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09.28.2023 | Legal Update

Headlines

1. CFPB Issues Guidance on Credit Denials Using Artificial Intelligence in Underwriting
2. FDIC Chairman Warns of Financial Stability Risks of Nonbank Financial Institutions
3. Court Issues Nationwide Injunction Delaying Compliance with CFPB Data Collection Rule
4. Annual Mortgage Review Finds Increasing Closing Costs and Denials for Insufficient Income
5. Other Developments: Lease Financing and Equal Housing

1. CFPB Issues Guidance on Credit Denials Using Artificial Intelligence in Underwriting

The CFPB has published guidance about compliance with Regulation B, which implements the Equal Credit Opportunity Act (ECOA), when lenders deliver denial notices based on underwriting decisions using artificial intelligence and other complex credit evaluation models. The guidance issued on September 19 describes how lenders, including banks, must describe specific and accurate reasons in notices of adverse actions taken against consumers. The guidance explains that lenders may not use sample adverse action forms and checklists provided in Regulation B if those forms or checklists do not accurately reflect the reason for the denial of credit or change of credit conditions. The guidance emphasizes that this requirement is particularly important if the factors actually considered or scored by the lender “may be surprising to consumers,” which may be the case when a lender relies on complex algorithms that consider data that are not typically found in a consumer’s credit file or credit application. Click here for a copy of the CFPB’s guidance.

Nutter Notes:  The CFPB noted that banks and other lenders are increasingly relying on complex algorithms, sometimes referred to as artificial intelligence, and other predictive decision-making technologies in their underwriting models. Because lenders often can include data that may be harvested from third-party sources of consumer surveillance, these complex algorithms may result in credit decisions based on data that was not provided in a consumer’s application for credit or available in the lender’s credit file on that consumer. As a result, a consumer may be denied credit or otherwise be subject to an adverse change of credit conditions for reasons the consumer may not consider relevant to their finances. ECOA and Regulation B require a lender to provide a credit applicant with a statement of specific reasons in an adverse action notice that must “relate to and accurately describe the factors actually considered or scored by a creditor.” According to the CFPB’s guidance, where the CFPB’s sample forms and checklists do not reflect the principal reasons for the adverse action, then the lender must provide an appropriate explanation, so that the applicant receives a statement of reasons that is specific and indicates the principal reasons for the action taken.

2. FDIC Chairman Warns of Financial Stability Risks of Nonbank Financial Institutions

In a recent speech, FDIC Chairman Martin J. Gruenberg discussed unique risks that nonbank financial institutions pose because they are generally not subject to the same degree of regulation and supervision as banking organizations. Gruenberg noted in his September 20 address that nonbank financial institutions are often less transparent in their operations because of this lack of oversight, and suggested options for greater federal oversight of nonbanks. He also pointed out that they may rely on excessive leverage and more volatile funding sources than banking organizations. Gruenberg expressed concern that nonbank financial institutions can transmit risk to other parts of the financial system, and particularly to banking organizations that providing funding to support nonbank activities, when market shocks combine with the vulnerabilities unique to nonbank financial institutions. In his discussion of how those risks might be addressed, Gruenberg emphasized a need for greater availability of information about the risks undertaken by nonbanks. Click here for a transcript of Gruenberg’s remarks.

Nutter Notes:  Gruenberg focused on certain categories of nonbank financial institutions that he said play significant roles and therefore represent larger risks to the financial system. These nonbanks include open-ended mutual funds, money market funds, leveraged investment vehicles such as hedge funds, and nonbank lenders. Gruenberg noted that these types of institutions hold a substantial amount of leveraged loans, which are commonly syndicated and sold in the form of collateralized loan obligations (CLOs). Gruenberg discussed how bank investments in CLOs, including those that contain leveraged loans, increased to at least $174 billion in first quarter 2023, up 13% from the end of 2021. Gruenberg warned that these investments “expose the banking system to disruption in the underlying leveraged loan market,” suggesting that CLOs may become a subject to increased regulatory scrutiny by bank examiners.

3. Court Issues Nationwide Injunction Delaying Compliance with CFPB Data Collection Rule

A federal court in Kentucky has issued an order granting a nationwide injunction that delays the compliance dates for the CFPB’s final rule governing the collection of small business lending data required by Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The court order issued on September 14 will delay all deadlines for compliance with the final rule while the Supreme Court hears a related case challenging the constitutionality of the CFPB’s funding structure. The court’s order comes in a case separate from that addressed by a July 31 Texas federal court order that was not national in scope. The more recent case was brought by certain state-chartered banks and a national bank in Kentucky, along with the Kentucky Bankers Association, who argued that the CFPB’s funding structure violates the U.S. Constitution’s separation of powers. Because the CFPB’s small business lending rule was issued with funds allegedly derived from unconstitutional sources, the plaintiffs argued that the rule itself violates the Constitution. The court order enjoined the CFPB from enforcing the small business lending rule until the Supreme Court issues an opinion ruling that the funding structure of the CFPB is constitutional. Click here for a copy of the court’s order.

Nutter Notes: The CFPB issued its final rule amending Regulation B to implement Section 1071 of the Dodd-Frank Act on March 30, 2023. Under the final rule, covered financial institutions, including banks, would be required to collect and report data on applications for credit for small businesses, including those that are owned by women or minorities. A covered origination generally includes any extension of credit under Regulation B to a small business according to the final rule. Compliance by financial institutions that originated at least 2,500 covered originations in both 2022 and 2023 was to begin on October 1, 2024. Institutions with volumes of at least 500 but less than 2,500 covered originations would have had until April 1, 2025 to begin complying with the rule. Those with volumes of at least 100 but less than 500 covered originations would have had until January 1, 2026. The CFPB has not yet announced whether it will delay or otherwise adjust the compliance dates pending the outcome of the Supreme Court’s decision.

4. Annual Mortgage Review Finds Increasing Closing Costs and Denials for Insufficient Income

The CFPB’s latest annual report on residential mortgage lending activity and trends indicated that, in 2022, mortgage applications and originations declined significantly from the prior year, while rates, fees, discount points, and other costs to borrowers increased. The CFPB’s report released on September 27 also found that borrowers are spending more of their income on mortgage payments, and that lenders are denying applications for insufficient income more frequently. The increase of reported average monthly payments was attributed almost entirely to the rising interest rate environment. In response to the report, CFPB Director Rohit Chopra announced that he expects these trends will continue in 2023 due to further increases in average mortgage interest rates, and that the CFPB will be “devoting more attention to ensure that borrowers can sufficiently navigate alternatives to foreclosure when faced with financial distress,” including possible amendments to mortgage servicing standards. Click here for a copy of the full report.

Nutter Notes:  The CFPB’s mortgage lending report also found that most refinancings during 2022 were cash-out refinancings, and that the median credit score of refinance borrowers declined below the median credit score of purchase borrowers, representing a reversal of recent trends. The CFPB reported that the number of residential mortgage loan refinancings was 8.3 million in 2021, and that the number dropped to 2.2 million in 2022, a 73.2% reduction. The CFPB also warned that cash-out refinancings may increase the risk of foreclosure because they typically involve higher interest rates, higher monthly payments, and higher balances than other refinancings. In addition, such refinancings can result in unsecured debt, such as credit card debt, becoming secured by a consumer’s home according to the CFPB. Chopra indicated that the CFPB intends to explore options for making the refinancing process simpler for residential mortgage loan borrowers, but did not indicate how the CFPB might address that issue.

5. Other Developments: Lease Financing and Equal Housing

• OCC Updates the Lease Financing Booklet of the Comptroller's Handbook

The OCC released a revised version of its Lease Financing booklet of the Comptroller's Handbook on September 27. The revised booklet replaces the version of the booklet with the same title issued in January 2017, and reflects changes to lease accounting standards applicable to national banks and federal savings associations since the booklet was last updated, among other changes. Click here for a copy of the revised booklet.

Nutter Notes: The revised Lease Financing booklet also reflects OCC guidance published and rescinded since the booklet was last updated, and includes clarifying edits relating to supervisory guidance, sound risk management practices, and legal language. 

• FDIC Releases New Equal Housing Lender Posters

The FDIC announced on August 31 that updated versions of the Equal Housing Lender (EHL) posters are available from the FDIC Online Catalog through FDICconnect. The FDIC revised certain information contained in the posters, including the name of the office to which complaints should be addressed, and the web address of the FDIC’s web-based complaint portal. The effective date for these changes was June 23, 2023. Click here for instructions on how to obtain updated posters.

Nutter Notes:  The name of the FDIC’s unit that receives complaints was changed from the Consumer Response Center to the National Center for Consumer and Depositor Assistance. Banks are required by the Fair Housing Act to maintain up-to-date EHL posters in branches; however, they are not required to obtain the posters from the FDIC Online Catalog. Banks may create their own posters or use third-party providers, provided that they make good-faith efforts to update the EHL posters as soon as reasonably practicable.

Nutter Bank Report
Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, after interviewing our clients and our peers in the profession, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. Visit the U.S. rankings at Chambers.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Heather F. Merton. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich kehrlich@nutter.com Tel: (617) 439-2989	Matthew D. Hanaghan mhanaghan@nutter.com Tel: (617) 439-2583	Michael K. Krebs mkrebs@nutter.com Tel: (617) 439-2288

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