Fair lending violations represent one of the greatest threats to nationally distributed mortgage lenders today. The threat pertains to the magnitude, complexity and depth of how fair lending affects the mortgage operation; departments such as origination, compliance, technology, secondary and servicing, only to name a few, are directly or indirectly involved in detecting, measuring, enforcing and deploying effective fair lending strategies. But what is fair lending? Does fair lending equate to “equal lending”? Is lending always fair amidst myriad variable factors, many of which relate to a borrower’s past, present, and future financial and economic circumstances? The greatest concern shared by mortgage lenders is receiving a fair lending violation that subjects the institution to regulatory penalties and operational and technical changes and often presents detrimental public relations challenges.
Several regulatory agencies oversee the requirements of fair lending practices by financial institutions with regard to the consumers they serve, including the Office of the Comptroller of the Currency, the U.S. Department of Housing and Urban Development (HUD), and the Consumer Financial Protection Bureau (CFPB). These agencies enforce their fair lending agenda through various legislative acts, including the Fair Housing Act, the Equal Credit Opportunity Act and the Home Mortgage Disclosure Act (HMDA). Protections are in place prohibiting discrimination based on race or color, national origin, religion, sex, familial status, handicap, marital status, and age.
The focus on fair lending is not without merit. Prior to 2008, lenders – in practice or in process – engaged in lending practices, knowingly or unknowingly, that were predatory in nature and, thus, steered borrowers to higher-paying and, therefore, higher-margin loans. In turn, this yielded unsustainable payment options due to variable and introductory interest rates for reasons beyond the creditworthiness of the borrower or the borrower’s circumstance. This led, for instance, to disproportionately high occurrences of subprime originations amidst minority borrowers and, therefore, unprecedented foreclosure rates. Since the market crash, the reverse effect has also been true. To mitigate risks and to recover from deep and devastating losses, the tendency was to tighten the access to credit to consumers to only prime borrowers, who are disproportionately white, middle to upper economic classes. This pendulum narrowed the scope of the economic recovery, leaving minorities, immigrants and the working class white population outside of homeownership, further resulting in homeownership rates being just below 63%, the lowest level since 1965.
How do lenders know if they are violating fair lending laws? In many cases, they do not. The reasons leading to violations primarily arise from a lack of clear guidance, a true misunderstanding of the law, a lack of technology or processes to detect unacceptable variances, or a lender’s lack of focus. It also includes, of course, overzealous lenders that lack a serious regard for fair lending laws in an effort to grow market share. As it pertains to fair lending, the seriousness of the regulatory landscape could not be greater today. In addition to regulatory scrutiny, lenders are also exposed to potential litigation stemming from individuals seeking protection of their rights, and more recently, lenders are becoming the direct targets of overly zealous lawyers and class action litigation.
Expansion of HMDA
Lenders are now focusing on the implementation of the CFPB’s new HMDA rule requiring expanded reporting and disclosure of data, which will become effective as of Jan. 1, 2018. The rule will add in 25 new data fields, modify 14 of the original 23 points, and require a total of 48 reporting entries. Some of the points added will include reporting on interest rates, credit score, property address, total loan costs and age, and a portion of the points will be made publicly available on the CFPB’s online HMDA tool. Along with modified ethnicity, race and sex points, the changes are expected to aid the CFPB in identifying discretionary lending practices. Due to the transparency of the reporting and information available, the question is whether lenders will face an increased risk of fair lending litigation – whether directly from regulatory agencies or from consumers.
Prior to the November election, the CFPB announced that enforcement and supervision with regard to redlining would be a priority in 2017. To subdue industry concerns that public disclosure of the expanded data points will increase cybersecurity burdens, the bureau has advised that a balancing test will be used to determine how data points will be modified prior to public disclosure. This modification would be an attempt to prevent hackers from aggregating data that could be used to identify borrowers. The CFPB has also advised that lenders will not be liable for unauthorized improper use of such public data so long as they reported the data in accordance with the law. Notwithstanding, even if the CFPB does not hold lenders liable for improper use of the HMDA data, borrowers may not be as forgiving. Both individual and potential class action suits may arise as a result of the transparent disclosure of such information.
The City of Miami
Fair lending is becoming a front-and-center topic in large lawsuits against lenders. At the forefront of recent litigation are two related cases that were consolidated and argued on Nov. 8, 2016, in front of the U.S. Supreme Court: Wells Fargo & Co. v. City of Miami and Bank of America Corp. v. City of Miami. The decision has not yet been rendered on the main two issues:
1) Whether the term “aggrieved” in the Fair Housing Act imposes a zone-of-interests requirement more stringent than the injury-in-fact requirement of Article III of the Constitution; and
2) Whether the city is an “aggrieved person” pursuant to the Fair Housing Act.
In December 2013, the City of Miami brought forth two lawsuits in federal court in the Southern District of Florida – one against Wells Fargo and the other against Bank of America. In both complaints, the city alleged that the banks violated the Fair Housing Act for injuries caused by the defendants’ pattern or practice of illegal and discriminatory mortgage lending. The city argued that in these cases, the practices resulted in a disproportionate and excessive number of defaults by minority home buyers and, thus, were the cause of significant direct and continuing financial harm to the city.
In the Bank of America case, the City of Miami alleged that the bank engaged in intentional and disparate impact discrimination by the practice of redlining and reverse redlining. The city claimed that this led it to experience reduced property tax revenue, a decrease in the value of vacant properties and a decrease in the value of properties around those that were vacant. The city also claimed that it faced increased costs associated with having to provide additional municipal services to remedy the blight and unsafe and dangerous conditions in areas with a high rate of foreclosures. The city sought both injunctive relief and damages for financial injuries due to the disproportionate number of foreclosures in minority neighborhoods.
In July 2014, ruling in favor of the bank, the federal court dismissed the case, stating that the city lacked standing to bring a case against the bank pursuant to the Federal Housing Administration. With the same presiding judge as in the Bank of America case, the Federal Court made an identical ruling in the suit against Wells Fargo. Subsequent to both losses, the City of Miami appealed to the 11th Circuit Court of Appeals on both the Bank of America case and the Wells Fargo case (which became combined), and on Sept. 1, 2015, the court ruled in favor of the City of Miami. The 11th Circuit’s finding was contrary to the lower court’s ruling and found that the city did, in fact, have standing because it experienced an “injury in fact,” and the court remanded the case back to the federal court for the Southern District of Florida.
The federal court for the Southern District of Florida ruled in favor of Bank of America and Wells Fargo, again dismissing the City of Miami’s complaint on March 17, 2017. The city filed a writ of certiorari with the U.S. Supreme court, and on June 28, 2016, the Supreme Court granted certiorari and consolidated both cases. The Bank of America Corp. v. City of Miami case was argued before the U.S. Supreme Court on Nov. 8, 2016. The City of Miami relied heavily upon the 1979 decision made by the Supreme Court in Gladstone v. Bellwood, wherein the Village of Bellwood and HUD brought suit against Gladstone Realtors for discriminating against minority individuals who were actually “testers” working for HUD in renting properties. The City of Miami argued that it suffered direct injuries and, therefore, had standing to bring its claim. Both Bank of America and Wells Fargo set forth that that standing and statute of limitations aside, the damages experienced by the city were simply too far attenuated and such a case would open up a door to an onslaught of litigation by any business experiencing slow sales.
Although the Supreme Court case has not yet been decided, and a decision is not expected until later in 2017, it appeared during oral argument that the court may be inclined to follow the Gladstone holding and find that the City of Miami did meet Article III standing to bring suit. If the opinion is evenly split among the justices, or if the 11th Circuit holding is upheld, the case would set a precedent by which lenders could be exposed to a wave of litigation by other municipalities around the country seeking similar damages.
A litigious climate
Fair lending cases do not all get published publicly, and many get settled prior to a court’s decision. For example, as the industry awaits the Supreme Court’s decision in the City of Miami case, another case related to unfair lending practices reached a settlement on Jan. 18, 2017. JP Morgan Chase agreed to pay $55 million to settle a U.S. Department of Justice (DOJ) lawsuit accusing the lender of discrimination against minority borrowers. The suit alleged that in 2006 through 2009, Chase permitted mortgage brokers to originate mortgage loans to Hispanic and African American borrowers charging higher interest rates than loans made to their white counterpart borrowers. Although Chase was not directly involved in the discriminatory actions, the bank did not require the mortgage brokers to provide reasons when the rates were changed, and thus, the DOJ accusation was that the lender, therefore, failed to address the racial discrimination. Although the loans in question date back eight to 11 years, the message from the regulatory scrutiny continues to apply: Lenders need to be vigilant in how they approach fair lending, including overseeing third parties and not turning a blind eye.
The implications of fair lending run deep from within the mortgage operation. Aside from policy or procedure infractions or steering practices, which largely have been corrected with loan officer compensation rules and enforcement, the genesis of fair lending can be found in the margin stack at the branch level of a mortgage lender. In any distributive retail model, there are branches set up across numerous markets or many branches within one market. There are many variables involved – the loan officer compensation; the determined margin for Federal Housing Administration, Veterans Affairs, U.S. Department of Agriculture, conventional and jumbo products; the effective costs of the branch; and corporate allocations accounted for in either the built-in margin or the fees paid for by the consumer. In order to maintain pricing stability and consistency, lenders deploy a number of strategies that may include fixing loan officer compensation across a market or metropolitan statistical area; fixing product margins by product type or possibly prohibiting loan officers from offering specific types of products because of the balance between their compensation; the inherent risks with a particular type of loan; or the costs to manufacture a specific type of loan.
Where compliance and the interpretation of risk as acceptable affect the operation, this can have a negative consequence on the sales force. Further, this can affect how market-competitive a mortgage lender is in either expanding into a new market or building market share in an existing one. The lack of regulatory guidance, although ostensibly intentional, raises suspicions that, though there is no clear interpretation or application of fair lending rules, the enforcement of such violations will, nonetheless, be regulated to court settlements. One such $19 million settlement pertained to the CFPB’s action in June 2015 against national lender RPM Mortgage Inc., a non-depository mortgage lender based in Alamo, Calif. This settlement included not only an $18 million fine against RPM, but also a $1 million civil penalty against its founder and CEO, Rob Hirt. This action was viewed by many as regulatory overreach, causing speculation as to why CFPB Director Richard Cordray would levy such a penalty with no fault assigned or no wrongdoing acknowledged.
After reviewing pricing in 2011-2013, RPM internally and independently confirmed its rates were always competitive and, for the majority of its loans, matched or beat the average rates in its markets of northern and Southern California. Nevertheless, despite the lack of disclosed evidence, Cordray insisted that consumers were harmed and the practices were unlawful. The CFPB held Hirt personally liable, an act that appeared as a personal attack on a visible leader within the mortgage industry who was widely viewed by many as having high integrity and who has invested heavily in technology and compliance systems, resulting in a compliant organization sensitive to consumer needs. To avoid a costly defense and the public relations challenge associated with active litigation with the CFPB, RPM settled the complaint by acknowledging no wrongdoing and paying a fine that would otherwise close the doors of most mortgage lenders. However, the question remains: If an organization as heavily capitalized and well managed as RPM can be a target, aren’t lesser capitalized firms with fewer resources seriously at risk? It is likely that the means and capital of RPM were the initial targets by the CFPB to begin with, but if lesser and heavily capitalized firms are both at risk, who is safe from the undefined liabilities of fair lending?
Thus, although lawsuits may sometimes result in wins for lenders, they are forced to incur a tremendous amount of litigation expenses. The concern, therefore, is whether lenders should now increase their reserve funds, seek outside capital or possibly explore being acquired due to a potential increase in frivolous litigation related to fair lending litigation. The years of 2017 and 2018 are expected to be times of fair lending enforcement, but will they lead to years of further industry consolidation? If so, fair lending will directly be the driver of this end result.
Debbie Hoffman is chief legal officer for Digital Risk, a division of Hewlett-Packard’s Mphasis company that provides quality control, valuation and fulfillment solutions. She can be reached at firstname.lastname@example.org. Rick Roque runs Menlo Co., an industry consulting firm focused on retail growth strategies, mergers and acquisitions, and capital fundraising for mortgage companies. He can be reached at email@example.com.