ABA Bank Compliance - November/December 2007 - (Page 4) lenders under greater scrutiny than they may face at the state and local levels. Whether or not such legislation passes, lenders should expect regulatory inspection of their anti-predatory lending practices to increase in 2008. Before any audits or subpoenas arrive, banks should be fully prepared to explain their past decisions, defend their policies, and show they are taking proactive steps to eliminate any programs that could be reasonably construed as outside borrowers’ best interests. Given this challenging environment, lenders may be tempted to drastically rethink their policies, and a pragmatic review of priorities may be in order. However, it’s important to remember that because many subprime borrowers are concentrated in lower income areas, an abandonment of subprime loans would very likely put the lender at odds with CRA regulations, which basically require that high-income borrowers aren’t the only ones with access to credit. Since the October 4, 2006, issuance of the final regulatory guidance on nontraditional mortgage products, many lenders have assumed a more hands-on approach. These lenders are seeking ways to educate their customers about the features and terms of interest-only adjustable rate mortgages (ARMs) and payment option ARMs. Additional steps are available to address this recent federal guidance and better inform borrowers about the features and terms of these products. Lenders can institute internal controls and employ available technology that will help detect the features in many loan products that can ultimately lead to borrowers’ defaulting on their loans. These actions will reduce the number of defaults, helping to protect consumers from assuming too much debt. At the same time, lenders should improve the quality of their loan portfolios, a healthy practice regardless of the business environment. Monitoring high-cost loans, as well as monitoring mortgage brokers conducting business in multiple states, could be a management nightmare for institutions. However, compliance systems can automate the process to make it seamless. Because many problematic subprime loans are coming from less-regulated, independent mortgage brokers, traditional banks and mortgage banks that fund those loans should carefully monitor these brokers. Lenders should ■ assess each borrower’s ability to repay by checking for high-cost interest rate limits based on the fully indexed mortgage rate, not the introductory qualifying rate ■ assess the benefit of refinance loans for the borrower (this is now required by at least nine states) by comparing the characteristics of the old loan to the new loan ■ independently recalculate APR during each high-cost analysis (fully amortize “exotic” loan products) ■ check for prepayment penalties, and verify that if they exist, they comply with individual state limits ■ identify high-cost loans and check for truth-in-lending violations prior to closing ■ verify the state licensing status of loan brokers These loans reached $50 billion in 2006. But with such a big number comes big risk. Lenders are putting much of this lending in the hands of auto dealers who employ auto finance specialists, allowing these specialists great discretion in their dealer markups. Although it is usually a small subsection of auto dealers who expose the bank to fair lending risk, it only takes one or two dealers to expose a lender to significant financial and legal jeopardy. At first blush, auto dealers are an ideal target for class-action lawsuits. However, dealers don’t have pockets as deep as lenders financing auto loans. Captive auto finance companies, banks, and other auto lenders have become prime targets for class action lawsuits and even criminal prosecution. Banks with auto dealer relationships should carefully monitor the loans these third-party lenders make. Unfortunately, this is not always the case. Auto finance specialists do not always adhere to fair lending regulations, exposing financial institutions to risk, both regulatory and reputational. Because dealers don’t have fair lending systems in place to monitor these loan originations, the banks doing business through auto dealers should. Such systems should include robust technology to monitor these loans from both the front and back ends of the auto-lending process. Auto lenders must find avenues to prove to federal regulators, the Department of Justice, state district attorneys, class action judges and juries, and activist groups that their institutions are proactively monitoring dealers. The goal is to ensure there is no disparate treatment of or impact on protected classes. Lenders must identify those dealers who are causing the risk and take steps (education, controls, and, if necessary, termination of the relationship) to prevent future problems. Management and executives responsible for fair lending must have full transparency into the behavior of their auto dealers from a high-level aggregate risk assessment all the way down to the individual dealers and the paper they bring to be funded. Summary In the face of a seemingly endless array of regulatory hurdles, financial institutions that proactively adopt best practices will be in a strong position to address current and future compliance challenges. These banks will be well prepared to work with regulators and remain in compliance. Adopting best practices that help prepare for the regulators will minimize both reputational risk and regulatory risk. Doing so will enable institutions to better focus on meeting business goals BC and serving their communities. Ab ou t the Au thor Edward B. Kramer is executive vice president–regulatory programs for Wolters Kluwer Financial Services’ line of PCi compliance analytics solutions. Wolters Kluwer provides compliance, content, and technology solutions and services that help financial organizations manage risk and improve efficiency and effectiveness across their enterprises. Reach Mr. Kramer at edward.kramer@wolterskluwer.com. Indirect Auto Lending: Tighter Control Over Third-Party Relationships Indirect lending, such as for auto loans, can be big business for banks. Posted with permission of ABA Bank Compliance Magazine, 1120 Connecticut Avenue NW, Washington DC. (202) 663-5378. Copyrighted © 2007. #1-22681745 Managed by The YGS Group, 717.399.1900. To request a quote online, visit www.theygsgroup.com. www.theygsgroup.com
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