Special Treatment for Commercial Customers — Fair Lending Concern or No?

Article by: Ben Giumarra, Spillane Consulting Associates, Inc.

Some thoughts on what can be–but probably shouldn’t be–a sticky situation. 

It makes you cringe … your bank’s best commercial client comes in for a personal mortgage loan and they want special treatment — a better rate, closing cost rebate, etc. “Do you know who I am???”

But having just returned from your annual fair lending training, you’re concerned that this runs afoul of fair lending regulations and preferential treatment will lead to trouble. “I’m sorry Mr. Commercial Borrower, I know your business has millions in deposits and several large commercial loans wutg , but I can’t give you a residential mortgage rate at 3.125 because today’s prevailing rates are 3.25. I’m really sorry.”

Short Answer

Yes, this can be a fair lending concern. It’s not something to ignore. But – and I’m not saying this makes sense for everyone – depending on how bad you want to, there can be some flexibility here for commercial customers.

Fair Lending Refresh

Drastically oversimplified – fair lending means you can’t treat any borrower (or prospective borrower) differently. More specifically, there are certain discriminatory factors that cannot have an impact on your lending practices: age, ethnicity, gender, etc. etc.

But this doesn’t just simply prohibit blatant discrimination – that’s only one of three prohibited items:

1. Overt Discrimination

A lender blatantly discriminates, e.g., intentional policy decision to combine debt-to-income for married borrowers while calculating separate debt-to-income for non-married co-applicants.

2. Disparate Treatment

A neutral policy is applied unevenly, e.g. Lender adopts a non-QM policy but makes exceptions for men more frequently than for women.

3. Disparate Impact

A neutral policy is applied evenly, but nonetheless the end result has a discriminatory impact. This practice can be justified by business necessity if the lender can show there’s no reasonable alternative available that doesn’t have such a discriminatory impact. The classic example of disparate impact is having a minimum loan amount–not doing loans for anything less than say $100,000. If more minorities are denied credit based on this policy (which is applied evenly and appears neutral on its face), the lender will have to demonstrate a business necessity and no alternative. Here- the business necessity might be that the lender makes no profit on loans under $100,000. While that’s a good start- the argument fails because there is a reasonable alternative that has a less discriminatory impact– simply charge higher fees on loans under $100,000 rather than shutting off lending completely.

*This third type of fair lending violation has always been the most controversial, but the CFPB has done nothing but support this. P.S. for anyone build a fair lending training, here’s a simple but good FDIC powerpoint to start from.

Flexibility with Commercial Customers

So the simple approach with the scenario above is to refuse to give the commercial customer special treatment. That’s the safest approach in terms of fair lending risk.

But if customer experience for certain commercial customers is that important to you, and you’re willing to put in extra work, you can safely provide some special treatment to commercial customers.

The “extra” work comes from the fact that providing special treatment on a case-by-case basis just isn’t safe — that’s where the fair lending risks comes in.  Here are the two things you’ll have to do well to Here’s the “extra” work.

#1 – Careful documenting the file

Denying a loan to someone with a sub-600 FICO score isn’t discrimination, no matter what race, gender, or age they happen to be. But in that case it’s clear why the decision is being made. When you provide a commercial customer with special treatment, best practice would be to document the file to make it just as clear. In other words, the exception is being made because of the commercial relationship (a completely legitimate and non-discriminatory factor) and not because of their race, ethnicity, etc. But silence on this won’t be your friend if this comes up down the road.

#2 – Careful to provide same “special” treatment to everyone similarly situated

If you discount the standard mortgage rate by 1/8th for one customer, documenting the exception in the loan file as the existence of “significant commercial accounts, long-term customer” — well, just make sure that other mortgage borrowers who also have commercial accounts get a discount too. Or, I suppose, you could just hope that over the course of the year no discriminatory trends accidentally appear (not recommended).

In Conclusion

You can see how these two steps add work: policies, training, extra effort documenting the loan and monitoring for this. So it’s completely an institution-specific decision. Just putting out there the possibility — this isn’t any different from discounting loans for employees, or for providing a closing cost rebate for borrowers who open a checking account. Really the same analysis. This comes down to how hard you want to work to make this happen safely. A case-by-case free-wheeling approach is trouble. But you can push the boundaries in the name of customer service if you take the extra effort.

In Other News

  • Fair Lending still making headlines in Massachusetts (subscription required): Article by B&T
  • Try to steal Massachusetts’ women’s car – get sprayed with gasoline? I would expect no less!
  • TESLA valued more than Ford??? (Yes, but over the last 5 years Ford has netted over $20 billion where TESLA has lost $2.3 … it’s all about how you crunch the numbers!)

On My Mind …

What’s a community institution’s moral obligation to its local neighborhoods and people? What distinguishes a community institution from Wells Fargo? Thought this was addressed very well in this case study on The Bank of Prairie Village … will make all those community-oriented institutions feel warm and fuzzy, I think.

Two highlights, but plenty more in the full article:

  • Most notably, there are cultural distinctions between the megabanks and community banks. A community bank is not a faceless corporation. It is an institution rooted deeply in the community. The Board of Directors usually comprises of local business leaders, not the wealthiest men and women of America. “If it fails, it’s not a shareholder write-off. It’s a family. The family and the community. I’ve got to make my community survive,” remarks Bolen. The bank and the people of the community are engaged in a symbiotic relationship.
  • Bolen argues the personal nature of community banks inherently makes them more ethically run: “It’s easier to be ethical when every day you’re tied to it. I have to look every one of them [clients] in the eye. They come in with their kids or grandmother. There is almost a built in check and balance.” Due to their symbiosis with the community in which they operate, community bankers are incentivized to make lending and investment decisions that are in line with the long-term best interests of the community and its members. If a community banker behaves unethically, he or she faces backlash from her friends and neighbors and suffers “reputational risk”.

“Let the future tell the truth, and evaluate each one according to his work and accomplishments. The present is theirs; the future, for which I have really worked, is mine.”

– Nikola Tesla

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Thank you to Ben Giumarra, Spillane Consulting Associates, Inc., a member of our Education Committee, who with the support of other experts at SCA have put together this newsletter.  

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