How to Prepare for a Fair Lending Examination: Part II – The Examination
by Margaret Wright, Esq.
Assistant Vice President & Senior Counsel
A lender’s understanding of the examination procedures established under the Interagency Fair Lending Examination Procedures is vital in establishing a valuable fair lending self assessment program. Following the same steps for self assessment as in a regulated fair lending examination is key to ensuring fair lending compliance. This series of articles provides an overview of the fair lending examination process under the Interagency Fair Lending Examination Procedures.
The Compliance Management Review
Once the scope and key focal points have been determined by the examiner, the first step in the examination is the compliance management review. The compliance management review will determine the lender’s “reliability of practices and procedures for continuing fair lending compliance.”
The examiner will review the lender’s compliance policies and procedures in order to ensure that the policies and procedures “enable management to prevent, or to identify and self-correct any illegal disparate treatment in transactions as related to fair lending.”
To make this determination, the examiner will review records as well as interview key employees. Also useful for lender’s self -assessment, the Appendix to the Interagency Fair Lending Examination Procedures includes a “Compliance Management Analysis Checklist” which the examiner will utilize in this portion of the examination. The checklist is broken into two portions: a larger “Preventative Measures” section and the shorter “Corrective Measures” section.
Areas reviewed under the “Preventative Measures” portion include “Lending Practices and Standards” and “Compliance Audit Function”. The “Compliance Audit Function” measures whether the Lender’s self-testing or self-evaluation program adequately meets the fair lending assessment requirements.
The “Corrective Measures” portion of the checklist is used by examiners to determine whether or not lender has taken the appropriate corrective measures when discrimination was uncovered. The questions include examples of borrower restitution and the determination of the lender’s internal actions to ensure that the discrimination was not allowed to continue to occur.
Upon completion of the compliance management review, the examiner will be able to further determine the sample size of the fair lending examination based on the compliance program’s completeness. At this stage the examiner will also be able to identify “any compliance program or system deficiencies that merit correct or improvement” to include in the final report.
Data Integrity
Once the sampling size has been determined, the examiner must “verify the integrity of the data” being utilized for the review. A likely form of data verification is the comparison of the HDMA LAR information against the loan information found in the actual loan file. In anticipation of this, lenders may wish to perform an occasional HMDA scrub, even outside of the usual final review before submission of the final LAR under HMDA reporting requirements. If a fair lending examiner finds too many errors, they may require the data be corrected before they are able to complete the full examination.
The Examination Format
Once the scope, focal points, sampling size and data integrity has been determined the examiner begins review of the loan files. The examination may include the following file analyses in determining the lender’s overall fair lending compliance:
1. An underwriting comparison of denied and approved loan files, between prohibited group applicants denied loans and control group approved loans. The examiner will utilize an applicant profile worksheet comparing income, loan amount, debt, loan product and underwriting criteria used for each group of files reviewed. The examiner will also identify ‘marginal transactions’ where the applicants were neither clearly qualified nor clearly not qualified, and compare those files with each other. A common occurrence, the Interagency Fair Lending Examination Procedures Appendix includes examples of indicators that identify the application as an approved or denied marginal transaction.
2. A comparative file review, statistical analysis or combination of both for pricing or terms and conditions disparities between groups. This portion of the exam will be tailored more to the lender’s practices than general underwriting criteria in determining pricing and terms and conditions offered.
3. A review of whether applicants were steered toward certain products based on a prohibited basis rather than the applicant’s needs, even if no actual financial harm resulted. A lender offering numerous different products available through multiple sources presents a higher steering risk. Examiners will look at common ‘red flags’ products such as loan offerings based on credit risk level, non-traditional loans with pre-payment penalties or if the lender has a ‘sub-prime’ division.
4. Comparative redlining file analysis to determine whether the lender is excluding certain geographic areas bases on racial or demographic characteristics, either by refusing to offer attainable and affordable programs in the area or by “reverse” redlining where the area appears to be targeted for less favorable loan programs than others for which the applicant in a different area would otherwise qualify. Redlining can also include market areas in which the lender does not advertise or solicit. The examiner may also interview third parties and compare with lender’s peer’s performance in the area. If a discrepancy is uncovered, the lender will be given the opportunity to explain that the difference in treatment is credible and reasonable.
5. The fair lending examination may include a review of lender’s marketing practices including the usage of pre-approval solicitations, media usage, promotional materials, telemarketers, and lender’s relationships with realtors, brokers, contractors or other industry professionals.
6. The examiner may review any customized credit scoring model, the use in lender’s underwriting system of a standard credit bureau credit score, adverse action decisions based on credit scores alone and the determination of disparate treatment in the application of credit scoring programs.
7. The examiner will also document any instances of overt discrimination uncovered through comparative file review and the scope determination process. Instances of overt discrimination may be either written or unwritten.
Disparate Treatment
If upon review the lender’s policies give rise to a disparate impact in treatment of a prohibited group the examiner must determine whether the policy has a legally sufficient justification. The Interagency Fair Lending Examination Procedures Appendix outlines examples of common lender justifications concerning comparative disparate treatment:
- “The institution’s personnel were unaware of the prohibited basis identity of the applicant”;
- “The different in treatment was justified by differences in the applicants (applicants not similarly situated)”;
- “The different results stemmed from an inadvertent error”;
- “The apparent disparate treatment on a prohibited basis is a misleading portion of a larger pattern of random inconsistencies” (where similarly situated);
- “Loan terms and conditions” where “risks and costs are legitimate considerations in setting prices and other terms and conditions of loan products.”
The Appendix also includes lender responses to consider when overt evidence of disparate treatment is uncovered:
- “Descriptive references vs. lending considerations”;
- “Personal opinions vs. lending considerations”;
- “Stereotypes related to credit decision”;
- “Indirect reference to a prohibited factor”;
- “Lawful use of a prohibited factor” (such as a special purpose credit program).
Conclusion of the examination
Once the fair lending examiner has gathered all the information necessary to determine the lender’s fair lending nondiscrimination compliance, they will begin to prepare the examination results.
This article is the second in a three part series outlining the 2009 Interagency Fair Lending Examination Procedures. The next article will outline the examination results and include additional self-assessment tips.
About the AuthorMargaret is AVP & Senior Counsel of Bankers Advisory and serves as the firm’s Director of Regulatory Compliance Research. She received her Juris Doctor from Suffolk University Law School and admitted to the Massachusetts bar. She serves on the Compliance Committee of the Massachusetts Mortgage Bankers Association. She can be reached at margaret@bankersadvisory.com
Margaret Wright, JD, is regulatory compliance director with CLA. She is a graduate of Stonehill College and earned her juris doctor at Suffolk University Law School. She is admitted to the Massachusetts Bar.
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