United States: Resurgence Of Redlining Scrutiny

The regulatory agencies as well as the Department of Justice have been signaling for some time their interest in redlining. Redlining, of course, is the practice of avoiding lending in certain areas based on racial composition and is a violation of both the ECOA and the FHA. Although it may be difficult to imagine in an economy such as ours which is struggling to recover, any lending institution avoiding making loans, the absence of lending in sensitive geographies (i.e. minority census tracts) absent of sufficient explanations may be all that is required to peak an examiner's interest and draw at least a tentative conclusion concerning the bank's lending practices.

An important point to bear in mind is the current quantitative nature of fair lending reviews. Although more subjective reviews such as file comparisons are still routinely done by examiners, in today's environment fair lending reviews of any real significance likely will take on elements of statistically-based analyses. This data-driven approach began with the CRA changes that were implemented in 1996-1997 and has now engulfed the entire fair lending arena. Redlining is no exception, and increasingly regulatory examinations appear to rely on "patterns of statistically significant disparities". This presents a particular challenge for banks in the case of redlining accusations due to problems with measurement and also availability of information. For example, if during a review examiners note statistically significant deficiencies in lending penetration with respect to minority geographies, there are obviously many factors that could influence the geographic lending distribution; but these are sometimes difficult to identify and even more difficult to quantify.

The entire concept of redlining is somewhat subjective. 1 CRA regulations are no help in this regard as the evaluation guidelines call for "reasonable" penetration throughout the bank's assessment area. We also see references concerning redlining and CRA that refer to "conspicuous gaps" in lending patterns where there is a racial component involved. These are subjective concepts, and any bank's lending distribution has to be viewed through a set of qualifiers such as branch network, product offerings, business focus, competition, and loan demand. Such qualifiers are difficult to quantify, however, and it can be even a greater challenge to obtain data. Although we cannot cover all these issues in this article, below we summarize a few of the key pressure points and what can be done to address them.

First, if your bank is a HMDA and/or CRA reporter, you must evaluate across your footprint what your lending data looks like geographically compared to aggregate, publicly available lending

data.2 This should be evaluated based on all aggregate data as well as a set of "peers" that the bank would consider comparable. The Federal Reserve has also adopted an alternative comparison called the "adjusted aggregate" which consists of all lenders in respective market areas that have a HMDA market share between 50% and 200% of the institution being evaluated. Further, from this group lenders would be excluded that have a rate spread incidence of greater than 25%.3 Such evaluations should involve some statistical tests to determine if any differences noted are statistically significant. If there are disparities noted with respect to geographies with greater than 50% minority composition, then explanations should be developed; and, if applicable, marketing efforts should be conducted to enhance penetration in these areas as needed.

Secondly, a bank should examine its assessment area delineation and make sure that any exclusion of minority tracts is sensical and justified. The surrounding areas should be considered even if there are minority tracts located in an adjacent jurisdiction outside of the assessment area. This is especially important if there is lending activity outside of the assessment area in non-minority tracts while minority tracts within the assessment area reflect little or no penetration. Bear in mind as well, that we are now operating under 2010 census figures and demographic and tract configurations may have changed in some of your assessment areas. If a review has not been done using the new census definitions, it is something that should be done as soon as possible.

Finally, the bank should examine all lending activity throughout the assessment area with a focus on minority-majority census tracts. Attention should be paid to minority tracts where there is no activity or where penetration is sparse

relative to other areas. The bank should know these areas; and if factors such as competition or loan demand impairs lending for the bank, this should be documented and quantified as possible.

Note that in some areas, there may be concentrations of more than one minority group. For example, it could be the case that there are tracts where the combined minority percentage (all minority groups) exceeds 50%, but there may be others where one particular minority group comprises over 50%. Just as a hypothetical example: if there were 20 census tracts in the assessment area that were greater than 50% minority but out of these 10 of the tracts were over 50% Hispanic, regulators could choose to focus on just the 10 tracts and the one minority group as opposed to minority population overall. If your bank is located in markets that have this degree of diversity, then these must be analyzed separately to truly evaluate potential risk.

Managing these issues requires a holistic approach that encompasses the entire mission and operation of the bank. Fair lending issues in particular and compliance issues in general are no longer just the job of the bank's compliance department. Evaluation and analysis are a starting point; but as these analyses raise questions, these questions must be answered by management and lending staff. Further, any unexplained deficiencies must be addressed as well, which will likely include management's support as well as marketing and advertising efforts. To coordinate these effectively, it is best done through a Board/CRA Fair Lending Committee; and it should be done on an ongoing basis.

As a closing point, the importance of the enhanced HMDA/CRA reporting on the horizon cannot be overstated. There will soon be a tremendous amount of the bank's data publicly available for access by regulators but also various special interest groups. There seems to be a renewed effort by such groups to take a more active role in the regulatory process, and the new HMDA and CRA reporting requirements will provide them with a vast amount of data which can be used to critique financial institutions. If it has not been done already, it seems wise to get a head start and begin examining or having your data examined sooner rather than later.

Footnotes

1 Although subjective, there is some indication that the agencies and the Department of Justice may be adopting a statistically derived template to identify lending patterns they would consider "redlining."

2 Criteria and discussion available online at: http://www.philadelphiafed.org/bank-resources/publications/consumer-compliance-outlook/2013/second-quarter/fair-lending-webinar.cfm

3 HMDA and CRA data are available on FFIEC.gov.

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