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#1586424 - 08/02/11 05:40 PM Fair Lending/Living Expenses
NewNana
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The OCC and the bank's external loan review firm have recommended that the bank begin factoring living expensess into debt-to-income calculations. I've always understood that living expenses are considered paid from discretionary income, which is already factored into the ratio. I believe this process could have a disparate impact on our borrowers-particularly those in LMI ranges, resulting in increased denials. Does anyone else have experience with this, arguments for or against? I would appreciate any feedback. Thanks!

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Lending Compliance
#1586427 - 08/02/11 05:47 PM Re: Fair Lending/Living Expenses
Rocky P Online
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Fannie Mae and Freddie Mac generally set the standards for residential loans, especially those that will, or may go to the secondary market. This is for consistency so information can be electronically evaluated. So until the GSE's change their guidelines, all secondary market loans will be underwritten excluding the living expenses from the calculations.

Now, along comes the OCC, and an examiner deciding that the underwriting guidelines may be too liberal. If (s)he gets his way, the bank will be underwriting including the living expenses, at least for portfolio loans.

Now, if a bank sells on the secondary, but also portfolios loans, from what you indicated, banks will have to underwrite the loan twice, and keep two sets of information - once for Fannie/Freddie to ensure they are underwritten to their guidelines, and one to satisfy the regulators.

IMHO, tell the examiner that they have a great idea, but to convince Fannie/Freddie first.

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#1586483 - 08/02/11 06:53 PM Re: Fair Lending/Living Expenses Rocky P
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What about potential fair lending issues here?

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#1586520 - 08/02/11 07:30 PM Re: Fair Lending/Living Expenses
TB 12 Offline
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Did the regulator give some guidance on "living expenses"? Which to use, how to document, etc? Just utilities, or do they want to factor in child care, auto insurance, etc?

VA loans do take some "living expenses" into account. I think it is a good idea overall, but without specifics from the regulator, or until the agencies issue something, I agree with Southern Banker.
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#1586526 - 08/02/11 07:36 PM Re: Fair Lending/Living Expenses
Rocky P Online
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If similarly situated applicants have different outcomes, it could be a fair lending issue.

IMHO, if neither party wants to compromise, the bank would have to underwrite to the more stringent conditions.

I would talk to your local terrorist group (the OCC) and ask them for the basis for their request. You should also request that they coordinate with the GSE's and, if they have an underwriting mandate to put it in writing, as their request could have fair lending implications.
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#1586583 - 08/02/11 08:39 PM Re: Fair Lending/Living Expenses Rocky P
NewNana
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The OCC couldn't tell us how to factor them. PBS gave different scenarios for calculating them, including 15-20% of gross income with a maximum allowance.

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#1586724 - 08/03/11 01:58 AM Re: Fair Lending/Living Expenses
rlcarey Offline
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The OCC couldn't tell us how to factor them.

Are you talking the "OCC" or is this one examiner? I would call the district office and talk to the regional supervisor and request information in writing what they are talking about. As far as your external loan reviewer, I would be looking for a new one. This has so many fair lending issues written all over this if all variables are not properly factored, it is hard to fathom where these people are coming from.
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#1586738 - 08/03/11 11:37 AM Re: Fair Lending/Living Expenses rlcarey
Rocky P Online
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NewNana, is it possible that the regulators were talking about grossing up non-taxable income? If so, that is a different animal and encouraged.
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#1586827 - 08/03/11 02:12 PM Re: Fair Lending/Living Expenses Rocky P
NewNana
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No, Southern Banker, we've always grossed up non-taxable income. This recommendation results from tax return analyses and borrowers "living out of their businesses." We live in a tourist area where many borrowers have been affected by the economic downturn. Basically, we are applying this principle to loans made to individuals for business purposes. All major living expenses are considered, e.g., taxes, insurance, tuitions, utility costs, personal expenses. We are no longer factoring living expenses for consumer purpose loans.

Randy, thank you for weighing in. This process makes me very nervous. This was an OCC mandate, not from one examiner. I welcome more feedback on this subject.

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#1586920 - 08/03/11 03:18 PM Re: Fair Lending/Living Expenses
Kathleen O. Blanchard Offline

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So you are saying this request relates to commercial/business purpose loans. Wouldn't your cash flow analysis take all monies taken out of the business into consideration? This seems like a superfluous request. Small business owners all "live out of their business". Where else would they get money? They are self employed. Taking too much out - well again that should be obvious in the analysis.
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#1587192 - 08/03/11 08:10 PM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
NewNana
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Yes, you are understanding correctly. The bank has made a provision in its credit/underwriting policies to deduct income taxes and living expenses in hopes of getting a more realistic picture of debt coverage. Apparently no one has given any thought to the finer points of fair lending--disparate treatment, disparate impact. I can see this being a nightmare!

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#1587299 - 08/03/11 10:51 PM Re: Fair Lending/Living Expenses
Kathleen O. Blanchard Offline

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That is why a cash flow analysis in commercial lending is more realistic, and essentially the industry standard. You would already be reflecting any cash taken out of the business by the owner - regardless of use - and treat everyone the same.You don't need to know what it was used for if they took it out as personal draw, etc.
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#1588041 - 08/04/11 11:45 PM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
EmilyAnn Offline
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For what it's worth, we are a national bank supervised by the OCC on the west coast - and we've had examiners out of California bringing up the same issue. It sounds like some of them might have attended the same loan training session recently and are bringing their new ideas out into the exam field all on their own.

We were told by one examiner in particular, but it was reinforced by other examiners, that we MUST consider living expenses. They happened to be looking at commercial loans, so I don't know if they would apply the same logic to consumer loans. In any case, they did not provide any specifics. Only that if, for example, you have a debt service coverage ratio that seems adequate, but the cash left over after debt service is minimal, you should take that into consideration (e.g., can a family of four make it on $1,000 a month without eventually defaulting on its credit obligations). If owner draws were already included in the DSCR calculation, then you could make the argument living expenses were already considered - but again, are the owner draws plus cash left over after debt service sufficient to support living expenses.

It is definitely a potential fair lending issue and we are watching our underwriting and declines very closely. It would have to be a fairly extreme situation for our lenders to turn a loan down based on inadequate living expenses. However, I believe there is another side to the argument based on fair lending in which considering living expenses could be a plus.

Considering an extreme case - If a bank made a loan to a protected class borrower that met its underwriting criteria for debt service coverage and/or debt-to-income, but the bank knew that it was only leaving the borrower $250 a month to live on, I can see the bank being painted in a very bad light from a fair lending perspective.

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#1628638 - 11/15/11 06:52 PM Re: Fair Lending/Living Expenses EmilyAnn
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Where is Anonymous Regulator?

I know another OCC supervised institution that has been told the same thing. I am also concerned about this from both a CRA and Fair Lending standpoint.

It has made it almost impossible for the Bank to find a credit worthy small business borrower.

Or - perhaps the OCC just does not want small banks to lend to small businesses?
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#1628643 - 11/15/11 06:55 PM Re: Fair Lending/Living Expenses Princess Romeo
Kathleen O. Blanchard Offline

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How can you establish a standard on living costs? It will vary from customer to customer.

Life style, is home paid for, variation in taxes, are there dependents, are they in private school or public, do they bargain shop for groceries or just buy whatever they want, etc.

It is not a clear concept.
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#1628723 - 11/15/11 08:12 PM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
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Not only that, but the "living expenses" are to be imputed ABOVE the expenses shown on the Financial statement and credit report. So if you are already including the mortgage/rent, car payment, any credit card debt (including gasoline cards) and so forth, you STILL have to impute living expenses -but there is no way to distinguish between folks who put groceries and gas on credit cards (and payoff) vs those who pay cash so I'm not sure the OCC has really thought this through.

It sounds like another knee-j-erk reaction to Safety and Soundness issues. The regulators didn't stop the run-up to the housing bust, so I guess they are trying to make up for it???
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#1628730 - 11/15/11 08:27 PM Re: Fair Lending/Living Expenses Princess Romeo
Kathleen O. Blanchard Offline

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I guess, by preventing new loans.

What size banks are they trying this out for size at? All or smaller ones?
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#1628737 - 11/15/11 08:30 PM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
Kathleen O. Blanchard Offline

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I would do a full analysis of the cash flow process, demonstrating what expenses are included, and demonstrate that double counting can cause issues, fair lending issues, incorrect financial analysis, etc.

Do a really full blown risk assessment of this concept, state what risks are supposedly being addressed, how to best ensure that expenses are considered, and how to best ensure there is no double counting.

I really would have to fight back on this because it is inaccurate as described here, unfair, etc.

I wonder if it started at a bank that did not take any expenses into consideration at all...no cash flow analysis...and has taken on a life of its own?
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#1628778 - 11/15/11 09:21 PM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
Princess Romeo Offline

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Originally Posted By: Kathleen B
I would do a full analysis of the cash flow process, demonstrating what expenses are included, and demonstrate that double counting can cause issues, fair lending issues, incorrect financial analysis, etc.

Do a really full blown risk assessment of this concept, state what risks are supposedly being addressed, how to best ensure that expenses are considered, and how to best ensure there is no double counting.

I really would have to fight back on this because it is inaccurate as described here, unfair, etc.

I wonder if it started at a bank that did not take any expenses into consideration at all...no cash flow analysis...and has taken on a life of its own?



I don't know if OCC is imposing this only on the smaller banks, but so far, I've only heard about this from smaller banks. And the problem is that smaller banks really don't have the resources to do a full blown risk analysis on all this, because they're too busy doing all of the other risk analysis that the OCC requires AND still trying to find ways to make loans because it's about the only revenue generating activity that small banks can do these days.

Anyone here have a connection with the advocacy folks at ABA to take this up?
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#1628785 - 11/15/11 09:24 PM Re: Fair Lending/Living Expenses Princess Romeo
Kathleen O. Blanchard Offline

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Sometimes it is important to realize that in the time being spent to comply, a bank could have fought back and saved more time in the long run.
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#1628789 - 11/15/11 09:31 PM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
EmilyAnn Offline
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We're under $500M in assets, and our OCC examiners brought it up with us. I would note that their comments lead me to believe this was a very subjective analysis that should be completed after the debt service coverage ratio is calculated.

Their point was something to the effect of "could this borrower really live on $1,000 a month?" They wanted our lenders to comment on whether the amount left over after debt service was sufficient - not actually impute some kind of living expense figure into the debt service calculation itself.

Are other examiners actually requiring the inclusion of a living expense amount into the debt service calculations?

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#1628853 - 11/15/11 11:14 PM Re: Fair Lending/Living Expenses EmilyAnn
Kathleen O. Blanchard Offline

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I could live with that...a reality check.
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#1628886 - 11/16/11 02:51 AM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
rlcarey Offline
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All I can say that if you are making a commercial loan to an individual and the principal can qualify with only $1,000 a month left over to support a family of four, (with any analysis or not) you have some real deficiencies in your commercial underwriting criteria.
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#1628891 - 11/16/11 03:09 AM Re: Fair Lending/Living Expenses rlcarey
Kathleen O. Blanchard Offline

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Exactly. I don't understand where this is coming from. Were some banks not being realistic in their underwriting so now we need common sense mandated?
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#1629008 - 11/16/11 03:02 PM Re: Fair Lending/Living Expenses Kathleen O. Blanchard
NewNana
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Hello all--was surprised to see this topic revisted, as I was the original poster. To elaborate, my bank has always performed very detailed cash flow analyis; we have specialized software and a department dedicated to verifying lender computations and analyzing tax returns. The bank is over 500mm in assets and is located in an area largely dependent on tourism dollars; therefore, we have many small business loans. Needless to say, we aren't making very many new loans now since factoring living expenses into the debt service coverage ratio. After lengthy discussions with the OCC and the bank's external loan review team, this is what management has implemented:

When calculating debt service coverage ratio for loans to individuals, provisions should be made for living expenses and income taxes. If tax returns are not available, use 20% of gross income as the income tax figure. Deduct that figure from the gross income and then take 15% of that figure for the living expenses with a maximum of $35,000 and a minimum of $12,000. In this instance, we will use debt service coverage ratio instead of debt to income ratio.

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