Fair Lending DOJ's Definition of "Fair"
At a recent meeting of the Washington, D.C. Compliance Peer Group, Larry Platt shared his observations of the DOJ enforcement actions under the Fair Housing Act and the Equal Credit Opportunity Act. Larry represented the Long Beach Mortgage Company ("Long Beach") in its defense and ultimate settlement of the first fair lending case to involve a lender that makes loans to "B" and "C" risk-rated borrowers.
Long Beach specializes in refinancings. Their market niche involves refinancings to provide lower interest rates and payments on existing loans. Their customers usually live in low or moderate income neighborhoods. Long Beach also concentrates on "B" and "C" rated borrowers who, because they usually pay higher interest rates, are interested in refinancing at lower rates. These are customers that many traditional mortgage lenders avoid. Long Beach's loan specialty is offering a less expensive mortgage product to customers who already own their home.
Long Beach has its own loan officers and also makes loans brought to it by mortgage brokers. In either situation, Long Beach is the original lender. However, when mortgage brokers bring in a loan, the terms have been agreed to by the borrower.
Internally, loan officers have wide latitude in the terms they negotiate. Their principal constraint is that the terms they negotiate must lower the terms of the applicant's current loan. Loan brokers work with a price list which Long Beach provides to them. The terms must meet Long Beach's rate sheets. The broker keeps all overages.
Platt emphasized that there was no evidence that Long Beach took prohibited bases into account in making loan decisions or setting policy. The case is based purely on the use of statistics the analysis of the results or cumulative effect of Long Beach's decisions on loans.
The Department of Justice attorneys relied on several concepts in this case. First, the charges contain allegations of unfairness that reach beyond the specific rules and prohibitions in the Fair Housing Act, ECOA, and Regulation B. This approach gives a very broad construction to the term "fair" and reaches beyond specific prohibited practices or prohibited bases.
For example, the complaint alleged that Long Beach actively marketed in minority neighborhoods products that were not the most favorable to a customer. Loan officers and mortgage brokers were only motivated to lower the borrower's rate or payment but not to identify the best possible rate for them.
Similarly, DOJ was concerned that loan officers emphasized that a loan through Long Beach would lower the applicant's payments but did not advise the borrowers to compare the APR and specific finance charges such as points. Platt observed that DOJ seemed to be working with a concept that the lender has a fiduciary obligation to the borrower to advise them of the optimal mortgage product while trying to sell their own. This is eerily similar to the suitability standard in the sale of securities.
Another element in the case was the role of pricing and mortgage officers and brokers. This case was not the first to deal with pricing differences. In Huntington, an enthusiastic minority loan officer dedicated to generating loans in minority communities, successfully negotiated high rates from customers, resulting in higher rates paid by minorities. In Fleet, DOJ also found that minorities paid more in overages than did non-minorities.
The key question is what is the bank responsible for? The Long Beach cases raises, but does not resolve, the question of whether the lender has the same duty to monitor and control the behavior of loan brokers as its own employees. Justice relied heavily on the fact that Long Beach made loan decisions by accepting the deals brought in by brokers.
Unanswered is what the lender should do when the broker's deal raises fair lending questions. Should the lender reject minority applicants who are charged more, even though this would increase its denial of minority applicants? Should it tell the broker to lower the price they have already negotiated?Finally, statistics played a key role in the Long Beach case. DOJ looked for differences in rates and prices throughout the Long Beach portfolio. They also took several creative steps in the use of statistics. For example, they found that most of the borrower's tended to pay off their loans within four years. DOJ then created a 4-year APR calculation which had the effect of increasing discrepancies in rates paid because differences were amortized over four years instead of thirty.
Where do we go from here?
One unsatisfying feature of the Long Beach case is that it raises some very significant questions but provides little guidance on how lenders should structure their business practices to avoid the types of discrimination alleged. In some ways, Long Beach stands for the opposite of the Chevy Chase case. Long Beach was penalized for targeting minority neighborhoods while Chevy Chase was penalized for not doing so.
The common denominator of the two cases is the availability of loans to minorities at favorable prices. The Department of Justice will look not only at whether a lender made loans in minority areas, but also at whether the terms were fair. Platt advises any lender that uses overages to compensate loan officers or loan brokers to carefully monitor the impact of those overages.
This is the first case against a lender that was not subject to CRA. However, DOJ inserted the "unfairness" concepts which had the effect of imposing CRA-like obligations on the lender. This means that DOJ still relies strongly on "CRA-think."
If a lender allows overages or negotiated rates, that lender has a duty to monitor the impact of overages on minorities and on low and moderate income borrowers. Making the loan is not enough. It must be "fair."
Finally, doing business in minority or low and moderate income neighborhoods carries with in an obligation of fairness that reaches beyond the law. As Platt summed it up: "If you go into minority neighborhoods, don't rip off the population."
- Discuss sales techniques with loan officers. Find out how they sell loans, particularly what they say to the customer. Ask them what terms and features the customers ask about and are interested in.
- Keep this information handy.
- Review the pricing of loans, paying particular attention to points and overages. Look for any patterns based on the identity of borrowers or the loan officers.
- If your bank uses a risk rating system, review that system carefully. Pay particular attention to the factors used to rate risk. Evaluate the relevance of each factor.
- Talk with loan officers who use the risk rating system to develop an understanding of how they use the system and whether they use it consistently.
- Analyze the correlation between the risk rating and the actual performance. Look at default and collection rates by risk rating.
- Review each factor in the risk rating system for unintended impact on a prohibited basis. If you find one that has a high correlation, get rid of it.
- Develop information on the length of time that customers keep their mortgages with you. Look for any patterns by borrower group in time to pay off the loan. If you have spreads in pricing, review the impact of up-front fees as measured by the length of time the loan was held.
- If you do business through loan brokers, send the brokers your most recent fair lending policy statement and remind brokers of the importance of fair lending practices to them and to your institution.
- Consider performing a statistical analysis of your loan portfolios. In doing this, establish careful controls. In particular, identify and define what is similarly situated. Be prepared to deal with the results.
Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 17, 11/96
First published on 11/01/1996