Brenda Baylor and Lauren E.T. Chriss
Mortgage lenders spent the last 12 months planning for the regulatory changes enacted on January 1, 2018, by the Home Mortgage Disclosure Act (HMDA). It has been a “race to the finish line” wrought with challenges: adding system fields, testing system changes, training staff on new data collection processes, interpreting new reporting requirements, filing in a new data portal under the old rules while collecting new mortgage application data under the new rules, and many more. By now your institution has filed its 2017 HMDA Loan Application Register (HMDA-LAR). Congratulations! You can stop, take a deep breath, and pat yourself on the back … for all of five minutes. Now you need to execute part two of the “HMDA Games.”
All HMDA reporters should be proactively preparing for impacts that the new rules will have on their fair lending monitoring program and examination approach. To date there is little to no regulatory guidance on expanding your fair lending analytics to encompass the new 2018 HMDA-LAR data. But don’t wait for published regulatory guidance or enforcement actions to spark reactive changes to your fair lending analytics, or you may very well find your institution unprepared for heightened examination scrutiny or unwanted fair lending allegations and investigations. To be ready, lenders need to create a strategy to navigate complex and uncharted challenges, requiring even more collaboration, inventiveness, and leadership than heretofore demanded of the fair lending team.
How can you minimize the surprises and help prepare your institution to manage this new age of fair lending risk?
Have a Plan
Two critical questions to start with are:
1. When should you expect a fair lending examination that incorporates the new HMDA data?
Since this will vary for each lender, you may want to pose the question to your regulator. If doing so is uncomfortable, then you can estimate the timing based on your historical exam cycle. Large banks may have more rigid demands for providing HMDA-LAR data and undergoing fair lending evaluations; smaller banks likely won’t be examined until after the March 1, 2019, filing deadline. But, if the answer to this question is completely unknown, then you should plan on being ready sooner rather than later.
2. When do you need to modify current fair lending analytics to accommodate the new HMDA data?
To be proactive, you can design and test the new analyses now. That way, the new models will be ready to use when you have collected sufficient 2018 HMDA data to produce meaningful and reliable analytics.''
Having some idea of those target dates enables you to plan an implementation time frame, and everything else can be built as milestone events within that framework. Additional considerations to start thinking through include, but are not limited to:
Evaluate the Impacts
- Which new or modified HMDA fields can impact existing fair lending analytics?
- Are there non-quantitative fair lending risks arising from the changes?
- How should you risk rate, prioritize, and incorporate HMDA data collection changes under the fair lending risk assessment?
- What needs to happen to ensure the fair lending testing team gets the new HMDA data file in time to produce, evaluate, and report on the new fair lending analyses?
- How should you handle overlapping time periods for mortgage records that fall under the old HMDA requirements versus the new HMDA requirements? (Likely, you can expect at least a few overlaps in the fourth quarter of 2017, since a loan application taken in December 2017, but closing after January 1, 2018, must be reported under the new rules.)
- How will new fair lending analytics impact your trend analysis, since you are no longer comparing “apples to apples”?
- Do any of your institution’s fair lending-related policies and procedures need to be revised to accurately reflect the new HMDA changes?
• What modifications are needed for fair lending training, and when should new training take place?
- When should the control testing team review changes to the fair lending monitoring program?
- When should the model validation team review changes to the fair lending monitoring program?
- When should the audit team review changes to the fair lending monitoring program?
- When should you hold discussions with regulators on changes to (1) your fair lending analysis and monitoring program and (2) the regulators’ fair lending examination process?
- What should be reported to senior leadership and the board of directors, and when?
The new HMDA rules have increased the number of reportable HMDA fields from 26 to 110. At least 44 (40 percent) of the total represent new or modified fields that contain data relevant to fair lending analytics. The vast HMDA data changes will undoubtedly impact and increase the complexity of fair lending analytics. Five of the most difficult changes relate to the following categories: Race, Ethnicity, Gender, Free Form Data Fields, and Government Monitoring Information (GMI) Reporting Based on Visual Observation or Surname. The following chart summarizes potential fair lending risks arising from those five categories of HMDA data reporting changes.
- Focus on Data Integrity: Data integrity is critical to producing reliable fair lending analytics. While this is not a novel idea, the new HMDA data collection requirements will sharply increase a lender’s compliance risk due to the magnitude of changes and the potential for new challenges that lenders will face in getting the data right. In other words, if your institution struggled with HMDA data collection under existing rules, it can expect more challenges in the coming months. Enhance or add to your data quality review controls, if necessary, to ensure the data provided for fair lending analytics is complete and accurate. An example might be to add another layer of testing for an initial period of time post-implementation (i.e., compare file documentation to loan origination system data to the HMDA-LAR).
- Communicate and Collaborate: This is one of those areas where it truly “takes a village” to ensure changes are implemented successfully. Ensure you communicate and collaborate with key stakeholders within your institution’s first, second, and third lines of defense (i.e., lines of business, risk management/compliance, and internal audit), so that everyone understands the heightened fair lending risks and can help to manage them appropriately. Put some thought and planning into what is needed to ensure robust communication and partnering. For instance, form a working group that includes the fair lending team, legal, business lines, control testing team, model validation, information technology, risk management, and audit to implement necessary fair lending analysis and monitoring changes. Also consider outlining a communication plan for key stakeholders to (1) provide ideas and recommendations; (2) be kept apprised of implementation progress and examination preparedness; and (3) be informed of the results of the new fair lending analytics, independent testing, and audit reviews.
- Seek Regulatory Guidance: Tackling the “unknowns” of future fair lending examinations is key for the industry because it will provide more solid direction on the changing needs of lenders in terms of monitoring and analysis. With that goal in mind, your institution can make efforts to understand and interpret implications for fair lending examinations through close communication with experienced fair lending attorneys (both in-house and external, as appropriate), conversations with your examiner(s), industry networking opportunities (e.g., peer groups or fair lending-related round tables), and training seminars or conferences (particularly those involving regulatory agencies).
- Update the Risk Assessment: Incorporating changing risks and controls into your risk assessment is critical to effectively planning and implementing new and revised fair lending analytics as an offshoot of the new HMDA rules. A risk assessment helps to ensure controls are in place to capture the right data, identify any monitoring and analysis gaps, and determine the magnitude of potential threats. Updates will be required to policies and procedures, operating systems, and training materials. A risk assessment will allow you to ensure (1) all moving parts of the implementation have been addressed; (2) key stakeholders understand the changing risk profile and are collaborating; (3) obstacles are resolved and escalated (as needed); and (4) appropriate training, testing, and documentation are put in place.
You might ask, “Why make changes to our fair lending analytics program when there is no regulatory guidance giving insight into how regulators will examine the new HMDA data?” The answer is simple: Proactive planning and risk assessments are expected by regulators and indicative of a strong compliance management system. To that end, you should formulate a risk management plan and update your risk assessment to identify potential areas of heightened fair lending risk resulting from implementation of the new HMDA rules. Developing and executing a multi-pronged plan to address unprecedented and complex fair lending program changes will require input and support from numerous stakeholders. The end-to-end process will likely take months and require specialized expertise in the fair lending space. Your institution will be better positioned by starting on this change management process before your regulator shows up on your doorstep.
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