FAIR LENDING: UNDERSTANDING YOUR RISK
We think it’s safe to say that our community banks, by and large, do not set out to discriminate against minorities in their lending practices. Perhaps it is a little “Pollyanna-esque”, but we believe we are all trying to do the right thing. Unfortunately, discrimination and redlining still happen, and it can be a bit insidious, so we must be vigilant and deliberate about preventing it. It is important to bear in mind that Fair Lending compliance doesn’t just happen. It must be a conscious, deliberate intent on the part of Management and the Board to understand the institution’s risk and make good faith efforts to provide equal access to credit without regard to any prohibited bases, as defined by the Equal Credit Opportunity Act (Regulation B) or the Fair Housing Act.
Discrimination, on the other hand, does not require a proof of “intent” to discriminate for a violation to occur. How’s that for a moving target? Nevertheless, it is very costly, and those costs are not limited to capital outlays for fines and settlements. It also takes the form of significant reputation damage; interrupting business as usual to divert resources to specific remedial actions mandated in consent orders, such as developing programs to assist in qualifying or subsidizing lending offers to minorities who were harmed; opening branches in previously excluded minority areas within your markets; and expanding or developing product offerings tailored to minority communities or populations, among others. Take a look at these recent enforcement actions as cautionary tales:
So, what are we missing? How can we know what our Fair Lending risks are and how can we make sure we are not allowing prohibited bias to seep into our lending practices? It might surprise you to know that in the United States, only 61%
of the total population is now White, Not Hispanic, or “non-minority”, compared to 69% in 2000. So nearly 40% of the population is now considered a “minority”, which is getting closer to making that term a misnomer. Granted, many minority populations are historically more concentrated in certain metropolitan areas, such as Miami, Los Angeles, Chicago, and southern border towns, but it is critical that we understand our markets, even in rural midwestern areas. And don’t forget about religion being a prohibited basis: enter the Amish. There are unique characteristics of lending to Amish that you may need to consider and accommodate if you have Amish communities in your market area, such as the lack of electricity in their homes, and non-traditional methods of insuring a property (Amish Aid).
We are going to parse this out for you in a series of three articles. We’ll start from the top and work our way down, and from the outside in. Obviously, the commitment must be set by the Board, first and foremost, that prohibited discrimination of any kind cannot be tolerated. With that established, our first layer will address the bigger picture of evaluating our markets and demographics. From there we’ll look at your policies, pricing, and underwriting. Finally, we will address analytics, looking at your lending data (applications and originations), and provide an overview of comparative file testing fundamentals.
For now, let’s consider three main focal points:
1. Market area demographics
2. Applications and loan originations – where are they coming from and where are they NOT coming from?
3. Defining our peer group and comparing our institution to what our peers are doing in these markets.
Take a look at your market area. This includes your CRA Assessment Area, but it doesn’t stop there. Also evaluate your Reasonably Expected Market Area, or REMA. Per FFIEC Fair Lending Exam Procedures, your REMA is where you actually marketed and provided credit and where you could reasonably be expected to have marketed and provided credit. Some REMAs might be beyond or otherwise different from your CRA Assessment Area. Another way banks define their markets is by “trade areas”. This is the area where you primarily market and lend. It is not based on location of branches, and is typically larger than the delineated CRA Assessment Area.
When we talk about CRA, it is generally in terms of Low- to Moderate-Income or LMI areas or census tracts. When we get into the Fair Lending realm, we focus on “Majority Minority Census Tracts”, or MMCTs. Geographical groupings that are convenient for CRA may obscure racial patterns. For example, an underserved, low-income, predominantly minority neighborhood that lies within a larger low-income area that primarily consisted of non-minority neighborhoods, may seem adequately served when the entire low-income area is analyzed as a unit. However, a racial pattern of underservice to minority areas might be revealed if the low-income minority neighborhood shared a border with an underserved, middle-income, minority area and those two minority areas were grouped together for purposes of analysis.
There are a few key resources you will want to have front and center for analyzing your market area demographics and identifying minority concentrations:
Evaluate your existing branch and LPO locations, planned branch or LPO locations relative to the demographics of your market area. Where are the MMCTs and where are your branches? LPOs? If your institution has multiple branches and LPOs, do their locations form an odd configuration to exclude MMCTs? Remember that you may not be able to consider an LPO part of your CRA Assessment Area if you do not have a full-service branch or deposit-taking ATM there, but you will still consider it for Fair Lending purposes.
Fair Lending and redlining remain key areas of emphasis in examinations for 2018. “Redlining” is the discriminatory practice by banks or other financial institutions of denying or avoiding providing credit services to consumers because of the racial demographics of the neighborhood in which the consumer lives. If your branches or LPOs are in reasonable proximity to Majority Minority Census Tracts, are you meeting the credit needs of those communities? If not, what are you doing about it? It’s not enough to say they just don’t come to our bank. Your self-assessment of Fair Lending compliance should recognize the disparity, and in response you would make meaningful efforts to attract minorities as well as non-minorities. For example, are your marketing channels designed to reasonably penetrate minority areas within your REMA? Do you have outreach efforts in those communities? In recent examinations, we’re seeing a growing supervisory expectation that banks are not simply taking the passive approach of “we can’t force people to bank with us”. You want to be able to show that you proactively and consistently take reasonable measures to ensure your bank has a presence in those markets. Often LPOs are overlooked, because they’re not considered a branch. They don’t take deposits or, for the most part, have foot traffic. Nevertheless, lending efforts from a Loan Production Office will absolutely weigh into your Fair Lending risk. If you haven’t done so already, consider the proximity or market reach of an LPO in terms of Majority Minority communities. Determine whether you have Fair Lending or redlining vulnerabilities out of that office and devise a plan to ensure that you are not excluding or discouraging minority applicants. Again, mitigating Fair Lending risk requires knowledge of markets and lending patterns, as well as deliberate efforts to be inclusive of minority areas in lending activities.
Evaluate not only loan originations, but also loan applications that were not originated. The focus is generally on residential mortgage lending and small business, and small farm. But if your institution has a significant portfolio of non-real estate consumer loans, consider those as well. Where in your markets are applications primarily centered? Is there a reasonable distribution among areas that may have larger concentrations of minorities, or MMCTs? Are minority applications more likely to receive negative consideration? Consider also your deposit base. Do you have minorities with deposit accounts at your bank but very few loans to minorities? It is a good idea to periodically evaluate the demographics of your deposit base against your markets and lending activity. If the deposit base reasonably mirrors the demographics of your market area, but your loan applications and originations do not, it should prompt some self-examination of lending practices and marketing efforts in minority communities.
Are you comfortable that peer institutions are generating a similar level of loan applications and originations from minority areas? Regulators don’t approach your bank in a vacuum when they conduct Fair Lending examinations. They identify your peer institutions and evaluate your lending in MMCTs within your markets against what your peers are doing. If the community bank across the street is showing four and five times the level of lending in MMCTs as a percentage of all lending activity, that’s when you will likely have some hard conversations with your regulator, and possibly the Department
of Justice. PREVIEW A SAMPLE FAIR LENDING RISK ASSESSMENT FROM SPRINGHOUSE COMPLIANCE!