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Disparate Impact, Fair Lending and the CFPB-Part One

Disproportionate adverse impact violations (Disparate Impact) are the hardest to defend against and the ones causing the biggest settlements.  In a nutshell, this means that your institution has a policy or criterion that has a disproportionate impact on the protected class population of the areas you serve.  This can occur in the way that you price loans or underwriting overlays.  So far, every lender that has been found to be in violation has settled, because defending this is too costly and abstract.

One example is Luther Burbank Savings in California who has paid a 2 Million dollar settlement.  They were told by their regulator to get into mortgages.  So, they decided to go into it slowly and offer one product.  The minimum loan was $400,000 and it was an interest only loan.  The problem was the $400,000 minimum.  In the area they served, this caused a disparate impact because average loan amounts in areas of protected classes fell below that.  So while this wasn’t “overt disparity” it did have a disparate impact.

Now the question remains, how do you reduce your risk exposure to Adverse Impact Violations?  The first task begins with a detailed market analysis and a determination of your risk tolerance.  If you want no risk, then stick to the investor guidelines, price the same within each MSA, add more programs available from the secondary market products and do not add your own overlays.  If you can accept a little more risk, then decide what overlays in underwriting, pricing or product line; make the risk worth taking to your bottom line.  Now quantify that “there appears to be no equally effective alternative for it”.  This is the exact language you will hear from the CFPB.  When I say quantify, I’m referring to documenting that severely.  For instance, they may say to you that it appears your credit score threshold is 700, yet your investor tolerance is 620 in their guidelines. Statistics within your MSA shows the average credit score of the protected class areas is 680. If you answer that you are mitigating buyback risk, then the question may be “can you show us they would not buy a loan that met their own criteria”?  In other words what do you have that demonstrates that belief?  Otherwise, it appears (right or wrong) that you are excluding portions of your population base that are protected classes.

The next issue that is often raised is that of a lender offering a very limited mortgage product range.  Some lenders may be new to mortgages or they just do not want to offer certain types of mortgages.  Again, if you are “leaving out” a protected class area within your MSA by virtue of offering only this program, then you may have an issue.  Steven Rosenbaum, who is the Chief of the Civil Rights Division of the Department of Justice, made a very profound statement at a recent conference I attended.  “You’re either in mortgages or you not”.  Meaning that if you choose to jump in the mortgage origination pool, you better make sure your product lines, align with the qualified clients in the entirety of your MSA area, not just a few that you choose.  For most mortgage bankers, product diversification is not an issue.  Instead the issues revolve around the overlays, marketing outreach and pricing differentials within the MSA, and how those decisions impact the protected class areas you serve.  For small financial institutions, like a bank or credit union who offer limited products that exclude, intentionally or not, protected classes in an MSA, you might want to consider expanding your product line to accommodate the qualified clients in the entirety of your MSA.  This will lower your level of risk.

Because this issue is so complex and the least understood, I intend to write further articles that will break it down into bite size chunks that help you evaluate and hopefully mitigate your risk.

Tammy Butler, Master CMB

Author Tammy Butler, Master CMB

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