|Fair lending reheats (June 2010)|
Wells Fargo’s settlement with the NAACP highlights key vulnerabilities
By Lucy Griffin and Nancy Derr-Castiglione, contributing editors
Fair-lending enforcement always seems to go through cycles. After a lengthy lull, enforcement activity is rapidly rising. Several factors brought this on. First, a change in administration usually brings a change in fair-lending enforcement. Second, there is more information available, through HMDA, for private organizations to use in evaluating lender practices. Third, examiners have maintained fair-lending exams, with the result that 31 cases were referred to the Department of Justice during 2009. And finally, when the mortgage market implodes, as it did, fingers will point in all available directions, including fair-lending.
In this environment, every bank should carefully review its fair-lending program and performance. A recently settled case provides guidance. Wells Fargo Bank, N.A., has struck an agreement with the National Association for the Advancement of Colored People to settle a fair-lending lawsuit. While details about what the bank will do are still being worked out and have not been made public, there is much to learn from the complaint and from agreements that NAACP has reached with other banks.
Reviewing the complaint
NAACP’s March 2009 complaint alleged that Wells and its affiliate Wells Fargo Home Mortgage, Inc., discriminated against African Americans by using racially neutral policies and practices that had a disparate impact on minorities. NAACP compiled information showing that many of the defendants’ African American customers were given subprime loans in spite of the fact that these minority customers qualified for a conventional or prime loan. Further, the particular group of alleged victims received subprime loans for which they could pay the initial low interest rate, but they could no longer afford payments when the rates adjusted upwards.
The complaint alleges that the defendants took advantage of the relative lack of experience of the victim group in dealing with financial institutions and in shopping for mortgages. The complaint also alleges that the defendants were aware of the relative lack of financial sophistication among the customers placed in subprime products. This allegation appears based on the concept of common knowledge, meaning that all lenders should know this. In short, all banks should assume this knowledge.
To support the complaint, NAACP cited studies by the Center for Responsible Lending, the National Community Reinvestment Coalition, and the Federal Reserve. The Center for Responsible Lending found that even when accounting for income and credit risk, African Americans were 31% to 34% more likely to receive higher-rate subprime loans. NCRC reported pervasive discriminatory and predatory practices by lenders in six major metropolitan areas. The Federal Reserve, in its annual analysis of HMDA data, reported that African Americans are more likely to pay higher prices for mortgages than similarly situated Caucasians. NAACP alleged in its complaint that, based on the consistent findings of these studies, the defendants knew or should have known that their practices resulted in disparate treatment of African Americans.
Questions of law that arise
Key is the question of whether a mortgage lender is responsible for advising the borrower about the most favorable loan terms for which they qualify or whether the lender may simply process an application.
Consumer advocates, including NAACP, have long argued that lenders have a responsibility to advise customers when they qualify for a conventional loan rather than merely process an application for a more-costly product. The argument is that many consumers go directly to subprime lenders, assuming that banks don’t want their business and not realizing that the products may be different. To many consumers, a mortgage was a mortgage.
There are several practices involved in this question. They begin with marketing and the question of whether the lender advertised fairly. Marketing only subprime products to minority areas fails to provide information about the range of products. If a group of consumers only hears about subprime loans, they don’t know to ask about other products and have no information to use comparing products.
Targeting marketing materials may have efficiency for marketers, but the practice can harm consumers.
Next is the issue of whether the defendants steered minorities into more expensive products. In raising this, NAACP alleged that compensation structure actually motivated loan officers to push subprime products—the alleged targets lacking the sophistication to challenge loan officers and to ask about conventional loans.
Compensation practices also motivate loan officers to make as many loans as possible, rather than spend time comparing the customer’s qualifications with the full array of products available.
Another issue raised in the complaint has been addressed by changes to Truth in Lending and Regulation Z. NAACP argued that lenders should not evaluate consumer qualifications based only on a teaser rate. By selecting a group of borrowers who qualified for the teaser rate but not for the rate adjustment, NAACP was able to demonstrate clear harm.
Wells Fargo and NAACP have signed a consent agreement and are working out program elements for lending that are satisfactory. We can expect the program to contain actions to respond to the charges in the complaint—affirmative advertising, changes to underwriting, and revisions to compensation. All banks should pay close attention to. Fair-lending programs should include ways to address:
Advertising. Design marketing materials to reach all audiences. Avoid practices that target specific groups for certain products. In particular, don’t aim advertising for subprime products at minority audiences while failing to give equal marketing for prime products.
Compensation. Consider what impact compensation has on lender behavior. It is human to aim for the largest benefit. If compensation is greater for subprime loans, those are the loans that lenders will push.
Underwriting. Generally, underwriters work the numbers based on the specific loan request. NAACP recommends that during this process, the lender also consider whether the applicant is qualified for a different, less-risky or less-costly loan.
Education. All NAACP agreements stress education programs. These range from financial education offered through schools and organizations to working directly with students and their parents to learn about financial management.
Self monitoring. Review HMDA and CRA information regularly. This can provide warning about market changes. It also flags trends that could indicate disparate treatment.
Griffin is Senior Advisor, Paragon Compliance Group, and Derr-Castiglione is owner of DC Compliance Services.
The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0610/index.php?startid=38
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