Prior to the 2008 housing crash, predatory lending and subprime mortgages were becoming the norm either in practice or in process. In many cases, in their sales and marketing practices or in their product priorities, lenders unknowingly engaged in practices that are considered predatory. Given the demographic targeted and the complexity of the mortgage process, borrowers failed to fully appreciate the terms and conditions of their loan. Within these product and consumer groups, disproportionately high rates of delinquency were realized. In many cases, this negatively impacted immigrants and communities of color across the United States.
To recover from 2009 losses, lenders narrowed access to credit through underwriting overlays on government guidelines, primarily to mitigate their operating risks. Elevated corporate margins on top of historically low cost to borrower funds enabled lenders to recover significant losses and to build stronger balance sheets. Such practices, while economically reasonable, had the counter effect of minimizing the housing recovery to middle to upper class, white borrowers. Fair lending grew less “fair,” neither by design nor intent, but due to the consequences of public policy failures.
Causes of Violations
Fair lending—what does it really mean, and how can compliance be achieved? In the most basic format, fair lending laws were put into place prohibiting discriminatory practices, specifically in the categories of race, color, national origin, religion, sex, familial status, handicap, marital status, and age. Regulatory agencies that oversee the requirements of fair lending practices by financial institutions include the Federal Deposit Insurance Corporation (FDIC), Federal Reserve Board (FRB), Office of the Comptroller of the Currency (OCC), the U.S. Department of Housing and Urban Development (HUD), National Credit Union Administration (NCUA) and the Consumer Financial Protection Bureau (CFPB). These regulatory agencies enforce their fair lending agendas through various legislative acts, including the Fair Housing Act (FHA), Equal Credit Opportunity Act (ECOA), and the Home Mortgage Disclosure Act (HMDA).
While there are a number of systemic causes of fair lending violations, among the top three are pricing disparities by branch and market, interest rate offerings, and incentive pay of loan officers. Pricing issues and discrepancies have become challenging to oversee and manage—particularly due to the misunderstanding about pricing including the utilization of Metropolitan Statistical Area (MSA) and pricing adjustments that may need to be made across the nation given the demographics.
How is an “MSA” defined, and what are the implications on branch pricing? In May 2017, on the eve of the summer production ramp by retail mortgage banks, Dr. Rick Roque, founder of MENLO, a leading M&A and Retail Mortgage Banking firm and currently VP of Business Development at American Eagle Mortgage, observed how difficult it is when the guidance from the compliance community varies broadly on matters such as pricing within specific MSAs. “In many markets, you have depositories who define entire states as an ‘MSA’ and in the same geography you have mortgage banks who define it as neighborhoods within suburbs. The implications of this are dramatic when it comes to recruiting good loan officer talent and it directly impacts the pricing the consumer receives.” Non-uniform pricing across lenders is part of the competitive landscape and it is difficult to manage, especially when “neighborhoods” could be racially or ethically characterized, thus directly effecting communities of color without directly intending to do so. Dr. Roque continued, “Whether the executive team is aware or not of the fair lending violation, some companies simply do not want to fight the battle with their own sales teams and others think it is a non-issue due to their legal or compliance guidance. It makes it a moving target. Perhaps it is a good thing there is a lack of clarity on the subject because it leaves it open for lenders to compete differently, but the absence of leadership, comment or even enforcement on the subject makes it very difficult to do the ‘right thing’ by Retail management and to provide adequate coaching to their respective sales teams.”
Company and branch margins are directly related to the end interest rates that consumers receive. Violations in this arena occur when lenders offer lower interest rates in various markets that directly or indirectly impact specific demographics of consumers. Furthermore, interest rates, by definition, are a tool to mitigate risk between borrowers and are considered more credit worthy than alternative methods. The concern, however, is when some consumer groups are more likely to receive a higher rate than others; it is a fine line to grant an interest rate reduction based upon a score. What happens, however, when that score is prejudicially effecting communities of color? Are lenders then, in turn, engaging in racism or discriminatory practices? Possibly. The issue is “profits” versus “practices,” and how lenders can help apply lower interest rates perhaps, but insist on consumer education tools or solutions. There are, in fact, many solutions, but without the proper guidance, too few of these options will get implemented beyond token efforts.
Cost of Fair Lending
If a mortgage institution is subject to a litany of regulatory laws, there is, without a doubt, increased cost associated with compliance. The increased cost may detract from a lender’s ability to offer products, expand into new markets, and incur higher fees associated with the mortgage process. For instance, with the new Home Mortgage Disclosure Act requirements going into effect in January 2018, there is an increase of 40 percent more nonbank lenders who incur the expense of gathering data and complying with the new reporting. While the lender may be able to pass some of this cost on to the consumer, to stay competitive a lender may have to take on some of this increased cost itself. This diminishes the lender’s ability or willingness to offer mortgage financing and may cause some lenders to pull out of the industry altogether, thus decreasing competition and choice for consumers.
Implications of Fair Lending
Fair lending implications reside deep from within the mortgage operation. While policy and procedure infractions or steering practices exist, the majority of these have been corrected with loan officer compensation rules and enforcement. In most distributive retail models, how branch and corporate margins are established varies across every branch across the company. With this, there are many variables: the loan officer compensation; the determined margin for FHA, VA, USDA, conventional and jumbo products; and the effective costs of the branch. To maintain pricing stability and consistency, lenders institute a variety of strategies, which may include: (a) fixing loan officer compensation across a market or MSA, (b) fixing product margins by product type, or (c) prohibiting loan officers from offering specific types of products because of the balance between their compensation, the inherent risks with a particular type of loan, or the costs to manufacture a specific type of loan.
Ultimately, where an operation accepts certain practices as acceptable risks, the result can have a negative consequence on the sales force. Further, this can affect a mortgage lender’s appetite for competition in expanding into new markets or building market share in existing ones. The lack of regulatory guidance, while presumably intentional, raises concern that without clear interpretation or application of fair lending rules, the enforcement of such violations will nonetheless be regulated to the judicial branch of government.
There are many other enforcement actions occurring against well-established lending institutions. Thus, the questions remain. – if organizations that are heavily capitalized prior to regulatory scrutiny and presumably well-managed and others can be prime targets, what about regulatory risks against lesser capitalized firms with fewer resources? More broadly speaking—who is safe from the undefined liabilities of fair lending?
Debbie Hoffman, Esq is a financial services attorney with a specialization in technology innovation. She serves as the 2017-18 Chairperson of the Association of Corporate Counsel Financial Services Committee and can be reached at DKHNY@Yahoo.com.