FAIR LENDING AND THE CFPB understanding the current landscape and cost effective compliance options Ari Karen Offit Kurman [email protected] 917-312-2294 301-575-0340

Countrywide • Countrywide Consent Decree: Investigated by New York Attorney General • Regression analysis by state economist alleged that racial and ethnic differences in pricing were principally explained by pricing exceptions and broker compensation.

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Countrywide • Countrywide (cont’d) • Settlement mandated that Countrywide perform at least two regression analyses per year to determine if material pricing differences in pricing exceptions • Also required to analyze whether high-minority customer bases have higher overages than other branches in the same MSA 3 © 2010 Offit Kurman, PA. All Rights Reserved.

Countrywide • Countrywide (cont’d) • Also required analyses of LO compensation, loan products provided to minority customers, educational programs and loan file reviews.

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Forms of Fair Lending • Disparate Impact – neutral policy that has discriminatory effect. • Usually deals with manner in which loans are priced • Must show existence of challenged policy AND that the challenged policy is having discriminatory effect • Lender is still not liable if business necessity © 2011 Offit Kurman, PA. All Rights Reserved.

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Disparate Impact • Disparate impact likely to garner significant attention – increasing trend • To defend need to examine policies and justification for policies • To defend need to show that you have policies and practices in place to prevent discriminatory results • Consider pricing policies, LO training, random quarterly samplings, overview of all pricing policies © 2011 Offit Kurman, PA. All Rights Reserved.

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Disparate treatment • Focus is on intentional discrimination • Can be inferred by policy and outcome • Potential targets – Different geographical pricing – Margins different at locations – LO’s on different comp plans determined by geography

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Enforcement Uptick • US Department of Justice creates new fair lending enforcement unit • US Attorney General announces crackdown on fair lending violations • Last but not least…

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Consumer Financial Protection Board • Scope of coverage is very broad – applies to any consumer financial transaction and all parties involved with such financing • Leadership – Director is 5 year term, nominated by president and appointed by senate. • CFPB has near complete autonomy • Republicans planning all out assault on Warren. Administration silent but getting pressure from political left © 2011 Offit Kurman, PA. All Rights Reserved.

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Office of Fair Lending and Equal Opportunity • Enforces fair lending laws including ECOA and HUMDA • The Bureau can declare any “unfair” practice unlawful if – causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers; – And practice is not outweighed by countervailing benefits to consumers or to competition.

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Office of Fair Lending and Equal Opportunity Can declare Abusive practices illegal if: - Takes disadvantage of consumers’ lack of understanding - Consumer cannot protect themselves - Consumers reasonably rely on the covered entities

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Fair Lending • CFPB takes over fair lending issues but does so in conjunction with state regulators and state enforcement as well as Federal Reserve, USDOJ • Will see larger more widespread issues handled by CFPB and smaller issues – States • More regulators=Increased enforcement • Dodd Frank act explicitly mentions fair lending enforcement in conjunction with overlapping of authority. © 2011 Offit Kurman, PA. All Rights Reserved.

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Compounding Problems • Loan officer duty of care • Loan officer ability to repay analysis • Offering products for which consumer likely qualifies • Loan officers evaluated by pull through rates • All of these require and incentivize initial evaluation and determination by loan officer without full information © 2011 Offit Kurman, PA. All Rights Reserved.

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FAIR LENDING MYTH • Many believe that it is not permissible to have any differentiation in pricing or compensation •

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False: for example, courts have held that even when the plaintiff can show evidence discrediting the bank's articulated reasons for taking a certain action, and evidence of less than thorough handling that does not conform generally to customary industry practices, will not support an inference of intentional discrimination without some evidence that similar "non-protected" applications have received dissimilar treatment. Simms v. First Gibraltar Bank, 83 F.3d 1546 (5th Cir) However, courts have held that, the plaintiff’s allegation that the lender knew that offering a yield spread premium caused brokers to act in a discriminatory manner and that the lender “targeted” minorities for higher cost loans by “purposefully utilizing brokers who served minority communities” was sufficient to state a disparate impact claim for racial discrimination 14 © 2010 Offit Kurman, PA. All Rights Reserved.

Defending Disparate Treatment Claim • Force Plaintiff to establish that non-protected borrowers were treated differently • Plaintiff does “not have to show an exact match between his application and the applicants outside of the protected class who received a loan, but the comparator loan files must be 'significantly parallel in every material respect.'" Hood v. Midwest Sav. Bank (6th Cir. 2004) • Even if Plaintiff can surpass that hurdle, lender can establish non-discriminatory basis for decision to avoid liability (recordkeeping!) 15 © 2010 Offit Kurman, PA. All Rights Reserved.

Defending Disparate Impact Claims • First step: undermine claims that there is any discrete policy identified by the Plaintiff (ie simply paying one LO higher bps than another does not constitute a policy capable of supporting DI claim unless particular pattern established)

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Defending Disparate Impact Claims • Second step: attack Plaintiff’s ability to provide statistical support for allegations. • Are the statistics supported by sufficient data? Is there a legitimate sample size? Has the Plaintiff proven a connection between the policy at issue and the alleged disparity?

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Defending Disparate Impact Claims • Third Step: Establish business necessity. • Even if there is a disparity, establish that failure to implement the policy at issue would cause significant competitive disadvantages; inability to retain effective LOs. • No less “discriminatory” alternative available 18 © 2010 Offit Kurman, PA. All Rights Reserved.

Bottom Line • Key is to have sufficient data, records, training and policies to support a basis for differentiation and clear-cut, unambiguously enforced policies prohibiting discriminating and reducing discretion which could form the basis for disparate impact.

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Damned if you do… • First National Bank of St. Louis: Discrimination charged fro not locating enough branches in minority areas • Prime Lending: Settlement for giving wide discretion in overages resulting in disparate treatment where there was no monitoring in place. • Citizens Republic Bank: Failing to offer mortgages to residents of minority areas © 2011 Offit Kurman, PA. All Rights Reserved.

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Fair Lending Risks • Opal Jones v. Wells Fargo Bank – jury reaches 3.5 million dollar verdict for not offering lower price loan products in minority areas • Decatur Federal Savings & Loan. Failing to advertise in minority areas • First United Security Bank: Failing to offer mortgages to minorities • Barrett, et al. v. H&R Block, Inc., and Option One Mortgage Corp., the plaintiffs assert that the wholesale lending practices of Option One illegal because allowed Brokers to set origination fee. © 2011 Offit Kurman, PA. All Rights Reserved.

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Fair Lending Risks • Discrimination in the underwriting or pricing of loans, such as discretionary mark-ups and fees; • Redlining through the failure to provide equal lending services to minority neighborhoods; • Reverse redlining through the targeting of minority communities for predatory loans; • Steering minority borrowers into less favorable loans; and • Marital status, gender and age discrimination in lending. © 2011 Offit Kurman, PA. All Rights Reserved.

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Underwriting • Subjective or vague underwriting guidelines • Substantial disparities in approval/denial rates • Broad use of exceptions and disparities in exceptions

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Pricing • • • •

Substantial discretion in pricing Substantial disparities in pricing Disparities reflected in HMDA data Risk based pricing that is subjective or inconsistently applied • Existence of consumer complaints alleging fair lending © 2011 Offit Kurman, PA. All Rights Reserved.

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Advertising • Advertising patterns or practices that reflect targeting or avoidance of groups; • Advertising only in media serving non-minority areas; • Use of marketing programs that exclude regions with higher percentages of minority group residents

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Origination • Substantial difference in number of originations of minority vs. non-minority • Substantial difference in type of loan products • Substantial difference in loans falling outside 3 lowest cost alternatives

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Common practices? • Branches with different pricing or margins? • Allowing branch level oversight on pricing and exceptions or allowing branches to set pricing? • Allowing brokers to set different fees/pricing? • Unlimited discretion in pricing • Targeted marketing to higher income areas

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Relief through CFPB • • • • • • • • •

Rescission/reformation Refunds and returns Restitution Disgorgement Damages Penalties (Tiers 5k, 25k, 1M PER DAY) Public notice Injunction Recovery of costs © 2011 Offit Kurman, PA. All Rights Reserved.

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Enforcement Powers • Can engage in joint investigations – specifically mentions fair lending • Can issue subpoenas and compel testimony of witnesses • Civil investigative demands can be issues requiring worn written answers depositions, sworn document productions, etc. • Can conduct hearings and issue cease and desist orders • Can issue temporary C&D orders without hearing whenever needed to prevent prejudice to consumers. • Can commence litigation on its own behalf © 2011 Offit Kurman, PA. All Rights Reserved.

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HMDA • You will have the HMDA Data – Use it • Federal law does not protect self-analysis of loan and application files • Only protects “new data,” such as fake mortgage applications used for testing and compliance. • The common law self-critical analysis privilege may apply, depending on where you’re located, but likely will not

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Be Smart about Reports Have Data analysis limited to one key persons (depending on your organization’s size). They should know: – to keep comments to a minimum – that not everything has to be in writing – to be smart about what is said

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Data Integrity • Must confirm to source documentation • Must conform to loan documents • Failure to do so is critical and can lead to significant problems

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HMDA – Currently Required • • • • • • •

Application/loan identification number. Date application received. Type of loan (e.g., FHA, conventional, etc.) Property type. Purpose of loan. Occupancy. Loan amount

THIS HAS NOT CHANGED AND WILL STILL BE IN EFFECT UNTIL THE ACT BECOMES EFFECTIVE AND CFPB ISSUES NEW RULES © 2011 Offit Kurman, PA. All Rights Reserved.

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HMDA – Currently Required • If the loan requested is for a purchase, whether there was a request for preapproval. • Type of action taken. • Date of action taken. • Property of location, in terms of metropolitan statistical area. • Census tract number. • Ethnicity of applicant. • Race of applicant. THIS HAS NOT CHANGED AND WILL STILL BE IN EFFECT UNTIL THE ACT BECOMES EFFECTIVE AND CFPB ISSUES NEW RULES

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HMDA – Currently Required • Gender of applicant. • Income of applicant. • Type of purchaser (to indicate whether a loan that your institution originated or purchased was then sold to a secondary market within the same calendar year). • Reasons for denial. • Rate spread between the APR and the applicable average prime offer rate. • HOEPA status. • Lien status. THIS HAS NOT CHANGED AND WILL STILL BE IN EFFECT UNTIL THE ACT BECOMES EFFECTIVE AND CFPB ISSUES NEW RULES

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Dodd Frank Adds the Following FOR ALL COMPLETED LOANS: – Itemization of the number and amount of loans by age. – Itemization of the number and dollar amount of mortgages with respect to the total points and fees payable at origination for the applicable mortgage. – The APR of the applicable loan must be compared to the benchmark rate of all relevant loans. – Itemization of the term (in months) of any prepayment penalty. © 2011 Offit Kurman, PA. All Rights Reserved.

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Dodd Frank Adds the Following FOR ALL COMPLETED APPLICATIONS – – – –

Value of any real property pledged as collateral. Term of any introductory interest rate period. Term of the loan in months. Channel through which each application was made (e.g., wholesale, broker, etc.). – Availability of the option to the borrower to adjust the payment schedule. – Applicant's credit score.

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What will be done with that Information? In the case of mortgage bankers, CFPB will analyze data to: – Determine how institutions are serving the housing credit needs of their communities. – and help identify possible discriminatory lending patterns and assist regulatory agencies in enforcing compliance with antidiscrimination statutes. – Your focus should be to analyze the data with respect to preventing and avoiding discrimination claims

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Plans for Self-Analysis • Review HMDA Data Quarterly • You can use Vendors to do regression analysis and also to assist with compliance -- easiest and, depending on your size, most cost-effective way. • If smaller, you can analyze the Loan Application Register information yourself • Ensure there is responsible person for data, training, periodic self evaluation © 2011 Offit Kurman, PA. All Rights Reserved.

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Self-Analysis • Analyze branch data to determine if there are outlying branches or loan officers • If utilize pricing buckets examine highest and lowest cost LO’s • Analyze all exceptions to pricing • Analyze on a completely random sampling • Take account for credit/LTV/DTI/timing • NYLX systems up to date analysis tools © 2011 Offit Kurman, PA. All Rights Reserved.

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Do You Have A Fair Lending Problem? • If you have flat level pricing and no discretion to LO’s? • If you allow LO compensation to change over time based on various performance criteria and LO’s have pricing discretion? • If you charge different pricing to reflect the LO compensation? • If you have different pricing to reflect cost of business in particular region or pricing reflects competition? © 2011 Offit Kurman, PA. All Rights Reserved.

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Answer • Depends on supporting documentation and related policies, procedures and training, self evaluation efforts • Company’s with internal controls and proper documentation to avoid fair lending are in significantly better shape even if a fair lending problem arises • Need to know in advance your strengths and vulnerabilities © 2011 Offit Kurman, PA. All Rights Reserved.

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• • • •

Trained compliance staff or responsible staff Annual training of loan officers Dissemination of policies and procedures Organizational structure – decentralized controls and evaluation; local discretion; • Management and compliance oversight and attention to fair lending • Clearly written lending policies and procedures • If you have discretion it is important to have well articulated policies limiting its use © 2011 Offit Kurman, PA. All Rights Reserved.

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• Are marketing materials disseminated through forums with wide appeal and/or geographically diverse areas • Are incentives or special programs equally advertised and equally available at all locations • Types and extent of monitoring of advertising, pricing, locations, policies, procedures • Is all marketing reviewed by compliance staff including social media and websites

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THANK YOU

Ari Karen Offit Kurman [email protected] 917-312-2294 301-575-0340

Bill Heyman Offit Kurman [email protected] 301-575-0393