Fair Lending Compliance in the Midst of Mortgage M&A

Today’s high interest rates and historically low levels of housing availability create a difficult business environment for residential mortgage lenders. This is especially true for non-bank lenders that lack the larger balance sheets and diversified revenue channels of their bank competitors.

Prolonged stress may lead mortgage lenders to consider strategic transactions, whether to raise capital, sell to a strategic buyer, or acquire a distressed competitor. When evaluating these opportunities, lenders should be aware that fair lending scrutiny is rising. They should carefully consider risk profiles of the target and combined institution to minimize post-transaction compliance issues.

Access Priorities

The Biden administration’s position is that federal government “has a critical role to play in overcoming and redressing this history of discrimination and in protecting against other forms of discrimination by applying and enforcing Federal civil rights and fair housing laws.”

Federal agencies with fair lending enforcement authority have been aggressively following this policy directive, including those responsible for supervising mortgage lenders’ compliance.

The Department of Justice “vigorously enforces federal fair lending laws to protect equal access to credit,” and recent enforcement trends confirm that non-banks face multiple areas of heightened fair lending risk.

Perhaps most significantly, in 2021, Attorney General Merrick Garland launched a DOJ initiative to combat redlining—or failing to make credit available in minority communities—in partnership with the Consumer Financial Protection Bureau and other agencies.

The DOJ announced it would expand investigations of “potential redlining to both depository and non-depository institutions,” and made public a consent order resolving redlining allegations against a non-bank—the first of its kind.

Since then, mortgage lenders responsible for complying with fair lending laws have been notified that they must effectively monitor and manage redlining risk to ensure credit is made available in both minority and non-minority communities.

Property valuations are another increased fair lending risk area. In 2021, the Biden administration initiated a task force to combat bias in home valuations. The DOJ made its position clear in a statement of interest it filed in lawsuit brought by individual plaintiffs.

In Connolly v. Lanham, an online mortgage lender allegedly violated fair lending laws by relying on an appraisal conducted by an appraiser who supposedly lowered the home valuation because of the homeowners’ race. The DOJ argued it is illegal for a mortgage lender to rely on an appraisal it knows or should know is discriminatory.

The CFPB most recently reported to Congress that it “focused much of its fair lending supervision efforts on mortgage origination” issues. Such issues include redlining, potential discrimination in underwriting and pricing, steering applicants on a prohibited basis, and integrity of demographic data reported by lenders under the Home Mortgage Disclosure Act.

Fair Lending

Current economic conditions present increased merger and acquisition opportunities for mortgage lenders. With this in mind, lenders must take a proactive approach when assessing fair lending risk. Every buyer of a mortgage lender should prepare to confront increased risk around fair lending in the post-transaction phase as well.

It’s critical to assess the target mortgage lender’s system of managing compliance around fair lending, as the surviving entity will inherit the target’s fair lending problems, if there are any. Such assessments can help identify potential compliance management system weaknesses and enable the surviving mortgage lender to prepare an action plan ahead of the transaction.

Common post-acquisition enhancements to fair lending programs include fair lending training, modifying fair lending policies, implementing statistical fair lending monitoring of underwriting, pricing, product steering, and minority-area lending, and reporting risk to the board.

Best practices also include evaluating any new service area or market areas where the target lender operates, ensuring the acquiring institution can continue serving credit needs of minority and non-minority communities within those areas. Buyers should consider the target lender’s product offerings, loan officers, and physical locations from a fair lending perspective.

They also should ensure the fair lending impacts of any contemplated post-closing discontinuations of products or services, or closures of brick-and-mortar locations, are thoroughly evaluated and documented.

Comprehensive due diligence may include reviewing the target lender’s fair lending monitoring reports on underwriting, pricing, and geographical distribution of mortgage loans. This step can help evaluate trends and anticipate possible adverse impacts on the surviving lender.

When negotiating an acquisition, buyers should seek to negotiate protections into their transaction documents—against fair lending-related issues that might arise between signing and closing, or liabilities that might arise after closing.

Being thoughtful about issues—such as conditions to the buyer’s obligation to close, how and when the purchase price is payable and released, and seller indemnities for post-closing liabilities—can significantly mitigate these risks to a buyer.

Ideally, the buyer’s position on these issues will be informed by comprehensive due diligence on the fair lending risks associated with the target’s existing business, and the anticipated combined organization’s post-closing business plan.

The stress many mortgage lenders are facing in the current environment creates opportunities for strategic investors, opportunistic buyers, and sellers looking for an exit.

When evaluating and negotiating their deals, parties need to bear in mind that fair lending is a government policy priority, and risk is therefore heightened. This risk can be mitigated by careful consideration of fair lending issues during due diligence and proper structuring of the transaction.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.


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