Recent Developments to Combat Redlining

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Regulators have worked on a variety of anti-redlining proposals in recent months, including a joint initiative by the Department of Justice, the Consumer Financial Protection Bureau, and the Office of the Comptroller of the Currency.

These proposals come in tandem with recent initiatives from the Securities and Exchange Commission to increase the emphasis on ESG factors, a set of non-financial environmental, social and governance factors that publicly filed companies can use to identify material risks and growth opportunities.

Though anti-redlining legislation initially came into law when Congress enacted the Community Reinvestment Act in 1977, it has recently seen a refocus in the Combatting Redlining Initiative led by the DOJ Civil Rights Division’s Housing and Civil Enforcement Section. During Acting Comptroller Michael Hsu’s initial unveiling of this initiative, he highlighted the importance of providing “fair and equitable access to credit — to everyone” in order to build wealth among minority and underrepresented groups. He emphasized that modern redlining, as compared to its 20th century predecessor, is “often more subtle, harder to detect, and resource-intensive to find.”

Initial reactions to the initiative expected it to focus on the redlining seen in the Trustmark Corp. settlement, where the Jackson, Mississippi-based bank discriminated against Black and Hispanic neighborhoods by “deliberately not marketing, offering, or originating home loans to consumers in majority Black and Hispanic neighborhoods in the Memphis metropolitan area,” according to the CFPB. The $17.6 billion bank settled for a $5 million penalty.

But in recent weeks, though a final rule is not yet in place, the acting comptroller made it clear the focus is not only on direct discrimination, but also on indirect discrimination through climate redlining. Climate redlining occurs when certain minority communities are subject to heightened climate change risks based on where they are located; those heightened risks pose a disproportionate impact on minority groups.

Though official rules have yet to be proposed related to the policies, banks can take the following actions in preparation:

1. Review any neutral algorithms used in the lending process. Redlining is not always overt; it may be a byproduct of algorithms that appear neutral on the surface but disproportionately target minority communities based on targeting certain income brackets, risk factors or the demographic compensation of the surrounding area. Bankers should make time to carefully review the factors being input into their institution’s algorithms and consider whether those factors might create inadvertent bias.

2. Review any policies related to geographic filtering. Minority groups are disproportionately impacted by the effects of climate change; this disparate impact is expected to grow as the frequency of climate events increases. Rising water, more frequent fires and extreme weather events are all examples of events some banks might choose to geographically exclude in order to keep lending risk portfolios low. But by filtering out these events and impacts, banks may be inadvertently redlining. Banks should take the time to carefully examine any exclusions they make based on geography or weather history in preparation of any final rules, and compare them to demographic information on the bank’s lending practices.

3. Review branch locations. One of the reasons regulators found Trustmark to have engaged in redlining practices was its lack of branch locations in majority Black and Hispanic communities. This meant that not only were those residents not able to receive banking services, they also were not being marketed to when it came to potential lending opportunities. Banks should review the footprints of their branches relative to the demographics in the cities in which they are located to determine whether they are over- or under-represented in certain demographics.

4. Public bank holding companies should review ESG factors. With both proxy season and annual filing season upon publicly traded companies, now is a good time for publicly traded bank holding companies to evaluate their current treatment of environmental, social and governance risks. If a bank identifies that it may be inadvertently engaging in redlining, the affiliated bank holding company should carefully think through potential disclosures.

Could a Republican President Mean More M&A Activity?

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Banking-Industry-8-12-15.pngWith the first prime time Republican primary debate of the 2016 election cycle in the rear view mirror, we have all gotten an inkling of what the candidates think about the banking industry. I did take particular note of Senator Marco Rubio when he stressed the importance of repealing the Dodd-Frank Act. As Commerce Street Holdings’ CEO shared in an article on BankDirector.com, “many bankers feel that given the legislative and regulatory environment coupled with low rates, low margins, low loan demand and high competition, growth is very difficult.”  So repealing Dodd-Frank is a dream for many officers and directors, and Rubio is echoing their concerns.

Senator Rubio’s comments build on those of former Texas Governor Rick Perry, who recently laid out a sweeping financial reform agenda earlier. He believes the biggest banks need to hold even more capital—or Congress should possibly reinstitute elements of the Glass-Steagall Act. While his campaign appears to be winding down, I do agree with his call for government to work harder to “level the playing field” between Wall Street banks and community institutions.

With so much political scrutiny already placed on banks, it is interesting to think of the pressures being placed on institutions to grow today. On one side, you have politicians weighing in on how banking should operate. On the other, regulatory and investor expectations are higher now than in recent years. Buckle up, because I believe the coming election will only further encourage politicians with opinions, but little in the way of detailed plans, about “revitalizing” the economy.

Against this political backdrop, today’s business environment offers promising opportunity for bold, innovative and disciplined executives to transform their franchises. But I believe regulatory hurdles are making it tougher to do deals. Indeed, the recently approved merger of CIT Group and OneWest Bank creates a SIFI [Systemically Important Financial Institution] which will have to submit to increased regulation and scrutiny. However, when the deal was first announced, CIT’s CEO, John Thain, suggested that his purchase of OneWest could spur other big banks to become buyers. A year later and such activity has yet to be seen.

I see the absence of bigger deals reflecting a reality where any transaction comes with increased compliance and regulatory hurdles. For CIT, going over the $50 billion hurdle meant annual stress tests will now be dictated by the government, as opposed to run by the bank. The institution will have to maintain higher capital levels. Thain seems to think that those added costs and burdens are worth it. By the lack of action, other banks haven’t yet agreed.

Without a doubt, regulatory focus has impacted strategic options within our industry. For instance, we learn about CRA [Community Reinvestment Act] impacting deals and also find fair lending concerns and/or the Bank Secrecy Act delaying or ending potential mergers. Consequently, deals are more difficult to complete. As much as a bank like CIT can add cost savings with scalability to become more efficient, you can understand why banks in certain parts of the country need to debate whether it is better to sell today or to grow the bank’s earnings and sell in three to five years.

The evidence is clear that big banks are not doing deals. Maybe a GOP victory in the next election will thaw certain icebergs, creating a regulatory environment more friendly to banks. While regulators have to comply with existing laws, the leadership of regulatory institutions is appointed by the president and the tone at the top is critical in interpreting those laws. Until we see real action replace cheap talk, I’m looking at CIT as an outlier and simply hoping that political rhetoric doesn’t give false hope to those looking to grow through M&A.