As we move out of the holiday season and prepare for the new year, we wanted to take a moment and remind you of (4) HIGHLY critical issues at our doorsteps affecting lending compliance. We provide a brief summary of each of these with associated Action Items.
Evaluation of the Impact of 2020 Census Changes
Census geographies and their associated demographics are critical to compliance, affecting both fair lending and CRA. Although the demographics for geographies, such as race, ethnicity, and income levels may change from year-to-year, the most significant changes occur every 10 years with the Decennial Census. These not only dramatically affect the demographics, but the boundaries of the geographies have also changed in many cases. Such changes are the most significant in areas with dynamic populations (either growing or declining).
- Because there is no peer data (HMDA of CRA) yet available for the new geographies for precise (see note below) numerical examination of the impact of these changes, the key consideration at this point is evaluation of AA’s (Assessment Areas) and/or REMA’s (Reasonably Expected Market Areas) delineations in light of the new geographies. These should take into account both race, ethnicity, and income levels of the associated geographies.
- It is highly recommended this be done from both a data and graphic perspective by overlaying the critical demographics by census tract on a map encompassing current AA’s and REMA’s, surrounding areas to determine if the AA/REMA should be expanded or contracted, and 2010 boundaries and demographics. This should also take into account the MSA/non-MSA designations of the pertinent counties.
- In terms of proposed CRA regulation changes forthcoming (discussed below), take into account for large institutions (assets > $2 billion) that:
- Partial counties will no longer be allowed and
- Assessment areas must be defined for any MSA outside their branch network where there are 100 mortgage or 250 small business loans
- Document that this evaluation was conducted and adjustments that were made.
Note: Although peer data is not yet available for the 2020 geographies, we are able to provide estimates of the impacts by relating the new and old geographies as an early look. Please contact us if this is something you are interested in for more details.
1071 Small Business Data Reporting
The long-awaited addition of HMDA-like reporting requirements to be added for small business lending as dictated by Dodd-Frank appears now to becoming a reality. Indications are the CFPB will issue a final rule by March 31 of this year.
Reporting of these data will provide the same fair lending pressure points available with HMDA reportable lending to small business lending, bringing a largely “off-limits” portion of bank lending into the fair lending spotlight.
The additional risk created is substantial, as this is an area that has largely been unmonitored, often governed internally by subjective and flexible policies (coupled with the fact that transactions are often highly competitive and negotiated), and, in the event of an enforcement action, remediation could be substantial due to the larger sizes of the credits compared to consumer lending.
- Delineate the segment of loans for your institution anticipated to fall under 1071 reporting – https://www.consumerfinance.gov/1071-rule/.
- Evaluate and begin to refine and establish objective and quantifiable policies, procedures, and lending criteria that affect primary fair lending pressure points, including underwriting, pricing, steering, redlining, and lending penetration to protected classes.
- If not done already, an analysis of small business lending from a fair lending perspective should be considered as a benchmark and to evaluate where your institution is in this regard.
- If your institution has lenders that do ONLY, or primarily only, commercial lending, they have probably been largely disconnected from the fair lending world. It is time to connect them.
Community Reinvestment Act Reform
The Federal Reserve, the OCC, and the FDIC have released their joint proposal regarding the changes to implementation of the Community Reinvestment Act. We will not do an exhaustive review of the changes in this post, but only bring this to your attention as a reminder and to hit the highlights.
Most of the changes will impact banks with > $2 billion in assets, with additional requirements for banks > $10 billion, including tracking of deposits.
Small banks will be defined as <$600 million, intermediate banks as $600 million – $2 billion, and large banks >$2 billion. Note, as above, banks >$10 billion will have additional requirements.
- Review of, and planning for, the implementation of the forthcoming changes specific to your institution – https://www.fdic.gov/news/financial-institution-letters/2022/fil22018.html.
CECL (Current Expected Credit Losses) Implementation
Relating to the safety and soundness side of the house, the new accounting standard to be used for calculating loan loss set-asides known as CECL has been in effect for most SEC filers already. It now applies to all institutions as of December 15th of 2022.
The new CECL standard, which requires institutions to recognize lifetime expected credit losses for financial assets as opposed to the incurred loss methodology, differs from the former method in several key respects.
Estimating expected credit losses over the life of an asset under CECL, including consideration of reasonable and supportable forecasts, results in earlier recognition of credit losses than under the existing incurred loss methodology. In addition to incorporation of reasonable and supportable forecasts in developing an estimate of lifetime expected credit losses, CECL also demands more rigor be used in the development and application of qualitative factors used in adjusting credit loss reserves.
Allowances also now cover a broader range of financial assets than allowance for loan losses (formerly known as ALLL) under the incurred loss methodology, and now include certain debt-securities. The loss reserve calculation is accordingly now known as the ACL (Allowance for Credit Losses) as opposed to the ALLL.
Although there are shortcut methods to CECL compliance that may closely resemble what institutions may have been doing or are using now under the incurred loss approach, these methods may not be viable in the longer term. Regulatory matters tend to become more demanding over time, and as familiarity and comfort with the new requirements increase among agency staff, expectations will likely increase as well. This, of course, will be amplified with cycles of economic uncertainty.
- We have found that many, if not most institutions are outsourcing CECL. If you are not CECL compliant, or are unsure about your current efforts, we can help get you there.
If your institution needs any assistance understanding, preparing for, or implementing on any of these critical concerns, please reach out to us. We hope you have a great 2023 and beyond.