Back in 1990, alarm swept through the banking industry over the prospect that Community Reinvestment Act ratings might be made public. Individual bank scores had always been confidential, and the fear was that weak ratings, once revealed, would be grist for the headline mill.

That nightmare never materialized; only a tiny percentage of banks, mostly very small ones, have received poor CRA marks, and publicity has been scant. But these days, a nasty headline would be tantamount to a light slap on the wrist. The industry is now convulsed by another CRA issue whose implications are far scarier and more far-reaching: prosecution on charges of lending discrimination. Instead of dealing with banking regulators who might be inclined to be more understanding, banks and thrifts are being called on the carpet by the Department of Justice and the Department of Housing and Urban Development (HUD)--new players with an overtly political agenda and a generally deaf ear to bank protestations.

In the past 10 months, Justice has announced four consent orders in which it has settled charges against banks over alleged fair lending violations rather than take the matters to court, and other investigations--perhaps dozens--are underway. Prior to that time, only one such order had ever been signed. And HUD has talked tough about loan bias and taken scores of lenders, mostly nonbanks, to the woodshed, assessing civil penalties or barring lenders from participating in federally insured housing programs. Officials there have also considered drafting a sweeping new regulation on fair lending through the Fair Housing Act that could give HUD vast new powers.

The push by HUD and Justice comes with the blessing of President Clinton, who has committed the government to a renewed assault on discrimination--an issue Comptroller of the Currency Eugene Ludwig has harped on since he took office last year. But the drive also gained momentum from forces that predate Clinton's election, including regulators' analysis of Home Mortgage Disclosure Act (HMDA) data that has revealed apparent patterns of discrimination in mortgage lending; the October 1992 study by the Federal Reserve Bank of Boston, especially, opened the gates to allegations of bias.

Since then, despite clamoring by banks that the industry has built new bridges to minority communities, consolidated HMDA data continues to show sharply higher denial rates for blacks and Hispanics than for whites. And preliminary figures from the Federal Financial Institutions Examination Council for 1993 reveal a stubbornly high denial rate of 34% for blacks, compared to 25.2% for Hispanics and 15.4% for whites. Comparable 1992 numbers were 36%, 27% and 16%.

Bankers have assailed these statistics time and again as misleading--credit histories and property characteristics aren't factored in--even as authorities have latched onto them. Moreover, the numbers aren't always accurate (see "The Nuts and Bolts of Toeing the Line," page 48). "The data has its limitations," says Robert P. Chamness, executive vice president and chief counsel at consultant and software vendor CFI ProServices in Portland, OR. "Everyone recognizes that it's not proof of anything. HMDA is a can opener. It shows anomalies."

If it's a can opener, the can is mortgage lending. "Fair lending" is a catch-all phrase that applies to four federal laws, including the CRA and the Fair Housing Act (FHA), and it has virtually become synonymous with mortgage operations, essentially because that's the only place where data on possible discrimination is kept. Regulators don't have similar numbers on small-business or consumer loans; institutions aren't required to compile them. The situation gets confusing, because fair lending is only one aspect of compliance under the broader umbrella of the CRA, and enforcement often comes under other laws like the FHA. Those laws include HMDA, which requires lenders to report data like racial, gender and income composition of mortgage applicants; and the 20-year-old Equal Credit Opportunity Act, which permits Justice to file "pattern or practice" lawsuits based on discrimination claims.

As CRA initiatives have become more established and successful, this fair lending enforcement push has been like a kick in the solar plexus to the banking industry. Attorneys talk of "CRA prosecution," implying that the CRA, a vague and still-evolving law, has been given new teeth by combining it--some say unfairly and unclearly--with the FHA and its penalties for discrimination. With that, lending bias claims are hogging the spotlight, and some bankers chafe that the allegations are deflecting attention from real gains banks have made in community reinvestment.

"It's unbelievable," fumes a Southeastern banker who asked for anonymity. "These people are trying to enforce a change in social policy over the back of the banking industry." Says Jo Ann S. Barefoot, president of Barefoot, Marrinan & Associates in Columbus, OH: "There's an enormous gap between where the industry is and the vision of HUD and Justice on this issue. That gap isn't an easy one to close."

As much as bankers want to be seen as responsive citizens, they argue that forcing institutions to open branches or offer easier-term loans in specific neighborhoods constitutes credit allocation, and that one outcome could be erosion of safety and soundness. Sources say that high-level regulators have expressed concern in recent weeks that pushing lenders too far in that direction could conceivably imperil the industry's health.

Questions Linger

Discrimination is a vexing issue for bankers. They deny they treat applicants differently, but the data raises questions that linger despite the ready explanations that loan denials are tied to risk, not race. Bankers are eager to fight any accusations of bias, but confronted with the fath-omless pockets of the Justice Department and the publicity of protracted litigation, the strong inclination is to settle and move on.

The subject has taken on new urgency with the August consent order announced by Justice against Maryland's Chevy Chase Federal Savings Bank. The thrift agreed to pay a total of $11 million to settle charges that it discriminated by not marketing its services in minority neighborhoods near Washington.

New York attorney and CRA expert Warren Traiger says Chevy Chase sends a chilling message about branching. "The ramifications are enormous. Banks have been trying to shed branches. This is going to be more and more the focus of community group demands." Rick Marsico, a law professor at New York University, agrees: Had this ruling been in effect two years ago when he counseled a community group challenging a Bank of New York merger, he says, the group would have asked the bank to establish a branch in an underserved area.

When the order broke, fair lending was splashed in general newspaper headlines and editorial pages for days. The conservative Washington Times called it a "shakedown," and most bankers undoubtedly agreed; simmering resentment over mandates that banks reach out to minority areas in ways that other businesses don't has mixed with fear that a series of bias claims could touch off a national conflagration.

"It's the area causing the greatest concern and uncertainty throughout the whole banking industry," says Kenneth Guenther, executive vice president of the Independent Bankers Association of America. "It's certainly the issue of the day. Everyone's very concerned," echoes David Van L. Taylor, executive vice president of the Bank Administration Institute, which has been drafting a guide for fair lending.

Banks don't have to be deemed guilty of a willful intent to discriminate, but merely of policies that create "disparate treatment" or "disparate impact." However you play this theme, it still gives bankers nightmares. While reform of the CRA in still a ways off (it's being rewritten for a second time by regulators, to be followed by a new set of comments) and its shape unclear, the combination of Justice and HUD has introduced a new set of players and a huge set of unknowns that threaten both new costs and management headaches.

"These are agencies that the industry isn't used to dealing with," says Traiger. "That means a few things--(banks) don't have the same access, and the agency isn't as familiar with how you operate as your primary regulator."

Justice has historically been interested in other, more blatant forms of civil rights abuse, and HUD--whose public housing role has shriveled in recent years through lack of federal funding--was best known in the 1980s for a string of scandals. But with a Democrat again in the White House, social issues like discrimination have taken on renewed urgency, and Cabinet departments are leading the charge.

Under HUD Secretary Henry Cisneros, a former mayor of San Antonio and arguably the nation's most powerful Hispanic politician, fair lending has become a crusade that has received at least as many resources as HUD's other targets. Cisneros speaks of four other goals: reducing homelessness, improving public housing, expanding affordable housing and "empowering communities." Banks are willing and able to help with affordable housing, which, coincidentally, carries none of the punitive aspects of meeting fair lending tests.

Appeals to Trade Groups

HUD's greatest leverage is not on banks but on nonbank mortgage lenders; the agency oversees the reporting of their HMDA data, and can assess penalties for noncompliance or fair lending violations. On Sept. 14, after weeks of rumors, officials from HUD and the Mortgage Bankers of America announced an agreement in which the MBA urged its 2,900 members to ink individual pledges with HUD setting dollar targets for lending in specific minority communities. That same day, Countrywide Funding Corp.--the nation's biggest mortgage originator--did just that, agreeing to be monitored by HUD on fair lending initiatives through 1995.

HUD Assistant Secretary Roberta Achtenberg and other agency staffers have been urging top banking trade group officials to put heat on their members to sign similar agreements. But the bank groups haven't exactly jumped. "I don't think there's a banking trade group that will sign such an agreement. There's no reason for it," says the IBAA's Guenther. "We are not here to carry forth HUD's social agenda."

And what could a bank gain from signing such a pact? HUD's teeth on this issue aren't especially sharp: Apart from Federal Housing Administration and Veterans Administration loans, it has relatively little oversight of bank and thrift mortgage lending. And HUD officials concede they cannot penalize an institution that elects not to sign. A bank that does so might expect to get a break should the government allege any discrimination. Still, attorney Barry A. Abbott, a member of the Fed's Consumer Advisory Council and head of the financial services group at Howard, Rice in San Francisco, expects lenders will sign suchagreements "because people are afraid they're going to be sued."

If agency investigators were to team with the prosecutors at Justice, HUD could make life tougher for banks. And that seems to be happening: They're now sharing information and staff, creating a potent force that's eager to flex its muscles. Justice added 18 attorneys last year specifically to investigate such allegations, and the importance it attaches to the issue was underscored when the Chevy Chase announcement was made by Attorney General Janet Reno herself.

In fact, the administration's hammering on the bias issue has become a kind of anvil chorus. Clinton signed an executive order last January creating a Cabinet-level Fair Housing Council, headed by Cisneros. HUD and Justice had pushed for stiff fair lending enforcement in guidelines developed by the banking agencies, but when the agencies thought the measures went too far and wouldn't go along, HUD and Justice elected to join forces and go their own way.

Paul Hancock, chief of the housing and civil enforcement division at Justice, told the IBAA earlier this year that "we think you're on notice now ... I don't think there can be any challenge of the notion that there is discrimination in this industry, and the focus has become how to get rid of it."

Of course, perceptions of mortgage discrimination aren't new, and they didn't become part of Justice's game plan when Clinton settled into the Oval Office. The landmark case was Georgia's Decatur Federal Savings, which signed a consent decree with Justice in 1992 that cost it $1 million. But the big push is on now, and experts say more bombs could go off at any time.

Before the Chevy Chase order came ones against: Shawmut Mortgage Corp., told in late 1993 to create a $960,000 compensation fund for "victims" of what was perceived to be underwriting discrimination; Blackpipe State Bank in South Dakota, ordered in November 1993 to create a $125,000 compensation fund and expand marketing to native Americans; and First National Bank of Vicksburg, MS, ordered in January to improve fair lending efforts and pay some $700,000 to affected African-American borrowers.

Sending a Message

As shots across the bow, these actions have caught the industry's attention. "I think the idea is to make an example," says Traiger. "They want to send a message."

Certain provisions repeat themselves in these consent orders, notes Paul H. Scheiber, an attorney with Blank, Rome, Comisky & McCauley in Philadelphia: outreach to minority communities through advertising; training programs for employees; attracting new minority hires, and "second look" programs to reassess rejected applications.

These are the kinds of CRA-related programs community activists have been working for years to incorporate in voluntary lending agreements hammered out with banks. But activists have embraced the government's tougher stance. "The lawsuits and administrative complaints filed in the past few years reflect the growing awareness among fair housing advocates of how lending policies discriminate against individual borrowers and neighborhoods," says Shanna Smith, executive director of the National Fair Housing Alliance.

There's been much talk of testing programs to uncover policies that might foster unintended discrimination. The FDIC and Fed have advocated self-testing, where a bank runs the screens itself or hires a consultant for that job. (The FDIC considered and then tabled its own testing program.)

But at the OCC, Ludwig announced a program last year that would use OCC-sponsored "testers" to "shop" banks for mortgages and report their findings. This program, which remains in a "pilot" phase, has drawn flak from bankers and other regulators alike but is "going well," says OCC spokeswoman Janis Smith. She says the agency won't talk about how many banks have been tested, or where they are, and adds that most that have been or will be shopped may never realize it. The pilot will last until year-end, when the OCC will decide whether to continue the process or change its approach.

Smith says the agency has been sampling banks where it believes "a potential for preapplication discrimination appears to be present," which rules out many institutions in areas with little or no minority population. She confirms that the OCC is the only banking regulator currently doing its own testing, though HUD is also conducting bias tests. Last spring, for instance, Achtenberg noted that HUD-sponsored testers were working in three metropolitan areas, attempting to gauge the treatment of applications early in the loan-origination process.

The notion of self-testing generally sits well with lenders, but there's a nagging fear that if they do uncover discrimination, the results could be used against them, even--gulp--referred to Justice. Some institutions have looked at having their attorneys do the work so they could invoke attorney-client privilege. The Consumer Bankers Association has urged the agencies to support federal legislation protecting "the results of self-testing from disclosure in state and federal private litigation."

Regulators and Justice officials have moved quickly to try to allay those fears. "I wouldn't be too frightened by the notion of finding a problem and then having it made known to the regulators," Richard J. Ritter, a special litigation counsel with Justice, told a fair lending conference earlier this year. "The bottom line is that people are going to be screwed a lot worse if they don't self-test," says Chamness at CFI ProServices. "The problems will be magnified over time."

Ludwig the Moderate?

Ludwig's insistence on using outside testers has raised hackles not just with bankers but with fellow regulators, especially in the Federal Reserve. But with Justice and HUD taking up the cudgels, Ludwig comes off increasingly as a moderate. Bankers have reacted positively to his insistence that character, not just numbers, must remain a component of lending decisions.

Five bank trade associations responded to last spring's "Policy Statement on Discrimination in Lending" by predictably asserting that anti-discrimination "is the law, it is the right thing to do." But they fretted about over-reliance on statistics and argued that the statement might work against safety and soundness, adding that the crazy-quilt evolution of fair lending standards has perplexed bankers everywhere.

"There is growing confusion about these rules," says James Hance, chief financial officer for Nations-Bank. "Some of the regulations are starting to overlap; some contradict each other, and a growing number of agencies, offices and regulators are involved in the oversight process."

Carping about confusion is one thing, but outright resistance may well be fruitless and expensive. Most major banks are trying, just as in their broader CRA initiatives, to look proactive. More than a few have reacted to events by beefing up staff training and minority recruitment.

At Harris Bank & Trust in Chicago, for instance, employees with regular customer contact took part this year in a seven-hour diversity and sensitivity training course. Southern National Corp. in North Carolina has implemented diversity training for loan officers and management, developed external lending initiatives for minorities and begun a second loan review process.

But resentment has been building like magma in a newly active volcano, and with the Chevy Chase decree, finally exploded like Mount St. Helens. Several bank attorneys interviewed complain that its branch-allocation provision sets a terrible precedent, and the Independent Bankers Association of America suggests the decree might violate both the Equal Credit Opportunity Act (by making one group more equal) and branching rules established by the 1989 thrift bailout law.

One Northeastern banker active in community development issues frets that many community reinvestment programs may get trampled in a rush to placate the fair lending forces. "Justice just leapfrogged over the regulators and said, 'We are now in control, and fair lending is where it's at,'" he says. "Speaking to my colleagues, everybody has the same sense that it goes beyond the intent of what community lending and CRA is all about."

Referring to Chevy Chase, he adds: "After reading all the requirements in the consent decree, I was thinking, 'Why didn't they just call it the Justice Department S&L? They'll be running it.'"

Says attorney Abbott: "What's disconcerting now is that both (Justice and HUD) are really acting through consent decrees and promulgations, trying to change the law. They're picking out smaller institutions that don't have the wherewithal to litigate these matters."

Banks Won't Be Alone

Experts say it won't be long before mortgage bankers and insurance companies are drawn into the anti-discrimination net. Mortgage companies have been hearing regulators' hoof beats for many months, and they reacted bitterly in July when Jonathan Fiechter, director of the Office of Thrift Supervision, floated a plan that would require them to expand lending in poorer areas. "This would put us out of business," snaps one mortgage banker who asked for anonymity.

Meanwhile, the House has passed legislation that would require insurance companies to report sales data from 25 major metropolitan areas. And a new California law, due to take effect Jan. 1, would require insurers to keep information on applicants' race and other attributes. "Insurance is the next big wave," says Abbott.

It's widely agreed that lending discrimination is less a conscious act than an outcome of circumstances and policies. Even minority vendors recognize that gap. "Our research has shown that while very few lenders set out to intentionally discriminate, issues such as biased internal processing systems and loan representatives who do not put equal effort into developing applications can lead to discriminatory effects," says Michael Taliefero, managing director for Channel Link Capital, a black-owned mortgage advisory firm.

Bankers have voiced agreement that, even without identifiable bias, the industry hasn't delivered the level of home lending in minority areas that it could. The 1991 HMDA numbers "made clear that we did not have the right products and that we were not penetrating many of the markets we serve," Chemical Banking Corp. president Edward D. Miller told a recent community reinvestment conference.

Three years ago, "HMDA was widely seen as more burdensome than useful," Miller added. "Today, I think we can all agree that HMDA led to actionable solutions and results--more mortgage lending to lower-income and minority home-buyers."

Industry trade groups have offered videos and pamphlets and stumped for heightened awareness, and federal regulators have been trying to do their part. Besides the joint statement issued in March, they mailed out a pamphlet late in 1991, "Home Mortgage Lending and Equal Treatment," that noted how banks can inadvertently discriminate by using certain underwriting guidelines or declining to make loans below a certain size. And Fannie Mae and Freddie Mac have been hard at work revamping their own guidelines for loans they buy.

Clearly, there's a undercurrent running through a lot of bankers' public comments about fair lending that says they're guilty of nothing more than ignorance or poorly drawn policies. "I'm convinced that most business people and bankers want to do the right thing, and it is a matter of their acquiring the knowledge and experience of doing business in an unfamiliar area," says Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City.

But there are economic issues that also come into account: smaller loans are harder to administer and less profitable; minorities' credit histories tend to be weaker, and they take more counseling to set right; property values in inner-city areas may be eroding; poorer borrowers are much less likely to generate profitable relationships than more affluent ones. Wipe away CRA and fair lending laws, and a lot of banks, especially small ones, might drop their "do-good" programs in a heartbeat.

Race aside, the link between income and approval rates is irrefutable. Analysis of 1992 mortgage data in New York City and Long Island revealed that on average, denial rates for all applicants plummeted as income rose. KPMG Peat Marwick found that applicants with under 80% of median income had adenial rate, almost twice the 19.4% for those with over 120% of median income.

Loan officers will never be color-blind, just as they will never be blind to risk factors like age, debts and marital status. But increasingly, experts predict, banks will be forced to revisit--and revise--their programs. Lenders can take small comfort from the misery-loves-company notion that. in coming months and years, mortgage banks and insurers, many totally unaccustomed to any bias scrutiny, will be in the same boat.

Events like the Chevy Chase order have upped bankers' anxiety levels dramatically, and attorney Abbott believes that's the intent. "That seems to be a strong part of this administration's goals, to scare people," he says. He questions the continued focus on loan data, saying "the issue is not equal results, but equal opportunity."

"The problem was becoming clear to those that listened that CRA was being criminalized, and that it would be enforced through fair lending mechanisms," says Chamness at CFI ProServices. If banks believe they can make nice with Justice as they have with their own regulators, Chamness says they'd better think again. "They're dealing with prosecutors, and prosecutors don't give a damn." While bankers could lobby Congress to strip that prosecutorial power from Justice, Chamness sees that going nowhere fast. "Fat chance," he snorts. "Not in this lifetime."

With almost uncanny prescience, Comptroller Ludwig noted in an interview last year with U.S. Banker that "if I wanted headlines, I'd hide in the bushes and have the Justice Department jump on the banks. We'd get a lot of press."

He may disavow credit, but that has happened. "If the enforcement effort stays on the track it's on, we have a long, long road ahead of us," Barefoot says. She thinks bankers should be taking their case to the regulators, who have to balance fairness issues with safety concerns and "see the complexity in the real world." But unless the banking agencies pressure the prosecutors into applying the brakes, bankers' shouts will just be thrown back to them by a freshening wind.

Making an Example in Maryland

August may be the Dog Days in more ways than one, judging by the howl that erupted after the announced Aug. 22 settlement of a fair lending suit by the Justice Department against Chevy Chase Federal Savings Bank, a $5.1-billion-asset thrift in Washington's Maryland suburbs.

The thrift agreed to finance $140 million in discounted loans for residents in largely black communities in the greater Washington area at an expected cost of $7 million. Chevy Chase must spend another $4 million to alter its internal operations, such as hiring more lenders, opening more branches and expanding marketing efforts--all over a five-year period when the decree is in effect.

Attorney General Reno said the order broke new ground: It marked the first time Justice has pursued a lender that appeared to discriminate by not offering branches in inner-city areas. "You can't deny service if no service is offered," she said of the thrift's apparent rationale. Despite the area's large minority population, Justice investigators argued that 97% of the loans made by Chevy Chase and its B.F. Saul Mortgage Co. subsidiary in 1976-92 were made in predominantly white areas. "lt's discrimination, pure and simple," Reno asserted.

B.F. Saul II, its chairman, said the thrift "adamantly denies all the allegations," but agreed to settle because of the potential cost and its commitment to the community. The thrift argued that its minority approval rate over the past three years was 88%, "among the highest in the nation."

The probe at Chevy Chase had been underway for 14 months. Late in August, a published report said that Justice was also investigating branching patterns by Bane One's Cincinnati bank, though bank officials insisted they were unaware of any probe.

"I think they picked on a semi-weak thrift that had some capital problems and was privately owned, so the stock market couldn't beat up on it. and decided to make an example of it," says Alexandria. VA. banking consultant Bert S. Ely. "I've been surprised by the impact. It had the desired effect."

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