{"id":1773,"date":"2018-09-06T06:00:23","date_gmt":"2018-09-06T11:00:23","guid":{"rendered":"http:\/\/blogs.luc.edu\/compliance\/?p=1773"},"modified":"2018-09-06T06:00:23","modified_gmt":"2018-09-06T11:00:23","slug":"compliance-failures-result-in-hundreds-of-accidental-foreclosures","status":"publish","type":"post","link":"https:\/\/blogs.luc.edu\/compliance\/?p=1773","title":{"rendered":"Compliance Failures Result in Hundreds of Accidental Foreclosures"},"content":{"rendered":"

Richard W. Shepherd<\/em>
\nMarketing & Symposium Editor<\/em>
\nLoyola University Chicago, J.D. 2019<\/em><\/p>\n

Compliance failures in banking can often result in real harm to borrowers.\u00a0 In the case of Wells Fargo, a compliance error resulted in 400 of the bank\u2019s customers losing their homes.\u00a0 Due to an issue in the bank\u2019s software system, the institution denied loan modifications to borrowers who should have qualified.\u00a0 This latest failure adds to the myriad<\/a> of issues Wells Fargo bungled over the past several months.\u00a0 For compliance professionals, the failure demonstrates the risks of automation in compliance, the importance of technical expertise, and the risks of decision-making without putting the interests of the customer first.<\/p>\n

<\/p>\n

What Happened at Wells Fargo<\/strong><\/p>\n

The bank initially disclosed<\/a> the error in a regulatory filing.\u00a0 In itsQ-10<\/a> filing with the Securities & Exchange Commission, the bank disclosed the fact that they were setting aside $8 million to compensate borrowers who were incorrectly denied mortgage modifications ($12,800 per customer).\u00a0 The modifications were made available to borrowers under the Treasury Department\u2019s Home Affordable Modification Program<\/a>, a 2009 program enacted to help Americans make their mortgage payments during the housing crisis.\u00a0 The error resulted in 625 customers in foreclosure to be denied mortgage modifications, 400 of which eventually lost their homes.<\/p>\n

In their Q-10 filing, Wells Fargo stated: \u201cThis error in the modification tool caused an automated miscalculation of attorneys\u2019 fees that were included for purposes of determining whether a customer qualified for a mortgage loan modification.\u201d Essentially, a calculation error in software developed by the bank resulted in the foreclosures.<\/p>\n

In a mortgage loan modification<\/a>, the borrower can change the terms of their loan to make it easier to repay.\u00a0 Modifications may extend the term of the loan, reduce the interest rate, or forbear the principal balance.\u00a0 During a modification, the bank can also roll other fees such as insurance and attorneys\u2019 fees into the new loan balance.\u00a0 A modification can be a part of a federal program such as the Home Affordable Modification program, under which the government would provide the bank with an incentive to modify the loan, so the borrower can stay in their home.\u00a0 In a foreclosure context, modification is a type of loss mitigation.\u00a0 During foreclosure, banks are required to attempt loss mitigation by working with the borrower to resolve the issue before the court decides how to rule.<\/p>\n

When a borrower applies<\/a> for modification, the bank performs underwriting to determine whether or not to approve the application.\u00a0 Under federal programs, the target amount for the modified mortgage payment is 31% of the borrower\u2019s income.\u00a0 The bank also has to calculate whether or not the new loan would make them as much money as the old loan.\u00a0 If that\u2019s the case, and the borrower\u2019s debt-to-income ratio is within an acceptable range, the modification should be approved.<\/p>\n

To make these calculations<\/a>, Wells Fargo developed software called the automated-decisioning tool.\u00a0 The tool analyzes the individual borrower and their loan, and uses various constraints, including an incorrect calculation of attorneys\u2019 fees, to decide whether or not to approve the loan.\u00a0 The software generates a yes or no decision.\u00a0 Only the decision, and not the actual calculations, are exported to different parts of the bank, meaning the error was not noticed for five years.\u00a0Because attorneys\u2019 fees were being calculated incorrectly, 625 borrowers who qualified for modification were denied. Overall, Wells Fargo approved 28% of modification requests, below average for the nation\u2019s largest mortgage servicers.<\/p>\n

Lessons for Compliance Professionals <\/strong><\/p>\n

For compliance professionals, this episode provides multiple take-aways.\u00a0 The failures at Wells Fargo demonstrate the risks of automation in compliance, the importance of technical expertise, and the risk of decision-making without putting the consumer and ultimately the reputation of the enterprise first.<\/p>\n

Banking compliance is often complex, especially for institutions with thousands of loans and customers.\u00a0 Software systems can provide a useful solution in managing a bank\u2019s day-to-day operations.\u00a0Further, consumer\u2019s desire for online and mobile banking services provides additional incentive to automate decision-making.\u00a0 An individual can easily apply for a mortgage, credit card, or in this case a loan modification online or through a smart phone app.\u00a0 The bank can create a system to analyze the borrower and determine whether or not to approve the loan within seconds.\u00a0 Doing so provides an efficient solution to a complex workload.\u00a0However, in creating software, banks need to be sure the assumptions and overall framework utilized by the bank are correct.\u00a0 Further, an effective auditing system must be implemented to continually analyze whether the system is working correctly.\u00a0 As this case demonstrates, using incorrect assumptions or constraints can result in catastrophic consequences to a borrower.<\/p>\n

The case of Wells Fargo also demonstrates the importance of technical expertise, both in information technology and financial regulation.\u00a0 Wells Fargo did not notice the software error for five years.\u00a0 Thus, no internal audit, board oversight, or regulatory examination revealed the issue for five years.\u00a0 This demonstrates<\/a> the need for more technical expertise in banking.\u00a0 As the industry becomes more technology-based, it\u2019s paramount that institutions and regulators employ more individuals with information technology backgrounds, and better educate their existing employees on the intricacies of information technology.<\/p>\n

Finally, this demonstrates the importance of putting the needs of the customer first.\u00a0 In comparison to the financial and housing crises of the past decade, this episode is a drop in the bucket.\u00a0 However, for the 400 families who lost their homes, their lives are changed forever.\u00a0 The decisioning tool developed by Wells Fargo offered efficiency, but cost the bank reputational and legal damage, and costs borrowers their homes.\u00a0 It\u2019s hard to imagine George Bailey<\/a> making an incorrect calculation resulting in a foreclosure.\u00a0 When making decisions, institutions need to think more like George Bailey and less like Mr. Potter.<\/p>\n

Looking Forward<\/strong><\/p>\n

Both Congress and regulators have begun looking into this episode further.\u00a0 Several questions hang over the investigation including the role of regulators while the error was ongoing at Wells Fargo.\u00a0 Specifically, whether a lack of regulatory due diligence allowed the error to continue.\u00a0 Additionally, what further issues arising from the immediate aftermath of the financial and housing crises could become apparent over time.\u00a0 Finally, with an administration<\/a> determined to deregulate financial services, what consequences will institutions actually face for failures like this.<\/p>\n","protected":false},"excerpt":{"rendered":"

Compliance failures in banking can often result in real harm to borrowers.\u00a0 In the case of Wells Fargo, a compliance error resulted in 400 of the bank\u2019s customers losing their homes.\u00a0 Due to an issue in the bank\u2019s software system, the institution denied loan modifications to borrowers who should have qualified.\u00a0 This latest failure adds to the myriad of issues Wells Fargo bungled over the past several months.\u00a0 For compliance professionals, the failure demonstrates the risks of automation in compliance, the importance of technical expertise, and the risks of decision-making without putting the interests of the customer first.<\/p>\n","protected":false},"author":7,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[26],"tags":[252,256,851,895,1364,2130],"class_list":["post-1773","post","type-post","status-publish","format-standard","hentry","category-finance-banking","tag-banking","tag-banks","tag-finance","tag-foreclosure","tag-mortgage","tag-wells-fargo"],"_links":{"self":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/posts\/1773","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/users\/7"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1773"}],"version-history":[{"count":0,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/posts\/1773\/revisions"}],"wp:attachment":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1773"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1773"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1773"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}