Brooks' post was first published by Carolina Banker, a quarterly magazine from the North Carolina Bankers Association.

Late last year, the Department of Justice (“DOJ”) and the Consumer Financial Protection Bureau (“CFPB”) brought a joint action against Hudson City Savings Bank (“Hudson Bank”) for redlining. Hudson Bank, based in New Jersey, was (prior to its recent merger with M&T Bank) a regional bank with operations in Connecticut, New Jersey, and New York. The suit, settled by Consent Order on November 4, resulted in the largest residential mortgage redlining settlement in history which included a civil penalty of $5,500,000 in addition to requirements that Hudson Bank invest $25 million in a loan subsidy program, invest in targeted outreach and consumer education, and open new full-service branches in minority neighborhoods within its MSA.

This past June, the DOJ and the CFPB brought another joint action for relining, leveling their aim southward at BancorpSouth Bank (“BancorpSouth”), a regional bank based in Tupelo, Mississippi with branches throughout the Southeast and Texas. We will examine the BancorpSouth case in more detail below, but it’s fair to say the DOJ and the CFPB have made investigations of redlining a priority, particularly in light of the DOJ’s press release last autumn in which the head of its Civil Rights Division announced that the Hudson Bank case “should send a message to lenders throughout the country….”

This article is intended to provide a better understanding of what redlining is, particularly in the context of mortgage lending, and, at the same time, underscore the need by lenders to ensure that they have policies in place to avoid potential exposure for redlining violations.

“Redlining,” in a very general sense, is simply the practice of denying or limiting credit or other services to residents of a certain geographic area because their particular geographic area has a relatively large percentage of minorities. Another way to think of it: imagine a lender or other type of service provider drawing a red line around a certain neighborhood on a map, because of the neighborhood’s racial makeup, and then avoiding doing business with residents of that particular neighborhood specifically because of the neighborhood’s racial makeup (without considering the residents’ creditworthiness). This used to be a routine practice with respect to residential mortgage lending before legislation was enacted to prohibit it.

For some historical context--and this will come as a surprise to many--the federal government not only sanctioned but effectively institutionalized redlining in the 30s, contributing to its widespread use in the private sector for decades by lenders. Here’s how it happened: During the Great Depression, lenders had become increasingly reluctant to make mortgage loans, and when they did, terms had become prohibitive for most Americans. “Mortgage terms were so steep few could afford them anyway. The typical home loan in 1930 required a 50% down payment and had to be paid off within 5 - 7 years.” To address this problem and the concurrent foreclosure crisis during this period, President Roosevelt, as part of the New Deal, signed into law the Home Owners’ Loan Act in 1933 which established the Home Owners’ Loan Corporation (“HOLC”). The HOLC’s “key role was to refinance mortgages to slow down the rate of foreclosures. The HOLC established a precedent by introducing long-term, fixed-rate mortgage financing.

A year later, in 1934, President Roosevelt “established the Federal Housing Administration. The goals of this agency were to encourage the building of new homes and, in the process, create jobs for thousands of unemployed construction workers.” A federally guaranteed mortgage program was initiated under the Federal Housing Administration and this, along with the long-term, fixed rate mortgage financing established by the HOLC “made possible, for the first time, the types of mortgage terms we take for granted today.”

Once the Federal Housing Administration was in place, banks “handling federally guaranteed loans needed clear guidelines indicating where loans could safely be made…A massive inventory was initiated, starting in 1936, to evaluate all residential areas in the nation.” The HOLC was the agency tapped to handle this vast project. “The HOLC set strict standards. First, the appraisers (real estate personnel, mostly) looked for any signs of decay or neglect that might indicate a neighborhood was in decline. Surveyors also looked for any sign of minorities. This included not only African Americans but also Jews and ‘foreign born whites’…In only one year this project produced a collection of ‘residential security’ maps covering every town and city in the country -- several hundred maps in all. These maps were highly confidential; only federal officials and senior bank personnel were allowed to see them -- or even know they existed…Residential areas on these maps were graded on a scale from ‘A’ to ‘D’ with each ranking denoted by a particular color. The ‘A’ or ‘First Grade’ areas were colored green and had the federal government's full blessing…’D’ [or ‘Fourth Grade’] neighborhoods were usually struggling for survival -- and the ‘Fourth Grade’ designation guaranteed the struggle would be a losing one. Characterized by ‘undesirable population or an infiltration of it,’ mortgage lenders would often refuse to make any loans on properties in these neighborhoods.”

Neighborhoods with large minority populations were arbitrarily provided with a “Fourth Grade” designation that corresponded with the letter grade “D.” “Red was the color used to indicate these ‘Fourth Grade’ [or ‘D’] areas on the map and, thus, a new term came into our vocabulary: ‘redlining.’”

During this same timeframe, African Americans were often unwelcome in white neighborhoods which frequently instituted racial restrictive covenants to keep them out. So African Americans often had little choice but reside in these “D” designated areas on the residential security maps, thereby ensuring they would have little to no access to mortgages. In an article for the Washington Post in which reporter Emily Badger examines the origins of redlining and its impact, she notes that “[t]his government practice was swiftly adopted by private banks, too, during an era of massive homeownership expansion in the U.S…To redline a community was to cut it off from essential capital.” In sum, redlining, initially sanctioned and encouraged by the federal government in the 1930s, flourished for over three decades during a period of homeownership expansion for most of the rest of the country before it was outlawed by federal legislation in the 60s and 70s.

In the 60s and 70s, the Fair Housing Act (“FHA”) and the Equal Opportunity Act (“ECOA”) were enacted and, since their enactment, government agencies have relied specifically upon these two Acts when pursuing actions for redlining. The FHA, which is title VIII of the Civil Rights Act of 1968, makes it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap, or familial status. Anyone who is in the business of providing housing-related loans is subject to the FHA. The ECOA, enacted in 1974, “prohibits creditors from discriminating against credit applicants on the basis of race, color, religion, national origin, sex, marital status, age…” Anyone who is in the business of providing housing-related loans is subject to the ECOA as well. These two Acts—used in tandem--are the government’s principal tools in cracking down on the “practice of denying a creditworthy applicant a loan for housing in a certain neighborhood even though the applicant may otherwise be eligible for the loan.

As for the DOJ’s and the CFPB’s redlining case against BancorpSouth, their investigation--and their subsequent suit--focused on BancorpSouth’s operations in the Memphis MSA, an area with a relatively high number of minority neighborhoods. The complaint, filed in the U.S. District Court for the Northern District of Mississippi on June 29, 2016, alleges among other things that BancorpSouth avoided the credit needs of minority neighborhoods and discriminated against African-American applicants in both its underwriting of mortgages and pricing of mortgages. The parties entered into a Consent Order on July 25, 2016 pursuant to which BancorpSouth must deposit $2,776,890 in escrow to provide redress to affected consumers, pay a civil penalty of $3,030,756 to the CFPB, and invest $4 million in a “Loan Subsidy Program” aimed at extending mortgages to applicants in the Memphis area. In addition to these hefty sums, the Order, over 30 pages long, contains a host of steps that BancorpSouth must implement in order to improve its compliance management system, reduce its fair lending risk, and increase its lending in minority areas.

One notable distinction about the BancorpSouth case from the CBPB’s perspective is that the

CFPB, as part of its investigation, used “match-pair tests” or “testers” of different races. Specifically, the CFPB sent an African American Tester and a white tester, posing as first-time homebuyers, to the same loan officers at various BancorpSouth branches in an effort to determine whether the African American tester received less favorable treatment. While other government agencies, including the DOJ and HUD, have used testers in prior investigations of discrimination, the BancorpSouth case represents the CFPB’s first use of testers as part of its investigation.

Going forward, in their redlining investigations, the CFPB and the DOJ will continue to rely upon testers, in addition to the more quantitative measures they typically use (such as lenders’ HMDA data, lenders’ peer comparisons, and how lenders’ branches are located in their respective CRA areas). For lenders, reviewing and, where necessary, strengthening their training and policy implementation initiatives are a starting point. Beyond that, lenders should be vigilant in providing attention to all the metrics which the DOJ and the CFPB consider in their redlining investigations. The CFPB started its matched-pair tests in the BancorpSouth case in 2013--the point being: a redlining investigation tends to commence well before a lender is aware that it is being investigated.