Focus On Two Key Areas to Capitalize on Overdrafts


overdraft-10-16-18.pngBy all accounts, the outlook for overdraft programs is encouraging for community banks.

Increasingly more consumers are choosing to access the service as a short-term funding solution, while regulatory burdens are easing. Banks that manage their customers’ overdrafts with outdated programs—those that do not put their account holders’ best interests at the forefront or utilize outdated technology and procedures—cannot capitalize on this real opportunity to improve service and compliance, as well as fee income.

The Overdraft Landscape
According to Moebs Services Inc., an economic-research firm, overdraft revenue increased 3 percent industry wide from 2016 to 2017, the largest increase since 2009, and is on pace to an all-time high above $37 billion by 2020.

One reason for this increase in overdraft fee income is more consumers are making the decision to access the service when funds fall short. Moebs Services reported there were approximately 1.12 billion overdraft transactions in 2016, up from nearly 1.09 billion in 2015. According to a 2017 Wall Street Journal article, these numbers suggest many consumers consider overdraft a safety net—a convenience—for which they are willing to pay a price. Analysts said in the WSJ article that the increase in overdraft revenue should be expected, since rules and regulations have been in place for some time now.

In addition, the Consumer Financial Protection Bureau withdrew overdraft rulemaking from the agency’s spring rulemaking agenda in May after having been on the agenda for years, signaling that no new overdraft regulations will be forthcoming.

With this landscape set, how should your bank capitalize on it?

A Data-Driven, Automated Solution
The first place to start is to review your current overdraft procedures and software capabilities to ensure you are using a modern, data-driven solution—one that automatically manages risk and strives to meet customer expectations. Although there are several essential components of such a system, two are listed below.

Intelligent Limit-Setting
Updated automated overdraft programs should enable your bank to set individual overdraft limits that align with an account holder’s ability to repay the overdrawn balance. The software analyzes the key risk variables of your accounts, identifies the accounts that have the highest probability of charge off and calculates individual “intelligent” limits. It then reassesses that ability to repay daily.

Providing these dynamic limits helps to serve customers better than employing fixed overdraft limits (where the same overdraft limit is assigned to every customer of a certain account type) by granting higher overdraft limits to those customers whose ability to repay warrants it, while pulling back on those who have more limited repayment capacity.

Just as important, using intelligent limits addresses the Federal Financial Institutions Examination Council (FFIEC) 2005 Joint Guidance on Overdraft Protection Programs, which states, “Institutions also should monitor these accounts on an ongoing basis and be able to identify consumers who may represent an undue credit risk to the institution. Overdraft protection programs should be administered and adjusted, as needed, to ensure that credit risk remains in line with expectations.”

Reg. E Outreach
Eight years have passed since most banks conducted a formal outreach program in response to the 2010 Amendment to Regulation E, or Reg. E, which requires affirmative consent from customers for banks to charge an overdraft fee on ATM and one-time debit card transactions. Does your board know the number of customers who did not provide a decision back in 2010 or at a subsequent account opening?

Without consent, banks do not extend overdraft privilege through these channels, which can result in multiple unexplained debit card declines. Customers may not recall making a Reg. E decision or are unaware it is even an option, which leads to confusion and irritation for the customer.

Data-driven overdraft software allows your bank to identify these denied transactions and sort them by a customer’s Reg. E decision. With this knowledge, you can reach out to those customers who have not provided a decision and explain the reason for the denial, offer overdraft alternatives and obtain a Reg. E preference. Customers appreciate this level of communication, which provides assurance your debit card will consistently help them meet their liquidity needs.

Capturing just a few percentage points more Reg. E opt-ins can result in a tangible increase in both interchange and fee income as well. A qualified third-party overdraft provider will offer employee training, best practices and scripts to ensure your Reg. E outreach program is successful and compliant.

Is your bank positioned to capitalize on the opportunity for better service and income that a well-run overdraft program represents? With the right technology and procedures, you can.

AI is Groundbreaking Technology—But What Will the Regulators Say?


FinXTech-4-19-18.pngIn one sense, regtech—a recent word invention that stands for regulatory technology—is just a rebranding of an evolutionary process that has been going on for decades. Ever since the first IBM mainframe computers rolled off the assembly line in the 1960s, banks have been deploying technology to improve the efficiency and effectiveness of their operations and lower their costs. Of course, technology has come a long way since the dawn of the IBM mainframe—or “Big Iron” as they were sometimes called. Consider for a moment that anyone walking around today with an Apple iPhone 8 has more computer power in the palm of their hand than the Apollo 11 astronauts used on their 238,900-mile journey to the moon.

Another example—one with the potential to revolutionize the task of regulatory compliance—is artificial intelligence, or AI. “People see it as something that can solve all of your problems,” Harshad Pitkar, a partner at the consulting firm PricewaterhouseCoopers, said during a presentation at Bank Director’s The Reality of Regtech event, which took place April 18 at the Nasdaq MarketSite in New York.

While it holds great promise, Pitkar said deployment of AI in the regulatory compliance space needs time to mature, with more focus on building on “practical applications” that address specific compliance challenges within the bank. Pitkar also cautioned that like many complex technology solutions, AI projects take time and patience to get off the ground. “[They’re] not so easy to implement,” he said. “It’s not as easy as turning on a switch.”

It is still unclear however, how regulators will embrace technology-driven compliance solutions. Concepts and emerging technologies like AI in oversight of the compliance process are taken very seriously.

Regulators are by nature conservative, so it shouldn’t be surprising they may be slow to warm up to an innovative new technology solution proposed to replace a more manual, people-driven process they are very familiar with. At the same time, financial regulators are well aware of the many innovations emerging in regtech and financial technology generally—and the need for them to keep pace with this innovation. A number of regulatory agencies around the world, including a few in the United States, are establishing “reglabs” or “regulatory sandboxes” to test new ideas.

James Kim, an attorney with Ballard Spahr and a former regulator at the Consumer Financial Protection Bureau, said during a later panel discussion that banks should make a concerted effort to educate their supervisory agencies about regtech projects they have undertaken. “Educate your regulators,” Kim said. “They need to feel comfortable that your new technological systems are effective.” Speaking from experience, Kim said regulators will always be playing catch with the banking and fintech communities as the innovation tide rolls on. “They probably will always be dead last in having the expert knowledge in this area,” he said. “They need to be led.”

Cautious Optimism for Bank M&A


industry-1-29-18.pngThere is a general sense of optimism about the state of deal-making in the banking industry at Bank Director’s Acquire or Be Acquired conference in Phoenix, Arizona. Bankers and industry observers pointed repeatedly throughout the first day to the fact that bank stock valuations have soared in the 14 months since the 2016 presidential election, opening up new possibilities for interested buyers and sellers.

Bank stocks faced an uncertain if not bleak future two years ago, a point that Thomas Michaud, president and CEO of Keefe, Bruyette & Woods, used to set the scene for the state of banking in 2018. Oil prices had dropped to below $30 a barrel, economic growth in China seemed to be tempering and the United Kingdom was lurching towards a nationwide referendum on quitting the European Union. This trifecta of bad news led bank stocks to drop, producing a dour outlook for prospective sellers.

Yet, you only had to flash forward to the end of 2016 to find a dramatically altered landscape. Stocks soared following the presidential election. And no industry benefited more than banks, where share prices rose by nearly a third over the next four months. Since the beginning of 2016, large-cap bank stocks have climbed 55 percent while regional bank stocks have gained 44 percent—both having bettered the S&P 500’s 36 percent advance over the same stretch.

This has resulted in meaningfully higher valuations, a core driver of deal activity. Prior to the presidential election, banks were valued below their 15-year median of 15.2 times forward earnings per share estimates. After peaking at 18.8 times forward earnings in the immediate wake of the election, they have settled at 15.4. But even though bank valuations are up, which makes deals more attractive to buyers and sellers with higher multiples, they are nowhere near euphoric levels, given the mere 20 basis point premium over the long-run average.

Virtually everyone you talk to at this year’s gathering of more than 1,000 bankers from across the country believes there is still room for these valuations to climb even higher. This was a point made in a session on the drivers of a bank’s value by Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking. In just the last five weeks of 2017, six deals priced for more than two times tangible book value were announced, creating strong momentum for 2018.

Underlying all of this is an improved outlook for bank profitability, the primary determinate of valuation. In the immediate wake of the financial crisis, it was common to hear people say that banks would be lucky to return 1 percent on their assets. Now, a combination of factors is leading people like Michaud to forecast that the average bank will generate a 1.2 percent return on assets.

Multiple factors are playing into this, beginning with the pristine state of the industry’s asset quality. You have to go back to the 1970s to find the last time the current credit outlook for banks was this good, says Michaud. This has some industry observers watching closely. One of them is Tim Johnson, who leads KPMG LLP’s deal advisory financial services sector. Johnson commented in a panel discussion on deal-making that he believes the consumer credit cycle could take a turn for the worse this year. But there are others, like Tom Brown, founder and chief executive officer of the hedge fund Second Curve Capital, who doesn’t see any reason to be worried about consumer credit trends in light of the low unemployment rate and high consumer confidence.

The expected changing of the guard atop the regulatory agencies is a second factor fueling optimism that profitability will improve this year. Former banker Joseph Otting is the new comptroller of the currency, while Jerome Powell has been confirmed as the new chair of the Federal Reserve Board. Jelena McWilliams awaits confirmation by the U.S. Senate as the new chairman of the Federal Deposit Insurance Corp., and President Donald Trump is expected to nominate a new director to lead the Consumer Financial Protection Bureau. While there are few signs of tangible benefits in terms of a lower compliance burden from the new administration, this should eventually change once new leaders are in place at the top of all of the agencies.

Last but not least, the biggest boost to profitability in the industry will come from the recently enacted corporate tax cuts, which lower the corporate income tax rate from 35 percent down to 21 percent. The drop is so significant that it caused KBW to raise its earnings estimates for banks by 14 percent in 2018 and 12 percent in 2019. And when you factor in the likelihood that many banks will use the savings to buy back stock, KBW projects that earnings per share in the industry will climb this year by 25.6 percent over 2017.

The atmosphere on the first day of the conference was thus upbeat, with presenters and attendees projecting a sense of cautious optimism over the improved outlook for the industry. At the same time, there is recognition that the longer-term macro consolidation cycle that shifted into high gear following the elimination of laws against interstate banking in the mid-1990s could soon reach critical mass. If that were to happen, banks that don’t capitalize on today’s improved outlook by seeking a partner could be left standing alone at the merger alter.

Privacy Concerns Remain as HMDA Implementation Date Arrives


CFPB-12-27-17.pngAfter more than three years, the implementation date for the Consumer Financial Protection Bureau’s amendment to Regulation C of the Home Mortgage Disclosure Act (HMDA) has finally arrived. While much has been written about the increased data points to be collected and reported under the rule, and the regulatory risks this presents to covered entities, the data privacy issues have been largely overlooked and are still being debated at this late stage.

HMDA data is not only public, but the CFPB provides tools that allow anyone to explore this data. The CFPB also allows the raw data to be exported with ease to spreadsheets and other data analysis programs. The fact that the data is so easily analyzed, combined with the increase in data points collected under the new rule, drove the financial industry to repeatedly raise privacy concerns to the CFPB. As early as 2015, covered entities questioned why the rule failed to establish a method to mask certain data fields that would protect an applicant’s identity. The CFPB didn’t directly address these concerns, stating only that the bureau will use a balancing test—a subjective test to explore a legal or regulatory issue—to “determine whether HMDA data should be modified prior to its disclosure in order to protect applicant and borrower privacy while also fulfilling HMDA’s disclosure purposes.”

The results of this balancing test were finally announced in September 2017, when the CFPB published guidance in the Federal Register. Not surprisingly, the guidance was met with criticism and further concern from the industry, as evidenced by a recent comment letter submitted by several industry trade groups. The CFPB’s guidance proposes to modify the public loan-level HMDA data to only exclude:

  • the universal loan identifier,
  • the date of the application,
  • the date action was taken by the financial institution,
  • the address of the property securing the loan,
  • the credit score or scores relied on in making the credit decision,
  • the Nationwide Mortgage Licensing System and Registry Identifier (NMLS ID),
  • the result generated by the underwriting system, and
  • free-form text fields used to report applicant or borrower race and ethnicity, name and version of the credit scoring model used, principal reason for denial (if applicable), and the name of the automated underwriting system.

As the comment letter points out, this leaves all other data points available to the public, including the borrower’s income, age, sex, race and ethnicity; the census tract, county and state; and the interest rate, combined loan-to-value ratio (CLTV), loan purpose and term, as well as many other data points. This makes applicant identification by the public not only possible, but probable. The data being collected and reported can be used for criminal purposes such as identity theft, but will also be extremely valuable to third-party marketing services. In an age where the mining and aggregation of personal information creates valuable data sets, it is reasonable to believe that the reported HMDA data will be analyzed to exploit anyone applying for a mortgage in 2018 and beyond.

Those involved in mortgage lending should be concerned with their applicants’ data privacy, given the litigation and reputational risks that accompany any successful attempt to improperly utilize or re-identify an applicant through reported HMDA data. Consumers are becoming increasingly attuned to their privacy and the need to protect it. Once it is determined that HMDA data was used for an unauthorized or possibly criminal purpose, covered entities should expect a flurry of lawsuits filed and public backlash against whatever institutions were involved in the collection and reporting—not necessarily the CFPB that promulgated the rule and guidance. Given that it is a regulatory requirement to do so, HMDA covered entities will likely avoid liability for this disclosure, but at that point the reputational price and legal costs will already be incurred. Banks and other lenders must start collecting this data effective January 1, 2018, which will be scheduled for publication by the CFPB a year later. The risk presented to not only applicants and lenders through the public disclosure of this data is real, and it must be addressed by the CFPB. There is still more than a year before this data will be publicly reported. All mortgage lenders and industry groups should continue to push for a more conservative plan in regards to the publication of said data, with a greater focus on the data privacy risks to borrowers and the risk exposure to the lenders.

Does the U.S. Need Its Own Version of PSD2?


banking-12-22-17.pngIn January 2018, the Revised Payment Services Directive (PSD2) takes effect in the European Union, requiring banks there to open their payment infrastructure and data to third parties. The consumer-focused initiative is intended to give individuals control over their financial data while simplifying the payments ecosystem. Belgium, Germany and Italy have had a common protocol for providing third-party access to account information since the 1990s, and Australia is considering measures similar to the EU’s PSD2 initiative, according to a report from McKinsey & Co. With so much momentum behind the concept of open banking, should the United States explore a similar uniform data sharing policy?

Currently, the U.S. sees data sharing between banks and third parties take place through a patchwork of one-off deals. Often, agreements are struck between a financial institution and an intermediary that aggregates data from several institutions and provides that information to third parties, such as personal financial management apps, lending platforms or other consumer-facing service providers. These types of agreements do little to further a holistic national agenda of financial innovation and inclusion.

Many stakeholders—banks and technology companies alike—believe that these one-off data sharing agreements are not enough. For banks, current methods used by technology companies to gather data from their systems can result in security breaches, and carry the potential for brand or reputational risks. These issues illustrate the need for a uniform protocol that addresses both the technical aspects of connecting with third parties and the liability issues that can arise in cases of consumer financial loss.

What’s more, while the demands of secure API implementation are huge expenditures for a financial institution, the shift to open banking can also lead to new opportunities. (An application program interface, or API, controls interactions between software and systems.) As an example, PSD2 requires that banks provide access to data, but it does not prohibit an institution from monetizing its data in ways that go beyond the statute. Banks can capitalize on this mandate by providing more detailed data than is required by PSD2, or by providing insights to accompany the raw data for a fee. In addition, the development of API expertise will move institutions closer to offering many different financial services through a digital platform. Leveraging APIs can allow institutions to efficiently provide advice and services that customers demand today. (For more on this, read “The API Effect” in the May 2017 issue of Bank Director digital magazine.)

For technology companies that require access to bank data to operate, open APIs offer more reliable, accessible data. Without a direct line to bank data, technology companies must often resort to “screen scraping” to gather needed information. This technique requires a bank customer to provide log-in credentials to the third party. Those credentials are then used to collect account information. This method is much less secure for banks than controlling an API interface would be, and it’s a lot less smooth for bank customers that want to provide the technology company with access to their data.

Also, the process of entering into data-sharing agreements with multiple financial institutions is a daunting task for even the most sophisticated technology companies. Connectivity requirements vary from bank to bank, as do security protocols. Add to that a significant price tag for each deal, and the task of building a customer’s financial profile across multiple institutions is a significant barrier to entry that prevents the delivery of innovative financial services to consumers.

While the U.S. has been slow to act on open banking initiatives, there have been some signs of life. In October of 2017, the Consumer Financial Protection Bureau released its principles on data sharing and aggregation and confirmed its view that individuals, not the companies they work with, own their financial data. While this is only guidance coming from an embattled regulator, it hints at American interest in the open banking movement.

Innovation, enhanced security and the drive for greater competition are the golden triptychs at the heart of PSD2,” wrote Alisdair Faulkner of the digital identity company ThreatMetrix, based in San Jose, California, in August 2017. Those would seem to be values that every government should strive to uphold, and with benefits for both incumbents and new technologies, perhaps exploration of a PSD2-like initiative can take hold in the U.S.

Changing the Regulatory Landscape


regulation-12-8-17.pngThere is perhaps no other area of the federal government where personnel have a greater influence on policy than bank regulation. By picking the right regulators, the president can have a meaningful impact on the banking sector and the economy at large.

Banking has long been a bastion of static thinking on the regulatory front, and it needs a shot of dynamism. With recent confirmations at the Federal Reserve and the Office of the Comptroller of the Currency, and the nomination of a new chair of the Federal Deposit Insurance Corp., the administration is on the cusp of an overhaul of regulators that will have potentially far-reaching consequences. A new director—and new thinking—at the Consumer Financial Protection Bureau would also have a positive impact on the regulatory culture under which banks are operating.

The president’s new team of regulators can make an impact without any changes in the law or regulation in three key areas.

First, these regulators can approve new banks. Only six new banks have been chartered since 2010, and more than 2,000 have gone away. The attendant lack of dynamism and entrepreneurial disruption is palpable. Community banks are losing critical funding and payment market share to large banks and fintech companies. Traditional banks are crowding around discrete areas of the American wallet: middle-market commercial loans, owner-occupied commercial real estate and small business lending. Mortgage and consumer lending are increasingly offered by big companies that can afford to comply with costly rules. Customer contact and loan pricing is increasingly automated and regulated. New bank founders need the flexibility to build diversified portfolios, certainty around the capital required to implement a given business plan and certainty around the timeliness of the approval process. Greater transparency in these areas would contribute far more to stimulating new charter development than revising handbooks and holding conferences. Agency leaders can give that clarity right now, and they should.

Second, the burden of onsite bank exams is a continual concern. Most of these complaints are from banks so small that if any 200 of them were to fail tomorrow, it would hardly make a dent in the FDIC’s reserves. Banks divulge massive amounts of information to regulators on a quarterly basis. Couldn’t regulators perform remote exams of these small banks, with onsite spot checks as needed? Further, the rigid application of compliance regulations are eliminating small dollar lending programs at many community banks—to the detriment of the very customers these rules are supposed to be protecting. Wouldn’t community banks be better off if they could diversify their loan portfolios by offering products needed by their communities? Wouldn’t the industry be better served if examiners’ efforts were focused on large banks, where the customer experience needs improvement, and the consequences of failure are more severe?

A final element of dynamism relates to the ability to exit. Banking is one of the few industries where the government approves the sale of the company—and takes months, if not years, to do so. Even the smallest transactions are subject to geographic competition tests normally seen when titans merge and make no sense in this age of digital banking. The list of incentives for regulators to say “no” is long and getting longer. Third-party protest groups have no direct skin in the game, yet have great influence over the process. Meanwhile, stakeholders, customers, employees and communities are all in limbo. Regulators could address these concerns by setting deadlines, actively brokering conversations between all parties and holding public hearings in a matter of days, not months. Restoring a timely process could make a big difference in resolving these issues.

None of these efforts require changing a law or a regulation. All of them would improve the transparency and timeliness of regulation. Unfortunately, few of the beltway types that frequently occupy regulatory chairs have a business executive’s skill and experience in gathering information and making timely decisions. These skills are badly needed now in the regulatory arena. As the new administration gets its team in place, the president should know he can make a significant difference in banking just by choosing the right people to occupy the regulatory chairs—and then letting them do their work.

Trump’s Big Chance to Remake Banking’s Regulatory Leadership


regulation-7-28-17.pngWhile the prospects for Congressional passage of a financial deregulation bill in 2017 are uncertain, that doesn’t mean bankers can’t look forward to a possible future loosening of the regulatory restrictions they’ve operated under since passage seven years ago of the Dodd-Frank Act.

On June 8, the Republican-controlled House of Representatives passed on a near party-line vote the Financial Choice Act, sponsored by Jeb Hensarling, R-Texas, chairman of the House Financial Services Committee. The measure would repeal several key components of Dodd-Frank including restrictions against proprietary trading (known as the Volcker Act), while also drastically altering the structure and authority of the Consumer Financial Protection Agency (CFPB).

But the Financial Choice Act faces much tougher sledding in the Senate, which the Republicans control by just two seats. There, any financial deregulation bill would need 60 votes to pass and many Senate Democrats have voiced strong opposition to any significant unwinding of Dodd-Frank, which was enacted by a Democratic-controlled Congress following the financial crisis. Brian Gardner, a managing director and Washington research analyst at Keefe Bruyette & Woods, expects any relief measure coming out of the Senate to be modest in comparison to the House measure. “I don’t think there will be a bill on the president’s desk this year,” he adds.

But does that mean bankers can’t expect any regulatory relief in Washington where Republicans control both houses of Congress and the White House? Not necessarily, because the Trump Administration has the opportunity to appoint new—and perhaps friendlier—leadership at several key bank regulatory agencies.

The administration has already nominated former banker Joseph Otting to head up the Office of the Comptroller of the Currency, which supervises nationally chartered banks. Otting would replace former Comptroller Thomas Curry, an Obama Administration appointee whose five-year term expired earlier this year. Otting, who was chief executive officer at OneWest Bank from 2010 to 2015, might be expected to take a more sympathetic view of the regulatory burden that banks operate in—much of it related to Dodd-Frank. Curry, by contrast, was a career regulator who had never run a bank.

The Trump Administration also has the opportunity to appoint an entirely new slate of directors to the Federal Deposit Insurance Corp.’s five-member board over the next year and a half, including a replacement for Chairman Martin Gruenberg, whose five-year term as chairman expires in November. President Trump nominated former congressional staffer James Clinger to replace Gruenberg, but Clinger has since withdrawn his name from consideration, citing family concerns. Gruenberg was a Senate staffer and trade association president before coming to the FDIC.

The FDIC board consists of three independent directors appointed by the president, as well as the comptroller of the currency and director of the CFPB. Richard Cordray’s five-year term as CFPB director runs through July 2018. A piñata for Republican criticism in Washington almost from the day he took the job, Cordray most certainly will not be reappointed by Trump, and it has been reported that he may run for governor in his home state of Ohio next year.

There are also three open seats on the Fed’s seven-member board of governors, including someone to serve as the Fed’s point person on financial regulation. Former Fed Governor Daniel Tarullo had played that role during the Obama Administration, and was known for taking a tough regulatory stance on the country’s largest banks, stepped down from the board in April. His place would be taken by Randal Quarles, a former Treasury department official under George Bush who has been nominated to serve as vice chairman for supervision. Quarles said in his prepared remarks before the Senate Banking Committee this week that post-crisis bank rules need some “refinements.”

But the most important regulatory position of all belongs to Fed Chair Janet Yellen, whose term ends in February 2018. Not only is the Fed considered to be first among equals of the regulatory agencies, but Yellen also controls the agenda at the Fed—including what gets talked about at meetings, Gardner says. Yellen was an Obama appointee and has largely been supportive of the past administration’s regulatory philosophy. Gardner says that historically most Fed chairs get two terms, although Trump has been noncommittal about reappointing Yellen. While it would be unusual for Yellen not to be reappointed, Trump has shown that he’s not a slave to convention. Asked what he thinks the president will do, Gardner, laughing, says “I have absolutely no idea.”

Keeping an Eye on the Red Line: Avoiding Fair Lending Regulations


fair-lending-6-19-17.pngNot long after the November election results became official, politicians, lobbyists and bankers began discussing the topic of bank regulatory reform. With a Republican in the White House, the Republican-controlled Congress vowed to push through its long-desired and promised reform of Dodd-Frank. While it is a decent bet some form of bank regulatory reform will emerge, it is unlikely reform will extend to the area of fair lending compliance. It seems most likely vigorous fair lending examination and enforcement are here to stay.

Each year, the Consumer Financial Protection Bureau prepares and issues a report specifically addressing its efforts in the area of fair lending supervision and enforcement. After touting its work from the previous year, CFPB specifically stated in its April 2017 Fair Lending Report that it will “continue to enforce existing fair lending laws at a steady and vigorous pace.” Furthermore, in a blog post from December 2016, Patrice Ficklin, director of CFPB’s Office of Fair Lending and Equal Opportunity, similarly indicated that the bureau’s work was far from over when it comes to stamping out lending discrimination.

The CFPB’s 2016 annual report identified three specific fair lending priorities for 2017, including redlining, mortgage and student loan servicing, and small business lending. While each of these priorities is important, redlining seems to be the hottest of the three in regulators’ eyes and deserves particular attention.

Redlining is a form of unlawful lending discrimination under the Equal Credit Opportunity Act (ECOA). It is defined as providing unequal access to credit, or unequal terms of credit, because of the race, color, national origin, or other prohibited characteristic, of the residents of a particular geographic area seeking credit. The unlawfulness of such practices is not new, but as with many consumer compliance issues, this one seems to go in and out of favor over time. It just so happens now it is back in favor.

The federal regulatory agencies take a risk-based approach to compliance examination, especially fair lending compliance examination. To determine the depth and breadth of the examination, the regulators evaluate and analyze the fair lending risk in the bank’s products and services. The results of this risk factor analysis affect the determination of whether, and to what extent, further examination is needed.

To identify redlining risk at a particular bank, the regulators may look at some or all of the following described risk factors:

CRA assessment area: The bank’s Community Reinvestment Act assessment area indicates where the bank expects to make loans. In assessing this risk factor, the examiner looks for exclusion (or non-inclusion) of geographic areas with high concentrations of minority race or ethnic residents.

Branch and loan production offices: Similar to the bank’s CRA assessment area, the location of the bank’s branches and loan production offices indicates from where it expects to attract loan customers. In assessing this risk factor, the regulators look for an unwarranted absence of locations in predominantly minority race or ethnic communities. Regulators look for so-called donut holes in the bank’s branch network?minority areas without a branch surrounded by majority areas containing branches.

Marketing and outreach: An effective marketing campaign attracts the customers the bank wishes to attract. In assessing the redlining risk attendant to the bank’s marketing efforts, the examiner looks to see whether the bank’s efforts expressly exclude, or will not include, racial and ethnic minority consumers. They consider to what zip codes or neighborhoods direct mail campaigns are sent and which real estate brokers are targeted for referral business. They also consider whether the bank makes affirmative efforts to reach out to racial and ethnic minority consumers as potential customers.

Complaints: Sometimes the most obvious indication of a problem is someone telling you there is a problem. Complaints about potential redlining may come directly to the bank by way of direct communication from an individual or advocacy group. But it is just as likely a complaint will be lodged on social media or in the press. In any case, the compliance examiner reviews complaints, including those received by regulatory authorities, in order to determine the existence and level of redlining risk.

Identifying and correcting unlawful redlining is a regulatory priority for 2017. Boards and senior management teams of banks of all sizes and geographies would be wise to redouble their efforts on making sure their bank’s policies, processes and procedures keep an eye out for that red line.

What Are the Prospects for Regulatory Reform?


regulation-6-7-17.pngEditor’s note: The House passed the CHOICE Act Thursday 233-186 but it isn’t expected to earn enough votes in the Senate to become law.

Financial regulatory reform is a priority for President Donald Trump and his administration, which views burdensome and costly regulation as a significant impediment to lending and economic growth. However, more than 100 days into the Trump presidency, neither the president nor Congress has taken meaningful action on financial regulatory reform. While it is impossible to predict what the administration’s legacy will ultimately be on regulatory reform, its actions thus far with respect to regulation generally, proposals introduced in Congress by Republicans, and the president’s power to appoint agency officials may offer some clues of what’s to come.

Financial CHOICE Act
The Financial CHOICE Act, which House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has called a blueprint for financial regulatory reform, passed the House Financial Services Committee on a party line vote on May 4. The current version of the CHOICE Act would, among other things:

  • Transform the Consumer Financial Protection Bureau (CFPB) from an independent agency to an executive agency, subject to Congressional oversight and the Congressional appropriations process, with its director removable at will by the president.
  • Make the CFPB an enforcement agency without a bank supervisory function.
  • Eliminate the CFPB’s authority to enforce unfair, deceptive or abusive acts and practices.
  • Provide regulatory relief to community banks and those engaged in residential mortgage lending.
  • Repeal the Volcker rule, which prohibits banks from proprietary trading.
  • Provide regulatory relief for banks that maintain a 10 percent leverage ratio.
  • Overturn the U.S. Second Circuit Court of Appeals’ decision in Madden v. Midland Funding.

While the CHOICE Act is likely to pass the House in some form, its chances of passage are remote in the Senate since 60 votes are required to overcome a filibuster. Nevertheless, some targeted reforms, including regulatory relief for community-based institutions, could be enacted.

Executive Orders
With material changes to the Dodd-Frank Act likely to die in the Senate, President Trump’s executive orders may form the basis of the administration’s regulatory reform strategy. President Trump has signed six executive orders impacting the financial services industry. Among other things, these executive orders:

  • direct the Treasury secretary to consult with the nine member agencies of the Financial Stability Oversight Committee and draft a report to the president analyzing current laws and regulations for their consistency with the seven so-called core principles of financial regulation;
  • require each agency to repeal two regulations for each new regulation implemented;
  • require a cost/benefit analysis before new regulations are adopted; and
  • require agencies to establish regulatory reform task forces and appoint regulatory reform officers whose job will be to identify burdensome regulations and evaluate their consistency with the core principles.

However, executive orders can accomplish only so much. Just as President Obama could not unilaterally repeal legislation, President Trump will not be able to roll back statutory provisions of Dodd-Frank without acts of Congress. Further, while it may be possible to soften the impact of certain Dodd-Frank regulations, the Administrative Procedures Act generally requires that any regulations implemented through a notice and comment process go through a similar process before they can be repealed.

Appointments
President Trump’s broadest impact on financial regulatory policy may come from his appointments to federal agencies. Treasury Secretary Steven Mnuchin has been confirmed. Three vacancies currently exist on the seven-member Federal Reserve Board of Governors. Former Treasury Undersecretary Randy Quarles is expected to be appointed as the first vice-chair of supervision, filling one of these vacancies. When the terms of Chair Janet Yellen and Vice-Chair Stanley Fischer expire in February 2018, the president will have the opportunity to reshape the central bank. Likewise, the comptroller of the currency has been replaced on an acting basis by banking attorney Keith Noreika and may be replaced by former One West CEO Joseph Otting on a permanent basis. If CFPB Director Richard Cordray is removed or leaves of his own accord later this year to run for Governor of Ohio, as many suspect he may, the president would have the ability to appoint a new CFPB director. Further, there is currently a vacancy on the Federal Deposit Insurance Corp. board and current chair Martin Gruenberg’s term as director will end in November. Since the comptroller of the currency and the director of the CFPB also sit on the FDIC’s board, the president soon will have an opportunity to appoint four of the FDIC board’s five members.

While the president can’t order officials at these agencies to take particular actions, and his ability to remove agency officials may be limited, his appointees will likely exercise a more restrained approach to regulation than Obama-era appointees. Over time, we expect a tangible difference in how banking agencies approach supervision and enforcement. At the end of the day, the president’s appointment power may be the most effective tool in his tool box.

Can We Say Goodbye to Fair Lending Cases?


lawsuit-6-2-17.pngOne of the potential impacts of a new administration in Washington, D.C., is a lot less fair lending enforcement. For a number of banks, that would be a very good thing. Banks have been hit with fines, bad press and enforcement actions in the last few years, as the Justice Department and the Consumer Financial Protection Bureau have brought cases alleging everything from indirect auto loan discrimination to redlining, the practice of carving out minority neighborhoods to exclude from loans.

Institutions such as Fifth Third Bank and Ally Bank have been hit with the auto finance accusations, and Tupelo, Mississippi-based BancorpSouth Bank last year paid $10.58 million in fines and restitution to settle a case accusing it of redlining in Memphis. The $13.9 billion asset bank said it had taken several steps to improve its commitment to affordable lending products in low and moderate income and minority areas.

Many of the accusations have relied on the disparate impact theory, which has been upheld by the Supreme Court. The idea behind it is that no intentional discrimination has to occur for a violation of the law. Bank managers, as a result, must stay vigilant not only on their own lending policies and staff training, but they have to research lending patterns and loan terms to make sure that a disproportionate number of minorities aren’t stuck with loans on worse terms than non-Hispanic whites. If they are, there has to be a justifiable reason why this was so. Marketing efforts can’t exclude minority neighborhoods.

The most recent case was when the U.S. Department of Justice sued KleinBank, a small community bank in the suburbs of Minneapolis, accusing it of redlining. The bank’s CEO said the lawsuit had no basis in fact, and challenged the idea that the $1.9 billion asset bank has a duty to serve the urban areas of Minneapolis and St. Paul.

One of the odd aspects of the case is that it was filed on Jan. 13, 2017, right before President Donald Trump was inaugurated. Now, the new attorney general, Jeff Sessions, is in an excellent position to influence the case and whether it moves forward at all.

I would expect fair lending cases to be less a priority under Jeff Sessions,’’ says Christopher Willis, a fair lending attorney and partner at Ballad Spahr. “And the cases that would be brought would be less eager to explore new ground.”

John Geiringer, a partner at the law firm Barack Ferrazzano in Chicago, agreed. “Presumably, under the Trump administration, fair lending is not going to be on the front burner as much as it was in the Obama administration.”

But that’s not a pass-go card, not quite yet. The Consumer Financial Protection Bureau (CFPB) is moving ahead with plans to implement an expansion of the requirements for mortgage data under the Dodd-Frank Act. Basically, there are 25 new data points banks must send to the bureau, starting January 2018, on everything from the borrower’s credit score, to the parcel number of the property, to a unique identifier for the loan originator who originated the loan, according to the American Bankers Association, which has argued the rule should be repealed because of increased cost to banks and data security concerns. The Home Mortgage Disclosure Act already mandates 23 data points, the association says.

The fear is that the data will be used to initiate even more fair lending cases against banks, although regulators have said the data could be used to weed out unnecessary fair lending reviews. The CFPB and the Justice Department did not respond to a request to comment.

So far, it’s not clear that the rule will be thrown out, despite the change at the White House. The CFPB is led by Director Richard Cordray, whose term doesn’t end until 2018.

For now, bankers must assume that regulations due to go into effect will indeed do so. Fair lending enforcement won’t go away under the Trump Administration. It’s not just that the CFPB’s leadership is still in place. The agency’s goal from the Fair Lending Report for 2016, published in April, 2017, is to increase “our focus on markets or products where we see significant or emerging fair lending risk to consumers, including redlining, mortgage loan servicing, student loan servicing, and small business lending.” The banking agencies also can continue to pursue enforcement actions, even if the Justice Department doesn’t.

But the tone has changed. The former head of the Justice Department’s civil right division, Vanita Gupta, told The New York Times in January 2017 that “the project of civil rights has always demanded creativity… It requires being bold. Often that means going against the grain of current-day popular thinking. Or it requires going to the more expansive reading of the law to ensure we are actually ensuring equal protection for everyone.”

There’s a good chance that the creativity Gupta described is gone.