CFPB Embraces Contentious ‘Disparate Impact’ Theory for Discriminatory Lending

By Kate Davidson

APR 18, 2012 12:53pm ET

WASHINGTON – The federal government doubled down on fair-lending enforcement Wednesday when the Consumer Financial Protection Bureau said it planned to pursue actions against lenders even when discrimination was unintentional.

The bureau said institutions whose lending policies have a “disparate impact” – meaning they put certain groups of borrowers at a disadvantage even if that was not the clear intention – should be on notice in addition to those that outwardly discriminate.

In a press release issued Wednesday, the bureau said it will use “all available legal avenues, including disparate impact, to pursue lenders whose practices discriminate against consumers.” The agency also issued a compliance bulletin reaffirming its commitment to enforcing the Equal Credit Opportunity Act, which it enforces jointly with the Justice Department, by “recognizing the disparate impact doctrine.”

The Justice Department has raised the ire of banks in recent years by claiming violations of fair lending laws when a policy has a disparate impact on a group of borrowers.

“We cannot afford to tolerate practices, intentional or not, that unlawfully price out or cut off segments of the population from the credit markets,” CFPB Director Richard Cordray said in the release. “That’s why the CFPB is educating consumers about their fair lending rights and pursuing lenders whose practices are discriminatory.”

But the bureau said it would afford institutions some flexibility. Similar to the test used in previous fair-lending policies, the CFPB said some practices that have a discriminatory effect “meet a legitimate business need that cannot reasonably be achieved as well by means that are less disparate in their impact.”

“But sometimes, they do not,” the bureau said in the release.

The consequences of “disparate impact” discrimination, however unintentional, can affect consumers just as significantly as other forms of discrimination, Cordray said Wednesday in a speech to the National Community Reinvestment Coalition conference in Washington.

“Conduct that may seem benign – what the lawyers call ‘facially neutral’ actions – can create effects that are just as devastating for those marginalized communities,” he said.

“An example of this kind of conduct is giving loan officers wide discretion to determine how much to charge borrowers. This can result in an aggregate pattern of African-American or female borrowers paying more than similarly situated white or male borrowers.”

The Justice Department in December reached the largest fair lending settlement in history – a $335 million settlement with Countrywide Financial – for similar claims of pricing discrimination. The department’s fair lending unit filed eight lending-related lawsuits last year and reached eight settlements, most originating from referrals from other regulators.

But the CFPB, unlike other regulatory agencies, has the unique authority to bring its own cases against lenders in federal court.

Given this authority, the announcement Wednesday did not come as a surprise to industry observers, several of whom said they had long expected CFPB to join the Justice Department in aggressively pursuing fair lending cases.

“I think it does tell us that the CFPB knows that there is discussion going on about disparate impact, and it wants to say very clearly it believes in disparate impact theory, and so that’s useful to know,” said Jean Noonan, a partner with Hudson Cook LLP, “although I think we all knew that that was their position anyway.”

Isaac Boltansky, a policy analyst with Compass Point Research & Trading, said the announcement is one of several recent examples of the CFPB weighing in on current legal issues. In addition to the ECOA compliance bulletin released Wednesday, the bureau over the past month has also filed an amicus brief in a lawsuit related to the Truth in Lending Act, among other moves.

“The bureau is headed by a former AG, therefore I think that they have a natural tendency to want to expand and clarify the existing laws, more so than perhaps other bank regulators in the past,” Boltansky said.

But according to others, disparate impact is not a slam-dunk legal theory. Andrew Sandler, a co-chairman of the law firm BuckleySandler, said even though a relevant lending case before the Supreme Court was ultimately withdrawn, the high court had appeared ready to reject use of disparate impact.

“The courts will have many opportunities to address this issue in coming months,” said Sandler, who is representing one mortgage lender that announced plans to fight a Justice Department lawsuit earlier this month.

Meanwhile, the CFPB – more so than the Justice Department – may bring disparate impact cases in other credit sectors besides mortgages. The agency said its fair lending compliance bulletin would apply to a range of credit products, including mortgages, credit cards, student loans and auto loans, and would apply to both banks and nonbanks under its jurisdiction.

“Banks have been subject to this for a long time, and the major cases that have been to court .and cases that have been settled are mostly banking cases,” said Ron Glancz, a partner with the Venable law firm in Washington. “If in fact anti-discrimination laws are now applied across the board to the entire financial services industry, and the resources devoted across the board, that’s a good thing.”

The National Fair Housing Alliance also issued a statement praising the bureau for making its policy clear, and said open markets that are free from discrimination are critical to the lending industry.

“Policies and practices that have a disproportionate and discriminatory effect on protected groups create inefficiencies in housing and financial markets by inhibiting the full economic participation of all people,” said Shanna Smith, president and chief executive officer of the NFHA. “It is in our best interest to reverse and redress discriminatory practices and policies.”

Although the disparate impact theory is not new, industry lawyers said it had never been applied to lending until recently, catching many lenders off guard.

The bureau noted that the Justice Department and several other federal agencies issued a joint policy statement on lending discrimination in 1994, noting that the courts recognized “evidence of disparate treatment” and “evidence of disparate impact” as a method of proving lending discrimination under the Equal Credit Opportunity Act.

“The CFPB, which did not yet exist at that time, concurs with the policy statement,” the agency said. The bureau said its standard announced Wednesday will apply to all institutions under CFPB jurisdiction.

CFPB’s exam guidelines for ECOA, mortgage origination and mortgage servicing also reference the exam procedures outlined in the interagency policy statement, including those designed to identify evidence of disparate impact.

According to the Federal Reserve’s Regulation B, Congress intended to apply an “effects test” – outlined by two Supreme Court employment cases – to be applicable to a creditor’s determination of creditworthiness, the bureau said.

“The act and regulation may prohibit a creditor practice that is discriminatory in effect because it has a disproportionately negative impact on a prohibited basis, even though the creditor has no intent to discriminate and the practice appears neutral on its face,” the bulletin said, quoting the Fed’s commentary on the rule, “unless the creditor practice meets a legitimate business need that cannot reasonably be achieved as well by means that are less disparate in their impact.”

As CFPB exercises its supervisory and enforcement authorities, “it will consider evidence of the disparate impact doctrine as one method of proving lending discrimination under the ECOA and Regulation B,” the agency said in bulletin.

Wells, JPM Reclassify Billions in Mortgages In Response to Regulators

By Andy Peters and Victoria Finkle

APR 13, 2012 11:56am ET

JPMorgan Chase (JPM) and Wells Fargo (WFC) each reclassified more than $1 billion of mortgages as nonperforming loans at the urging of regulators – even though the loans are still in good shape, executives said Friday.

All U.S. banks holding similar loans are expected to make the same types of changes after four federal agencies issued guidance this year on monitoring credit quality for second liens on residential properties.

The $1.6 billion of loans reclassified by JPMorgan Chase are second mortgages that are current, but are subordinate to delinquent first mortgages, Chairman and Chief Executive Jamie Dimon said during a conference call to discuss first-quarter earnings.

“These are second mortgages that are paying behind delinquent firsts,” Dimon said. “We’re reserving those because we know they’re going to go bad. We’re just putting them in the nonperforming category before they’re nonperforming.”

The JPMorgan Chase loans are being reported as nonaccrual “based upon regulatory guidance issued in the first quarter,” it said in a press release.

The agencies – the Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and National Credit Union Administration – issued the guidance on Jan. 31. It pertained to allowances for loss-estimation practices for second mortgages secured by 1-to-4 family properties.

The agencies expressed concern about banks and thrifts overstating income because of faulty revenue recognition practices.

“Placing a junior lien on nonaccrual, including a current junior lien, when payment of principal or interest in full is not expected is one appropriate method to ensure that income is not overstated,” the agencies said in the joint guidance. “Consideration of these factors [should] take place before foreclosure on the [associated] senior lien or delinquency of the junior lien.”

Wells Fargo reclassified $1.7 billion of performing junior-lien loans and lines to nonaccrual status, Chief Financial Officer Timothy Sloan said in a conference call. Only 12% of these reclassified junior liens were 30 days or more past due.

Nonaccrual loans increased $722 million from the fourth quarter at Wells, Sloan said.

“This policy change had an immaterial impact on our earnings since the loans were already considered in our loan-loss allowance and the related interest income impact was minimal,” Sloan said. “Absent this policy change, nonaccrual loans would have been down $948 million from the fourth quarter.”

When an analyst asked JPMorgan Chase’s chief financial officer, Doug Braunstein, why the bank’s nonperforming loans increased from the previous quarter, he hesitated. Dimon said it was “OK” to answer, so Braunstein provided the initial explanation about the second-mortgage reclassification.

The vast majority – about 88% – of the $1.6 billion in second mortgages are current, Braunstein said. But the New York bank expects they will go delinquent soon.

When first mortgages go delinquent before a second mortgage, the junior mortgage “almost always becomes a total loss” later, Dimon said.

JPMorgan Chase has a total of about $4 billion in second mortgages that are current but subordinate to a delinquent first mortgage, Dimon said. But regulators asked it to reclassify only $1.6 billion of that group. Dimon said that only $1.6 billion was moved to nonperforming because of reasons related to their loan-to-value ratio, but he did not provide a further explanation during the conference call. A JPMorgan Chase spokesman did not return a phone call seeking comment.

As a result of the reclassification, JPMorgan Chase’s total nonaccrual loans increased 14% in the first quarter to $8.3 billion, from $7.3 billion a year earlier.

Fannie Fights Innovation, Insists on Foreclosure

By Joel Sucher

APR 17, 2012 3:20pm ET

The question of the government-sponsored enterprises’ future has yet to become a front-and-center campaign issue. It should.

Former Republican presidential hopeful Jon Huntsman made dismantling the Fannie Mae/Freddie Mac duopoly part of his campaign platform. GOP front-runner Mitt Romney has stayed strangely silent on the issue, despite reports that his campaign has taken money from a former Fannie lobbyist. President Obama and his team have lobbed softballs with calls for principal reductions bouncing off the thick skin of the GSEs’ enabler-in-chief, Federal Housing Finance Agency acting director Ed DeMarco.

Now, interestingly, the International Monetary Fund has weighed in, with its managing director Christine Lagarde telling an audience at the Brookings Institution that dealing with the U.S. housing crisis was a “matter of urgency,” and calling for the “big boys and girls, Fannie and Freddie” to be part of the solution.

Yes, indeed: time for the kids to start acting like adults – and stop behaving like Fannie has in the case of Louise Davidson, the subject of my last two BankThink posts.

Louise, evicted by Fannie April 4, remains locked out of her house. I’ve tried to get answers about what could be done to resolve the situation, but continued questioning of Fannie Mae spokespeople was akin, as my late grandmother used to say, to banging my head against the wall.

However, the Federal Housing Finance Agency, Fannie’s conservator, did weigh in with this comment: “We understand that Fannie Mae made substantial efforts to assist Ms. Davidson with a loan modification and, when that didn’t work, with additional financial assistance to help her vacate the property.”

The boilerplate response about “substantial efforts” strains credulity. If there had been the will, they certainly would have found a way. There was no real inclination to resolve the situation after Bank of America, the servicer, turfed responsibility for halting an eviction to Fannie, which refused despite the fact that Davidson had found new employment that put her back into the “can pay” category.

Regarding the “assistance” cited by the FHFA , Davidson asks how “having a work crew put all my belongings in trash bags and dumping them on the street” can be considered “helping me vacate the property.”

Whenever anyone criticizes the way Fannie conducts business, the response is invariably the same: retreating to the fortress, raising the drawbridge, and sending out legions of “home economists” armed with pie charts and scads of supportive statistics.

Enter Jorge Newbery, a competitive bicyclist and ultra-marathoner. In 2008 he had a unique idea. Create an organization, American Homeowner Preservation, to keep financially distressed families in place by getting lenders to agree to a short sale, then leasing back the house to the homeowner with deeply discounted monthly payments. Families would preserve equity in their homes while rebuilding their lives, without the dislocation of an eviction. Within a few years, the tenant can buy the home back at a discounted price, or AHP will sell it off, sharing any profits with the family.

It worked for some 200 families, but fell short of Jorge’s goals, owing to resistance on the part of major banks, servicers, and the GSEs- Fannie included – that didn’t countenance to the notion of keeping families in a house undergoing a short sale.

But Jorge is relentless, probably steeled in part by his athletic competitiveness, and has continued to press the case for AHP’s vision, and, along the way his work has caught the attention of major bloggers like Arianna Huffington, Felix Salmon and Martin Andelman.

Jorge got a call from Louise shortly before her eviction. AHP over the years had evolved into a sort of socially conscious hedge fund, and by late 2011 started to acquire pools of nonperforming loans. It now focuses on helping these borrowers and other homeowners who are referred by their lenders. The drawback of this new focus is that it limits the universe of borrowers who receive help.

But there was something about Louise’s case and her treatment by Fannie that got him going.

He started a petition on change.org (that’s how the case caught my attention), and sent word to Fannie that he’ll make Louise the exception to AHP’s new policy and buy her house as quickly as the papers can be drawn up. To date, there’s been no response.

Hopefully, with a bit of press exposure, good will and common sense will prevail. If not, Louise’s empty house may enter into the netherworld of Fannie-created programs like HomePath, an initiative that paints lipstick on the foreclosed pig in hopes it’ll sell quicker. Go to YouTube to check out the cheesy attempt at a marketing video, derivative of the successful HGTV series “House Hunters,” replete with an upbeat real estate agent escorting a bouncy young couple with requisite tots in tow through a HomePath foreclosure. Ooohs and Aaahs are nonstop. What a bargain, they’re led to believe, and, as the agent exuberantly proclaims, “only 3% down.” (Shades of Countrywide.)

HomePath is a registered trademark, which gives one pause for thought. Does Fannie fear that competitors are lurking in the shadows, waiting to expropriate this initiative for their own ends?

Yes they are, and for good ends. AHP and similar programs, like Boston Community Capital, are waiting in the wings, hoping to demonstrate that they have better ideas to ameliorating the foreclosure disaster.

Wells Fargo Goes Old-Fashioned in Mortgage Underwriting

By Kate Berry

MAY 1, 2012 12:51pm ET

LOS ANGELES – Wells Fargo (WFC) plans to give its underwriters more control in approving mortgages that it retains in its own portfolio, as the bank tries to add high-quality assets to its balance sheet.

Wells is touting the new strategy, which it calls “judgment underwriting,” as part of an effort to attract borrowers that may not qualify for conventional mortgages backed by Fannie Mae, Freddie Mac and the Federal Housing Administration. Mortgages that the San Francisco bank underwrites using these new guidelines will not be sold to the government-sponsored enterprises; instead, Wells will keep them in its “held for investment” portfolios.

Brad Blackwell, a Wells Fargo executive vice president in the bank’s home mortgage unit, said that regulations have caused most banks to shift towards rules-based underwriting, which can be less flexible than more old-fashioned, in-house underwriting processes that allows for variations in individual borrowers’ qualifications.

Wells Fargo’s new “judgment-based” underwriting is “anathema to what is happening in the mortgage industry today,” Blackwell said during a panel discussion at a homeownership conference in April. “The more regulated the mortgage industry gets, the less judgment is allowed to be used.”

But he acknowledged that going back to old-fashioned underwriting has its own challenges.

“This is hard to do,” Blackwell told American Banker after the discussion. “How do we create consistency in using judgment for our own portfolio?”

Bank spokesman Tom Goyda said Wells is in the early stages of implementing the new strategy, and acknowledged that it will require extensive analysis and underwriter training.

Banks already have the ability to classify loans into different risk buckets. But Blackwell said there are “compensating factors,” which he did not identify, that underwriters will be trained and encouraged to look for.

Most lenders currently rely on “some judgment . but it’s more rules-based today and we’re going to be bringing in more judgment,” Blackwell told American Banker. “The way we will be approaching this is much more of a thorough judgment-based approach that deemphasizes all the individual rules and increases the old-fashioned ‘I get to know you’” type of rules.

Joe Garrett, a principal at the mortgage banking advisory firm Garrett, McAuley & Co. says banks are having a hard time finding good assets to invest in. Those that are retaining mortgages typically do so on jumbo loans with low loan-to-value ratios, which ensure that the borrowers have enough equity to withstand home price declines.

“Judgment underwriting is what used to be called common sense underwriting,” Garrett says.

And some potentially qualified home buyers may be shut out of getting conventional mortgages backed by Fannie Mae or Freddie Mac. For example, banks are eager to lend to investor-owners who buy multiple properties at one time, often putting down large upfront payments -: but those borrowers are only able to get GSE financing for a maximum of ten properties.

“What if you want to put 60% down and your name is Bill Gates and you already have 10 loans?” asked Garrett. “There is room for common sense underwriting if it’s done correctly. It can be very effective and it can be safe and sound lending.”

Blackwell said that while credit scores are still considered to be the most “reasonable predictor of success,” the traditional Fico score “cannot be the sole judge of whether a loan can be approved or not.”

Wells held an average balance of $229.7 billion in residential first mortgages at the end of the first quarter, and $84.7 billion in junior liens in the same period.

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