K&LNG
DECEMBER 2006
Alert
Mortgage Banking/Consumer Finance Commentary
NYAG Settlement Focuses on Both Fair Lending and
Fairness in Lending
On November 22, 2006, Countrywide Home Loans, Inc. (“Countrywide”) voluntarily resolved an
investigation by the Attorney General of the State of New York (“Attorney General”) addressing the issue
of whether its loan pricing policies and practices discriminate on the basis of race and/or national origin in
violation of the New York Human Rights Law and the federal Fair Housing Act. Begun as a review for
possible price discrimination, the ultimate settlement incorporated other consumer protection issues,
particularly those arising from increased scrutiny of alternative loan products, and intertwined these issues
with possible claims of unlawful discrimination. The settlement defers largely to Countrywide's continued
refinement of an already sophisticated fair lending analytical program, confirms the significance of consumer
education, and establishes procedures to ensure that loan applicants are properly informed of the advantages
and disadvantages of various loan programs. The settlement is a harbinger of issues likely to be raised in the
future by both federal and state enforcement officials, and, while not imposing great burdens on Countrywide,
may raise difficulties for lenders that lack the resources and compliance techniques of a Countrywide.
I. BACKGROUND AND CONSIDERATIONS LEADING TO SETTLEMENT
Countrywide was one of several targets of the Attorney General's well-publicized focus on loan pricing
information reported under the Home Mortgage Disclosure Act (HMDA), for the first time, for the 2004
calendar year.1 A number of other targeted lenders asserted that the Attorney General did not have
jurisdiction over them due to federal preemption. Countrywide, which did not have a claim for preemption,
decided to cooperate with the Attorney General by submitting 2004 loan origination data and fully
explaining its compliance monitoring system. Countrywide was represented by Kirkpatrick & Lockhart
Nicholson Graham LLP.
Although the inquiry was initiated because of the perceived disparities revealed by the rate-spread loans
reported under HMDA, the Attorney General analyzed data regarding all of the 2004 loans, not merely those
reported as rate-spread loans. He retained an economist to conduct a regression analysis of the loan data.2 The
purpose of the regression was to determine whether, after controlling for credit and transaction characteristics,
the differences in average prices paid by minority borrowers as compared to similarly situated white
borrowers were statistically significant.
The Attorney General's press release accompanying the settlement reveals his conclusion that “legitimate
factors, such as credit scores or outstanding debts . . . explained much of the disparity” but he contended that
“on average black and Latino borrowers still paid more than whites for their mortgage loans.” The Attorney
General expressed the view that the remaining differences in price were caused by “racial and ethnic
differences in the discretionary components of pricing, principally Pricing Exceptions [i.e., departures from
the rate sheet pricing for a loan] in the retail sector and Broker Compensation in the wholesale sector.”
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DECEMBER 2006
The Attorney General also considered issues, such as product placement issues, that might not arise from a
regression analysis. It is significant to note that the settlement contains no contention that any identified
borrower did not make an informed decision in selecting an Alt A product, or that any identified borrower
who received a non-prime loan was qualified for a prime product. Yet, in the settlement, Countrywide agreed
to conduct additional analysis and inquiry to ensure that borrowers were properly informed and properly
placed in loan products for which they qualified.
The Attorney General commended Countrywide for its “full cooperation” with his inquiry, and the settlement
notes that Countrywide “has long had fair lending compliance protocols, policies and procedures in place.”
Countrywide fully explained its sophisticated and advanced methodologies for fair lending compliance,
including its own use of multiple regression analysis to analyze loan pricing and its monitoring of both retail
and wholesale lending to ensure compliance. Countrywide previously had monitored product placement to
help ensure that borrowers would not receive a non-prime product if they qualified for a prime product.
Perhaps this background caused the Attorney General to describe Countrywide as the type of lender “willing
to go the extra mile in their efforts to ensure that minorities do not pay higher prices for mortgages than
similarly-situated non-minorities.”
In sum, the investigation led to a conclusion that “the Office of the Attorney General and Countrywide share
the common goal of assuring that all individuals who apply to Countrywide for mortgage loans receive equal
treatment regardless of their race or ethnicity.” The settlement terms largely defer to Countrywide's continued
implementation of its fair lending compliance program, although an outside consultant will be responsible for
confirming that the program is reasonable. Certain issues the Attorney General raised will be analyzed more
carefully by Countrywide and corrective action will be taken, and monetary relief provided, in the event that
borrowers are identified who received an improper loan placement. Perhaps most importantly, the settlement
recognizes the importance of consumer education in achieving the joint objective of Countrywide and the
Attorney General.
II. SUMMARY OF KEY SETTLEMENT TERMS
A. Consumer Education Program
The centerpiece of the settlement is a consumer education program (“Program”) that enhances Countrywide's
existing consumer education efforts. The Program will provide New York consumers with instruction on the
home buying and mortgage loan application process through consumer education seminars and telephone
counseling. The topics to be covered in the Program will include the role a person's credit plays in the loan
application process, the different types of loan products available (e.g., fixed, ARM, reduced documentation
and nontraditional mortgage products), the fact that interest rates and fees are often negotiable, the role of
mortgage brokers and how they are compensated, the negotiability of price exceptions, the importance of
comparison shopping, and guidance on how to obtain the most affordable and appropriate loan product.
Countrywide agreed to invest $3 million over three years in the development, implementation and
advertisement of the Program. The sole purpose of the Program is to educate consumers in order that they
may be better prepared to obtain an advantageous mortgage from a lender of their choice. Countrywide will
not market its own products in the Program, but can identify itself as the Program sponsor and respond to
attendees' inquiries for contact information for the company.
B. Enhanced Monitoring
In the settlement agreement, “The [Attorney General] acknowledges that Countrywide currently has a series
of existing models, methodologies, and analyses for examining whether racial and/or ethnic disparities exist in
Pricing Exceptions and Broker Compensation.” Countrywide will continue to enhance its existing fair lending
monitoring procedures in connection with New York loans. Countrywide will engage an independent
consultant to provide advice on and approve the statistical and other models, methodologies, and analyses that
Countrywide will utilize in measuring performance. The consultant will not actually conduct the analyses, nor
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will it dictate the precise methodologies to be used by Countrywide. Rather, the consultant will be
responsible for certifying to the Attorney General that the models, methodologies and analyses adopted by
Countrywide to comply with the agreement are “reasonable,” and periodically ensuring that Countrywide is
conducting the regression and other required analyses in accordance with the approved specifications.
The settlement recognizes that the monitoring will be conducted separately for each of Countrywide's four
operating divisions, and will not, for example, compare loans made in its retail prime division to loans made
in its wholesale division. The enhanced monitoring will address the following topics:
1. Retail Pricing Exceptions:
At least twice a year, Countrywide will perform a regression analysis to determine whether there are
“material” disparities in the pricing exceptions (i.e., a departure from the rate sheet pricing for a
loan) granted to its black and Hispanic customers as compared to its similarly situated non-Hispanic
white customers. The agreement does not define the term “material”; instead, Countrywide and the
consultant must establish what constitutes a material disparity for each of the analyses to be
performed. This is noteworthy in that the agreement does not establish a bright line test identifying
when a disparity is large enough to warrant remedial action.
Countrywide also will analyze whether its retail branches or loan officers with significant black or
Hispanic customer bases have materially higher overages or lower underages than other retail
branches or loan officers in the same MSA with a predominantly non-Hispanic white customer base.
This second analysis is designed to identify any individual branches or loan officers that do not have
price disparities between their white and minority borrowers - typically because they have very few
white borrowers to serve as comparators - but whose overall prices are materially higher than other
branches or loan officers within the same market.
The settlement provides that Countrywide will take corrective action if and when its analyses reveal
material disparities for black or Hispanic customers. The corrective action taken will be determined
by Countrywide depending on, among other matters, the size, scope and persistence of the disparity
in question. Specific corrective actions will include counseling, retraining, enhanced scrutiny of
loan originations, limiting or eliminating price exception discretion and termination of employment.
The agreement requires additional action in connection with disparities in excess of 65 basis points.
If Countrywide identifies any retail branch or loan officer with a price exception disparity in excess
of 65 basis points for black or Hispanic customers, the company will perform a pre-closing review
on each of the loan officer's or branch's future loans to black or Hispanic customers to ensure that
any proposed pricing exception to such customers appears reasonable. Countrywide shall continue
such reviews for so long as the applicable price exception disparity remains 65 basis points or
higher. (This 65 basis point review should not be interpreted as a new compliance benchmark
below which remedial action is not required. Rather, it is a disparity threshold that the Attorney
General and Countrywide believe is so high that it warrants additional remedial action.)
2. Broker Compensation
Countrywide will perform similar analyses on broker compensation in its wholesale divisions.
In particular, at least twice a year, Countrywide will perform regression analyses to determine
whether there are material disparities in broker compensation paid by black or Hispanic customers
on a statewide basis and for any particular broker that delivers a sufficient volume of loans to
Countrywide to permit analysis. Countrywide also will analyze whether its brokers with significant
black or Hispanic customer bases have materially higher broker compensation than other brokers in
the same MSA with a predominantly non-Hispanic white customer base.
Under the settlement, Countrywide will take appropriate corrective action if and when its broker
compensation analyses reveal material disparities for black or Hispanic customers. The corrective
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action taken will depend on, among other matters, the size, scope and persistence of the disparity
in question. Specific corrective actions will include counseling, fair lending training, enhanced
scrutiny of the broker's loans, reducing broker compensation caps and severing the broker
relationship.
Countrywide will take additional action if it identifies any broker with a broker fee disparity in
excess of 65 basis points for black or Hispanic customers. In such cases, unless the broker can show
that the disparity was not caused by discriminatory factors or that it has already taken steps to
address the problem, Countrywide will reduce the broker's compensation cap by 20 percent. If the
disparity continues to exceed 65 basis points in the next review period, Countrywide will terminate
its relationship with the broker.
3. Underwriting Exceptions
The settlement agreement does not contain an allegation by the Attorney General that there were
unexplained racial or ethnic disparities in the underwriting exceptions that Countrywide granted to
its borrowers. Countrywide agreed, however, to develop and implement procedures to track and
monitor underwriting exceptions to ensure that they are granted in a non-discriminatory manner.
Countrywide will analyze its underwriting exceptions at least annually to determine if there are
material disparities in how they are granted. If its analysis reveals any such disparity, Countrywide
will take action - such as employee counseling and training - to correct the problem on a going
forward basis.
4. Product Placement and Reduced Documentation Disclosure
Countrywide offers prime, non-prime, and Alt A loan products. Non-prime products typically are
directed to borrowers of lower credit quality, while borrowers may choose Alt A products for a
variety of reasons. In many cases, for example, borrowers with prime credit may be unable to
document their income or assets as required under prime, full documentation underwriting
requirements. Such borrowers often can still qualify for financing under a reduced documentation
program, but typically will pay more than they would if they provided full documentation.
Countrywide agreed to develop and perform analyses at least annually to determine whether
black and Hispanic borrowers with prime credit receive subprime or Alt A loan products
disproportionately as compared to similarly situated non-Hispanic white borrowers. If
Countrywide's product placement analyses reveal material disparities for black or Hispanic
borrowers as compared to similarly situated white borrowers that are not caused by underwriting
criteria or informed borrower choice, Countrywide will take corrective action, such as retraining
and counseling. Countrywide also agreed to provide enhanced disclosures in connection with this
issue (see Section II.C, below).
5. APR Analyses
Most fair lending experts agree that mortgage loan pricing analyses should focus on the
discretionary components of a loan's price - typically overages/underages for retail loans and broker
fees for wholesale loans - because fees that can vary on a loan-by-loan basis in the discretion of an
individual are most susceptible to potential disparities. Government agencies have begun to focus
on APR, however, because the price component reported under HMDA - rate spread - is derived
from APR.3
Countrywide agreed to review its New York loans at least annually to determine whether there
are material disparities in the APRs paid by black and Hispanic borrowers as compared to similarly
situated non-Hispanic white borrowers. If such APR analyses reveal material disparities,
Countrywide will seek to determine the cause of the disparities - e.g., discretionary pricing,
underwriting exceptions, product placement. If these practices do not explain the APR disparities,
Countrywide will take additional steps to identify the cause and take “appropriate remedial steps.”
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6. Anonymous Audits
Countrywide also agreed to conduct anonymous audits (often referred to as “mystery shopping”) on
selected branches and loan officers to compare, among other items, products offered, prices quoted
and information provided to similarly situated non-Hispanic white borrowers, and black and
Hispanic borrowers.
C. Disclosure Requirements
Countrywide agreed to take steps to ensure that its retail loan officers inform their New York customers of
the best product options and to provide full documentation loan product quotes to applicants who received
reduced documentation product quotes. Countrywide also agreed to provide a Reduced Documentation
Product Disclosure Statement to its New York loan applicants who apply for a reduced documentation
loan product. Additionally, Countrywide agreed to advise its brokers that before they seek Countrywide's
approval on a reduced documentation loan application for a New York customer, they should make similar
disclosures and product quotes available to the customer. If Countrywide identifies any instance where these
undertakings have been violated resulting in the origination of a reduced documentation product that was not
in the customer's best interests, Countrywide will compensate the borrower.
D. Loan File Review
Countrywide agreed to conduct a match pair review of retail New York loans made in 2004. The purpose of
the review is to identify instances in which a black or Hispanic customer received a subprime or Alt A loan
when a similarly situated white non-Hispanic borrower received a prime loan. If a loan file review does not
explain the difference in product placement, Countrywide will compensate the borrower for the difference in
the cost of the loan he/she received and the lower priced loan he/she should have received.
In some cases, the file review will reveal that the borrowers did not receive a prime loan because they chose
to provide less than full documentation of their assets and/or income. In such cases, the borrowers will not be
entitled to compensation unless they demonstrate that they could have qualified for a full documentation loan.
If the borrower is able to do so, Countrywide will compensate the borrower for the difference in the cost of
the loan he/she received and the loan he/she could have received if he/she had provided full documentation.
E. Other Provisions
The settlement also includes provisions regarding enhanced fair lending training, fair lending complaint
processing and reporting, recordkeeping and compliance reporting to the Attorney General. The settlement
agreement will expire three years and three months following its effective date.
III. SIGNIFICANCE TO THE INDUSTRY
The amendments to Regulation C, which required the reporting of certain information regarding loan pricing
beginning with the 2004 calendar year, allowed regulators and enforcement officials, as well as private
advocacy groups, their first opportunity to evaluate the distribution of higher-priced loans to persons of
different races and ethnicities. Since the data became publicly available in the spring of 2005, the lending
industry has feared an onslaught of litigation. The onslaught has not occurred.
But, for almost two years, the federal financial regulatory agencies, the Department of Justice, HUD, the FTC
and state attorneys general have focused inquiries on individual lenders to determine whether claims of
unlawful conduct could be established based on the HMDA or other loan pricing data. The New York
Attorney General's settlement with Countrywide is the first product of those inquiries. That fact, by itself,
makes the settlement significant.
One conclusion that rings loud from the settlement is the HMDA data is not very meaningful in determining
whether a lender is discriminating in loan pricing. Rather, a complex analysis of a lender's pricing policies
and the implementation of those policies is necessary to reach conclusions. Even then, firm conclusions are
difficult to reach.
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For example, the Attorney General's sophisticated, and likely expensive, regression analysis of all 2004 loan
data - not merely the rate-spread loans - caused him to conclude that some of the variance in loan pricing
between white and minorities could not be explained by the nondiscriminatory factors considered, but he did
not identify any specific victim of unlawful conduct. Rather, the settlement allows Countrywide, with the
assistance of a new consultant, to continue to evaluate the issues and look for appropriate solutions.
Also, during the two-year period of review, fair lending pricing issues have become more complex and the
legal analysis, as revealed by the New York settlement, now seems to merge concepts of “discrimination”
with those of “consumer protection,” thus morphing fair lending into fairness in lending. For example, the
numerous loan products on the market today make it even more difficult to determine whether loan prices are
based on impermissible factors such as race or national origin, or permissible factors such as consumer
choice. The settlement agreement reveals the Attorney General's view that a defense of consumer choice may
be meaningful only if the consumer was fairly informed of the advantages and disadvantages of certain loan
products. The provisions of the settlement addressing informed consumer choice invoke typical “consumer
protection” concepts.
A consumer protection violation might arise if a consumer of any race or national origin was deceived into
purchasing a more expensive loan product, for example, by a loan officer who emphasized the apparent
advantages of the more expensive product but failed to describe the disadvantages. This claim may switch to
one of discrimination with an allegation that such practices are applied to minorities but not to whites.
These new concepts may present difficult compliance challenges for lenders, particularly those who have
made expanded efforts to remove barriers to minority homeownership. For example, a recent academic
paper presented to HUD identified underwriting guidelines that constituted potential barriers to Hispanic
homeownership, including citizenship requirements, sparse credit histories, and the requirements to document
income and assets. See, Review of Selected Underwriting Guidelines to Identify Potential Barriers to
Hispanic Homeownership, presented to HUD by Abt Associates Inc., March 2006.
One would expect that a program designed to remove the identified barriers would be of particular benefit to
Hispanics, and that Hispanics would therefore constitute a proportion of the borrower pool that exceeds their
proportion of the lender's overall borrower pool. One would also expect that such a program, although
presenting many layers of risk to a lender, would be viewed as a positive fair lending program. The New
York settlement instructs, however, that the very imbalance of Hispanic borrowers in the program may raise
a concern of possible discrimination, and lenders may be required to establish that Hispanics were not
improperly steered to such products instead of less expensive, but more onerous, standard products.
Further complicating the matter is the fact that loan files seldom answer the concerns like those presented in
New York. A lender may assume that a borrower seeking a stated income loan was making an informed
decision and believed it was to her advantage; a suspicious enforcement agency may contend that she
certainly would have documented her income if she were aware that a lower price loan was possible. Loan
files likely will not answer the questions. Certain Countrywide borrowers will be given an opportunity to
answer these questions. In the longer term, the public policy question is whether lenders will be required to
maintain better records demonstrating informed consumer choice to fend off such challenges.
The settlement as a whole does not impose significant burdens on Countrywide. The consumer education
program is expensive but is a consumer friendly action to take. Some individual borrowers may be
entitled to compensation, but the process to be followed may not result in many persons actually receiving
compensation. While enhancements will be made, Countrywide's overall fair lending compliance program
received a stamp of approval from the settlement terms. This does not suggest that the Attorney General was
soft on Countrywide, but rather that Countrywide already has a sophisticated methodology for addressing the
issues, as well as the commitment to continue to seek solutions. The Attorney General's objectives were
achieved by keeping the compliance burden in Countrywide's hands.
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The difficulty for the industry may be that Countrywide has set the compliance bar very high. It might be
argued that the settlement merely reflects how Countrywide previously had chosen to address compliance.
But Countrywide's compliance program is now embodied in a legally enforceable document, and may be
viewed as being “imposed” by the Attorney General to avert claims of unlawful conduct. If the settlement is
interpreted to mean that other lenders must mirror the Countrywide program, the challenge will be daunting
for those companies that do not have the resources or technical expertise to match the Countrywide program.
At the same time, all lenders can obtain guidance from the settlement even if they cannot mirror
Countrywide's program. Discretionary pricing can be limited and monitored to ensure that the discretion is
not exercised in a manner that results in higher pricing correlated with race or national origin. In particular,
pricing in the retail channel should be carefully addressed since many regulators are not interested in hearing
that a lender cannot control the loan pricing of its own employees.
Also, the settlement confirms the importance accorded by at least one regulator on seeking to exert some
controls on the pricing of loans originated through brokers. If one concedes that lenders have some
responsibility to monitor broker pricing, the settlement terms have at least some elements that are beneficial
to the industry. For example, the settlement confirms that wholesale pricing should be analyzed separately
from retail pricing.
Even more importantly, the terms of the settlement do not preclude Countrywide from controlling for broker
in conducting its regression analysis of broker pricing. It is not uncommon for brokers to serve borrowers of
a particular race or national origin, and a vexing problem that has troubled lenders is how to deal with
disparities that are caused by such brokers charging uniform prices to their customers, but prices that differ,
although not materially, from one broker to another within the same MSA. By not precluding Countrywide
from controlling for broker, the Attorney General seems to recognize that Countrywide is not responsible for
such disparities. Countrywide will, however, be required to examine whether brokers serving minority
borrowers of Countrywide are charging materially higher prices (a term not yet defined) than brokers serving
white borrowers in the same MSA, and take corrective action against such high-price brokers. An interesting
question is whether other enforcement officials and regulators will follow this approach.
At the same time, Countrywide agreed to monitor broker pricing and take remedial action if it appears that
brokers are discriminating on the basis of race or national origin. This program was already largely in place
at Countrywide and certainly is a positive fair lending effort, but it may present a significant new challenge to
other industry members.
The goal of avoiding business with brokers who discriminate certainly is noble, but it may be difficult to
identify those who actually discriminate. For example, the loans presented to Countrywide by a particular
broker may reveal pricing disparities correlated with race or national origin, but represent only a small portion
of the loans presented to other lenders by the broker. The overall portfolio of the broker may reveal no pricing
disparities correlated with race or national origin. Secondary market purchasers of loans struggle with similar
issues in attempting to implement fair lending compliance programs; they receive only a portion of a lender's
loans and thus have difficulty in determining the meaning of statistics revealing possible racial or ethnic
disparities.
Finally, the settlement terms may be read as addressing issues such as “suitability” that have been hotly
debated between industry representatives and consumer advocates. The requirement that Countrywide loan
officers “inform customers of the best mortgage loan product options, including with respect to price, for
which they qualify and that meet their expressed needs and preferences” may be read as approaching the
“suitability” issue. It is significant, however, that the requirement is to provide a product that meets the
borrower's “expressed needs and preferences.” Thus, the borrower, not Countrywide, has primary
responsibility for determining what is “suitable” for him or her.
Also, this provision of the settlement should not be interpreted as limiting discretionary pricing. The “price”
component refers to product. The settlement terms do suggest, however, that a customer who is fully able to
document income should not be pushed toward a more expensive state-income product merely to make the
work of the loan officer easier.
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It is reasonable to expect that, in the future, other enforcement officials will raise similar claims, based either
on consumer protection standards or laws prohibiting discrimination on the basis of race or national origin.
IV. CONCLUSION
It often is difficult to ascribe meaning to settlement agreements since they do not flow from an established
legal violation, but rather represent a negotiated agreement between the parties. At the same time, fair
lending compliance has generally been guided by settlement agreements reached with government agencies,
since few enforcement matters proceed to litigation. The New York settlement offers new guidance that
should be evaluated carefully, but with a recognition that Countrywide's compliance plan may not have to be
fully copied by other lenders. The “concerns” raised by the Attorney General may well arise again in other
enforcement contexts.
If you have any questions about the settlement, please call Melanie Brody, Paul Hancock or any other
member of K&LNG's mortgage banking/consumer finance group.
ENDNOTES
1 Pursuant to amendments to HMDA’s implementing regulation, in early 2005, residential mortgage lenders for the
first time publicly reported information about the prices borrowers paid on their loans. In particular, for those loans
on which the APR exceeded the yield on comparable Treasury securities, lenders reported the amount by which the
APR on loan exceeded the benchmark Treasury yield (these loans are referred to as “rate spread reportable loans” and
the amount reported is referred to as the “rate spread”). HMDA has long required lenders to collect and report other
information about certain residential mortgage loan applications, including the disposition on the application, the
location of the subject property and the race/ethnicity of the loan applicant(s). This has enabled regulators and other
interested parties to identify whether, among other matters, lenders are disproportionately declining minority
borrowers’ loan applications as compared to white borrowers’ applications. This new reporting obligation enabled
government agencies and others to analyze whether minority class borrowers appear to be paying more for loans
than white borrowers. The utility of the HMDA data is extremely limited, however, because it does not take into
account many of the differences in borrower credit and transaction characteristics that affect the price charged on any
given loan. Thus, HMDA data can be used as a screening tool to identify lenders with potential pricing disparities,
but is not sufficient to fully analyze whether apparent differences in prices paid by one group of borrowers as
compared to another are due to differences in the groups’ respective credit and transaction characteristics, or are
potentially evidence of discrimination.
2 If a difference is “statistically significant” at the 95% confidence level (the confidence level generally accepted by
courts), then there is a 95% probability that the difference is not attributable to random chance.
3 Some would argue that APR analyses are a waste of time and resources, because they require sophisticated and
expensive modeling and any disparities that are unexplained by neutral factors such as credit grade, LTV, property
characteristics, etc., often are caused by the discretionary components of the overall price. Thus, a lender that goes to
the time and expense to analyze APR disparities often will ultimately wind up focusing on discretionary prices.
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