Federal fair lending laws prohibit discrimination in credit transactions. The Equal Credit Opportunity Act (“ECOA”) and the Fair Housing Act prohibit discrimination in mortgage lending on the basis of certain factors including race or color, religion, national origin, sex, marital status, age, handicap or an applicant’s receipt of public assistance funds.
The spotlight in this blog post is on the tension between the potential requirements of fair lending laws and the regulatory pressure to originate relatively standardized mortgage products under relatively stringent underwriting guidelines. To the extent that tighter lending policies and a menu of plain vanilla mortgage products restrict access to credit in a way that disproportionately affects a protected class of borrowers, an increase in the number of disparate impact challenges by regulators and the Department of Justice (the “DOJ”) may result -- regardless of intent to discriminate and regardless of whether lending policies appear neutral on their face. Disparate impact theory may also be a basis for liability under the Fair Housing Act and the ECOA.
Still pending are regulations that could likely have the consequence of restricting credit, such as the Consumer Financial Protection Bureau’s (the “CFPB”) ability-to-repay regulations incorporating the “Qualified Mortgage” (“QM”) standard which we have written about frequently including here and here as well as the interagency “Qualified Residential Mortgage” (“QRM”) exception to the risk retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) which we have also written about here and here. In addition, revised capital rules may mean that holding mortgage loans other than what regulators deem low-risk mortgage loans will trigger increased capital requirements for certain financial institutions. These developments may significantly reduce lender interest in originating non-traditional loans, which, in turn, may trigger disparate impact claims. Fitch Ratings said last week that “nontraditional mortgages, viewed as high risk by regulators, may be effectively eliminated from broad availability at regulated banks.”
This topic was just addressed in a Webinar presented by Dechert partners Ralph Mazzeo, Bob Ledig, Tom Vartanian and Ben Rosenberg titled “Living With the Consumer Financial Protection Bureau.” Nearly 200 people registered for the Webinar that covered such topics as: Understanding the CFPB: rulemaking vs. enforcement; Who does the CFPB have jurisdiction over?; CFPB and the mortgage industry; CFPB and fair lending; and CFPB enforcement considerations, including relationships with state attorneys general.
A quick tutorial on three theories of liability related to discrimination in lending:
1. Liability for overt discrimination in lending exists when a lender overtly discriminates on a prohibited basis (e.g., lender offers potential borrowers Mortgage Products X, Y and Z but offers a protected class of borrowers only Mortgage Product Y).
2. Disparate treatment liability results when a lender treats a minority applicant differently than a similarly situated majority applicant (e.g., lender denies or charges minority applicants more for mortgage products than similarly situated majority applicants).
3. Disparate impact liability can be triggered when a seemingly facially neutral policy or practice that is applied equally to all applicants disproportionately excludes or burdens certain persons on a prohibited basis (e.g., lender requires applicants to meet certain loan qualification criteria such as a minimum downpayment).
The law on disparate impact as it applies to lending discrimination is subject to continuing dispute and may ultimately require a Supreme Court ruling. What we know is that, under the view of federal regulators, evidence of discriminatory intent is not necessary to establish that a lender’s policy or practice that has a disparate impact is in violation of the Fair Housing Act or the ECOA. And we know that a policy or practice that has a disparate impact is not, by itself, proof of a violation because such policy or practice may be justified by “business necessity.” However, even with a business necessity justification, such policy or practice may still be a violation if some alternative policy or practice could serve the same purpose with less of a discriminatory effect.
This month, the DOJ settled with Luther Burbank Savings (“Burbank”) to resolve discrimination claims under the Fair Housing Act and ECOA after the DOJ alleged that Burbank’s minimum loan amount (generally $400,000) for single-family residential mortgage loans had a disparate impact on African-American and Hispanic borrowers that was not justified by business necessity. Such settlements are not binding court precedent but they certainly have an effect on the policies of lending institutions. Another effect of such settlements may be that regulators and the CFPB may be more inclined to pursue disparate impact fair lending claims. See the recent “U.S. Department of Justice Turns Spotlight on Disparate Impact Discrimination Claims.”
Government actions that encourage or mandate restrictive lending standards have the potential to have a disparate impact on certain minority borrowers. Regulators may have to reconcile competing directives to lenders to maintain strict credit standards while avoiding or limiting policies that have a disparate impact. Institutions may find themselves in a difficult position between these two government objectives.
Lenders should carefully review their business justifications for lending policies that may have a disparate impact and consider whether there are acceptable alternatives that could have less of a disparate impact.