Overage. The very word should send shivers of fear down lenders' spines.
The Justice Department has initiated several investigations into the practice of paying overages - rewards to loan officers for securing higher rates or more points from borrowers.
Fair-lending attorneys have warned for months that this was an area ripe for trouble. The common horror story, retold by scores of lawyers and consultants, involves the aggressive loan officer who maximizes bonuses by making borrowers pay as much as possible.
The problem: Studies show white men as a group have more experience than other people in negotiating loan rates. The loan officer knows this and is more willing to negotiate with them. This means the officer's portfolio includes a disproportionate number of high-rate loans to women and minorities.
That's dangerous, said Jean Veta, a partner at Washington's Covington & Burling. She told the Consumer Bankers Association recently that the Justice Department is itching to bring one of these cases. If it does, watch out.
Prosecutors would interview female and minority borrowers, who would probably say that the bank never offered to lower rates for them. And prosecutors would probably find white men who claimed that officers agreed from the outset to negotiate with them.
That establishes a classic lending discrimination complaint, based on disparate treatment, that Justice could easily win, Ms. Veta said.
"In the fair-lending area, paying overages is "one of the highest-risk practices bankers have to deal with," she said.
Andrew Sandler, a partner at Skadden, Arps, Slate, Meagher & Flom in Washington, agreed that bankers need to be very careful. "You have to monitor it," he said.
Ms. Veta said the safest option is to charge flat rates. That would eliminate the fair-lending problem.
But that isn't practical from a business standpoint, because loans with higher rates generate bigger profits and attract the best loan officers, she said.
There is hope. Ms. Veta said banks can mitigate their risk if they reform their overage programs.
Bankers first should include an explicit antidiscrimination statement in their policy manual, she said. This should state that loan officers are not to systematically charge one racial or ethnic group more for loans. The statement would help prove that a bank did not condone a rogue officer's behavior, she said.
The industry also should provide these officer with fair-lending training. "Explain that this is a hot-button issue," she said. "Explain where the minefields are."
Training can help the loan officers avoid lending bias problems completely, she said.
To make sure the training works and to avoid liability, a bank must carefully scrutinize its record of overages. "Do it by lending officer, by branch, and throughout the institution," she said.
These reviews should determine if minorities or women are paying more, and whether loan officers consistently try to charge a higher rate to all types of borrowers, including white men.
"Get something in there to show the lending officer is trying to get overages across the board," she said.
The worst thing a bank can do is leave unaddressed a report showing an overage problem, she said. A court will see the report and note that the bank didn't care. That opens it to liability, she said.
"If you have a problem, correct it," she said.
Mr. Sandler recommended one additional protection: Bankers should put a cap on overages, limiting how much over the minimum interest rate a loan officer can charge.
That would reduce a bank's exposure, because it would have fewer loans with ultra-high rates on its books, he said.
Bankers shouldn't think they've tamed the overage beast once they have trained their own staffs, Ms. Veta said. Lenders must apply these preventive measures to outside vendors. The auto dealer who overcharges minorities can get you into as much trouble as your loan officer can, she said.
