Fair Lending Compliance, Ability-to-Repay and Qualified Mortgages

On October 22, 2013, the Consumer Financial Protection Bureau (Bureau), Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), and the National Credit Union Administration (NCUA) (collectively, the Agencies) issued a statement in response to inquiries from creditors about whether they would be liable under the disparate impact doctrine of the Equal Credit Opportunity Act (ECOA) [15 U.S.C. 1691 et seq., and its implementing regulation, Regulation B, 12 C.F.R. Part 1002] by originating only Qualified Mortgages as defined under the Bureau's recent Ability-to-Repay and Qualified Mortgage Standards Rule (ATR Rule). The ATR Rule implements provisions of the Truth in Lending Act (TILA).[1]

The Agencies' general approach and expectations regarding fair lending, including the disparate impact doctrine, are summarized in prior issuances.[2]

The Agencies state that they are issuing this statement to describe some general principles that will guide supervisory and enforcement activities with respect to entities within their jurisdiction as the Ability-to-Repay Rule takes effect in January 2014. Per the Agencies, the requirements of the Ability-to-Repay Rule and ECOA are compatible. ECOA and Regulation B promote creditors acting on the basis of their legitimate business needs.[3]

Therefore, the Agencies do not anticipate that a creditor's decision to offer only Qualified Mortgages would, absent other factors, elevate a supervised institution's fair lending risk.

The Bureau's Ability-to-Repay Rule implements provisions of the Dodd-Frank Act that require creditors to make a reasonable, good faith determination that a consumer has the ability to repay a mortgage loan before extending the consumer credit.[4] TILA and the Ability-to-Repay Rule create a presumption of compliance with the ability-to-repay requirements for certain "Qualified Mortgages," which are subject to certain restrictions as to risky features, limitations on upfront points and fees, and specialized underwriting requirements.

Consistent with the statutory framework, there are several ways to satisfy the Ability-to-Repay Rule, including, according to the Agencies, making responsibly underwritten loans that are not Qualified Mortgages.

The Bureau does not believe that it is possible to define by rule every instance in which a mortgage is affordable for the borrower. Nonetheless, the Agencies are recognizing that some creditors might be inclined to originate all or predominantly Qualified Mortgages, particularly when the Ability-to-Repay Rule first takes effect. The Rule includes transition mechanisms that encourage preservation of access to credit during this transition period.

Furthermore, according to the issuance, the Agencies expect that creditors, in selecting their business models and product offerings, would consider “demonstrable factors” that may include credit risk, secondary market opportunities, capital requirements, and liability risk. The Ability-to-Repay Rule does not dictate precisely how creditors should balance such factors, nor do either TILA or ECOA. Consequently, as creditors assess their business models, the Agencies are clearly stating they understand that implementation of the Ability-to-Repay Rule, other Dodd-Frank Act regulations, and other changes in economic and mortgage market conditions have real world impacts and that creditors may have a legitimate business need to fine tune their product offerings over the next few years in response.

Importantly, the Agencies seem to be recognizing that some creditors' existing business models are such that all of the loans they originate will already satisfy the requirements for Qualified Mortgages. An example given is where a creditor has decided to restrict its mortgage lending only to loans that are purchasable on the secondary market might find that - in the current market - are Qualified Mortgages under the transition provision. Thereby giving Qualified Mortgage status to most loans that are eligible for purchase, guarantee, or insurance by Fannie Mae, Freddie Mac, or certain federal agency programs.

With respect to any fair lending risk, the Agencies claim that situation here is not substantially different from what creditors have historically faced in developing product offerings or responding to regulatory or market changes. The decisions creditors will make about their product offerings in response to the Ability-to-Repay Rule are similar to the decisions that creditors have made in the past with regard to other significant regulatory changes affecting particular types of loans.

An example provided is where some creditors may have decided not to offer "higher-priced mortgage loans" after July 2008 (viz., following the adoption of various rules regulating these loans or previously decided not to offer loans subject to the Home Ownership and Equity Protection Act after regulations to implement that statute were first adopted in 1995). There were no ECOA or Regulation B challenges to those decisions.

Inevitably, creditors should continue to evaluate fair lending risk as they would for other types of product selections, including by carefully monitoring their policies and practices and implementing effective compliance management systems. As with any other compliance matter, individual cases will be evaluated on their own merits.

The OCC, the Board, the FDIC, and the NCUA believe that the same principles described above apply in supervising institutions for compliance with the Fair Housing Act (FHA), 42 U.S.C. § 3601 et seq., and its implementing regulation, 24 C.F.R. Part 100.[5]

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[1] See http://www.consumerfinance.gov/regulations/ability-to-repay-and-qualified-mortgage-standards-under-the-truth-in-lending-act-regulation-z/. Disparate impact is one of the methods of proving lending discrimination under ECOA. See 12 C.F.R. pt. 1002 & Supp. I.
[2] For instance, in 1994, eight federal agencies published the Policy Statement on Discrimination in Lending, 59 Fed. Reg. 18,266 (Apr. 15, 1994), and last year the Bureau issued a bulletin on lending discrimination, CFPB Bulletin 2012-04 (Fair Lending) (Apr. 18, 2012). In addition, the OCC, Board, FDIC, NCUA, and Bureau each have fair lending examination procedures.
[3] Even where a facially neutral practice results in a disproportionately negative impact on a protected class, a creditor is not liable provided the practice meets a legitimate business need that cannot reasonably be achieved as well by means that are less disparate in their impact. See 12 C.F.R. §1002.6; 12 C.F.R. pt. 1002, Supp. I, § 1002.6, ¶ 6(a)-2.
[4] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 1411, 124 Stat. 1376, 2142 (2010) (codified at 15 U.S.C. § 1639c).
[5] The OCC, Board, FDIC, and the NCUA have supervisory authority as to the FHA.

CFPB: Compliance Management System

On October 31, 2012, the CFPB issued its first issue of Supervisory Highlights: Fall 2012, a newsletter to the public and the financial services industry about its examination program, including the concerns that it finds during the course of its completed work, and the remedies that it has obtained for consumers who have suffered financial or other harm.

It is written as an Executive Summary, and it will not refer to any specific institution. But it will "signal to all institutions the kinds of activities that should be carefully scrutinized for compliance with the law."

According to the CFPB, it has already taken non-public supervisory actions against financial institutions participating in the credit card, credit reporting, and mortgage markets, confirming "remedial relief" to 1.4 million consumers, and causing the affected financial institutions to correct illegal practices. Importantly, and in consequence to the CFPB's examinations and actions, financial institutions were required to adopt effective policies and procedures to ensure that violations do not recur and, especially, mandating that they implement a robust Compliance Management System (CMS). 

The CFPB maintains that an effective CMS is a "critical component of a well-run financial institution."

After a brief discussion about the CMS concept, I should like to outline these three significant findings derived from the CFPB's examinations:

- Comprehensive CMS Deficiencies Found Through CFPB Supervisory Activities

- Deficiencies Related to Failure to Oversee Affiliate and Third-party Service Providers

- Deficient Fair Lending Compliance Programs

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IN THIS ARTICLE

Compliance Management System

Comprehensive CMS Deficiencies

Failure to Oversee Affiliate and Third-party Service Providers

Deficient Fair Lending Compliance Programs

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Compliance Management Systems

I consider the term Compliance Management System to be a proxy for the term mortgage risk management. Our firm was founded on the premise that such risk management was the best way to ensure a financial institution's safety and soundness with respect to mortgage banking. At the time, there was only the term "risk management", a catch-all term that was overly broad. So I coined the term "mortgage risk management" to bring mortgage compliance into greater focus, expertise, and application.

Over the years, the prudential regulators and state banking departments have included much guidance in preparedness for their mortgage banking examinations. And now the CFPB has further elaborated the crucial and central importance of managing risk and examination readiness. As recently as July 2012, I published a magazine article about The Rules of Operational Risk, in order to bring into strong relief the practical matters and unique circumstances of mortgage risk management.

The CFPB's conception of a well-conceived CMS is certainly consistent with the foundational features of mortgage risk management.

Both the CFPB and mortgage risk management require effective internal controls and oversight, training, internal monitoring, consumer complaint response, independent testing and audit, third-party service provider oversight, recordkeeping, product development and business acquisition, and marketing practices.

Mortgage risk management and the CMS both expect the development, maintenance, and integration of mortgage compliance practices across a financial institution's framework and applied to its entire loan product and service lifecycle.

As the CFPB states:

"Without such a system, serious and systemic violations of Federal consumer financial law are likely to occur. Further, a financial institution with a deficient CMS may be unable to detect its own violations. As a result, it will be unaware of resulting harm to consumers, and will be unable to adequately address consumer complaints."

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Comprehensive CMS Deficiencies

The CFPB has issued findings for financial institutions lacking an effective CMS across the entire consumer financial portfolio, or in which the company failed to adopt and follow comprehensive internal policies and procedures. In these instances, the finding held that this condition resulted in "a significant breakdown in compliance and numerous violations of Federal consumer financial law."

The corrective action required an adopting of appropriate policies and procedures, and establishing an effective CMS to ensure legal compliance, which had to include the "enhancement" of financial institutional regulatory knowledge and expertise to help ensure proper monitoring of business activities and prompt identification of potential risks to consumers.

In this regards, educating about and training employees in a company's policies and procedures should be fully implemented and routinely followed. I suggest a schedule of on-going education and training modules, given to both new hires and all active, affected personnel.

Keep in mind that the CFPB will exam not only the policies and procedures and their communication to employees but also management's inclination to be proactive or passive, preemptive or complacent, knowledgeable or disinterested. According to the CFPB, a financial institution’s CMS is “inadequate” where appropriate policies have been adopted, but management fails to take measures to ensure compliance with those policies.

In a typical CMS examination, the CFPB evaluates both the understanding and application of the financial institutions’ compliance management program by its managers and employees. The CFPB has stated that it has found "one or more situations in which the financial institution had articulated many elements of an appropriate compliance policy, but the policy was not followed."

Fair Lending Compliance - Some Red Flags

The Consumer Financial Protection Bureau (CFPB) will make Fair Lending a focus of its examinations.

I have written extensively on these examinations.*

Our firm is committed to providing comprehensive audit and due diligence reviews in preparation for the CFPB's Nonbank and Bank Supervision and Examination. 

And my firm has offered, freely, a CFPB Compendium of all parts and each section of the Examination Manual.

Our Compendium provides:

• Directory: All Sections
• Contents: Links to Compendium Text
• Contents: Links to CFPB Website Text

CLICK HERE TO REQUEST THE CFPB COMPENDIUM!

In preparing our Audit and Due Diligence procedures for our clients, we have combined all three parts into a single Directory with links to each section's CFPB Compendium texts and CFPB's website texts. There are over 700 pages in this CFPB Compendium.

A central feature of the CFPB exam is the review of a company's Fair Lending compliance.

In preparing your firm for a CFPB examination, it is important to explore how Fair Lending is practiced by your firm.

The term "Fair Lending" has been around for many years and is used as a catch-all phrase for several regulatory compliance requirements.

Let's consider four areas affecting Fair Lending compliance - areas to which financial institutions sometimes do not give sufficient consideration.

I will provide a brief list, grouped by category, and suggest some potential risks that should be considered.

The list is not meant to be comprehensive - I have chosen just four categories - but this exercise should guide you toward expanding the scope of your Fair Lending initiatives.

Please keep in mind that state banking department examiners and federal prudential regulators will also look for these potential infractions when conducting examinations.

IN THIS ARTICLE

Redlining
Pricing
Underwriting
Maternity Leave

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Redlining

Some Potential Risks

• Community Reinvestment Act (CRA) assessment areas do not comply with Regulation BB and/or exclude minority areas.
• Branches and expansion plans disfavor minority neighborhoods.
• Marketing strategies exclude minority geographies.
• Complaints about redlining by consumers or community advocates.

Pricing

Some Potential Risks

• Overages, fees, yield spread premiums, and pricing exceptions.

• Lack of specific guidelines for pricing (including exceptions).

• Use of risk-based pricing that is not based on objective criteria or applied consistently.

• Broad pricing discretion, such as through overages, underages, or yield spread premiums.

• Lack of clear documentation of reasons for pricing decisions (including exceptions).

• Lack of monitoring for pricing disparities.

• Financial incentives for loan originators to charge higher prices.

• Pricing policies or practices that treat applicants differently on a prohibited basis or have a disparate impact.

• Loan programs that contain only borrowers from a prohibited basis group.Complaints about pricing by consumers or community advocates.

Underwriting

Some Potential Risks

• Stricter underwriting policies, such as tighter credit standards in certain specific geographic markets.
• Lack of specific underwriting policies for Fair Lending risk, including both disparate treatment and disparate impact discrimination.
• Lack of monitoring and/or policies to manage disparate impact risks caused by varying origination channels or geographic areas.

Maternity Leave

Regulation B, the implementing regulation of the Equal Credit Opportunity Act (ECOA), prohibits using assumptions related to the likelihood that any group of persons will rear children or will, for that reason, receive diminished or interrupted income in the future.

Some Potential Risks

• Assuming that a woman will not return to work after childbirth.
• Not implementing underwriting policies that treat applicants on maternity or parental leave and applicants on other types of leave similarly.
• Failing to consider the requirements for verifying the income of an applicant on maternity or parental leave.
• Failing to review and respond to complaints by consumers who were on maternity or parental leave at the time of the loan application.
• Not incorporating remedies into a policy statement regarding maternity or parental leave.

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Consumer Financial Protection Bureau

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* Jonathan Foxx is the President & Managing Director of Lenders Compliance Group

Adverse Action and Risk-Based Disclosures (Final Rules)

On July 6, 2011, the Federal Reserve Board (FRB) and the Federal Trade Commission (FTC) jointly issued final rules (Rules) to implement the credit score disclosure requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

Our previous notification relating to this rule was on 7/7/11, on 3-2-11, and 1-3-11.

The Rules amend certain model notices in Regulation B (Equal Credit Opportunity), which combine the adverse action notice requirements for Regulation B and the FCRA, to reflect the new credit score disclosure requirements. 

If a credit score is used in setting material terms of credit or in taking adverse action, the statute requires creditors to disclose credit scores and related information to consumers in notices under the Fair Credit Reporting Act (FCRA).

The Rules amend Regulation V (Fair Credit Reporting) to revise the content requirements for risk-based pricing notices, and to add related model forms that reflect the new credit score disclosure requirements.

REGULATION B (ECOA)

Adverse Action Notice

Section 701 of the Equal Credit Opportunity Act (ECOA) requires a creditor to notify a credit applicant when it has taken adverse action against the applicant. The ECOA adverse action requirements are implemented in the FRB's Regulation B.

Section 615(a) of the Fair Credit Reporting Act (FCRA) also requires a person to provide a notice when the person takes an adverse action against a consumer based in whole or in part on information in a consumer report.

Certain model notices in Regulation B include the content required by both the ECOA and the FCRA adverse action provisions, so that creditors can use the model notices to comply with the adverse action requirements of both statutes.

The FRB is amending these model notices in Regulation B to include the disclosure of credit scores and related information if a credit score is used in taking adverse action.

The revised model notices reflect the new content requirements in section 615(a) of the FCRA as amended by section 1100F of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Effective: August 15, 2011

REGULATION V (FCRA)

Fair Credit Reporting Risk-Based Pricing Regulations 

On January 15, 2010, the Board and the Commission published final rules to implement the risk-based pricing provisions in section 311 of the Fair and Accurate Credit Transactions Act of 2003 (FACT Act), which amended the Fair Credit Reporting Act (FCRA).

The final rules generally require a creditor to provide a risk-based pricing notice to a consumer when the creditor uses a consumer report to grant or extend credit to the consumer on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that creditor.

The FRB and the Commission are amending their respective risk-based pricing rules to require disclosure of credit scores and information relating to credit scores in risk-based pricing notices if a credit score of the consumer is used in setting the material terms of credit.

These final rules reflect the new requirements in section 615(h) of the FCRA that were added by section 1100F of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Effective: August 15, 2011

LIBRARY

Equal Credit Opportunity
Regulation B
Adverse Action Notice
FRB: 12 CFR Part 202
Final Rule
July 15, 2011

Fair Credit Reporting
Regulation V
Fair Credit Reporting Risk-Based Pricing Regulations
FRB: 12 CFR Part 222
FTC: 16 CFR Parts 640 and 698
Final Rules
July 15, 2011