What Regulators Will Target Next

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WASHINGTON — Regulators recently offered a rare behind-the-scenes glimpse of what areas they are targeting for enforcement, saying that potential fair lending violations and how mortgages are priced and serviced remain top priorities for the future.

Speaking at a mortgage conference last week, top enforcement officials from the Department of Justice, Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency said they have ramped up investigations of the mortgage space.

Several attendees said they expected that the agencies will focus on fair lending scrutiny of their portfolios, but were still struck by certain regulators' sometimes aggressive tone.

"We do not regulate you. We do not supervise you. We do sue you," said Steven Rosenbaum, chief of housing and civil enforcement in the DOJ's Civil Rights Division.

Following is an account of what each agency is targeting — and the impact that could have on lenders:

Justice's Stark Warning on Fair Lending
The DOJ's Rosenbaum listed two areas of concern for the department, both related to fair lending: when lenders "redline" minority communities regardless of whether it was unintentional, and when lenders use price discretion on mortgages to attract investors.

"One of the things that has always been a mainstay in our work is concerns about redlining; concerns about banks not opening services in minority communities on the same basis which they are in other parts and services in white communities," Rosenbaum said at a Mortgage Bankers Association panel discussion. "We have seen an uptick in referrals of redlining issues."

Some observers said such a comment is telling.

"When Rosenbaum says 'we're seeing an uptick,' that's a message to me to say that more referrals are coming over [from other agencies] and therefore, more instances of this are likely happening," said Ed Kramer, executive vice president of U.S. regulatory affairs at Wolters Kluwer Financial Services.

Rosenbaum also noted that the way the Justice Department examines for redlining cases goes beyond just confirming compliance with the Community Reinvestment Act. In such an exam, investigators compare where banks do business, what products they're offering, to whom and the pricing of those products and services within the communities.

But Rosenbaum said banks also "need to be mindful" that the Justice Department is comparing those areas of a bank to their peer lenders in that community.

Kramer said banks need to be on guard.

It's "hard to find any banker intentionally redlining an area but if you don't monitor all of your areas … you're not going to able to know whether you have the potential" for being accused of redlining, he said. "But the regulators will make it clear for you if you don't intentionally check it yourself."

Rosenbaum also warned against lenders seeking higher profit margins by pricing a loan based on what the investor wants in order to buy the loan, which can lead to potential fair lending violations under the Equal Credit Opportunity Act.

Lenders "look at what investors will pay for the loan and they tell their loan officers or particular offices what their goals are in terms of pricing above or what the investor will pay," Rosenbaum said. "This introduces discretion in the pricing of loans … discretion is neither required by ECOA nor prohibited by ECOA but if your pricing is based on discretion, you have fair lending risk that needs to be managed."

Overall, Rosenbaum said he's noticed that regulators have ramped up their cooperation and referrals to the Justice Department. In the last three fiscal years, the department has received 55 referrals from other agencies, of which 24 were in the mortgage area.

"The number and ratio of mortgage referrals has increased for us in the last three years and" the office is projecting "that it will continue," Rosenbaum said, noting that they "work really closely" with the CFPB.

The CFPB Is Targeting Mortgage Servicers
Peggy Twohig, the CFPB's assistant director of supervision policy, also discussed how her agency decides to use its roughly 400 examiners to police its jurisdiction, which includes thousands of nonbanks and the largest banks.

"We have quite the challenge with this reach and number," Twohig said. So examiners "focus on our evaluation of where the greatest risks are to consumers."

Rather than examine based on each entity, Twohig said the CFPB has taken an "across markets" approach where it stacks product markets against each other and evaluates each market based on size and risk to consumers to determine what companies to examine.

Kristen Donoghue, the CFPB's acting deputy enforcement director of policy and strategy, added that when her department assesses a company for potential violations they start with the number of victims, then the size of individual harm leading to the size of overall harm.

Once the CFPB has particular company under review, it then looks at the product size within the institution and any data — including consumer complaints — based on the product the company heavily uses.

"For example, mortgage servicers have a relatively higher amount of servicing default portfolios," Twohig said. "That would be higher in our risk factors."

Twohig's comments on Sept. 29 were timely considering that hours later, the CFPB announced its first enforcement action using its new mortgage servicing rules against Flagstar Bank in Troy, Mich. The $9.9 billion-asset bank was cited for blocking struggling borrowers from getting modifications and agreed to pay $37.5 million in remediation to consumers and penalties.

The CFPB also made an unprecedented move by banning the servicer from obtaining servicing rights on default loan portfolios until it could prove it was in compliance with the mortgage rules that took effect in January. Additionally, the CFPB cited Flagstar on the new mortgage servicing rules for loans dating back to 2011, under the premise that the bank also allegedly violated the Unfair and Deceptive Acts and Practices Act.

"I took great interest in the mortgage servicing comments in light of the Flagstar consent order that came out afterward," said Steven Burt, an attorney at Ballard Spahr specializing in consumer financial services litigation and regulatory issues. "Flagstar is a shot across the bow to the industry; these are the standards, this is what is expected of you, and even though the mortgage servicing rules didn't go into effect until January 2014, certain practices that predate the rules may still be scrutinized as potential violations under UDAAP."

Twohig said during the conference that the agency is keenly focused on how servicers are modifying loans for struggling borrowers regardless of whether that process started before the new servicing rules.

Mortgage servicing "has been a top priority for the CFPB well before we had the rules in mortgage servicing," she said. "We have findings that predate the rules and we will continue to report our findings as we continue our supervisory program."

OCC Now Stepping Into Mortgage Mods
The OCC has also begun taking an interest in mortgage modifications, particularly in potential discrimination among minorities who may not have received a modification as a similarly situated white borrower.

Grovetta Gardineer, the OCC's Deputy Comptroller of Compliance Policy, said the agency has begun to recognize that servicers, regardless of the asset size, have set up "strong internal controls" on home retention at the front-end during the application and underwriting process, but they are lacking in the back-end.

"What we have seen is that they don't necessarily have the policies and procedures and appropriate internal controls for the back-end of that transaction where these modifications really come into play or the loss mitigation efforts," Gardineer said. "And that can actually introduce some fair lending concerns that we want to make sure that our supervised institutions are aware of."

Gardineer emphasized that banks need to show regulators that they have internal controls in place for the "life cycle" of the mortgage in order to avoid potential discrimination, even if it was unintentional.

"So many times what we'll see is a bank could inadvertently create a situation where they are engaging in some discriminatory activity by offering one borrower a term or modification that is not consistent with a minority borrower that is similarly situated," Gardineer said. "It's important that before any kind of product [release] — and mortgages in particular — where you have this level of litigation or potential discriminatory activity that a bank focus on what those criteria are and how to apply it so there is not the potential to offer more favorable terms to one class of borrowers as oppose to another."

The OCC has become increasingly concerned with modifications because of the vast amount of mortgages that were placed into a home retention program since the beginning of 2008, when the OCC started tracking it through its Mortgage Metrics report. As of the latest report, more than 3.5 million modifications have been implemented by largest servicers from January 2008 through March 31, 2014.

"The mortgage industry took the bulk of the blame for the financial crisis and one of the most significant fixes that came out of that was the modification program to help people stay in their homes," Burt said. "To the extent that regulators still perceive the mortgage industry as something that could have detrimental effect on the economy, it makes sense that they would focus home retention efforts… So the stakes are high on modifications and the potential for consumer harm is significant."

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