UDAP, Fair Lending Issues Causing CRA Downgrades

By Kate Davidson

MAY 8, 2012 4:27pm ET

WASHINGTON – With regulators increasingly cracking down on unfair and deceptive acts or practices, more banks are seeing the heightened scrutiny reflected in lower Community Reinvestment Act ratings.

That trend is likely to increase now that the Consumer Financial Protection Bureau has joined the team, industry observers say. Although the bureau does not have authority to enforce CRA, it has a broad mandate to root out fair lending violations, and plans to coordinate closely with the prudential regulators to ensure those findings are factored into CRA ratings.

“We’ve had a downward trend for a while,” Jo Ann Barefoot, a co-chairman of Treliant Risk Advisors, said of CRA ratings. “But the fact that UDAP is now being brought more proactively into the CRA evaluation process does mean that there will be an increasing impact on CRA by what the bureau does with UDAP.”

Regulators have been handing out harsher CRA ratings since the financial crisis began. While many of those downgrades could arguably be linked to the crisis – with banks focusing more on problem loans than lending in underserved communities – recent results indicate a strong link with UDAP.

Of the 28 banks whose ratings were released by the Office of the Comptroller of the Currency last month, for example, five had their ratings lowered to “Needs to Improve,” and three were downgraded specifically for illegal credit practices or discrimination relating to UDAP and fair lending violations.

The OCC said it found “substantive” violations of the Equal Credit Opportunity Act and Fair Housing Act that represented a “pattern or practice” of discrimination at the First National Bank of St. Louis in Clayton, Mo.

It also found unfair and deceptive acts or practices relating to the overdraft protection program at Woodforest National Bank in The Woodlands, Texas, as well as illegal credit practices in violation of the Federal Trade Commission Act at BankAtlantic in Fort Lauderdale, Fla. (BBX)

The percentage of banks receiving failing CRA ratings – including needs to improve and substantial noncompliance – has increased from 1.7% in 2007, to 4.3% as of March 31, according to data from CRAHandbook.com.

“It’s a combination of regulators getting tougher, but the broadening of the CRA net to include fair lending, UDAP, and other issues has also contributed to the lower ratings,” said Ken Thomas, an independent bank consultant and economist based in Miami.

All of the violations identified by the OCC were uncovered during CRA compliance exams, which occur about every three years.

But with the CFPB regularly supervising large banks for compliance with consumer financial laws, the bureau is likely to soon be the one finding these violations.

Information sharing will be critical, said Ann Jaedicke, a managing director at Promontory Financial Group and a former deputy comptroller for compliance policy at the OCC.

“The prudential regulators may have a finding of their own with respect to illegal credit practices or discrimination,” Jaedicke said, “but because the predominant regulations around those issues have been transferred to the CFPB, the CFPB will actually be doing examinations that would disclose those kinds of illegal credit practices or discrimination.

“There is going to have to be sharing of information so that the prudential regulators can factor the CFPB’s findings into their ratings,” Jaedicke said.

Patrice Ficklin, the CFPB’s assistant director for the Office of Fair Lending and Equal Opportunity, acknowledged the need for cooperation in a panel discussion at a conference of housing advocates in Washington last month.

Ficklin noted that CFPB only inherited two of the four federal fair lending laws: the Equal Credit Opportunity Act and the Home Mortgage Disclosure Act. The prudential regulators will continue to enforce CRA and the Fair Housing Act.

“Because of the split among the four federal fair lending laws, we have a significant obligation and interest in coordinating with our sister regulators,” Ficklin said.

For example, Ficklin said CFPB knows that both the Fair Housing Act and the Equal Credit Opportunity Act govern real estate related lending, and that the bureau’s fair lending exams will factor into CRA ratings.

“So the need for coordination is already recognized and well under way with regard to our interactions . . . with our fellow prudential regulators,” she said.

Because the fair lending issues are so intertwined, industry observers are waiting for more specific information, including clear protocols, on how the bureau intends to cooperate with other regulators.

The agencies have been working on a formal memorandum of understanding, expected to be released in the coming weeks, that would outline such procedures.

Barefoot said the intersection of fair lending issues makes it more likely that banks will be scrutinized, possibly by several different agencies for the same practice.

“One thing I’ve been hearing from the regulators is that a lot of times they get a UDAP issue and explore it, and when they look at who was most impacted by the UDAP issue, it’s a protected class,” she said. “So it’s also a fair lending issue. They refer it to the Justice Department, and in the meantime downgrade the CRA rating.

“It can start in any direction and fill up the whole space – fair lending, CRA and UDAP,” Barefoot added.

That means a higher likelihood of CRA downgrades based on those issues, industry observers agreed. The adverse ratings, of course, would cripple a bank’s ability to make acquisitions or merge with another institution.

“If I were an executive at a financial institution I would be talking with my CRA officer about what he or she thinks the forthcoming CRA rating might be and whether or not they’re concerned about it at all,” Jaedicke said. “The other thing banks can do is make sure they scour their portfolio to capture every possible lending relationship that might qualify for CRA credit.”