Fair Lending 2017: New Year, New Focus
Late last year, the Consumer Financial Protection Bureau (CFPB) issued a little noticed but highly significant statement on fair lending priorities for 2017. Announced by Patrice Alexander Ficklin, Director, Office of Fair Lending and Equal Opportunity, the statement complements a broader declaration of priorities that the bureau issued last February to explain the near-term focus of all of its work.
The new fair lending priorities are real, they provide a guide to enforcement expectations, and every company should review its lending practices with them in mind. Notably, the emphasis has changed from priorities of the past several years, to the following three priorities:
- Mortgage and student loan servicing
- Small business lending, with a focus on women-owned and minority-owned businesses
Importantly, the CFPB removed as priorities fair lending in the following areas: auto lending and credit cards. Of course, enforcement will continue in auto lending and credit cards if serious violations come to the bureau’s attention, but the CFPB has essentially “declared victory” by explicitly taking these two areas off the priority list for bureau-wide regulatory and supervisory work.
Kudos to the CFPB for clarifying its 2017 focus.
Note that it is possible these priorities (redlining, loan servicing, small business lending) could be changed by the Trump administration, but don’t count on it. No one wants to be against fair lending and any changes in emphasis will take time. So the best advice is to accept these priorities as the reality for now, while maintaining flexibility and watching for new announcements.
What To Do
Redlining reviews seek to evaluate whether lenders have intentionally avoided lending in minority neighborhoods. In this case the word “intentional” is not as limiting as one might surmise, as the effects of a lender’s policy are usually used to determine violations. Company management should deliberately and methodically answer key questions, including the following:
- Does your company have robust underwriting guidelines and policies that prohibit illegal discrimination?
- Is your company obtaining significant numbers of applications from minority neighborhoods?
- Are the numbers of applications from minority neighborhoods comparable to the number of applications from non-minority neighborhoods, adjusted for population and total applications?
- Do minority neighborhoods have access to your company through branches or alternative delivery systems?
- Are the rate of acceptance and cost of credit comparable between minority and non-minority neighborhoods, given similarly situated borrowers?
- Do your company’s marketing programs and campaigns, including websites and social media, ensure product offerings are visible to all potential customers?
- Do your company’s product offerings meet the credit needs of all the communities it serves?
- How does your company’s lending in minority neighborhoods compare to the lending patterns of your peers?
- Has your company received any complaints suggesting that consumers who live in minority neighborhoods believe their applications have been denied for discriminatory reasons?
Management needs to be prepared to demonstrate that they understand their community and their place in it and that they are being proactive. Good intentions are not satisfactory—measurable results are necessary.
Mortgage and Student Loan Servicing
While this priority is positioned as one category, it is actually two: mortgage servicing and student loan servicing. Most banks service these two types of loans separately, in different departments with different personnel. Non-bank financial service companies generally specialize in one form of servicing or the other.
The emphasis in both cases is generally on loan renegotiations, known as workouts or modifications. The CFPB has taken multiple enforcement actions against mortgage servicers for conduct that it viewed as unfair or deceptive to borrowers of all demographics, but its recent statement suggests that the bureau has become concerned about whether potential unfair treatment is related to a consumer’s membership in a protected class. A company should therefore determine, and be prepared to demonstrate, that similarly situated customers who request modifications are treated in a consistent way and that any exceptions have a legitimate, non-discriminatory basis. That is, do minority borrowers receive the same service and modifications as non-minority borrowers?
Now here is the important feature: your company should be able to demonstrate non-discriminatory treatment, not merely rely on good intentions.
For both student loans and mortgage workouts, here is a partial list of areas to evaluate:
- Does your company have adequate resources dedicated to assisting customers? Review hold times, hours of availability, access to information online, and timely response to inquiries.
- Does your company have clearly defined criteria for determining a customer’s ability to repay a loan based on their changed circumstances?
- Do those criteria have any potential for disparate impact (e.g., a limitation on the minimum loan amount that must be present to apply for a workout)?
- Are workout opportunities offered based on consistent criteria?
- Is your company’s willingness to consider a workout clearly communicated to all potential candidates?
- Does your company have a way to track applications for workouts and monitor outcomes for fair lending considerations?
- Does your company track customer satisfaction post-workout, looking for ways to improve?
Small Business Lending
This one is a game-changer.
Much of what banks have done historically in fair lending compliance for small business could change dramatically in 2017. The CFPB has announced that it has started to build a small business lending team and begun outreach to help determine the parameters of the new data it will collect. The exact changes are still a bit uncertain, but the direction is clear.
First, the definition of “small business” for purposes of the Community Reinvestment Act (CRA) and the Equal Credit Opportunity Act (ECOA) has been businesses with gross annual revenues of $1 million or less. For CRA reporting purposes, small business loans have been further definemd as only those loans in the amount of $1 million or less, classified as commercial and industrial loans or commercial real estate loans on a bank’s Reports of Condition and Income (Call Reports).
Section 1071 of the Dodd-Frank Act which required the CFPB to issue a rule on small business lending data collection stated that the definition of “small business” is to have the same meaning as the term “small business concern” in section
3 of the Small Business Act (15 U.S.C. 632). §632 directs that the administrator of the Small Business Administration (SBA) “may specify detailed definitions or standards by which a business concern may be determined to be a small business concern…”
These SBA criteria cover a much larger pool of loans and are far more complicated than the ECOA or CRA definitions. SBA size standards are based on the industry (using the North American Industry Classification System or NAICS) in which a business is engaged, and are set either by revenue amount or number of employees, depending on the industry. This classification includes all business types, not just those categorized by certain criteria on the Call Report, so commercial development entities such as land developers, homebuilders, and commercial real estate construction companies may also be covered. One bank we have worked with reports that approximately 95 percent of its commercial loans would meet these criteria.
To comply with the SBA definition for fair lending data collection, a lender would be required to obtain the accurate NAICS code, number of employees, and accurate gross annual revenue for its commercial borrowers. And to the point, a lender would have to determine the race, ethnicity, and gender of the owners of the business.
Although Dodd-Frank mandates a small business data collection rule, it contains no deadline for carrying out this requirement. So the timing of this process is uncertain.
Second, Dodd-Frank also defines the protected class of borrowers as “women-owned and minority-owned businesses.” Congress expressed a concern that these two classes of borrowers may experience discrimination when they apply for credit, and the CFPB is pursuing that concern. A lender should have in place policies that protect women- and minority-owned businesses against discrimination. Those policies should include both cost of credit and availability of credit. And as always, lenders should be prepared to demonstrate a non-discriminatory outcome, not just intent.
Fair lending analysis of small business credit could, by necessity, be different than fair lending analysis of consumer lending. For example, fair lending reviews of consumer credit have relied on the demographics of the census tract in which consumers live to determine a consumer’s race or ethnicity, but the demographics of the census tract in which a business is located may not be an effective way to determine the race or ethnicity of that business’s owner. The creditor should, therefore, maintain names of the owners in its database. Until the CFPB completes its criteria for the collection of monitoring information on business owners, this may provide the bank with a tool to analyze the ownership of its business customers by proxy information. The name methodology can be analyzed for race, ethnicity, and gender.
Overall, preparation for fair lending compliance should include the following five steps as a framework:
- Take This Seriously
Assemble your team to talk about the new fair lending priorities and develop an action plan. Ensure a culture of compliance exists at your company. Executive management should include compliance and fair lending personnel “at the table”. Management must communicate the level of importance and ensure the respect and cooperation of all lines of business for compliance, including fair lending—no exceptions. Particular focus should be given to those areas that may have previously escaped the close scrutiny of fair lending examinations, such as commercial real estate development.
- Ensure Your Company’s Fair Lending Risk Assessment is Current
A strong fair lending risk assessment should consider the inherent risk based on industry- and company-specific criteria and the controls that are in place to mitigate that risk. Use the assessment to determine the focus needed on products, lending channels, and operational areas, and communicate what is needed to your lines of business and management.
- Evaluate Your Company’s Current Fair Lending Program
Ensure that your program is properly documented with a fair lending policy approved by the board of directors and that it is reviewed annually. Perform regularly scheduled fair lending analysis on policies (such as underwriting criteria) and products, communicate the results to management, and have an action plan for identified risks. Have strong complaint management and training programs. Consider fair lending when evaluating new products, channels, and growth opportunities. Monitor marketing programs.
- Evaluate Your Company’s Data Systems
Does your company have systems to capture and analyze all necessary data? If not, now is the time to evaluate what is needed. Include regulatory compliance personnel and fair lending subject matter experts in the planning sessions to ensure all needs are captured.
- Consider the Positives
Regulation and evaluation have become very data-driven. Consider other uses for this data, such as a greater understanding of the needs of your company’s existing customers, as well as the assistance it may provide for marketing and strategic planning.
General Douglas MacArthur once famously commented that the history of failure in war can be summed up in two words: “Too Late!” Too late to prepare, too late to plan, too late to train, too late to gather and deploy resources, too late to start.
As in all compliance matters, failure will be the outcome of fair lending compliance efforts if you start too late.