Lending Practices: Fair and Unfair

Failures in lending compliance can cost as much as $14,000,000. That's the amount one lender will have to pay for unfair lending practices and compliance failures.

In early November, the OCC reached a consent agreement with The Laredo National Bank of Laredo, Texas and its subsidiary, Homeowners Loan Corp of Atlanta, Georgia (H.C.). The corrective action required in the order provides a clear outline of best practices with respect to consumer lending. The case was based on unfair or deceptive lending practices of the Bank's subsidiary, H.C., and the enforcement issues touch on a broad array of lending and consumer protection regulations.Program Structure

The required remedial action contains all the familiar elements of a compliance program, but with the added insight of the enforcement expectations. The essential compliance organization is a core piece of the agreement. The institution must establish a compliance committee. The interesting aspect of the enforcement order is that this compliance committee must include at least five directors. At least three of these directors must be independent of the bank. This places the responsibility for compliance oversight and supervision at a high level within the institution.The compliance committee is responsible for determining whether the program of internal controls is adequate to ensure compliance. This means that the committee, including the five directors, must discuss and evaluate the specific control elements in the program. While this level of director involvement may not be necessary in all institutions, the requirement in this consent order demonstrates that regulators clearly expect directors to be much more than rubber stamps for compliance.

In addition to the active design and supervision of the compliance program, the compliance committee must prepare and submit regular progress reports to the board. The content of the reports must include action taken to comply with the consent agreement, the results of the actions, and an analysis of actions that are still needed to reach the targeted compliance level. Even though this is a level of reporting activity placed on an institution with serious compliance problems, the expected process is significant. Reports must accomplish something. Reports are not a one-way system. The process that underlies reporting should be circular. Information should flow from the activity - such as implementation or monitoring - up through the compliance department to senior management and the board.

Reports should cover not only findings, but also steps taken or to be taken to correct the findings and prevent future problems. The findings should not sit isolated in a neat-looking report. The findings should cause something to happen.

At each step of reporting, the content of the report should be evaluated. Evaluation means both considering whether the process of finding and reporting issues is sufficient and considering the appropriate action to correct the findings.

After information has flowed up to the board, the circle must be completed by the board and senior management directing or authorizing the change necessary to correct compliance concerns. Once having done this, the board should expect and receive reports that include explanations of how their direction was followed - and, of course, whether it achieved the desired results.

Other Program Elements
The bank and H.C. must also establish compliance program elements that are familiar. These include a written program, policies and procedures, a system of internal controls, independent testing, and periodic reporting,

One of the less familiar elements is the requirement that the compliance program include procedures for monitoring loan officer telephone calls with borrowers. This requirement results from the problem identified: loan officers were providing misleading or deceptive information to consumers. Including this element illustrates how a compliance program should be adapted to respond to specific needs or findings.

Another element that is not often specified is an analysis of customer complaints. The agreement directs the institution to evaluate the issues raised in borrower complaints with specific attention to terms and conditions that may have been misrepresented to the borrower.

Advertising
There are two focal points for unfair or deceptive lending practices: advertising and representations made to the customer by the loan officer. It should be no surprise that the consent order places heavy emphasis on H.C.'s advertising practices.

The consent order specifically requires H.C. to avoid making any deceptive representation, whether by omission or commission. Advertisements have to meet several criteria. While not a requirement for all lenders, these standards should be useful in evaluating the targeted honesty of your advertisements.

In H.C.'s advertisements, any reference to a limitation or condition must be in at least 10 point type. Any reference to the condition or limitation must be flagged for the consumer using those or comparable words. The reference must also steer the consumer to the disclosure related to the limitation or condition. Finally, the disclosure itself must be readable and understandable by an ordinary person.

As used in the consent order, the terms limitation and condition refer to situations where a claim or representation is made about a specific feature or benefit that is subject to limitations. The consumer must be warned that the benefit or feature is not automatically available.

All advertisements must also include the credit terms required by Regulation Z.

To ensure compliance with the order, the compliance officer or legal counsel must review all advertisements and solicitations to assess compliance. This review must also include an analysis of all consumer complaints to determine whether there are any patterns alleging deception or misleading statements or information in the advertisements.

Lending Practices
Here is where the specific elements of the agreement can provide guidance on unfair or deceptive lending practices. First, all advertisements and solicitations should be periodically reviewed to ensure that they comply with all applicable consumer protection laws.

Next, there must be procedures to ensure that the loan costs disclosed on the GFE bear a reasonable relationship to the actual costs. Failure to include all appropriate costs or disclosing a cost that is misleadingly low is one of the issues in this enforcement action. Disclosures required by Truth in Lending and RESPA must also be delivered within the timing requirements.

Policies and procedures must also be designed to ensure that loan officers comply with underwriting and pricing guidelines. One critical component of underwriting is that all loans must be based on the borrower's ability to repay. Pricing guidelines should also be sufficiently clear and specific that lenders can adhere to them consistently.

The consent agreement requires the institution to develop written policies including a specific written anti-predatory lending program. Predatory lending, as one of the primary enforcement concerns, must be dealt with by clear and measurable standards. Prudent lending standards must take into account both safety and soundness and procedures that avoid or minimize borrower misunderstanding.

For the duration of the agreement, the institution must do more than comply with lending disclosure requirements. The institution must make additional disclosures that help the customer compare loan products and make choices. For example, the disclosure must explain that the customer may choose between an adjustable and a fixed rate loan. If the choice is available, the disclosure must also explain that the customer may choose a loan that does not have a prepayment penalty. Disclosures must include a general comparison of the pricing differences between these options.Early disclosures must also include and explain the APR and alert the customer to the possibility that there may be a prepayment penalty on the borrower's current loan.

Documentation
Documentation is a significant element in the consent. All significant differences between disclosed costs on the GFE and actual costs at settlement must be documented in the customer's loan file. Lenders must also document all changes in interest rate and loan term from those disclosed on the early TIL or GFE. Documentation of these changes must include the reasons for the changes. Loan officers must also document their conversations and correspondence on changes in terms and rates.

Documentation doesn't stop there. The files must contain evidence of the borrower's ability to repay the loan. Although the lender is not prohibited from making no-doc loans, any such loan must be based on an analysis of the borrower's credit history to demonstrate that they have not had difficulty making mortgage payments in the past.

Compliance Job
The agreement identifies specific responsibilities for compliance staff. While this assignment of work is not always the most effective method for all institutions, looking at the regulatory expectations is instructive. Compliance responsibilities include: correcting cited violations, providing training, performing monitoring, conducting compliance audits, reviewing management responses to audit reports, conducting timely follow-up reviews of corrective actions, maintaining current policies, procedures and forms, providing resources to staff of both institutions, reviewing regulatory compliance for proposed products and services, and reporting periodically to the board. It reads like a job description.

ACTION STEPS

Brief senior management and the board on the level of board involvement in this consent order and what it demonstrates about regulator expectations.
Review your system of compliance monitoring and audit reporting. Determine whether your reports contain the information on findings, action taken, and action planned.
Review advertisements for the past year and carefully consider whether they could be unfair or deceptive - or simply misleading - to a consumer.
Review loan files and assess the quality of documentation in the files. If improvements are needed, identify specific documentation that should be included and introduce these elements into procedures and training.
In the documentation review, give close attention to whether and how the borrower's ability to repay the loan is evaluated and documented. A best practice would be to require such documentation.