It is easy to say that you need to consider each of your overlays, and then apply a risk assessment to that decisioning. The process, however, is a bit more detailed. To assist you in developing your new road map, that will be consistent with new regulation, here are some tips to apply to your decisioning process.
Define The Overlay: Examine your end investor requirements for pricing and underwriting. Then, list any pricing or underwriting overlays that you impose. Yes, I know this is a lengthy and complex project and a good project manager can assist you. Also, take a look at what constitutes a QM. I have found that in reading this guidance it is more relaxed than most investor requirements. Knowing what a QM looks likes helps you position your case.
Question The Reason: Many of you will find that some of your overlays are so old you forgot why you have them. It may be that everyone else had them, so the profit potential was there and you added it. Whatever the reason, define the why.
Gather The Evidence: This is the hard part! For each overlay that you may keep, you will need to build your business justification case. This includes statistical and empirical data that backs up why you need the overlay. Business justification will be necessary for Ability-to-Repay clarification and fair lending defenses.
If you have an overlay that causes disparate impact or redlining issues, (intentionally or unintentionally excludes protected classes, or high minority areas within your MSA), the first thing you will get hit with from the examiner is “why’? When you pull out your “evidence” you look highly prepared and thoughtful with your compliance management system.
However, I will give you a final consideration. Just because you have a business justification does not mean you are off the hook. If others are able to compete without those overlays, earn profit, sell the loans to the market, and not have their compare ratios affected, then your argument may not hold water for disparate impact allegations.
Make Adjustments: Play the devil’s advocate for each of your overlays. Be the examiner and try to find reasons why you cannot justify the overlay. If you pass that test, then you may decide to keep it, document it and defend it. If not, you may decide that the risk is not worth the reward.
Train Your Staff: Train, test and monitor your staff. Make sure they do not fall into the “well that is the way we used to do it” mindset. Ensure that new rules are followed by having a senior person do a “second look” on loans that exceed normal conditions, or loans that are denied. Compile the anomalies in a report, so that you can see how your training is sticking to the brains of your employees. Use the report to identify overlays that may be causing fair lending issues as well.
Monitor: As part of your compliance management system, do a quarterly review that examines the overlays and business justifications for those overlays. Compare that with “real time” fair lending monitoring to check for market coverage and disparity. Stay in contact with leaders in underserved markets, so that you are aware of any economic changes in the market; as any market is subject to change. Also take a hard look at your loan denials or borrowers that inquired but never came into apply. This information may tell you loud and clear if you have disparity issues for fair lending. Re-verify your decisioning and proceed as normal.
Demonstrating your compliance management system for overlays shows the examiners that you take fair lending issues seriously. If they see that you have thoughtful processes, evidence, training and monitoring you have much less to worry about! tbutler@optimalblue.com
