Volume 5, Issue 3 Division of Depositor and Consumer Protection Dallas Region Quarterly Newsletter 3rd Quarter 2017 Revised Pre-Examination Planning Process I nside this i s s u e : Revised Pre- Examination Planning Process Implementing a Fair Lending Action Plan to Manage Discretion in Credit Decisions A Consumer Harm Focused Look at More Frequently Cited Violations 1 2 4 Overview of the Revised Pre-Examination Planning (PEP) Process The purpose of the FDIC s PEP process is to collect and review necessary information to understand the bank s business strategy and risk profile prior to arriving for the on-site portion of the examination. The information allows the examination team to plan for and conduct the off-site and on-site portions of the examination to accomplish supervisory objectives in an efficient and effective manner. The FDIC has revised its PEP process based upon feedback received from bankers, trade groups, examiners, and other stakeholders. The revised PEP process now includes two phases. During phase 1, examiners: gather background information about the bank; conduct an interview with appropriate members of bank staff; prepare a tailored Compliance Information and Document Request (CIDR) based on the information bank management shared during the interview process; and send an entry letter and the tailored CIDR to bank management. Typically, phase 1 begins at least 45 days prior to the on-site portion of the examination, and institutions have at least 30 days to gather and provide the information and documents requested and return it to the examination team for off-site review. During phase 2, examiners review the information gathered during phase 1, along with the bank s responses to the CIDR to identify areas where there are risks of consumer harm and to evaluate how the bank s Compliance Management System (CMS) helps mitigate those risks. Examiners then prepare and send a request for specific documents that will be used for transactional testing (primarily while on-site). As a result of this change of splitting the PEP process into two phases, institutions may receive shorter CIDRs than in the past, which should reduce the materials needed for bank staff to gather. Advanced Notification of Data Verifications The PEP process was also revised to include a formal notification to bank management when FDIC personnel will be conducting a validation review of the bank s Home Mortgage Disclosure Act and/or Community Reinvestment Act data prior to the on-site examination. In these instances, bank management will receive a letter explaining the validation process either with the Information Package or soon thereafter. Please note this change is limited to the notification, and the actual validation process remains unchanged. In Closing The FDIC is committed to tailoring its examination approach to focus on the specific products, services, and overall operations of each institution based on the potential risks of the institution. Our goal is to ensure that institutions are provided with ample notification to prepare for examinations, which includes time to gather and provide the requested information and documentation. We fully understand and appreciate the time and effort devoted to responding to our requests. We are hopeful that our revised PEP process will allow our examiners to spend less time on-site during examinations, while still performing the necessary examination functions based on the risk profile of each institution. The revised PEP process is reflected in FDIC s Compliance Examination Manual.
P a g e 2 Volume 5, Issue 3me Implementing a Fair Lending Action Plan to Manage Discretion in Credit Decisions Discretion: Webster s Dictionary defines it as the ability to make responsible decisions. For lending personnel, discretion could arise due to the ability to deviate from stated policies or procedures, or making credit decisions in circumstances where procedures are unclear. Most loan officers typically have some degree of discretion, and bank management expects them to use good judgment in determining whether to approve an application and how to price loans. The latitude an institution allows its loan officers varies, often depending on the experience of the loan officer or in the controls established by the bank. This article seeks to provide information on effectively managing and monitoring the use of discretion to ensure credit decisions are based only on pertinent credit-related criteria, in line with the Equal Credit Opportunity Act and the Fair Housing Act. See the Interagency Policy Statement on Discrimination in Lending 1 for additional information. When is discretion used? Discretion is often exercised in underwriting and pricing decision processes, but may also exist in other aspects of a credit transaction, including during the application, loan servicing, collections, and postmaturity processes. Discretion may be present within the institution, but may also be granted to third parties, such as automobile dealers who are granted discretion to mark-up the institution s buy rate or, alternatively, give concessions on granted rates. The latitude given to bank employees in exercising discretion is unique for each bank, and may vary by product type. In some banks, significant discretion is allowed across all types of bank products, while at other banks discretion is curtailed through in-depth underwriting processes, rate sheets, or other bank-enacted controls. In some cases, no discretion is allowed, such as when credit card applications are underwritten and priced by an automated system with strict credit-related parameters. You may ask, How much discretion is too much? There is no single answer appropriate in all cases. Rather, first and foremost, an institution should ensure it is aware of where discretion exists so it can decide how best to mitigate such risks. This is typically done by conducting a risk assessment that includes evaluating the content of policies and procedures. For example, if an institution is unaware that its policies and procedures are unclear to its loan officers, resulting in an unintended use of discretion by its officers, this could be an area of risk that is currently unknown and unmitigated. Thus, institutions should ensure they have properly identified fundamental areas of risk in their processes, products, and services. Discretion in and of itself is not prohibited, nor is it discouraged when appropriate controls are in place. As noted previously, banks expect their loan officers to exercise good judgment in determining which loan applications present an acceptable credit risk, and price those loans to earn an acceptable level of return based on the perceived risk. When significant discretion is allowed in credit decisions, it is in the bank s best interest to periodically review various factors for trend purposes such as application processing times, underwriting and pricing, and other credit-related decisions to determine whether an applicant has been treated less favorably on a prohibited basis. In other words, a greater level of discretion warrants heightened scrutiny. In determining the level of resources to allocate to monitoring the exercise of discretion, a bank should consider the size and complexity of the institution s lending program, the tenure and training of staff, past fair lending findings from internal or external audits or regulatory examinations, level of centralization in the credit decision process, demographics of its market areas, and other relevant information. Each of these factors affects the fair lending risk inherent in the institution. Also, monitoring procedures should be reviewed periodically, and adjusted as the bank s fair lending risk profile changes. Remember to look at all types of exceptions during your monitoring process not only applications approved outside of policy, but similar applications that were not approved. Compare denial rates for a prohibited basis group (the target group) to denial rates for the control group (for example non-hispanic whites for a racial or ethnic analysis, and male/joint borrowers for a gender analysis). This is relatively easy for residential real estate transactions which require the collection of government monitoring information. For other loan 1 https://www.fdic.gov/regulations/laws/rules/5000-3860.html
P a g e 3 Vo Volume 5, Issue 3me 4, Issue 4 Implementing a Fair Lending Action Plan to Manage Discretion in Credit Decisions (continued) types, tools are available for using giving names in a gender analysis or surnames for a racial or ethnic analysis. Banks should also monitor pricing decisions for consistent application of pricing policies across prohibited basis groups. The time frame covered by each monitoring review should be long enough to provide a meaningful analysis between the two groups in question. Banks can also review consistency in handling collections, loan modification requests, and foreclosures. Monitoring should evaluate the extent to which policies and procedures are followed and not simply track exceptions. Remember that reviews at an aggregate level across the institution or branches may uncover issues not apparent from reviews at the loan officer level. What else can a bank do to mitigate its fair lending risk? Training and clear communication about how to apply policies and procedures consistently among borrowers within each stage of a loan transaction can mitigate risk. Fair lending training should be tailored to your bank s fair lending risk profile and updated as the risk profile changes. Ensure all personnel involved in the credit decision process know the bank s policies, and under which circumstances exceptions may be made to policies. Consider requiring a higher level of approval for all exceptions. For banks with multiple branches or decision centers, consider defining measurable standards for compensating factors in making exceptions to ensure all eligible borrowers receive the same opportunities for exceptions. Maintain sufficient documentation supporting the specific circumstances or measurable compensating factors of each exception. Use the results of monitoring activities to assess whether fair lending training has been effective and whether the level of discretion allowed is still appropriate. Consider adjusting criteria or policy standards to mitigate fair lending risks when exceptions are occurring more than occasionally. Should monitoring reveal disparities, take action! Dig further to determine whether the differences are fully explained by pertinent credit factors. If such factors do not fully justify the differences, attempt to make harmed parties whole by offering to extend credit, adjusting interest rates, or providing monetary adjustments when appropriate. Evaluate whether additional harmed parties could exist in a larger universe outside of any monitoring sample and whether any corrective actions to make harmed parties whole should be retroactive in time. The Interagency Policy Statement on Discrimination in Lending provides additional information for addressing self-identified instances of discrimination, including notifying the parties of their rights under the Equal Credit Opportunity Act. Managing discretion in the fair lending process can be challenging, yet beneficial in supporting compliance and business objectives. Examiners consider risk mitigation efforts in setting the scope of fair lending reviews. A robust monitoring program will not only help identify potential issues before examiners do, it may reduce the amount of information requested and files reviewed during examinations. If you have any questions about this article, and how to better manage fair lending risk at your bank, feel free to contact your local FDIC field office or refer to the Interagency Fair Lending Examination Procedures 2 or the FDIC s Fair Lending Scope and Memorandum 3 guidance. An institution should ensure it is aware of where discretion exists so it can decide how best to implement mitigating controls. 2 https://www.fdic.gov/regulations/examinations/fairlend.pdf 3 https://www.fdic.gov/regulations/compliance/manual/4/iv-3.1.pdf
P a g e 4 Vo Volume 5, Issue 3me 4, Issue 4 A Consumer Harm Focused Look at More Frequently Cited Violations Within the FDIC compliance examination process, violations of consumer protection laws and regulations are classified based on the level of severity, including the risk of consumer harm High (Level 3), Medium (Level 2), and Low (Level 1) Severity. The FDIC defines consumer harm as an actual or potential injury or loss to a consumer, whether such injury or loss is economically quantifiable (such as overcharge) or nonquantifiable (such as discouragement). Effective consumer protection requires supervisory and examination activities to be focused on identifying risks of consumer harm, taking effective action so that financial institutions address or mitigate those risks, and preventing harm by encouraging financial institutions to have effective compliance management systems. For additional information on how the federal bank regulatory agencies consider consumer harm within the context of their examination programs, see the FFIEC Guidance on the Uniform Interagency Consumer Compliance Rating System. While the vast majority of FDIC supervised banks adequately manage their compliance programs, violations of consumer protection laws and regulations at some banks have been designated a medium to high level of severity. To help identify current compliance risks, financial institutions often ask their regulators which violations are cited most frequently during consumer compliance examinations. To address this question, the FDIC conducted an informal review of Level 2 and 3 violations cited in reports issued January 1, 2015 through December 31, 2016. Although the violations were not commonly found at most FDIC-supervised financial institutions, the table below offers useful information about the types of violations we have seen through our examination program and some examples. The violations are categorized by regulation with a brief example of the consumer harm that was identified. In many of these circumstances, customer restitution was included as an element of the bank s corrective action. Types of Cited Violations Resulting in Consumer Harm (2015-2016) Regulatory Citation Examples of Consumer Harm Truth in Lending Act Regulation Z Section 1026.5(c) Section 1026.7(a)(6) Sections 1026.18(d) and (e) Section 1026.19(b)(2) Sections 1026.19(e)(3)(i) and (ii) Closed-end loan disclosures did not reflect or were inconsistent with the terms of the legal obligation between the borrower and the bank. Fees classified as finance charges (FCs) were funded by the initial advances on a home equity line of credit; however, the fees were neither individually itemized nor included in the FC portion of the initial periodic statement (resulting in an understated FC). The annual percentage rate (APR) or FC disclosed on a closed-end loan to the customer was understated by more than regulatory tolerance. For example, this understatement may have been caused by the bank not disclosing a construction draw fee, tax service fee, life of loan flood zone determination fee, or settlement fee as a FC on a residential mortgage loan. Consumer was not provided with a variable rate program disclosure with the required information at the time of an adjustable rate mortgage application or before the consumer paid a non-refundable fee, whichever is earlier. A fee disclosed on the Closing Disclosure (CD) increased from the amount disclosed on the Loan Estimate (LE) by greater than the corresponding regulatory tolerance; however, the lender did not cure the violation.
P a g e 5 Vo Volume 5, Issue 3me 4, Issue 4 Types of Cited Violations Resulting in Consumer Harm (2015-2016) continued Regulatory Citation Examples of Consumer Harm Section 1026.36(c) Home loan customers were not provided with a conforming payment notice detailing the bank s payment crediting procedures, including cut-off times and processing days. In the absence of this notice, loan payments must be credited as of the date of receipt unless the delay does not result in additional charges to the borrower (i.e. late fees/interest) or negative credit bureau reporting. Sections 1026.38(i) and (o) Section 1026.40(d) Sections 1026.43(c)(1) through (c)(3) Information was disclosed inaccurately on the Calculating Cash to Close and Loan Calculations tables on the CD that misrepresented the costs and terms of a residential mortgage loan. Key application disclosures were not provided to consumers about their home equity line of credit product. For example, the application disclosure omitted an estimate of various closing fees. Bank did not make a reasonable and good faith determination that the consumers would have the ability to repay home mortgage loans using all eight underwriting factors delineated in the regulation. Further, loan officers did not obtain third-party verifications for income, assets, and employment. Real Estate Settlement Procedures Act Regulation X Section 1024.7(c) Sections 1024.7(e)(1), (e) (2), and (i) Section 1024.7(f) Section 1024.17(c)(1)(ii) Disclosed closing costs related to a home mortgage were not made available for at least 10 business days from when the LE was delivered to the applicant. Settlement charges on the CD exceeded the LE s estimated charges by more than the regulatory tolerance. The bank did not provide reimbursement within 30 calendar days following settlement in order to cure the tolerance coverage. A revised LE was provided with increased settlement charges that were not related to the changed circumstances that prompted the revised LE. Bank collected monthly escrow payments in amounts in excess of that allowed under the regulation. Truth in Savings Act Regulation DD Section 1030.3(a) Section 1030.4(b) Section 1030.5(a) Deposit account disclosures were not clear and conspicuous, such as when required information was inconsistent between the initial disclosures and the monthly periodic statements. The lack of clear and conspicuous disclosures caused consumer harm by presenting confusing and sometimes contradictory information about the costs to open and maintain a deposit account. Deposit account opening disclosures were not accurate, particularly when fees were understated or terms of the account were more onerous than disclosed. Notification was not delivered to deposit consumers at least 30 days before the effective date of a change that adversely affected the customer.
P a g e 6 Vo Volume 5, Issue 3me 4, Issue 4 Types of Cited Violations Resulting in Consumer Harm (2015-2016) continued Regulatory Citation Section 1030.5(b)(1) and (b)(2) Section 1030.8(a) and (d) Examples of Consumer Harm Required disclosures were not provided to automatically renewing certificate of deposit customers in a timely manner. In particular, this violation raises the potential for consumer harm when the terms of the certificate have changed and adversely affect the customer. Bank deposit advertisements were misleading, inaccurate, or misrepresented the deposit contract. Further, advertisements failed to provide sufficient or clear disclosures pertaining to a bonus offered in connection with an account. Electronic Fund Transfers Act Regulation E Section 1005.17(b)(1) Section 1005.6(b) and 1005.11(c) Fees were inappropriately imposed on customers for overdrafts that were created by an ATM or one-time debit card transaction without the bank providing a written or electronic notification, and following the regulatory opt-in requirements. Bank s error resolution procedures did not fully provide consumers their rights as required by Regulation E and procedures imposed consumer liability in excess of regulatory limits. Fair Credit Reporting Act Regulation V Section 1022.42 Reasonable written policies and procedures were not established and implemented to ensure the accuracy and integrity of the information that the bank furnished to consumer reporting agencies. Servicemembers Civil Relief Act (SCRA) Sections 207(a)(2) & (3) of SCRA Bank did not forgive interest in excess of 6 percent (as well as reduce corresponding periodic payments) on loans to active-duty servicemembers. Flood Insurance Act Part 339 Section 339.3(a) Adequate flood insurance was not in place when making, increasing, extending, or renewing a designated loan secured by a building, a mobile home, or personal property. Or, adequate flood insurance was not maintained during the term of the loan. Section 339.7(a) Flood insurance was not force placed after the borrower failed to obtain insurance within 45 days of notification of a lapse as required by the regulation. Issues in both this and the section above expose the bank and borrower to losses that would not be covered, which is particularly important given the elevated flood risk in special flood hazard areas. Expedited Funds Availability Act Regulation CC Sections 229.10(c)(1) (vii), 229.12(b), and 229.13(b) Exception and case-by-case check holds were placed on funds from deposits longer than permitted by the regulation.
P a g e 7 Vo Volume 5, Issue 3me 4, Issue 4 Types of Cited Violations Resulting in Consumer Harm (2015-2016) continued This article shares some of the types of violations that the FDIC has identified and that displayed elevated levels of consumer harm, so bank management can consider the information as it manages its compliance program, assesses potential risks, and ensures that it has dedicated appropriate resources to mitigate these areas of risk. In general, to reduce the risk of violations and consumer harm, the Board of Directors and senior management should develop the following: A compliance risk assessment that identifies the potential for consumer harm and is used to allocate compliance management system resources accordingly. Policies, procedures, and training programs designed to ensure that the directors, officers, and employees are familiar with applicable laws and regulations; Monitoring and/or audit programs to ensure compliance with laws and regulations in daily operations; and Mechanisms for detecting and reporting compliance deficiencies and material findings to the Board and senior management, as well as ensuring identified items are corrected promptly with lasting effects. FDIC Division of Depositor and Consumer Protection 1601 Bryan Street, Suite 1410 Dallas, Texas 75201 NOTICE REGARDING NEWSLETTER The purpose of this periodic communication is to provide you with information on matters that affect your consumer protection program. This information is NOT official FDIC guidance or instruction, but should provide you a meaningful summary of items that may impact your institution.