of information at banks collectively to the experience of individual borrowers at banks.  Information on the application process and the results of the application were added to HMDA data collection requirements in the 1980’s. 

At the turn of the 21^st century, the focus of the information collected changed again and this time the type of credit being offered became the focus.  As a result the terms of the loans and more information about the lien status of the loans was added to HMDA.  

Dodd Frank Changes

The changes in HMDA that are being brought about by Dodd Frank are another step in the progression of the regulation.   The idea here is that HMDA will be used to develop more information about the overall status of the mortgage industry.  For example, the CFPB noted in press releases that;  

“While a lot of information is contained in HMDA….additional mortgage information could help federal regulators, state regulators, lenders, consumer groups, and researchers better monitor the market. For example, no data is currently gathered on home equity lines of credit which surged prior to the housing crisis nor on teaser mortgage rates which had a hand in causing it.  HMDA data currently contains only limited information about loan features and interest rates.”[1]

In addition, the Dodd Frank changes will also require a HMDA-like program that will collect information on women and minority owned businesses.   Don Sokolov, the Deputy Associate Director, Division of Research, Markets & Regulations for the CFPB put it this way: 

“The Dodd-Frank Act helps small businesses by filling a major gap in knowledge about the market for small business credit. Section 1071 of the Dodd-Frank Act amends the Equal Credit Opportunity Act to require that financial institutions collect and report information concerning credit applications made by small businesses and women- or minority-owned businesses. One stated purpose of Section 1071 is to strengthen fair lending oversight. The CFPB and other authorities will be able to use these data to improve the effectiveness and efficiency of fair lending enforcement efforts ^[2]”

The type of information that will be required here is still very much unknown and we will discuss this area further in Part Two of this series. 

Update-Types of Loans Reported

One of the most significant changes that will occur when the new HMDA rules are effective is that that the all loans that are secured by a dwelling will be reported.  This means that HELOC’s will now be required to be reported on the HMDA LAR.  Reverse mortgages will also be reported on the LAR.  This also means that one headache for reporting, the unsecured home improvement loan will no longer have to be reported.  

 Update- HMDA Reporters

There are several significant rule changes that were included in the CFPB announcement.  The first of these changes is the definition of who is a HMDA reporter.  Under the new rules, any institution that originates more than 25 mortgage loans in the previous calendar year, will be subject to HMDA reporting.  It is as simple as that. 

Update-Disclosure Requirements

The new guidelines will change the way HMDA data is disclosed.  For large originators (more than 75,000 entries annually) HMDA data will be reported quarterly.  For all reporters, the disclosure will be made available to the public through a website. 

Update-Staff Commentary

There will be additional staff commentary that is directed some of the thorniest questions surrounding the collection and reporting of data.  Questions such as the treatment of modular homes, refinancings and which structures are considered dwellings. 

Moving Forward-Getting Ready for Changes

Despite the fact that there are currently no regulations that specifically, address these changes, the CFPB has begun the process.  Therefore, one of the” known-knowns” is that the regulations are coming.     

We also know that there are several data points that will be part of the new regulation.  We know this because these data points are written into the law and will be required to be part of the new regulations.  The Dodd-Frank Act specified new data points to be collected and reported: namely, the total points and fees of the mortgage; property value and improved property location information; the length of any teaser interest rates, prepayment penalties, and non-amortizing features; lender information, including a unique identifier for the loan officer and the loan; and the borrower’s age and credit score.

 Finally, we also have a good idea of additional changes that the CFPB is considering.  We know this because they released a factsheet that shows they required changes and changes being considered. [3]

Using what we know about the changes that are coming, we know that there are at least different approaches that financial institutions can take to prepare: 

1)       Do nothing and what for the regulations to be published;

2)      Address the “known-knowns” by collecting the data that is written in the law;

3)      In addition to the above attempt to start collecting data on the proposed areas.  

We whole heartedly do not advise taking the first approach.  While it can seem prudent to wait until a change is actually made, in this case, we know that the change is coming.  Waiting until the rule is published leaves your bank open to higher risk and the costs associated with last minute alterations that need to be made.  The risk adverse route is to marshal forces now to get ready for the changes that you know are coming. 

Taking the second route and addressing the areas that are certain to be part of the new regulations is, in our opinion, a risk adverse approach. 

The following is a list of data that is required by Dodd Frank, along with the CFPB comments; 

New Data Element	CFPB  Description
Age & Credit score	Unscrupulous lenders may target the elderly for unsuitable and costly loans – having applicant age will help regulators identify and potentially take action to discourage these schemes. Credit score will make it easier to understand why some borrowers are denied and why some borrowers pay higher rates than others. Credit score will also help regulators identify lenders  who may warrant closer review.
Total points and fees at origination	It is critical that regulators understand how much borrowers are paying for their loans in the form of the total points and fees and the rate spread. These data points will significantly enhance financial regulators’ understanding of pricing outcomes and risk factors for  borrowers.
Value of property securing loans	The value of a property is an important part of a lender’s decision whether to make a loan and what rate to charge. Property value information  will help regulators better understand lenders’ acceptances and denials, and the rates and fees they charge borrowers. Improved location information will help with analyses of local mortgage  markets.
Introductory fixed-rate period for variable-rate loans, Prepayment penalties,  Ability to make other than fully-amortizing payments	Particularly in the years leading up to the mortgage crisis, certain types of loan features have been  problematic  for consumers. Including this information in HMDA will give financial regulators a  better  view of the effect of riskier loan features.
SAFE Act unique identifier, Universal loan identifier.	Including  information such as an identifier for the loan officer who works with the borrower, a unique identifier  for the loan, and information about whether the applicant or borrower works with a mortgage broker,  would help regulators keep track of lenders’ business practices.

 

There are several points of information that are also being considered by the CFPB.  We will discuss these and the implications for reporting in our next post. 

Since we know that this information will be part of any new regulation, now is the time to start developing the processes and getting the training necessary for staff to understand the requirements.  In doing so, your institution will make the transition smooth, reduce risks and overall costs. 

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[1] See Swanson- CFPB Changes HMDA Data Collection-Mortgage News Daily February 2014

[2] Testimony of Testimony of Dan Sokolov Deputy Associate Director, Division of Research, Markets & Regulations Consumer Financial Protection Bureau

[3] CFPB FACTSHEET: CONSUMER FINANCIAL PROTECTION BUREAU TAKES STEPS TO IMPROVE INFORMATION ABOUT ACCESS TO CREDIT IN THE MORTGAGE MARKET  February 7, 2014

Are you Aware that the FFIEC has released Guidance 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. The final rule was issued and took effect on June 10, 2015.   

 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 does require that an annual statement on the diversity practices of the Banks and credit unions.  Based upon the standards in the 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

 

What does Diversity Mean? 

For purposes of this definition, “minority” is defined as Black Americans, Native Americans, Hispanic Americans, and Asian Americans, which is consistent with the definition of “minority” in section 342(g)(3) of the Act.

The final Policy Statement also states that this definition of diversity “does not preclude an entity from using a broader definition with regard to these standards.” This language is intended to be sufficiently flexible to encompass other groups if an entity wants to define the term more broadly. For example, a broader definition may include the categories referenced by the Equal Employment Opportunity Commission (EEOC) in its Employer Information Report EEO-1 (EEO-1 Report), [4] as well as individuals with disabilities, veterans, and LGBT individuals.

 

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?   

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.    

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 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 whether the final guidance will have significant costs associated with it, 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

Strategic Planning for Compliance

In the Summer, 2015 issue of Supervisory Insights, the FDIC focuses on the idea of strategic planning for banks in a shifting earnings environment.[1]  While this article addresses the need for overall strategic planning at banks, it brings to mind the idea that the compliance program at your bank specifically should undergo strategic planning.   In fact, the same principles that are outlined in the text can be directly applied to the compliance program at community banks.  

Changing Environment

The financial crisis of 2009 lead to many bank failures, a greater number of regulations and overall uncertainty in the banking industry.   As all of the financial pain from that upheaval began to sort itself out many banks have been left to find their way in a changing environment.   The competition for good and reliable borrowers has become intense while net interest margins have been squeezed by persistent low interest rates.   Alternative lending institutions that do business to business lending have also started to make inroads in the pool of potential customers for community banks. 

Simultaneous to a shrinking pool of good customers is a growing list of regulations that require active participation on the part of bank management.  The expectations of regulators are that banks will make a strong effort to monitor their products and activities to ensure compliance with the requirements of the regulations.  In both the immediate future and the long term, it will be necessary for banks to be flexible and innovative when addressing the need to stabilize and grow profits.   

The compliance program has to be part of the growth and innovation.  As the products and services that a bank offers change to meet the needs of the community, so must the compliance program.  New products have different compliance risks that range throughout the lifecycle of the product.[2]

Governance

In the area of compliance, governance of the program is critical to its success.  Oftentimes, at smaller financial institutions, this is an aspect of compliance that is overlooked.   The Board and senior management must be a part of the overall strategic planning process for compliance.  Just like every other area of bank administration, it is the role of the Board to establish the risk appetite that will be implemented in the compliance program. 

As a best practice, the compliance risk assessment should be comprehensive, performed annually and should be a part of the strategic planning process.  Completing a compliance risk assessment should not be simply a rote exercise.  The risk compliance risk assessment should take into account current resources versus needs and be a comprehensive and honest assessment of the capabilities and effective ness of the current program.   The compliance risk assessment should be presented to the Board and senior management as part of the strategic planning process.  In this manner, the Board has a clear picture of the compliance program and can more accurately establish the risk appetite of the financial institution.  

Working with the Board to establish priorities for resources in a given year is a critical part of strategic planning for compliance.     

Budgeting

One of the problems that often confront compliance programs is lack of adequate resources.    This can take the form of lack of staff, inadequate training, insufficient time to perform essential duties, missed deadlines or missed audits or reviews.  Unfortunately, there is a tendency for compliance staff to try to maintain a static level of resources.  Compliance is often seen and a noncontributing expense and increasing the budget can be met with withering opposition.  However, despite its lack of earning potential, an ineffective compliance program can be the source of dramatic expenses.  In this case, an “ounce of protection” in the form of an adequate compliance program is worth a pound of cure.   An effective compliance program must have adequate resources to meet the risk appetite of the financial institutions.  This does not necessarily mean hiring additional staff; outsourcing is a practice that many financial institutions employ.   Outsourcing allows the leveraging of resources to meet the specific needs of a financial institution.  

Take a look at the training, management information systems and audit/compliance review resources that are available based upon the current risk environment.   If there are gaps, the strategic planning process is the time to make the resource requirements known.  The level of earnings that are projected at your financial institution must have taken the compliance budget into account.  Otherwise, an ineffective compliance program can result in enforcement actions that wipe out the entire earnings. 

Forecasting

For a compliance program to be truly effective. It has to be part of the forecasting for a financial institution.  If new products or markets are being contemplated, the compliance resources required must be considered.  For example, in the event your financial institution decides that they will once again offer HELOC’s, does the compliance staff have sufficient knowledge of the disclosure, servicing and reporting requirements for these loans?  If not, how difficult will it be to acquire this knowledge?   Does the core system have the ability to properly account for the compliance requirements for these loans? If not, what are the costs for upgrading systems?  These are costs that rightly should be considered in the strategic planning process.   Even if no new products are being offered the regulatory environment can change from one year to the next.  For example, in 2016 there will be entirely new flood insurance rules.   These rules will apply not only to new loans, but to the existing portfolio.  The training and reporting systems changes that will be necessary to comply with these new rules should be part of the strategic planning process so that sufficient resources are allocated to this change.    Being a part of change at the Bank is an essential compliance function.  

One of the useful habits of financial institution regulators is that they announce potential changes to regulations well in advance of the changes actually taking place.   All of the regulators announce publicly the changes that they are proposing and invite comment.  For example,

On May 22, 2015, the CFPB released its Spring 2015 regulatory agenda, which updates the status of the regulatory issues and rulemakings on which the CFPB is currently working:

 

Final Rule

• Completing a final rule under Regulation C to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act’s (Dodd-Frank Act) amendments to the Home Mortgage Disclosure Act. The rulemaking proposal is available; the CFPB expects the final rule to be issued in August 2016.

• Completing a final rule under Regulation E to regulate prepaid financial products. The proposal is available; the CFPB expects the final rule to be issued in January 2016.

• Issuing a final rule on June 10, 2015, to supervise larger, nonbank participants in the consumer automobile financing and leasing markets, defined as nonbanks that annually originate at least 10,000 automobile loans, automobile loan refinancing’s, purchase of automobile loans, or leases. The rule became effective August 31, 2015. [3]

At least two of these rules will have a direct impact on the compliance demands on your bank in the very near future.  This information is readily available but is often overlooked due to strained resources and lack of sufficient time.   Part of the overall forecasting for compliance should include a component that allows for the forecasting of compliance needs in the immediate future.  

By employing many of the same principles that are part of overall bank strategic planning to the compliance area, the compliance program can increase efficiency and can maintain an appropriate view of the resources necessary to remain effective.  

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[1] https://www.fdic.gov/regulations/examinations/supervisory/insights/sisum15/SISummer2015.pdf

[2] For a good discussion or risk management throughout the lifecycle of a product see Consumer Compliance Outlook second quarter 2015-Federal Reserve Bank publications

[3] Ibid