Which Burners Are Hot

by Pat Patrick, BANC ONE National Regulatory Compliance Division

If you want to stay out of trouble with fair lending issues, you have to know which of the many burners are hotter than the others. Pat Patrick recently attended CBA's Fair Lending Conference, and identified several problem areas that should get your compliance program's attention.

Predatory Lending
First, what is "predatory" lending? The U.S. Department of Justice is concerned that banking companies may be "pushing borrowers into high-cost, sub-prime" lending units when those borrowers "could qualify for lower cost" loans at other lending units in the companies, stated Acting Assistant Attorney General for Civil Rights Bill Lann Lee.

Lee was one of three speakers who focused on alleged predatory lending practices by companies that have multiple lending units. Predatory lending occurs when the bank or bank holding company has multiple products and has the ability to steer customers into certain - usually more expensive - products.

DOJ attorney, Alexander "Sandy" Ross, and nationally-known community activist Allen Fishbein pursued the issue. Borrowers are on a "one-way referral street," they complained. They observed that bank applicants get referred "down" to the higher-cost sub-prime and/or finance company units, but applicants at those units don't get referred "up" to lower-cost bank loans for which they would qualify.

"This is going to be a real explosive subject," said Fishbein, general counsel for the Center for Community Change in Washington, D.C. It is worth noting that a plaintiff could easily measure harm in dollars as well as "pain and suffering."

Special Litigation Counsel Ross went further, saying that companies with multiple lending units "cannot have different" underwriting standards and prices for an applicant seeking the same loan product in one market. Or, to put it another way, an A- or B-type applicant should be qualified, risk-rated and priced the same when he seeks a particular product in a specific market, no matter what channel he uses - whether he approaches a company through its bank or its finance company. (Author's note: For simplicity, I refer to this as the "same standards-product-market- price" or SSPMP theory/process.)

Ross and Fishbein clearly thought that one-way (downward only) referrals and lack of a SSPMP process are unethical, predatory practices. But . . . Are they illegal discrimination? Not per se. The prudent lender will always start applicants at the top, with the lowest priced product for the lowest risk customer. Then, if the applicant is not qualified, refer the applicant to the next product.

However, some warned that referral practices may have a disparate impact, where sub-prime and finance company customer bases are composed largely of lower-income groups and "protected >
Marketing
What a lender does to advertise its products is a tangible piece of evidence to work with. It has been a favorite allegation as well as a required remedy in DOJ's fair lending cases. Now, DOJ is paying particular attention to companies which are "targeting minority and elderly" populations with home-secured loan products. Put this together with predatory lending and you have some real dynamite.

Lee indicated that his office believes that minorities and other protected groups are being "targeted" for what he called "unfair, misleading and deceptive practices" in marketing, disclosures and loan closing. While such practices may be "technically legal" under state and federal law, they may become illegal lending discrimination if targeted on prohibited bases, he said. He stated his office is working "collaboratively" with state attorneys general, the Federal Trade Commission and others to combat any such practices. Disparate treatment in loan terms and conditions (loan length, collateral, etc.) is also a concern, according to Lee.

Making Credit Decisions with Bureau Report Scores and Automated-Decisioning (Credit-Scoring)
Consumer groups and the DOJ are giving increased attention to the variety of ways that statistics are being used in making credit decisions. In particular, they are concerned about the impact that statistical decisions may have on the less traditional borrowers for whom flexible underwriting may be the key to obtaining credit.

A panel worried about individuals who hit just below a credit bureau score of "620". Activist Fishbein fears it has become "a wall," (lenders denying persons with scores just below 620), with no human effort to qualify marginal applicants. Studies have shown that "29 percent" of credit reports are "rife with errors," he stated, raising questions about whether creditors should place so much reliance on them. Too heavy reliance on credit bureau scores or automated- decisioning raises disparate impact issues, said Fishbein, about factors such as (1) how the systems handle renting versus owning homes, (2) consumer use of finance companies, and, (3) late payments.

Fishbein also challenged the audience with several new views. He commented that fees which lenders collect on late payments "may offset the cost of delinquencies," making it "inappropriate" to use late payments as a negative consideration. Fishbein also stated that he believes that applicants have a right to see their bureau scores.

Tying the credit scoring issue together with sub-prime lending concerns, Ross stated that DOJ is concerned that anyone with less than 620 is "getting pushed into sub-prime pricing."

Judgmental Decisions, Overrides and Turndown Reasons
How will examiners look at credit scoring? OCC Fair Lending Specialist Larry Riedman said the OCC doesn't typically "challenge what goes on inside the black box," but rather looks hard at lender discretion. Their primary concern is "what goes on outside the box where human intervention" in loan decisions and pricing occurs. In other words, how often do lenders go with their instinct instead of with the statistical system? These overrides, whether to approve or deny, may incorporate differential treatment.

Wrapping Up
What does all this mean? It means that you have to know what is going on in your bank, from product development, through underwriting techniques, to product delivery. Self-analysis with an eye to spotting disparate patterns early and understanding them remains the only prudent path.

ACTION STEPS

Establish clear lending and pricing criteria related to risk so that there is consistency in the products that customers are offered and qualify for.
Start at the top. Evaluate applicants for the best (cheapest) product and work through the higher-priced risk related products only if and after the applicant fails to qualify for the "flagship" product.
Review your advertisements for content accuracy and fairness. Then review where and how the ads were placed and distributed. Make sure that this strikes a fair balance in your market(s).
If your bank is using credit bureau scores to make credit decisions, review how the score is used.
Also review what the results are.
Review credit scoring overrides and look for any patterns. Also check the reasons for denial when there is an override denial.