DAVID HADLOCK
‘Tug-of-war dynamics’

For years, banks have undergone fair lending exams in Massachusetts, while mortgage companies did not. But due to a recent change in state law, non-depository institutions are now subject to fair lending exams and within the last few months, regulators have started their review of Bay State lenders.

The Massachusetts Division of Banks issued a letter and fair lending policy in mid-May to all licensed mortgage lenders in the state. The correspondence offered guidance to assist the lenders in understanding the new fair lending exam process and explained what regulators will expect.

“As part of the fair lending examination process, the licensed mortgage lenders’ underwriting policies, practices, standards and procedures will be reviewed,” the letter stated. “Internal controls and procedures for compliance with fair lending laws and regulations will also be evaluated.”

David Cotney, senior deputy commissioner of the Division of Banks, said the exams began this summer, but added he couldn’t comment on violations.

“It is premature to talk about violations,” said Cotney.

According to the Division of Bank’s letter, examiners will interview mortgage originators and other personnel to determine if consumers are treated in a “fair and equitable manner.”

“These interviews will also assist in determining if the credit application process is in compliance with applicable laws and regulations,” the letter said. “Examiners will also note any potential high-risk areas or weaknesses of the licensed mortgage lender.”

Also subject to review will be lenders’ training policies, materials and compensation for employees or agents.

The fair lending exam became law after “An Act Prohibiting Certain Practices in Home Mortgage Lending” was enacted in 2004. The act calls for the review of licensed mortgage lenders’ compliance with fair lending laws, which include, but aren’t limited to, the federal Equal Credit Opportunity Act, Home Mortgage Disclosure Act and Massachusetts Predatory Home Loan Practices Act. The exam is required for all lenders that have made 50 or more loans in the last calendar year.

The correspondence also stated regulators will assess the lenders’ advertising and marketing practices, among other things.

“The loan file review will analyze underwriting practices, as well as factors involved with loan pricing, credit scoring and loan terms and conditions,” the letter said. “The examiners may conduct side-by-side file reviews, which will encompass originated loans and denied applications, as well as foreclosure activity and exceptions to policy.”

James Dougherty, executive director of the Massachusetts Mortgage Association, said the association is taking a wait-and-see approach to fair lending exams and will be gathering feedback from members who go through the process.

“It’s just one more piece of the puzzle,” Dougherty said.

He added that it is hard to determine what the exams will turn up, but said the MMA is hopeful the new procedures are implemented smoothly and supports the law’s intent.

David Hadlock, counsel to the MMA, said one of the most interesting things to watch for is the exam’s impact on loan officers’ authority.

“One of the tug-of-war dynamics Â… is most mortgage companies have a situation where the loan officer has a very, very, very wide latitude on setting pricing on a loan-by-loan basis,” Hadlock said.

At most mortgage companies, the loan officer has the ability to negotiate rates for each customer.

“In some ways, there’s nothing wrong with that,” Hadlock said.

But when looking at the practice from a fair lending perspective, Hadlock said it might be conducive to discrimination.

On the other hand, if a mortgage company takes a loan officer’s authority away, Hadlock said those employees could “jump ship” and move to a company where they have more latitude and authority. Those two factors will become important for both company management and regulators to consider, he said.

Policies and Procedures
Hadlock also said the new exam is going to force lenders to shake some old habits.

“Some of the primary issues the industry faces is that written policies and procedures are not necessarily mandated and in place historically at mortgage companies,” said Hadlock.

The fair lending exam will require companies to show proof of a written company policy, but Hadlock said very few companies have something in writing. One problem, he said, is that many companies won’t have the appropriate pre-exam documents to send to regulators. A company policy on pricing and employee compensation doesn’t always exist in document form, especially at small companies.

“All companies have policies and procedures, but few have reduced it to writing,” he said.

When companies do eventually put their policies in writing, Hadlock warns that some will realize their procedures are not as well-defined as previously thought.

One mistake that has been made is going online or calling a friend to obtain a company policy. Hadlock advises against that because the policy isn’t company-specific.

Once a mortgage lender has overcome the written policy and procedure hurdle, there is still more to contend with. The interview and visitation aspect of the regulatory exam may be difficult to accept for long-time industry professionals. In the past, Hadlock said, company management would have more of a choice in determining which employees would interface with regulators. With the new law, regulators will be able to interview the back-office employees of a mortgage firm to verify employees are well-versed in the company’s policies and procedures.

For small to medium-sized companies, Hadlock said that could be an obstacle. Many smaller companies don’t have the resources to provide training to assure all their employees, even those who do not interface with the public – have digested its policies and procedures.

Although the Division of Banks isn’t likely to expect the same things from a small company as it would from a large firm, Hadlock said it is crucial that all companies have appropriate policies and training in place.

“It gets more to the issue of do you have the culture and environment that is more conducive to anti-discrimination as your result?” Hadlock said.

Home Mortgage Disclosure Act data will also be a significant factor in examinations, which could come as a surprise to some companies.

“For lending examinations, it hasn’t been a rule historically that data the [Division of Banks] will look for Â… is HMDA reporting,” Hadlock said.

There may be companies who never thought they needed to report HMDA data, but should have and vice versa, Hadlock noted. The new exam process will take note of those things that may have flown under the radar before.

In the past, unless the Division of Banks had a case-specific scenario, Hadlock said HMDA data typically was evaluated by the federal agencies, instead of the state.

According to the Division of Banks May letter, the fair lending exams will take place in conjunction with the agency’s regularly scheduled exams and inspections for compliance with federal and state consumer protection laws.