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Beware Fair Lending Risks Associated with Second Reviews & Exceptions

3 min read
Jun 22, 2016

A conciliation agreement between the US Department of Housing and Urban Development (HUD) and a North Carolina-based bank from earlier in June highlights potential Fair Lending risks associated with second reviews and exceptions. Below is a quick summary of the settlement and our observations.

On June 8, 2016, the US Department of Housing and Urban Development (HUD) announced an agreement with First-Citizens Bank & Trust Company to resolve allegations that the bank denied mortgage loans to African American and Hispanic applicants at a higher rate than white applicants. This agreement highlights the Fair Lending compliance risks involved in second reviews and exceptions. 

A Quick Summary of the Agreement

HUD alleged that the Bank discriminated based on race and national origin by disproportionately denying the loan applications of African-American and Hispanic applicants for certain residential loan products. 

HUD analyzed "mortgage loans originated through the retail channel via manual override of the automated underwriting system ("AUS") decision to decline." HUD further stated that “the preferential treatment of white applicants was not sufficiently justified by the identified factors." 

The investigation dates back to 2011 and reviewed mortgage loan activity from 2010 and 2011 originated by the bank's predecessor, South Carolina-based First Citizens Bank and Trust Co.

The Bank denied any allegation that it engaged in discriminatory lending on a prohibited basis in connection with loans originated through its retail channel, and the statistical disparities were sufficiently explained and justified. 

Details of the Fair Lending Settlement

As part of the settlement, the Bank agreed to the following:

  1. General Non-Discrimination: The bank agreed to “not engage in any act or practice which discriminates on the basis of race or national origin.” The prohibition applies, but is not limited to:  solicitation of applications for credit extension, requests for and consideration of qualifying applicant information, manual underwriting of credit and the provision of credit for residential loan products. It also includes the selection of sites for, and the provision of services at, branch offices; determining Community Reinvestment Act assessment areas; and the determination of the geographic areas in which applications are solicited or funded.
  2. Employee Training: The Bank will require all employees and agents who have substantial involvement in the manual underwriting of mortgages originated by the retail channel to attend four (4) hours of fair lending training (ECOA and CRA).
  3. Outreach and Assistance: The Bank will hire three mortgage banker specialists with a focus on diverse lending in key South Carolina metro areas. 
  4. Nonprofit Support: The Bank must make at least $140,000 available to nonprofit organizations that provide credit and housing counseling, financial literacy, and other related programs to first-time homebuyers in South Carolina.
  5. Advertising: Spend an aggregate of $20,000 for affirmative marketing, advertising, and outreach to the residents of majority-minority census tracts in South Carolina.
  6. Market Training: Continue to conduct financial education programs in the South Carolina market (minimum 24).
  7. Underwriting: Develop and document a more standardized, specific and objective set of guidelines for the secondary review of retail channel loan applications initially denied by the AUS in order to minimize discretion.  These guidelines should require that qualifying information be requested from all applicants equally in order to support the second review.  In addition, the bank must track and monitor all exceptions (e.g., overrides of AUS applications).

Ncontracts Viewpoint

Here are four quick observations about this settlement that all financial institutions may want to consider: 

  • Focus on Underwriting: While pricing is one of the most common trip wires for Fair Lending, it's just one piece of the puzzle. There are other risks; this specific allegation revolved around underwriting.
  • Manage Automated Underwriting: Automated underwriting helps bring consistency in the decisioning process and lowers Fair Lending risk. In this case, it was the second review and exception process following the AUS decision that was investigated.
  • Objective Second Reviews: Across the industry, it seems to be more commonplace to conduct a second review of loans that appear to be headed for denial. In this case, HUD has suggested that there be consistent process for second reviews, including standardized/objective guidelines, consistent data collection and processes. 
  • Monitoring Exceptions: Exception management continues to be a hot topic during regulatory reviews. As stated in prior blogs, there are 5 core elements to effective exception management programs: Policies/Procedures, File Documentation, Monitoring, Training and Management Participation.

Ncontracts monitors settlements in order to gain insights into how the regulators are approaching regulatory consumer compliance. This regulatory monitoring allows us to better serve our 500+ clients and thousands of readers nationwide. 

Related: Creating Reliable Risk Assessments


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