Preparing for the New Fair Lending Exam
Additional Risk Factors and Additional Statistical Analyses
It is no longer business as usual for institutions that engage in mortgage lending or servicing, or non-banks that engage in equity lending or other forms of lending. The risks are greater than they've ever been. With broadened government oversight and increasingly complex regulations, lenders could find themselves like deer in headlights if they are not prepared through self assessments, and increased diligence in understanding all the criteria used in every loan file.
In our previous blog, we discussed the Department of Justice's announcement that it has formed a special Fair Lending Unit to pursue residential lenders and brokers that engage in what the government calls "toxic and discriminatory" loans to the minority community. They outline "reverse redlining", the practice of offering products and terms that result in higher foreclosures, as a major focus of the investigative unit. Loan modifications will also get scrutiny that used to be reserved for primary loans. The DOJ's Fair Lending Unit will also review Home Affordable Modification Program data for signs of discrimination in modification terms and payment reductions.
Adding to the complexity for lenders are the revised FFIEC Interagency Fair Lending examination procedures announced in August 2009. The notice clarifies examination procedures related to pricing, steering, redlining, and broker activity. They also provide regulators with guidance on how to evaluate portfolios with small sample sizes and data accuracy. Here's what to expect in your next examination:
Pricing Discrimination - Examiners are directed to look at financial incentives such as overages, underages and yield spread premiums, where broad pricing discretion was used. New procedures increase analysis on pricing and incentives. The procedures also create a new pricing risk factor for disparities in the incidence or volume of higher priced lending among prohibited basis groups.
Steering - The Steering risk factors have been expanded to look at products, terms, conditions, and lending channels, especially as they may create disparity among minority classes. Examiners have been granted increased flexibility to broadly assess whether there is a risk that applicants might be steered to products or channels with potentially negative consequences.
Redlining - The procedures expand the redlining section to include "reverse redlining," where minority neighborhoods may have been targeted for credit on less favorable terms than offered in non-minority neighborhoods. A new FFIEC risk factor has been added to identify disparity in the number of originations of higher-priced loans, or loans with potentially negative consequences, in areas with relatively high concentrations of minority residents relative to other areas.
An additional redlining risk factor was added to determine if an institution's CRA assessment area may have been drawn to exclude areas with higher than average concentrations of minority residents.
Broker Activity - New procedures place increased emphasis on understanding an institution's mortgage broker activity when scoping an examination. Examiners are directed to evaluate fair lending with regard to underwriting, terms and conditions, redlining and steering.
Focal Points with Small Sample Sizes - In the past, institutions with low lending volumes or small sample sizes were often disregarded. The new risk factors, however, encourage examiners to pursue further investigation if risk factors are present, regardless of sample size.
Data Accuracy - Under the new procedures, examiners are directed to validate data before conducting the fair lending examinations....especially HMDA data.
Beware Broader Regulatory Analyses
So with these new areas of emphasis, how do you adequately prepare for your Fair Lending exam? The regulatory agencies will be employing specialized techniques, including statistical analysis, regression analysis to evaluate underwriting, steering and pricing matters. The Fair Lending Enforcement Section within DCCA now has responsibility for supporting the HMDA Analysis Program and for developing tailored statistical analyses. Additionally, the Fair Lending Enforcement Section has developed supplemental statistical analyses for redlining matters, and will support examiners with comparative file reviews, even in low volume institutions.
Reduce Risk with Proactive Steps
Due to the Home Affordable Modification Program (HAMP), an increasingly important part of fair lending compliance is loan modifications. Banks and servicers must have set criteria you are using across the board equally. There will be a need to test the impact of these modifications across groups to understand if there is any disparate impact. Understand any disparity that is showing. Redress your program to ensure you are eliminating issues before examiners arrive.
In other words..."know your data." We know you've heard that before, but with added oversight to lending, foreclosures, modifications and workouts, it is more important than ever that you understand the differences in loan outcomes between different classes of borrowers. One of the most proactive and effective steps you can take is to measure, test, and measure again. Even the government suggests that institutions conduct self evaluations. Their procedures imply that the institutions that self test and monitor should be in better standing and better prepared.
What we know is regulators will have new methodologies they use to scrutinize these loans. You should look at your data for evidence of disparate treatment, disparate impact and discrimination. The agencies are going to be more aggressive in their determinations and enforcement. Within this environment, lenders and servicers must continue to mitigate risk for their institutions, meet consumer needs fairly and be prepared for the regulators heightened enforcement activity.
We invite your comments and feedback on this blog. Do you have insights into what changed in your most recent examination? If so, please share with our readers, so we can all benefit from your knowledge.
And let us know what you'd like to see discussed and highlighted in future columns. Feel free to tell us what is most on your mind. We want to contribute to making our readers a little better prepared every time they visit TruPoint Partners' Smart ComplianceTM Blog. And there are no better experts than those of you managing your institutions day to day, through challenging operations and examinations.
Until next time,