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Banking Regulators Finalize Revised CRA Guidance
On November 15, the Federal Reserve Board, the FDIC, and the OCC finalized revisions to the “Interagency Questions and Answers Regarding Community Reinvestment” (Q&As). The agencies adopted the revisions largely as proposed, with some minor changes in response to comments. The new Q&As, which include revisions to five questions and answers and two new questions, generally are intended to: (i) clarify how the agencies consider community development activities that benefit a broader statewide or regional area that includes an institution’s assessment area; (ii) provide guidance related to CRA consideration of, and documentation associated with, investments in nationwide funds; (iii) clarify the consideration of certain community development services, such as service on a community development organization’s board of directors; (iv) address the treatment of loans or investments to organizations that, in turn, invest those funds and use only a portion of the income from their investment to support a community development purpose; and (v) clarify that community development lending performance is always a factor considered in a large institution’s lending test rating. The new Q&As take effect when they are published in the Federal Register.
Prudential Regulators Release Stress Test Scenarios
On November 12, the FDIC released the economic scenarios that will be used by certain financial institutions with total consolidated assets of more than $10 billion for stress tests required under the Dodd-Frank Act. Each scenario includes key variables that reflect economic activity, including unemployment, exchange rates, prices, income, interest rates, and other salient aspects of the economy and financial markets. The baseline scenario represents expectations of private sector economic forecasters; the adverse and severely adverse are hypothetical scenarios designed to assess the strength and resilience of financial institutions and their ability to continue to meet the credit needs of households and businesses under stressed economic conditions. The FDIC release follows the recent release of stress test scenarios by the Federal Reserve Board and the OCC. The Federal Reserve Board also recently issued a final policy statement that describes the process by which it will develop future stress test scenarios.
Report On CFPB's Auto Finance Forum
This morning, the CFPB hosted an auto finance forum, which featured remarks from CFPB staff and other federal regulators, consumer advocates, and industry representatives.
Some of the highlights include:
- Patrice Ficklin (CFPB) confirmed that the CFPB, both before issuing the March bulletin and since, has conducted analysis of numerous finance companies’ activities and found statistically significant disparities disfavoring protected classes. She stated that there were “numerous” companies whose data showed statistically significant pricing disparities of 10 basis points or more and “several” finance companies with disparities of over 20 or 30 basis points.
- Much of the discussion focused on potential alternatives to the current dealer markup system. The DOJ discussed allowing discretion within limitations and with documentation of the reasons for exercising that discretion (e.g., competition). The CFPB focus was exclusively on non-discretionary “alternative compensation mechanisms”, specifically flat fees per loan, compensation based on a percentage of the amount financed, or some variation of those. The CFPB said it invited finance companies to suggest other non-discretionary alternatives. Regardless of specific compensation model, Ms. Ficklin stated that in general, nondiscretionary alternatives can (i) be revenue neutral for dealers, (ii) reduce fair lending risk, (iii) be less costly than compliance management systems enhancements, and (iv) limit friction between dealers on the one hand and the CFPB on the other.
- There was significant debate over whether flat fee arrangements, or other potential compensation mechanisms, actually eliminate or reduce the potential for disparate impact in auto lending. There was also criticism of the CFPB’s failure to empirically test whether these “fixes” would result in other unintended consequences. Industry stakeholders asserted that such arrangements fail to mitigate fair lending risk market-wide while at the same time potentially increase the cost of credit and constrain credit availability. Industry stakeholders also questioned the validity of the large dollar figures of alleged consumer harm caused by dealer markups. When assessing any particular model, the CFPB’s Eric Reusch explained, finance companies should determine whether (i) it mitigates fair lending risk, (ii) creates any new risk or potential for additional harm, and (iii) it is economically sustainable, with sustainability viewed through the lens of consumers, finance companies, and dealers.
- Numerous stakeholders urged the CFPB to release more information about its proxy methodology and statistical analysis, citing the Bureau’s stated dedication to transparency and even referencing its Data Quality Act guidelines. The DOJ described its commitment to “kicking the tires” on its statistical analyses and allowing institutions to do the same. The CFPB referenced its recent public disclosure of its proxy methodology, noting that this was the methodology the CFPB intended to apply to all lending outside of mortgage.
- Steven Rosenbaum (DOJ) and Donna Murphy (OCC) pointedly went beyond the stated scope of the forum to highlight potential SCRA compliance risks associated with indirect auto lending.
Additional detail from each panel follows. Please note that these details are based on notes taken during the event and could differ from actual statements made during the event. The entire report is subject to alteration or clarification, particularly if a transcript or archived video are made available.
Opening Remarks
Director Cordray opened the forum. He stressed the importance of vehicles to individual consumers and to the broader economy. He stated that some consumers may be subject to discrimination that may result in millions of dollars in consumer harm each year.
As he did in a Senate hearing earlier this week, Mr. Cordray emphasized that neither the 2012 fair lending bulletin nor the March 2013 auto finance bulletin were new; they simply served as a reminder to finance companies of liability under ECOA, particularly with regard to indirect auto finance.
He stated that the CFPB uses proven statistical methods and publicly available data to assess the probability that a particular customer belongs to a particular racial group or is of a particular national origin.
The March bulletin provided guidance about steps auto finance companies might consider taking to ensure they are ECOA-compliant. One approach described by the Director is to develop robust fair lending compliance management systems to monitor for disparate impact and promptly remedy consumer harm on an ongoing basis when it is identified. The bulletin also stated that finance companies could take steps to comply with the law by adopting some other pricing mechanism that fairly compensates dealers for their work but avoids the fair lending risks that are inherent in pricing by discretionary markup. Director Cordray stated that such mechanisms include: a flat fee per transaction, or a fixed percentage of the amount financed, or other nondiscretionary approaches that market participants may devise that would work to address these concerns.
He acknowledged that dealers are entitled to fair compensation, but stressed that the CFPB wants to make sure the process is transparent. He stated it is worth considering further how the disclosure of markup practices actually works.
Panel 1
Patrice Ficklin (CFPB): Ms. Ficklin described and defended the March bulletin, asserting that the CFPB did not provide any new legal interpretations, but rather reminded finance companies about existing law. She noted and defended the CFPB’s proxy methodology, as described recently in letters to Congress, but did not provide additional detail. She stated that the CFPB’s supervisory and enforcement work in this area is more substantial than it was in March, and continues to indicate fair lending risk—the CFPB has found “substantial and statistically significant” disparities between African Americans, Hispanics, and Asians and similarly situated white borrowers. The CFPB has identified numerous institutions with disparities over 10 basis points, and several over 20 or 30 basis points.
Going forward, the CFPB is committed to continuing a constructive dialogue with industry, a dialogue in which alternative compensation structures has been the key theme to date.
Melissa Yap (FRB): Ms. Yap described the Fed’s ECOA authority post-Dodd-Frank. She stated that pricing remains the greatest area of risk. The Fed employs the 2009 interagency fair lending procedures and looks at (i) financial incentives, (ii) the amount of discretion, and (iii) disparities in note rate and markup over buy rate. She described the Fed’s proxy methodology, which differs slightly from the CFPB’s, but which the Fed believes is appropriate for the size and complexity of the institutions it supervises. For race, the Fed geocodes and defines majority-minority census tracts as those over 50%. She defended name proxies for gender and ethnicity, stating they are as likely to over count as under count. She also referenced two webinars the Fed and other hosted this year, which included discussion of these issues, see e.g., August webinar.
Steven Rosenbaum (DOJ): Mr. Rosenbaum described the DOJ’s broad authority to enforce ECOA and noted that it has a number of investigations ongoing, including joint investigations with the CFPB. He stated that Congress created the issue that requires the use of proxies, given that ECOA protects classes in consumer lending but does not require data collection similar to HMDA. The DOJ is using the CFPB’s method on joint investigations, but it continues to “kick the tires” on its methods and analyses and invites finance companies to do the same.
He stated, twice, that ECOA does not require nor prohibit discretion in pricing; risk from discretion can be managed, for example by setting caps or requiring justifications and documentation.
Mr. Rosenbaum added that the DOJ also enforces SCRA, and stated that if finance companies have not thought about SCRA compliance in their auto finance programs, they ought to do so. He also acknowledged the DOJ’s ongoing investigation of buy-here, pay-here dealers, though the issues differ in that those dealers may be offering predatory products in minority neighborhoods.
Keith Ernst (FDIC): Mr. Ernst similarly described the FDIC’s jurisdiction and addressed in broad terms its approach to indirect auto financing. He stated that all examination and statistical results that are consistent with a violation are subject to independent review and all statistical analyses are reviewed by a team. The FDIC provides institutions with the results, data, and methods and provides an opportunity for questions and other feedback. Mr. Ernst also noted that this dialogue includes providing institutions with the opportunity to provide non-discriminatory explanations for statistical disparities. According to Mr. Ernst, the FDIC has amended analyses as part of these processes. The FDIC believes the vast majority of its banks are effectively managing fair lending risk in auto finance, but that examinations can reveal compliance management systems concerns that fall short of a fair lending violation.
Tonya Sweat (NCUA): Ms. Sweat stated that the practices identified in the CFPB bulletin are not prevalent in the credit union industry, but NCUA still examines for fair lending risk and safety and soundness. The NCUA advises credit unions that sound practices include sampling and testing of loans, particularly to ensure third-party compliance. Credit unions should implement written policies that require written approval of any changes to underwriting criteria.
Donna Murphy (OCC): Ms. Murphy provided only brief comments, and generally referenced and incorporated what others had said on proxies. The OCC is revising and updating its methods for fair lending risk assessments and scoping based on changes in markets, the legal environment, and technology. These changes are intended to result in more consistency in examinations and the ability of the OCC to conduct more analysis across banks. For auto finance, the OCC is looking at how it gathers factors regarding use of third-parties. Ms. Murphy also noted the OCC’s attention to SCRA, stating that last year it revised examination procedures and enhanced examiner training for SCRA, including in auto finance, and that those enhancements are reflected in this year’s examination cycle.
Panel 2
The second panel was moderated by the CFPB’s Rohit Chopra and featured remarks from the National Association of Minority Automobile Dealers (NAMAD), the National Consumer Law Center (NCLC), the Consumer for Auto Reliability and Safety (CARS), and the NAACP.
Stuart Rossman from the NCLC described his part in a series of class actions against auto finance companies in the 2000s. Those actions, as he described, resulted in markup caps, the last of which sunsetted last year. He asserted that the market forces that led to those actions persist, as do fundamental problems in discretionary pricing policies. Citing more restrictive class action requirements and less access to critical data, he called on the CFPB to take the lead in enforcement.
NAMAD acknowledged the possibility that bad actors exist in the market, but argued against eliminating discretion. NAMAD called for approval and documentation requirements for discretionary programs. NAMAD supports uniform data collection, enhanced proxies, training and education for dealers and consumers.
CARS noted California’s markup cap statute and reported that a proposal for a ballot proposition outlawing dealer discretion has been filed with the state attorney general. CARS also encouraged the CFPB to look at the impact of percentage rate markups in the motor home market.
Panel 3
Bill Himpler, American Financial Services Association (AFSA): Mr. Himpler stressed that the current indirect auto finance model is efficient and proven. He noted that auto finance complaints are at record lows, and pointed out that even the CFPB’s database shows a small number of complaints compared to other markets. Since the CFPB has refused to assess the impact of a broad market shift towards flat fee compensation structures or other alternatives, AFSA is commissioning an independent study to assess the present model and evaluate costs and benefits of alternative models.
Chris Kukla, Center for Responsible Lending (CRL): Mr. Kukla countered that the current compensation model gives rise to potential discrimination and should be ended. Consumers have no ability to know what part of their rate is based on risk and what is due to compensation. He defended the CRL’s 2011 study on indirect auto finance from attacks, including those that followed Senator Warren’s reference to the study during a Senate hearing earlier this week. That study concluded that consumers pay $26 billion each year in markups. Mr. Kukla explained that CRL never said consumers would not otherwise be charged a portion of those fees, and only sought to define the size of the market. He referenced other research that indicates a market-wide adoption of flat fee arrangements would have little impact on dealers.
Paul Metrey, National Automobile Dealers Association (NADA): Mr. Metrey outlined a preferred approach by federal regulators to unintentional disparate impact discrimination: (i) understand the market, (ii) develop appropriate methods, and (iii) if present, address in a manner that assists consumers. He called for the CFPB to pursue more open processes on this issue, including by identifying its complete statistical methodology and fully accounting for neutral legitimate factors. He presented NADA’s case against flat fee arrangements, in part on the basis that dealers still will have discretion to select among finance sources that may offer different flat fee arrangements.
Rich Riese, American Bankers Association (ABA): Mr. Riese challenged the CFPB’s post hoc approach to obtaining input on its auto finance program, stating that the forum does not substitute for the kind of engagement the issue requires. He argued that the guidance should have been proposed and subject to notice and comment. The ABA believes proxies should be viewed with skepticism; they can be useful to identify risks and can be useful in compliance programs, but they should not be used to prove violations. Citing the 1999 interagency exam procedures, he argued that discretion is not an appropriate area to apply disparate impact, and, before straying too much from prior policy, regulators should recognize that Reg. B applies to creditors determination of creditworthiness and the discretion being applied in auto finance is for compensation and is not part of a creditor’s determination of creditworthiness.
The panelists also discussed the comparison of indirect auto finance to the mortgage market, particularly the use of broker yield spread premiums. Mr. Riese pointed out that in the mortgage context, brokers were alleged to have steered borrowers into “bad” loans without considering suitability; that is not the case in the auto market where there are no option arms, teaser rates, etc. Mr. Himpler and Mr. Metrey agreed. Mr. Metrey added that the comparison is apples to oranges—the markets have performed differently; there is nothing going on in auto ABS like there was in MBS. He added that Congress directed an end to yield spread premiums and there has been no similar action in auto, and the Fed tested to see if a fix was necessary but there has been no similar testing in auto.
Mr. Kukla responded that the mechanics may be different, but the impact and incentives are the same. A broader view of “steering” covers any instance in which a consumer is provided a loan with less advantageous terms than the consumer otherwise would have received.
Prudential Regulators Issue Joint Agreement On Classification And Appraisal Of Securities Held By Financial Institutions
On October 29, the FDIC, the Federal Reserve Board, and the OCC issued a joint agreement to update and revise the 2004 Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts. The updated agreement reiterates the importance of a robust investment analysis process and the agencies' longstanding asset classification definitions. It also replaces references to credit ratings with alternative standards of creditworthiness consistent with sections 939 and 939A of the Dodd-Frank Act, which directed the agencies to remove any reference to or requirement of reliance on credit ratings in the regulations and replace them with appropriate standards of creditworthiness. The agencies adopted those new standards in 2012 (see, e.g., the OCC’s final rule). The joint agreement provides examples to demonstrate the appropriate application of the new standards to the classification of securities.
Banking Agencies Clarify Guidance On Troubled Debt Restructurings
Last week, the Federal Reserve Board, the FDIC, the NCUA, and the OCC released interagency guidance related to the accounting treatment and regulatory credit risk grade or classification of commercial and residential real estate loans that have undergone troubled debt restructurings (TDRs). The guidance clarifies the definition of collateral-dependent loans and states that impaired collateral-dependent loans should be measured for impairment based on the fair value of the collateral rather than the present value of expected future cash flows.
Financial Regulators Propose Framework for Assessing Diversity At Financial Firms
On October 23, the CFPB, the OCC, the FDIC, the Federal Reserve Board, the NCUA, and the SEC proposed joint standards for assessing the diversity policies and practices of regulated institutions. Section 342 of the Dodd-Frank Act required the Office of Minority and Women Inclusion (OMWI) at each agency to develop the standards. The Act specifically prohibits the standards from imposing requirements on or otherwise affecting the lending policies and practices of any regulated entity, or requiring any specific action based on the findings of an assessment, and the agencies state that the assessments will not occur within the standard examination or supervision process. The standards, which the agencies believe are designed to promote “transparency and awareness,” cover four general areas: (i) organizational commitment to diversity and inclusion, (ii) workforce profile and employment practices, (iii) procurement and business practices to promote supplier diversity, and (iv) practices to promote transparency of organizational diversity and inclusion. The agencies state that the standards account for variables including asset size, number of employees, governance structure, income, number of members or customers, contract volume, location, and community characteristics, and the agencies recognize the standards may need to change and improve over time. The proposed standards are subject to a public comment period, which will run for 60 days once they are published in the Federal Register.
Prudential Regulators Propose Large Institution Liquidity Rule
On October 24, the Federal Reserve Board issued a proposed rule it developed with the OCC and the FDIC to establish a minimum liquidity coverage ratio (LCR) consistent with the Basel III LCR, with some modifications to reflect characteristics and risks of specific aspects of the U.S. market and U.S. regulatory framework. The proposal would create for the first time a minimum liquidity requirement for certain large or systemically important financial institutions. The covered institutions would be required to hold (i) minimum amounts of high-quality, liquid assets such as central bank reserves and government and corporate debt that can be converted easily and quickly into cash, and (ii) liquidity in an amount equal to or greater than its projected cash outflows minus its projected cash inflows during a short-term stress period. The requirements would apply to all internationally active banking organizations—i.e., those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure—and to systemically important, non-bank financial institutions designated by the FSOC. The proposal also would apply a less stringent, modified LCR to bank holding companies and savings and loan holding companies that are not internationally active, but have more than $50 billion in total assets. The regulators propose various categories of high quality, liquid assets and also specify how a firm's projected net cash outflows over the stress period would be calculated using common, standardized assumptions about the outflows and inflows associated with specific liabilities, assets, and off-balance-sheet obligations. Comments on the proposed rule must be submitted by January 31, 2013.
Special Alert: Agencies Issue Joint Statement On Fair Lending Compliance And The CFPB's ATR/QM Rule
On October 22, the CFPB, the OCC, the FDIC, the Federal Reserve Board, and the NCUA (collectively, the Agencies) issued a joint statement (Interagency Statement) in response to inquiries from creditors concerning their liability under the disparate impact doctrine of the Equal Credit Opportunity Act (ECOA) and its implementing regulation, Regulation B by originating only “qualified mortgages.” Qualified mortgages are defined under the CFPB’s January 2013 Ability-to-Repay/Qualified Mortgage Rule (ATR/QM Rule). The DOJ and HUD did not participate in the Interagency Statement.
The Interagency Statement describes some general principles that will guide the Agencies’ supervisory and enforcement activities with respect to entities within their jurisdiction as the ATR/QM Rule takes effect in January 2014. The Interagency Statement does not state that a creditor’s choice to limit its offerings to qualified mortgage loans or qualified mortgage “safe harbor” loans would comply with ECOA; rather, the Agencies state that they “do not anticipate that a creditor’s decision to offer only qualified mortgages would, absent other factors, elevate a supervised institution’s fair lending risk.” Furthermore, the Interagency Statement will not necessarily preclude civil actions.
The Agencies acknowledge that although there are several ways to satisfy the ATR/QM Rule, some creditors may be inclined to originate all or predominantly qualified mortgages, particularly when the ATR/QM Rule first becomes effective. In selecting business models and product offerings, the Agencies “expect that creditors would consider and balance demonstrable factors that may include credit risk, secondary market opportunities, capital requirements, and liability risk.” The Agencies further understand that creditors may have a “legitimate business need” to fine-tune their product offerings over the next few years in response to the impact of the ATR/QM Rule, just as they have in response to other significant regulatory changes that have occurred in the past.
The Agencies advise creditors to continue to evaluate fair lending risk as they would for other types of product selections, including by carefully monitoring their policies and practices and implementing effective compliance management systems. Nonetheless, the Agencies state that individual cases will be evaluated on their own merits.
The Agencies state that they “believe that the same principles…apply in supervising institutions for compliance with the Fair Housing Act.” However, because neither DOJ nor HUD participated in issuing the Interagency Statement, it remains to be seen how those agencies would view this issue.
It is noteworthy that the standard articulated in the Interagency Statement (“legitimate business needs”) differs from HUD’s disparate impact rule relating to the Fair Housing Act. In its rule, HUD codified a three-step burden-shifting approach to determine liability under a disparate impact claim. Once a practice has been shown by the plaintiff to have a disparate impact on a protected class, the rule states that the defendant would have the burden of showing that the challenged practice “is necessary to achieve one or more substantial, legitimate, nondiscriminatory interests of the respondent…or defendant…A legally sufficient justification must be supported by evidence and may not be hypothetical or speculative.” (Emphasis added.)
Questions regarding the matters discussed in this Alert may be directed to any of our lawyers listed below, or to any other BuckleySandler attorney with whom you have consulted in the past.
- Jeffrey P. Naimon, (202) 349-8030
Agencies Propose Flood Insurance Rule
On October 11, the FDIC, the OCC, the Federal Reserve Board, and other federal agencies (collectively the agencies) proposed a rule to implement changes to certain flood insurance regulations required by the Biggert-Waters Flood Insurance Reform Act of 2012. The proposal generally would, among other things, require premiums and fees for flood insurance to be escrowed for any loans secured by residential improved real estate or a mobile home. The proposal incorporates a statutory exception for any institution with total assets of less than $1 billion that, as of July 6, 2012, was not required by federal or state law to escrow taxes or insurance for the term of the loan and did not have a policy to require escrow of taxes and insurance. The agencies also propose requiring lenders to accept private flood insurance that meets the statutory definition to satisfy the mandatory purchase requirement, but seek comment on whether the final rule should include a provision that expressly permits lenders to accept a flood insurance policy issued by a private insurer that does not meet the definition of "private flood insurance.” The proposed rule also would amend lender-placement provisions to clarify that a lender or its servicer has the authority to charge a borrower for the cost of coverage commencing on the date on which the borrower's coverage lapsed or became insufficient. The proposal also stipulates the circumstances under which a lender or its servicer must terminate lender-placed insurance and refund payments to a borrower, and establishes documentary evidence a lender must accept to confirm that a borrower has obtained an appropriate amount of flood insurance coverage. Comments on the proposal are due by December 9, 2013.
FDIC Advises Banks On Managing Interest Rate Risk
On October 8, the FDIC issued Financial Institution Letter FIL-46-2013, which re-emphasizes the importance of prudent interest rate risk oversight and risk management processes to prepare for a period of rising interest rates. The FDIC states that interest rate risk management should be viewed as an ongoing process that requires effective measurement and monitoring, clear communication of modeling results, conformance with policy limits, and appropriate steps to mitigate risk. It believes that for a number of FDIC-supervised institutions, the potential exists for material securities depreciation relative to capital in a rising interest rate environment. FDIC examiners will continue to consider the amount of unrealized losses in the investment portfolio and the degree to which institutions are exposed to the risk of realizing losses from depreciated securities when qualitatively assessing capital adequacy and liquidity and assigning examination ratings.