Mortgage Banking & Consumer Credit Alert
September 2008
Author:
Paul F. Hancock
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paul.hancock@klgates.com
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Congressional Effort to Enhance Fair Lending
Enforcement: A Flawed Approach That Will
Burden Lenders
While most eyes are scavenging the new housing recovery legislation’s provisions on
conservatorship and receiverships, buried within the almost 300 pages of text are provisions
granting authority to the newly established regulator known as the Federal Housing Finance
Agency to examine the portfolios of Fannie Mae and Freddie Mac in search for evidence
of unlawful pricing discrimination by individual lenders. The law requires the director of
the new agency to refer even preliminary findings of possible discrimination to the lender’s
regulator or other federal enforcement agencies. Yet information available to the director
may be insufficient to support a reasoned decision regarding pricing practices of the loan
originators, and thus the referral requirement may create an environment in which false
positives routinely occur. Referred lenders will likely face an even more comprehensive
review from their regulators and be required to expend significant resources to defend
themselves. If this new authority survives the conservatorship, modifications to lenders’
fair lending compliance programs may be necessary to avert legal risks.
Director Of Federal Housing Finance Agency Is Given Fair Lending
Authority And Responsibility
The new “Federal Housing Finance Regulatory Reform Act of 2008,” a component of the
“Housing and Economic Recovery Act of 2008,” establishes the Federal Housing Finance
Agency as an independent agency of the federal government with the responsibility
to supervise and regulate Fannie Mae, Freddie Mac and the federal home loan banks
(“enterprise(s)”). Most provisions of the new law are designed to advance the future safety
and soundness of the enterprises, but the law also includes important provisions impacting
fair lending enforcement by federal government agencies.
For the purpose of “eliminating interest rate disparities,” the law authorizes the director
of the new agency to request the enterprises to provide data for the director to review,
“to determine whether there exist disparities in interest rates charged on mortgages to
borrowers who are minorities as compared with comparable mortgages to borrowers of
similar creditworthiness who are not minorities.” In the event that the director finds a
pattern of disparities with respect to any lender, the director “shall (A) refer the preliminary
finding to the appropriate regulatory or enforcement agency for further review; and (B)
require the enterprise to submit additional data with respect to any lender or lenders,
as appropriate and to the extent practicable, to the Director who shall submit any such
additional data to the regulatory or enforcement agency for appropriate action” (emphasis
added).
The director is required to file a report with Congress each year to describe the actions
taken to examine potential disparities. The report may not identify any lender who has
not been found to have engaged in discriminatory lending practices “pursuant to a final
adjudication on the record.”
Mortgage Banking & Consumer Credit Alert
Targets Of The Law
The law does not require the director to examine
the pricing patterns of lenders who sell loans to the
enterprises, but certainly gives him or her authority to
do so. All lenders that sell loans to the enterprises are
subject to review for possible unlawful discrimination
in loan pricing. The director’s duty to report to Congress
each year on the actions taken to implement this new
authority likely will result in vigorous examination of
loan pricing. And, in the event that the director reaches
a preliminary conclusion of possible discrimination, he
or she is required, much like the provisions of ECOA,
to refer the matter to the lender’s primary regulator or
a federal enforcement agency, such as the FRB, OTS,
OCC, FDIC, FTC, HUD or the Department of Justice.
The referral is not discretionary; by use of the word
“shall” Congress mandated that a referral be made if
disparities are revealed. Unlike ECOA, the referral
requirement imposed upon the director arises upon
“preliminary findings” even if the inquiry has not been
completed.
Lenders subject to regulation by the federal financial
regulatory agencies are accustomed to the agencies’
review of their loan pricing policies and practices. In
the future, even these federally regulated lenders may
be the subject of a referral from the new regulator to
their primary regulator. Other lenders may face the
fearful prospect of a referral to HUD or the Department
of Justice.
Concerns Raised By The New Structure
A major concern with this new approach is that an
analysis by the director may not accurately reveal a
lender’s pricing practices. To start, it is not clear that
the director will have access to the myriad components
that are relevant to the pricing of individual loans.
Even if the director does have sufficient loan-level
data, it is obvious that the director will be examining
only a portion of the loans that the lender originated in
a particular product or program. In such circumstances,
how can he or she make a reasoned determination
regarding the pricing policies of any particular
lender?
The new approach will raise the same issues that
lenders encounter when they attempt to analyze
possible pricing disparities by brokers with whom they
do business. A lender may uncover pricing disparities
in the loans coming from a particular broker, but the
lender may be receiving only a small percentage of
the broker’s total business. Since the lender does not
have access to the data regarding the broker’s total
portfolio, the lender may not be in a position to make
any reasoned conclusion regarding the broker’s pricing
practices.
Similarly, under the new law, the director will be
examining only the portion of the lender’s loans
that were sold to the enterprise. Assuming that the
necessary data is available, the director likely will
have to use a statistical regression model since he or
she is required to consider “comparable mortgages to
borrowers of similar creditworthiness.” Perhaps an
informed decision can be reached if the lender sells all,
or almost all, of its loans to the enterprise. But for those
selling a smaller portion of their loans to the enterprise,
the director – who lacks the data regarding the total
portfolio – may reach a false conclusion.
The law does not describe the level of disparity that
will kick in the mandate to refer. The word “significant”
is not used to modify “disparity” in the Act’s language.
As drafted, the law might be read as requiring a referral
if any disparity is revealed. This, of course, would
be nonsense inasmuch as it is difficult to imagine an
analysis that will reveal precisely equal pricing between
minorities and non-minorities. One group or another
will receive different pricing, even if the differences are
slight. Let’s hope the law will be interpreted reasonably
to allow discretion to the director to decide the level
of disparity that will warrant a referral. But even this
imposes a difficult issue. Does a disparity of 40 basis
points warrant a referral? How about 10 basis points?
Or 5 basis points?
The law heightens reputational, financial, and legal risks
for lenders. Many lenders still are seeking to recover
from the reaction, or overreaction, of the government
agencies to the 2004 HMDA data that included, for the
first time, certain information on higher-priced loans.
The Federal Reserve Board reportedly referred some
200 lenders to other regulators and federal enforcement
agencies because the data revealed disparities correlated
with race or national origin.
The enforcement effort only confirmed the difficulty in
reaching a meaningful conclusion from the examination
of only a portion of a lender’s loan originations.
Nonetheless, lenders’ policies were examined under
September 2008 | 2
Mortgage Banking & Consumer Credit Alert
a microscope, and, although no enforcement actions
were filed solely because of disparities in higherpriced loans (the disparities usually were explained
by legitimate credit-quality differences), many referrals
morphed into a full-scale investigation of the pricing
of all loans in a particular program or of the total
loan portfolio. Those investigations never would have
been initiated but for the disparities revealed by a
portion of the loan originations, and yet many of the
investigations are continuing today, four years after the
release of the original data.
The false reads caused great financial injury to the
captured lenders. Proper defense of claims of systemic
pricing discrimination is burdensome, time-consuming
and expensive. Agencies receiving the referrals have
shown a reluctance to release the referred lender from
their grip – the agencies are under some pressure from
Congress and consumer groups to justify inaction
on referrals. They generally want to continue to dig
deeper even if the original basis for the referral does
not pan out.
Referrals by the director under the new law likely will
trigger similar episodes. What action, for example,
will the OCC take if the director identifies pricing
disparities in loans originated by a national bank?
The agency probably has been conducting regular fair
lending reviews of the bank, but now may be required
to start from scratch in light of the referral from the
director. The OCC’s analysis, however, will not be
limited to loans sold to a particular enterprise. Rather,
the OCC will examine all loans in a particular product
or program, or perhaps the entire portfolio. In the
long run, the bank may disprove the charges, but the
expense and burden may be significant.
Of course, the director is not authorized to reveal
publicly the referral of an individual lender (absent
a final adjudication), but lenders may face questions
regarding their own duty to disclose under licensing
or securities laws.
Actions To Address The New Risks
All of this suggests the need for modification of
fair lending compliance programs to meet the new
risks. “KNOW YOUR DATA” remains the mantra
that should guide lenders. When higher-priced loan
reporting became required by HMDA, lenders began to
analyze this portion of their loan portfolio and to search
for explanations for disparities. Perhaps this was not
done promptly enough, or perhaps more affirmative
efforts to inform regulators of the results might have
truncated the reviews that ultimately ensued.
The new structure should cause lenders to analyze
and monitor the pricing of loans that are sold to the
enterprises. In the event that disparities are revealed,
the cause for the disparities should be sought. It may
be necessary to consider whether the disparities are
caused by the failure to consider the lender’s entire
portfolio. The review may demonstrate the need for
corrective action, but it is preferable to address this
issue before, rather than after, a referral. If a referral
is made, the first question from the receiving agency
will seek the lender’s explanation for the disparities.
Lenders who have the explanation on hand are most
likely to truncate what might otherwise be an expensive
and damaging investigation.
In sum, the new law creates legal risks that warrant
risk-reduction considerations and actions.
On the other hand, this new structure may be designed
to entice the regulators to conduct more rigorous fair
lending reviews. The expected congressional pressure
on the regulator to explain its failure to act upon
referrals from the director may lead to an increase in
enforcement actions.
September 2008 | 3
Mortgage Banking & Consumer Credit Alert
K&L Gates’ Mortgage Banking & Consumer Finance practice provides a comprehensive range of transactional,
regulatory compliance, enforcement and litigation services to the lending and settlement service industry.
Our focus includes first- and subordinate-lien, open- and closed-end residential mortgage loans, as well as
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the fields of mortgage banking and consumer finance.
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September 2008 | 4
Mortgage Banking & Consumer Credit Alert
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