Bankers confused by the varying directions fair-lending examinations had been taking finally have some guidance. The Office of the Comptroller of the Currency issued comprehensive new fair-lending procedures last fall.
The much-needed clarification provided by the Comptroller's Office somewhat improves a bank's ability to prepare for a fair-lending exam. Still, it left many banks foraging for further explanation. What follows is a look at how banks can anticipate and ready themselves for the different nature of future exams.
The new procedures expand the methodologies examiners use to gather and assimilate information for matched-pair analysis. The sample input work sheet includes more than underwriting variables that may be relevant to underwriting decisions.
The input work sheet now contains additional information, such as data on loan pricing, including annual percentage rate, points, and fees. Until now many examiners, lacking specific guidance, did not focus on pricing. In the future, examiners are likely to begin capturing pricing information, which can easily be compared to identify disparate treatment.
In defending allegations of pricing disparities, the challenge is documentation. Lenders often do not adequately document pricing deviations or retain par price quote work sheets, and it is difficult to prove that an institution did not discriminate against a protected class when little documentation exists.
In addition, many lenders' pricing policies are complex. They are therefore applied inconsistently by loan officers or other personnel negotiating interest rates, points, and fees.
This is particularly troublesome for large multistate lenders that not only have branch originations in those states, but also have centralized telemarketing centers making pricing decisions that may differ from state to state because of varying consumer protection regulations. Though branch originators are aware of regulations in their state, telemarketers must deal with regulations of many states.
How does a lender monitor their compliance with fair-lending laws and regulations with respect to pricing? The answer beings with documentation- the ability to systematically extract data from loan files.
At a minimum, all lenders should be reviewing pricing, comparing prices received by protected versus nonprotected classes for parity. The accompanying table illustrates an example of a high-level pricing analysis.
This high-level analysis not only indicates who is paying the most for credit, but also provides enough information to determine where a group of applicants is being systematically overcharged or undercharged. With these bits of information, a lender can more effectively focus self-assessment efforts.
The new procedures also expand the scope of fair-lending exams beyond residential lending. Where volume warrants, consumer and small-business loans are also being examined.
As the OCC begins selecting nonresidential products in fair-lending examinations, institutions could be surprised because many lenders often do not perform comprehensive self-assessments on nonresidential products.
The new procedures state that "if the product selected lacks government monitoring information, but racial identifications could be inferred by using surrogates for racial or ethnic identity, such as surnames or geographical location of the property, the examiner should consult the district lead compliance expert about how to proceed."
Though many lenders question the accuracy of an ethnicity proxy based on surname, a systematic proxy for applications can be made based on census data. With as little information as an applicant's address, a proxy may easily be made for minority versus nonminority applications by assigning a census tract to each application based on the applicant's address and inferring race and income level using 1990 census data, which is available for each census tract in the United States.
With more and more lenders getting involved in credit scoring, the Comptroller's Office has expended a great deal of resources to understand the implications of credit scoring and has developed expertise in performing fair-lending examinations of scored products according to newly available evidence. The new examination procedures devote six pages to a discussion of credit scoring.
If a bank uses the credit score as one among many factors in making credit decisions, this fact should be clearly stated in its underwriting guidelines. Banks whose override rates exceed 10% should be concerned. With the issuance of guidance applicable to scored products, agency examiners have been directed to perform an evaluation of lenders' override policies to determine if they have been applied consistently.
The new exam procedures make frequent reference to the agency's economics and evaluation division. One of its responsibilities is to provide statistical expertise in the examination process by reviewing a bank's existing statistical self-assessment model; developing a statistical model to determine if discrimination exists; or providing assistance in developing statistical analysis of credit score overrides.
The OCC will likely give strong consideration to performing a regression analysis on any line of business with more than 50 minority denials that were not consistent with the lenders' underwriting criteria.
Though several large lenders are already performing regression analysis as a component of their fair-lending self-assessment programs, the majority are not.