Two Ways to Crack the Efficiency Nut

The costs of regulatory compliance are serious, comprising 7.2% of noninterest expense, according to surveys conducted in 2015, 2016 and 2017 by the Conference of State Bank Supervisors. But the costs of noncompliance are arguably higher — especially when it comes to compliance with fair lending rules and the Community Reinvestment Act. Remedying these regulatory infractions can be costly and distract banks from executing their strategy.

Most of a bank’s compliance budget is tied up in personnel, according to the CSBS surveys, but technology can help ease this burden.

Southern Pines, North Carolina-based First Bank, with $6 billion in assets, took a “leap of faith” when it left an industry-leading Home Mortgage Disclosure Act compliance tool to adopt a solution offered by NTRUPOINT, a provider of compliance analytics software and services. The company impressed First Bank Compliance Officer Kevin Saunders, particularly with their receptiveness to feedback from his bank — a significant change from their prior vendor. “[NTRUPOINT has] a good tool to start with, but if we think something could be a little better, we can make that recommendation and oftentimes we see that enhancement coming,” he says.

The bank’s compliance team uses the tool to visualize data and highlight risk areas to help comply with CRA and fair lending rules, including HMDA, sharing reports with the executive team and board. Putting the solution in use was easy: Since it’s hosted in the cloud, there was no integration with the bank’s core systems and no need to engage the bank’s technology staff.

“[We weren’t] able to visualize and wrap our heads around all this data. We have thousands of loans, and now there are hundreds of data points per loan, and when you look at all that, it’s hard to figure out what an examiner or community activist group might home in on,” says Saunders. A better understanding of the data has allowed the bank to be more proactive, which regulators appreciate. The bank can even quickly adapt as regulatory expectations change, he adds.

But it’s not just the technology that Saunders finds beneficial — he calls them “fair lending experts” for the bank. If regulators have questions, NTRUPOINT is just a phone call away to provide additional analysis and support.

Adopting a compliance tool that is more up to date, with a vendor that is more responsive to the bank’s needs, has resulted in roughly 50% in cost savings for the bank, reports Saunders.

NTRUPOINT was a finalist in the Best Solution for Improving Operations category at the 2019 Best of FinXTech Awards. Sandbox Banking was the category winner. (Sandbox also won the Best in Connect category.) Finalists were selected from the most innovative solutions found in the FinXTech Connect platform.

Hydrogen, another category finalist, leverages blockchain-based protocols and a library of application programming interfaces to help banks build new products and platforms. It worked with Toronto-based TD Bank Group to launch a goal-setting tool for the bank’s wealth management division earlier this year. Giving immediate advice to customers online allows the bank to serve them through a more efficient channel.

Given Hydrogen’s background in the robo-advice space, “they had the right balance between technology expertise and an understanding of the business,” says Jay Gedge, oversees automated investment management and advice in TD’s wealth digital innovation team. “The capabilities they bring across portfolio management and goal planning help us accelerate the work we’re doing to bring innovative solutions to market for clients.”

Within three months, Gedge says that 20,000 customers adopted the tool. And TD was able to deploy the solution faster — in just 10 months — than it would have through other vendors or internal development.

Hydrogen’s plug-and-play capabilities allow TD to expand the tool’s use throughout the organization. The two teams check in quarterly to walk through TD’s product roadmap and where Hydrogen can help. “They may quickly come up with something we can apply within the context of the work we’re already doing, or we may be able to find a place in our roadmap in terms of how mature the idea is or how it will impact value for our clients,” says Gedge.

For these banks, collaboration and expertise helped form the secret sauce to deploying technology solutions that meet a bank’s goals.

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.

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.

What Recent Deals Say about the Federal Reserve’s Focus on Fair Lending


lending-5-31-17.pngFair lending compliance and community benefit plans are increasingly important factors in the merger and acquisition (M&A) approval process. In 2016 and the first quarter of 2017, the Board of Governors of the Federal Reserve System (Federal Reserve) approved 20 bank or bank holding company M&A applications. Fair lending compliance history was an essential element of the regulatory analysis in these cases. While the Federal Reserve focused on compliance issues beyond fair lending —such as the Bank Secrecy Act, overdraft policies, residential servicing, commercial real estate concentration, and enterprise risk management—fair lending was one of the hottest compliance issues that arose from the merger approval process. Regulators also are reviewing applicants’ combined compliance programs and controls to ensure that the resulting institution will be properly suited to protect against the new risks created through the transaction, particularly where the transaction will result in an acquirer crossing a key regulatory growth threshold. For example, the Bank of the Ozarks received regulatory approval for two M&A transactions in early 2016 and crossed the $10 billion asset threshold while both acquisition applications were pending. As evidenced by the Bank of the Ozarks approval order for the larger acquisition, fair lending compliance was a significant factor in the Federal Reserve’s evaluation of the transaction.

Moreover, many of the institutions that obtained Federal Reserve approval for an acquisition during this period demonstrated a commitment to fair lending compliance beyond receipt of a satisfactory or outstanding Community Reinvestment Act (CRA) rating. Nearly all approved applicants had a designated CRA officer and/or CRA committee, and several applicants described detailed plans for improving community lending in particular assessment areas.

Community Benefit Plans Emerge as Important Factor for Regulatory Approval
The 2016 and 2017 M&A approvals also revealed the role of formal community benefit plans, as most clearly demonstrated in KeyCorp’s acquisition of First Niagara Financial Group, and Huntington Bancshares’ acquisition of FirstMerit Corporation. These two transactions received a considerable number of public comments focused on CRA and fair lending, and these large financial institutions used community benefit plans as an effective tool to demonstrate their commitment to fair lending compliance.

KeyCorp worked closely with various community organizations to develop a community benefit plan that was announced in March 2016, prior to KeyCorp’s receipt of regulatory approval for its merger. Under the KeyCorp plan, KeyCorp committed to lending $16.5 billion to low- and moderate-income communities over a five-year period, with up to 35 percent of the total commitment targeted at the areas where KeyCorp and First Niagara overlapped in New York, and to maintaining a vital branch and administrative footprint in western New York. Similarly, after submitting its merger application, Huntington adopted a community benefit plan committing to invest $16.1 billion in its communities, including low- and moderate-income communities, over a five-year period.

Notwithstanding the Federal Reserve’s reliance on the KeyCorp and Huntington community benefit plans in concluding that the relevant institutions are meeting the credit needs of the communities they serve, the Federal Reserve noted in the Huntington approval order that “neither the CRA nor the federal banking agencies’ CRA regulations require banks to make pledges or enter into commitments or agreements with any organization.” Accordingly, the Federal Reserve likely will not require a bank to make any community investment pledge to any organization in the absence of significant negative comments or, more importantly, adverse examination findings or a pending enforcement action. Nevertheless, given their apparent benefits, both for Federal Reserve applications and for general community and regulator relations, community benefit plans likely will remain a factor in the approval process for bank mergers that attract community groups’ attention—and likely will help expedite the approval process in the face of adverse community group comments.

Outlook
The 2016 and early 2017 merger approvals make clear that a comprehensive fair lending strategy, which may or may not include a community benefit plan, is likely to be well received by the regulators and considered in applicable approval analyses. We expect the regulatory staff of each of the federal banking regulators to continue to focus on fair lending compliance and that community groups will continue to comment actively on the fair lending compliance issues of bank M&A acquirers and attempt to influence their activities.

Should You Do Business With Marketplace Lenders?


Lenders-12-9-16.pngThe shift away from the traditional banking model—largely due to technological advances and the growing disaggregation of certain bank services—has contributed to the rise of the marketplace lending (MPL) industry. The MPL industry, in particular, offers consumers and small businesses the means by which to gain greater access to credit in a faster way. MPL, despite its increasing growth, has managed to stay under the radar from regulatory oversight until recently. However, in a short span of time, federal and state regulators—the Department of the Treasury, Office of the Comptroller of the Currency (OCC), Consumer Financial Protection Bureau (CFPB), the Federal Deposit Insurance Corporation (FDIC) and California Department of Business Oversight, for example—have begun to weigh the benefits and risks of MPL, with the OCC, for example, going so far as to announce its intention to grant special purpose national bank charters to fintech companies.

Given the evolving nature of the industry and its regulation, in this article, we discuss three key issues for MPL participants to consider. First, we discuss the regulatory focus on the third-party lending model. Second, we consider the potential fair lending risks. Third, we focus on considerations related to state usury requirements. We conclude with a few thoughts on what to expect in this changing landscape.

Third-Party Lending Model
The MPL model traditionally operates with three parties: the platform lender, the originating bank and investors purchasing the loans or securities. Based on the reliance on originating banks in the MPL structure, the FDIC, CFPB and others increasingly have considered the risks to banks from these third-party relationships. In particular, regulators appear to be concerned that banks may take on additional risk in these relationships, which are potentially similar to the lending model rejected by a U.S. District Court judge earlier this year when deciding CashCall was the real lender in dispute, not a tribal lender set up in South Dakota. Thus, the FDIC, for example, in its recent Guidance for Managing Third-Party Risk, asks institutions engaged in such third-party relationships to appropriately manage and oversee these third-party lenders before, during and after developing such a relationship. In addition, certain originating banks have also taken to retaining some of the credit risk to mitigate concerns that the MPL may be considered the true lender.

Fair Lending
Another potential area to consider relates to fair lending risks regarding extensions of credit in certain geographical areas, underwriting criteria and loan purchase standards. For example, the potential for fair lending risk may increase particularly with respect to the data collected on borrowers for underwriting purposes, for example, where the use of certain alternative criteria may inadvertently result in a disparate impact to protected classes. In addition, restrictions on lending areas or the types of loans sold to investors similarly could pose such issues.

State Usury Requirements
The recent Second Circuit decision in Madden v. Midland Funding LLC also highlights potential uncertainty regarding the MPL model. In Madden, the Second Circuit determined that a debt collection firm, which had purchased a plaintiff’s charged-off account from a national bank, was not entitled to the benefit of the state usury preemption provisions under the National Bank Act, despite originally being available to the originating national bank. Madden was appealed to the Supreme Court, which declined to hear the case. Thus, Madden has the potential to limit the ability for MPL firms to rely on their originating banks to avoid complying with state-by-state interest rate caps, as federal preemption would no longer apply to those loans later transferred to or acquired by such nonbank entities. Further, Madden increases the uncertainty regarding the originated loans that MPL firms may later sell to (or issue securities for) investors. While some lenders have chosen to carve out the Second Circuit (New York, Connecticut and Vermont) for lending and loan sale purposes, there is the continued risk that the decision may set a precedent in other circuits.

Conclusion
Even with the increasing scrutiny of the MPL industry, regulators appear to recognize the benefits of access to credit for borrowers. For example, the OCC, CFPB and the Treasury have indicated that any increase in regulation should be balanced with fostering innovation. This may be a potential signal on the part of regulators to adopt a framework by which financial innovation is incorporated into the traditional banking model. Thus, looking forward, we think the regulatory uncertainty in this space provides the opportunity for MPL participants to take a proactive approach in shaping regulatory policy for the industry.

Upgrade Your Small Business Lending Process


Fintech lenders offer quicker decisions for consumers and small businesses, but many banks don’t have the data infrastructure in place to meet those needs. In this video, Chris Rentner of Akouba Credit explains how banks can leverage technology to improve the lending process.

  • How has technology changed lending?
  • Why are some banks at risk?
  • How can technology solutions help banks improve the loan process?

Fair Lending Compliance Is Becoming More Complex and More Challenging


5-19-15-Crowe.pngCompliance with fair lending regulations has become dramatically more complex over the past several years. Although the underlying regulations have been in place for decades, monitoring by the Consumer Financial Protection Bureau’s (CFPB) Office of Fair Lending and Equal Opportunity, coupled with vigorous enforcement by the U.S. Department of Justice (DOJ), have increased lenders’ risk factors substantially.

Fair lending forbids discrimination based on “prohibited basis” factors: race, religion, ethnicity, national origin, gender, marital status, age, familial status, disability, receipt of income from public assistance sources, and the applicant’s exercise of rights under the Consumer Credit Protection Act. Problems can arise when lenders fail to monitor risk factors:

  • Underwriting. Lenders need to monitor and document any disparities in underwriting outcomes based on a prohibited basis as well as any inequitable application of exceptions to underwriting policies.
  • Pricing. Statistically significant differences in interest rates, fees, or other characteristics offered to applicants by prohibited basis create pricing risk.
  • Steering. It is illegal to steer members of a prohibited basis class to less favorable—often more costly—loan products. Offering similar if not identical products with different pricing through different business units can have the same effect as steering.
  • Servicing. Once all the loan documents have been signed and the customer is on board, posting of loan payments or waiving of late fees needs to be done equitably across a client base.
  • Redlining. Lenders need to be careful when analyzing where their customers live to avoid unintentionally redlining, which involves drawing red lines on a map around neighborhoods where lenders do not want to do business.

Enforcement Trends
In February 2010, the DOJ established the Fair Lending Unit to focus on potential abuses in the consumer lending sector. Since then, the DOJ has filed or resolved 36 lending matters under the Equal Credit Opportunity Act, the Fair Housing Act, and the Servicemembers Civil Relief Act. Settlements have provided more than $1.2 billion in relief for affected communities and individual borrowers.

Although much of this money came from settlements with major lenders, in 2013 the DOJ reached settlements with four community banks that each had less than $400 million in assets. Many of these settlements—large and small—involved pricing discrimination against minority borrowers.

Proposed HMDA Reporting Requirements
On July 24, 2014, the CFPB issued a proposed rule for the expansion of data that lenders need to report under the Home Mortgage Disclosure Act (HMDA). The CFPB wants to use HMDA data to increase awareness of the housing market and, more broadly, the availability of credit. The most significant changes to the HMDA would include:

  • Mandatory reporting of home equity lines of credit (HELOCs) and reverse mortgages
  • Quarterly reporting for large institutions
  • Changes to reporting thresholds—a 25-loan minimum for depository institutions
  • Inclusion of an additional 37 data fields, some of which involve qualitative factors, expanded borrower data, or items related to qualified-mortgage and ability-to-pay rules

Banks and their boards can begin to prepare for the changes by discussing the following questions:

  • How do we currently collect HMDA data?
  • Can our existing staff collect and record the required data values?
  • What steps are the developers of the mortgage application or underwriting system that we use taking to prepare for the changes?
  • Do individuals responsible for potentially newly covered areas such as HELOCs and reverse mortgages have sufficient experience with the HMDA?
  • Have we conducted data reviews to confirm accurate recording of HMDA data?
  • Are we prepared for the potential implications of the new data disclosures? Regulators, consumer rights organizations, advocacy groups, competitors, and others will be looking at HMDA data.

Raising the Ante on Compliance
Compliance with fair lending regulations requires a greater focus on data integrity and the ability to manage statistical models than in prior years. Lenders that have not yet made the investment in internal and external resources to handle the new, expanded and increasingly sophisticated tasks need to consider steps to remain competitive in a challenging marketplace.