fair lending in the student loan market nchelp/efc student loan legal meeting

Skadden, Arps, Slate, Meagher & Flom LLP

Fair Lending in the Student Loan Market

NCHELP/EFC Student Loan Legal Meeting

Anand S. Raman

August 6, 2012

Fair Lending in the Student Loan Market | 2 Skadden, Arps, Slate, Meagher & Flom LLP

Overview

• Fair lending laws• Types of lending discrimination• Cohort default rate• CFPB focus on student loans and fair lending• Fair lending statistical analysis• Other fair lending-related compliance issues

– Steering

– Servicemembers Civil Relief Act

• Best practices• Hypotheticals


Fair Lending Laws


Equal Credit Opportunity Act

• The primary federal fair lending law is the Equal Credit Opportunity Act (ECOA), 15 U.S.C. § 1691 et seq.

• ECOA prohibits discrimination against any applicant on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract), because all or part of the applicant’s income derives from any public assistance program, or because the applicant has in good faith exercised any right under certain laws


Scope of ECOA

• Prohibits discrimination with respect to “any aspect of a credit transaction”

• Limited to discrimination against “applicants,” and thus, has limited applicability to pre-application marketing– ECOA’s implementing regulation – Regulation B, 12 C.F.R.

Part 1002 – also prohibits “discouragement” of potential applicants on a prohibited basis


ECOA Enforcement

• ECOA is enforced primarily by the Consumer Financial Protection Bureau

• Other agencies with enforcement authority include the prudential bank regulators (OCC, FDIC, and Federal Reserve), the Department of Justice, and the FTC

• Private plaintiffs can sue for actual and punitive damages in individual and class actions


Other Fair Lending Laws

• The Civil Rights Act of 1866, 42 U.S.C. §§ 1981, 1982, prohibits intentional discrimination on the basis of race

• States and localities have anti-discrimination laws that may be applicable– Some of these laws contain prohibited bases in addition to

those under ECOA, such as sexual orientation or gender identity and military status


Types of Lending Discrimination


Theories of Fair Lending Liability

• Fair lending lawsuits are generally brought under three different theories of liability:– Overt discrimination

– Disparate treatment

– Disparate impact


Overt Discrimination

• Overt discrimination is where a lender’s policies or practices openly discriminate against a protected class in a manner that is not authorized by law

• Examples– Limiting a loan program to individuals 65 or younger

– Setting different rates for spousal co-applicant borrowers and non-spousal co-applicant borrowers

– A loan officer informs an applicant that he does not like to originate student loans to members of a particular ethnic group because their credit is weak


Disparate Treatment

• Disparate treatment is where a lender treats members of a protected class differently than non-protected class members

• Discriminatory intent must be shown• Often premised on statistical analyses indicating that members

of a protected class are harmed in some way as compared to similarly situated, non-protected class members

• Usually validated through review of individual files• Redlining – declining to do business in an area on account of

the racial or ethnic composition of that area – is a type of disparate treatment


Disparate Impact

• Disparate impact liability may occur when– a specific, facially neutral practice has an adverse effect on

a prohibited basis

– that cannot be justified with a legitimate business purpose, or

– where the business purpose can be achieved as well with a less discriminatory alternative


Disparate Impact

• Disparate impact has been relied upon frequently in government fair lending enforcement and class action litigation

• Last year, the Supreme Court agreed to hear a case to decide whether disparate impact can apply under the Fair Housing Act. The appeal, however, was dropped, and there is therefore some uncertainty as to the viability of disparate impact under the fair lending laws.

• Regulators are continuing to indicate that they will bring cases under this theory


Types of Lending Discrimination

• Underwriting discrimination• Redlining / reverse redlining• Pricing discrimination• “Steering” towards a product type or lending channel• Different levels of assistance• Loan servicing discrimination

– Fees and waivers

– Loan modifications and other loss mitigation


Cohort Default Rate


Cohort Default Rate

• Historically, a key fair lending concern for student lending has been use of a school’s “cohort default rate”

• The cohort default rate is a measure of the federal student loan repayment history of a particular group or “cohort” of borrowers, which is available at the school level

• Lenders have used a school’s cohort default rate for underwriting and pricing decisions

• It has been alleged that use of cohort default rate in the lending process has led to a disparate impact against minority students


Rodriguez et al. v. Sallie Mae (D. Conn.)

• Class action on behalf of minority student loan borrowers alleging pricing discrimination and steering to subprime private student loans in violation of ECOA, plus other violations

• Challenged use of underwriting and pricing criteria, including college attended, student’s credit history, and credit history of cosigner

• In October 2011, court approved settlement on behalf of Black, Hispanic, and Native American borrowers from 2003 to 2011– $500,000 for scholarships and credit education– $1.8 million in attorneys’ fees and expenses– Enhanced disclosures regarding school choice / cohort default rate

affecting loan terms


CFPB Findings on Cohort Default Rate

• The CFPB’s Report on Private Student Loans, released July 20, 2012 (the “Report”) found that some student lenders use Cohort Default Rate in custom scorecards used for underwriting and pricing decisions

• “[R]acial and ethnic minority students are disproportionately concentrated in schools with higher CDRs. Accordingly, use of CDR to determine loan eligibility, underwriting, and pricing may have a disparate impact on minority students by reducing their access to credit and requiring those minority students who meet the lenders’ eligibility thresholds to pay higher rates than are otherwise available to similarly creditworthy non-Hispanic White students at schools with lower CDRs.” Report, p. 80.


CFPB CDR Analysis


CFPB Focus On Student Loans And Fair Lending


CFPB Focus on Student Loan Fair Lending

“Today we are giving fair notice on fair lending. We are letting both lenders and consumers know that in our examination and enforcement work, we will combat unlawful, discriminatory practices—including those that have an illegal disparate impact on protected borrowers. We will look not only at mortgage lending, but also at other types of credit including student loans, loans for cars, and credit cards.”

Patrice Ficklin, CFPB Assistant Director for Fair Lending and Equal Opportunity, “Fair Notice on Fair Lending” (Apr. 18, 2012)


CFPB Fair Lending Authority for Student Lending

• The CFPB has fair lending enforcement authority over student lenders

• The CFPB has authority to supervise all non-depository private student lenders, as well as all banks with more than $10 billion in assets– The CFPB’s non-depository examination program

commenced in January 2012, with the appointment of CFPB Director Richard Cordray


CFPB Student Lending Activity

• CFPB worked with the Department of Education to release a financial aid “shopping sheet” designed to help students and parents better compare the costs of different colleges and understand their payment options

• Section 1035 of the Dodd-Frank Act established the Office of Private Education Loan Ombudsman in the CFPB

• CFPB has released several Q&As relating to private student lending on its “Ask CFPB” website– Most of the questions focus on collections and default


Student Lending Complaint Portal• The CFPB has established a complaint portal dedicated to student lending

complaints• The portal includes a discrimination question

• Complaints could prompt CFPB student lending fair lending inquiries• The CFPB has stated that it will focus primarily on complaints where the

consumer disputed the response or where companies failed to respond within 15 days

• Some data from the complaint portal is likely to be released publicly, including the identity of the lender


Private Student Lending Report

• Section 1077 of the Dodd-Frank Act required the CFPB and the U.S. Department of Education to prepare a report on the private student lending market

• The Dodd-Frank Act required the Report to address fair lending and borrower characteristics

• The Report was issued on July 20, 2012


The Report’s Fair Lending Findings

• As discussed above, the Report found that some private student lenders use Cohort Default Rate for pricing and underwriting and that this may raise disparate impact fair lending concerns

• The Report suggested consideration of compiling additional data regarding student lending underwriting outcomes, similar to the Home Mortgage Disclosure Act – “Additional outcome data might also give the public and federal

regulators greater confidence that underwriting is in compliance with the nation’s fair lending laws.” Report, p. 88.


The Report’s Demographics Findings

• The Report provided information on the age, sex, and race of private student loan borrowers

• Race– In the 2007-2008 academic year (the most recent data described), the

frequency of exclusive use of private student loans does not vary by racial group

– A higher percentage of African-American borrowers use a combination of federal and private student loans than all other racial groups

• Sex– There is a small but statistically significant higher proportion of women

(11%) who have a combination of private and non-private student loans than men (10%)

– There is no statistically significant difference for the percentage of men and women who have only private student loans


CFPB Data Analysis


DOJ Student Lending Enforcement

• As noted above, the Department of Justice may also enforce ECOA against student lenders

• “The [Department of Justice Civil Rights] Division also will focus on the challenges in the current market, including . . . discrimination in student lending”DOJ Civil Rights Division Report to Congress (Mar. 2012)

• The DOJ announced in March 2012 that it has one pending student loan pricing fair lending investigation, which was referred by the FDIC


Fair Lending Statistical Analysis


Statistical Analyses That Can be Performed

• Underwriting– Denial disparities

– Exceptions / overrides

• Pricing analysis– APR

– Discretionary pricing

• Redlining / market penetration• Loss mitigation


Statistical Analysis Issues

• Credit controls to identify “similarly situated” borrowers

• Controls for market• Controls for lender underwriting centers or by channel

or branch• Statistical significance• Conducting analyses under privilege


Data issues

• With student lending, race, ethnicity, and sex data on applicants may not be collected– As noted above, the CFPB’s Report on Private Student

Lending recommended enhanced data gathering on student lending

• Proxies must be used to assign protected class status to loans for statistical analysis– Geographic proxies for race

• As the Report noted, a student’s use of a temporary or dormitory addresses on loan applications could complicate use of geography as a proxy for race in a student loan analysis

– Name proxies for sex and ethnicity


Other Compliance Issues


Steering

• In its July 20 report, the CFPB raised concerns with borrowers obtaining high-rate private student loans (“PSL”) before applying for Stafford loans or exhausting Stafford limits

• According to the report, 10.9% of PSL borrowers apply for aid but do not take up Stafford loans. Similarly, approximately 40% of PSL borrowers with Stafford loans do not borrow the Stafford maximum


Steering

• The CFPB has stated that PSLs are “rarely an economical choice” relative to Stafford loans

• Lenders may be subject to increased “steering” scrutiny from regulators based on how they originate PSLs

• Regulators may focus on fair lending issues (i.e., whether prohibited basis group applicants were disproportionately steered to PSLs) or deception/unfairness in how PSLs and Stafford loans are promoted


SCRA

• The Servicemembers Civil Relief Act (SCRA) provides civil protections and rights to servicemembers

• Among the protections is a 6% cap on pre-service debts and restrictions on default judgments against members in active duty military service


SCRA

• The DOJ has recently pursued SCRA claims against lenders through the DOJ Civil Rights Division, although there have been no DOJ-SCRA enforcement actions to date relating to student lending.

• A large lender recently agreed to pay $2.3 million to settle a private SCRA suit– Servicemembers had alleged that they were charged more

than 6% interest on their student loans


Best Practices


Best Practices

• Dedicated fair lending compliance personnel• Policies and procedures

– Written fair lending compliance policies and procedures

– Lending policies and procedures should be reviewed for fair lending compliance

• Controls on exercise of discretion– Caps on pricing and other discretion, with monitoring

– Written policies to guide exercise of discretion

– Documentation of rationale for discretionary decisions


Best Practices

• Fair lending training• Complaint monitoring

– Fair lending complaints should be escalated

– Proactively review policies and products that lead to fair lending complaints

• New product review• Marketing review

– Review of marketing collateral

– Solicitation criteria


Best Practices

• Fair lending self-assessment• Internal audit• Monitoring

– Statistical analysis

– File reviews

– Remediation based on results, if necessary


HYPOTHETICALS


Hypotheticals

1. Our advertisements feature only younger-looking students. Is that problematic?

2. We require a co-signer for all of our private student loans. Can that lead to a disparate impact?

3. Our pricing model looks at the age of the applicant. I know that age is a prohibited basis factor, but are there circumstances where it is legal to consider age?

4. We use CDR as one of many factors in our model. Does that mitigate the risk of using CDR?


For More Information Contact

Anand S. Raman

[email protected]

(202) 371-7019

fair lending in the student loan market nchelp/efc student loan legal meeting

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