Conducting a Second Review of Adverse Action Notices
This Compliance Clip focuses on what should be considered when conducting a secondary review of adverse action notices. Adam explains the two main things that every financial institution should look for during a review and provides some examples of what to look for.
Video Transcript
The following is a transcript of this video.
This Compliance Clip is going to talk about conducting a secondary review of Adverse Action Notices. The question we have at hand is why would we conduct a review of Adverse Action Notices, especially a secondary review?
What a secondary review, first of all, is somebody else looking at it after a loan officer makes a decision and denies an applicant and completes the adverse action form. So, somebody else is going to take a look at that form.
Now, why would you do that? Well, the first reason is to assure technical compliance with the regulations, both Regulation B and the Fair Credit Reporting Act. So, that's the first reason, you want to make sure you have technical compliance with the rules and the second reason is to minimize fair lending risk, which I believe is the most important reason. We'll talk about that in just a minute.
Let's talk about the technical compliance review. First of all, what should be reviewed in this review? Specifically, we're going to be looking for technical compliance with both Regulation B and the Fair Credit Reporting Act. In other words, was the form filled out properly? That's the key piece to a technical compliance review. Was the form filled out properly? So, for denial reasons, was the correct denial reason listed? Were all denial reasons that needed to be listed, listed? Was the primary regulator of the financial institution listed? These are all pieces of Regulation B.
Or under the Fair Credit Reporting Act, you have things like the credit score, the range of scores, the date of the score, and the key factors that affected the score. All must be included in the adverse action notice when a credit score was used in the underwriting decision for the denial.
It's those types of things. Again, the bottom line of a technical compliance review is to ensure that you are completing the form properly. And a lot of banks do this, and a lot of times this is done by a compliance person, somebody who is specialized in the compliance rules and they're completing that review.
Now, in my opinion, the problem with that is that's only one of two reasons why you would conduct an adverse action review.
The second reason is for fair lending purposes. And, what should be reviewed during a fair lending review is actually different than what you would do during a technical review. During a technical review you're looking at “was the form completed properly?”, but during a fair lending review what you're checking is to see if the loan could have been made another way.
Basically, the loan was denied by Bob, but if Randy had done the loan, would it have been approved? Or, this loan was done in our secondary market, but could we have done it in-house? Or, it was done on this product, could we have done it on another product? So, really, that's what you're looking for in a fair landing review because you're not trying to confirm the denial, what you're trying to do is have affirmation that we could not approve it. Basically, instead of saying “yeah, I'm fine with the denial”, which is what a lot of banks do in a secondary review, which in my opinion is not good enough, what you should be doing is say “yeah, there's really no other way we can make this.” Those are two separate things, rather than saying I'm comfortable with the denial. But saying that, yeah, we probably should have done this a different way or no, there was nothing else we could do.
So the question becomes, who should be conducting this secondary review for fair lending purposes? Well, should the compliance person be doing that? I don't know. Probably not. How many compliance people have 25 years of lending? Right? The idea is, could we make this loan? Do your compliance people know all the products that are available or all the intricacies of your underwriting standards? Probably not.
So, in my opinion, what needs to happen typically is to have some sort of senior lending personnel review marginal files from a fair lending perspective. Now, do they have to look at every single denial? No. If the credit score was 212, then it's done. You don't need to have a second look at that. If the DTI was 150%, it's done. You don't need to look at it, but those marginal denials where your cut-off score for your DTI is 38% and this was 39%, maybe somebody should look at it. Or if your credit score cut-off is 620 and this was 615 or 619, somebody should definitely look at it.
There's a couple ways to do this. You can either have a senior lender skim through all your denials and look at this. Or you could have a compliance person basically flag the denial files, when they're doing the technical review, for a fair lending review and just refer on those marginal files that are close. And you could give your compliance person or your person reviewing for compliance some standards and basically say if it's below 600, I don't want to see it as far as a credit score, but if it's over 600, you need to pass that on. Or if the DTI is above 45% forget it, but if it's below, pass it on. Give some standards to have them look at it.
And this is really a key piece in minimizing your fair lending risk - to have a second review of Adverse Action Notices.
That's all we have for today in this Compliance Clip.