Analysis

Pandemic's Fallout May Include Heightened Fair Lending Risk

By Jon Hill
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Law360 (March 30, 2020, 9:39 PM EDT) -- With the coronavirus pandemic poised to wreak economic havoc on potentially millions of U.S. households in the coming months, the financial services industry could face a new wave of fair lending scrutiny as struggling borrowers fall behind on payments and seek relief on their mortgages.

Financial services attorneys told Law360 that over the next six months, a surge in requests for assistance coupled with a rising tide of defaults may heighten fair lending risks for banks, servicers and other industry participants, attracting attention from regulators and plaintiffs attorneys in the process.

"Concerns about the classes protected under the fair lending laws will become more prominent as the COVID-19 situation continues," said Quyen Truong, a Stroock & Stroock & Lavan LLP partner and former assistant director at the Consumer Financial Protection Bureau.

"When you're talking about potential loan modifications or other forbearance measures, some will raise concern about whether these protected classes are being disadvantaged in some way," Truong added.

Federal law bans intentional discrimination against borrowers on the basis of certain protected characteristics like age, race or sex. It also prohibits unintentional discrimination — that is, practices that don't target any one group but nevertheless have a "disparate impact" on protected classes of borrowers.

These "fair lending" standards apply not only when borrowers are trying to take out loans, but over the entire life cycle of those lending relationships. That means long after origination, decisions about loan modifications, forbearances and even collections and foreclosures can implicate the fair lending laws.

"Under the regulations, you don't have to provide additional assistance to borrowers — you're not required in a normal situation to do fee waivers and things like that," Hunton Andrews Kurth LLP partner Abigail Lyle said. "But if you do start doing that with certain demographics, you have to make sure you do so with all your consumers. If you're only suppressing negative credit reporting for some or if you're only waiving defaults for some, that could raise fair lending issues."

The risks aren't just hypothetical. After the Great Recession, concerns that minority homeowners weren't getting equal access to mortgage modifications and other relief prompted federal and state officials to step up fair lending scrutiny of industry efforts to work with struggling borrowers, resulting in beefed-up exams and even a few enforcement actions.

Linda Finley, a Baker Donelson Bearman Caldwell & Berkowitz PC shareholder and former chair of the firm's consumer financial litigation and compliance group, said the root of the problem often came down to bandwidth: The volume of borrower requests for assistance was just too overwhelming, leading to inconsistencies and oversights in how they were handled.

"It wasn't that the industry was not doing workouts and loan modifications," Finley told Law360. "In some instances, it was just that there wasn't enough manpower for what was happening at the height of the recession."

Given that experience, Finley said the industry has invested heavily in the years since in bettering its communication with borrowers, upgrading information technology systems and improving the efficiency of "loss mitigation" programs, where consumers at risk of foreclosure can seek help.

"The employees of servicers are also much better trained than at the beginning of the Great Recession," Finley added. "As an industry, I think we're much better."

But as part of this effort, Truong said the increased outsourcing of various business functions that has taken place at lenders since the financial crisis merits attention from institutions as a potential new source of fragility, concentrating where the logistical pressures may hit as the COVID-19 pandemic bears down.

"A large part of loan servicing is now done by third parties that focus exclusively or primarily on this work, so they will feel a much stronger impact from a dramatic rise in requests for forbearance," Truong said. "At the same time, you have unique restrictions around travel and social distancing, which could also reduce the available manpower to respond to the sharp increase in forbearance requests that will be coming down the pike."

And according to Richard Lawson, who ran the consumer protection division of the Florida Attorney General's Office at the height of the state's post-crisis mortgage market investigations, the aftermath of the Great Recession has primed officials to be on the lookout for fair lending issues and other potential abuses as borrower assistance requests start to pile up. 

"Those same concerns will be there," said Lawson, who is now a partner at Gardner Brewer Martinez-Monfort PA. "A lot of the various federal and state regulators involved back then are still there, so they're going to be drawing on that experience and watching these people very carefully as they try to work stuff out."

Even though borrowers affected by the COVID-19 crisis are already beginning to contact their lenders and servicers for relief, financial services attorneys told Law360 these fair lending risks may take at least half a year to materialize in the form of investigations and litigation. That's partly because a number of banking regulators have cut back on their exam activity to avoid straining financial institutions' resources while the pandemic rages, disrupting the usual supervisory channels through which fair lending issues might be flagged.

Millions of homeowners' mortgages are also now subject to temporary foreclosure moratoriums, and many state courts across the country have additionally extended deadlines or otherwise delayed foreclosure-related proceedings, giving borrowers and lenders more breathing room to pursue relief options.

Still, attorneys said there are several steps industry players should take now to minimize their fair lending risk in the coming months.

Truong stressed the importance of maintaining engagement with regulators and establishing straightforward, uniform policies for handling borrower relief requests. Although every borrower's circumstances will be different, standardizing the requirements that must be met to obtain a loan modification or other forbearance should reduce the kind of subjective decision-making that can get companies into fair lending trouble.

"Institutions should be more flexible in responding to requests for forbearance, but at the same time, they should ensure that they have clear guidelines for their representatives so that there's even-handed treatment which can be documented," Truong said.

Lyle said that any eligibility requirements included in those guidelines should also be rigorously vetted to avoid potential disparate impact, such as a loan-to-value threshold that winds up shutting out homeowners in lower-income neighborhoods.

"The time is now to take out those policies and procedures and really think about them," Lyle said. "I think institutions are actively looking for ways to try to help their consumers, but they have to make sure that all consumers are getting those opportunities."

Lawson similarly recommended that lenders and servicers review the regulatory settlements reached after the financial crisis, like the multibillion-dollar deal that several major mortgage servicers struck in 2012 with federal and state authorities.

According to Lawson, those agreements can aid compliance by showing where companies have gotten tripped up before and what regulators might target this time around. And while the settlements might not frame that past conduct specifically in fair lending terms, Lawson said problematic practices can be vulnerable to multiple angles of legal attack.

"Have adequate staffing, be very careful about adding fees and surcharges, and have a meaningful consumer appeal process," Lawson said. "Lenders that are doing all of that are going to sail through regulatory inquiries later, if they come at all, but I think they would do very well to take a look at what really bothered the regulators back then and how that was settled."

"Just make sure those things are being taken care of, because the flood will be coming," Lawson added. "Hopefully it's not like 2008, but it's coming."

--Editing by Breda Lund and Emily Kokoll.

For a reprint of this article, please contact reprints@law360.com.

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