The Latest Moves from DOJ

If you are hoping that the Department of Justice's interest in fair lending enforcement is fading, you are headed for disappointment. At ACB's recent Compliance Conference, Joan Magagna, Chief, Housing and Civil Enforcement Section of DOJ's Civil Rights Division, advised the audience that fair lending is at the top of the Department's priorities. It's right up there with hate crimes.

DOJ's focus of fair lending enforcement has been home-ownership - and for good reason. Owning a home is the key to American Dream.

DOJ has noted the significant progress made by the banking industry. But in spite of that progress, Magagna noted that HMDA data continues to show a significant gap between minorities and whites. Home-ownership levels of minorities are lower than whites and the rate of denial for minority mortgage applications continues to be higher than for non-minorities.

DOJ enforces fair lending laws by bringing actions against individual creditors. DOJ's role as an enforcer is to identify fair lending problems, challenge them, and change the practices that cause or perpetuate the discrimination. This means that any data reported by lenders is primary research material for DOJ attorneys.

Previous enforcement actions have involved marketing, underwriting, and pricing practices. DOJ is also looking at some newer areas, including sub-prime lending and small business lending.

Sub-Prime Lending
DOJ is concerned about sub-prime lending for several reasons. First, sub-prime loans cost more. Second, a significantly higher proportion of minorities than non-minorities get sub-prime loans. Finally - and this is where your risk lies - there are no fixed standards for sub-prime lending.

The secondary market, under the leadership of FNMA and FHLMC, effectively establishes underwriting consistency in the prime mortgage market. Most loans are made to the standards set by these purchasing entities. Even for loans that the originator does not plan to sell, lenders tend to follow the procedures and documentation standards of FNMA and FHLMC.

Sub-prime lending is another matter. DOJ is concerned about the way sub- primes are marketed. In particular, DOJ is concerned about the opportunities for predatory lending in this market. According to Magagna, they are most likely to find discrimination when loan officers have more discretion than guidance.

DOJ is presently investigating some sub-prime lending cases and is doing this jointly with some state Attorneys General. This is not good news. The state AGs - who have political visibility - have been the most avid pursuers of issues relating to consumer protection.

Small Business Lending
DOJ continues to hear allegations that minority-owned businesses have difficulty accessing capital. However, their interest in this area is complicated by the lack of data about loan applicants. Regulation B presently prohibits collecting information about the applicant for any type of credit other than mortgages. DOJ has been lobbying (hard) for a change to the regulation that would permit or require the collection of this data. In fact, DOJ attorneys believe that HMDA data has demonstrated the value of data collection. It is useful both for enforcement and for self-evaluation.

Credit Scoring
In addition to giving increased attention to sub-prime lending and small business lending, DOJ is investigating credit scoring. In this effort, they are working closely with the bank regulatory agencies.

Red flags for possible discrimination when using credit scoring are over-rides to approve and to deny applicants. Over-rides indicate that the system is not being used, or not being relied on in certain situations. The question for the investigator is whether there is a pattern to the failure to use the system and if that pattern runs afoul of discrimination laws.

The most important question for users of credit scoring systems is whether the system is being used in the market context and for the product(s) for which it was designed. Magagna did indicate that they do not expect to challenge the use that FNMA and FHLMC are making of credit scoring. However, lenders following FNMA and FHLMC guidelines should follow them carefully.

ACTION STEPS

Study your HMDA data. Look at application, approval and denial rates by location and by borrower identity. Find all the differences.
Now go to your lending and branch staff. Ask questions until you understand what causes the differences. Be ready to consider that part of the discrepancies may be the result of differential treatment or lack of effort.
If your institution is involved in sub-prime lending, be sure you have clear policies and procedures in place. Finish this off with training in procedures, fair lending concerns, and quality service.
Track any fair lending activities in your state. Know what your state Attorney General is up to.
If you use any type of credit scoring or purchased credit score, look for over-rides. Also review whether the system is being used consistently with its design and purpose.