When Hell Freezes Over-Make sure you Have Skates!
Special Considerations for Freezing or Reducing HELOCs

By James DeFrantz, BankVision

Introduction
Among the myriad effects of the current economic “slow-down”, consumers have experienced the phenomena of freezing or reducing credit lines on open-ended credit. Many credit providers have taken this unpopular stand as a risk avoidance strategy. More and more, consumers are shocked to find that their credit lines have been reduced to an amount that is close to the outstanding balance even though the credit is in good standing.  

Home Equity Loans (HELOCs) are traditionally some of the largest open-end credits and, unfortunately, some of the most dramatically affected by current market conditions. As the market values of homes all over the country continue to fall, many banks have taken the stand that it is prudent to reduce credit lines to reflect the new, lower value of the home that is being used as collateral for the loan. 

While establishing a program for reducing or freezing HELOCs may be a prudent business practice, banks should closely consider the Fair Lending and CRA implications of such a program, before aggressively pursuing it.  

Regulatory Environment 
While the current trend of reducing credit is highly un-popular, banks are well within their rights to pursue this action. For example, Regulation Z allows a bank to alter a home equity loan program when the underlying property has experienced a “significant decrease in value”[1]. The regulation details the rules for determining whether a significant decrease in collateral value has occurred and specifies the means for reinstating credit once the collateral value returns.  

On the other hand, banks need to be careful to be aware that the decisions that they make may trigger further disclosures. For example, Regulation B requires that when an unfavorable change in an account occurs that does not affect an entire class of customers, an adverse action has occurred. [2] In other words, the decision to reduce or freeze individual accounts due to a reduction in collateral value is an adverse action and triggers a Regulation B adverse action notice. 

Fair Lending Considerations  
However, the places where foreclosures are taking place and where real estate values are declining can often be in places where large concentrations of minorities reside. [3] In addition, the decision to reduce HELOCs can have a disproportionate impact on a certain segment of the customer base.  

For example, suppose a bank’s HELOC marketing program had been targeted at its woman owned business or Hispanic segment of its customer base. A decision to reduce or freeze these HELOCs could result in a large protected class of the customer base disproportionately impacted. This is the type of situation that was at the root of a lawsuit filed by the city of Baltimore , Maryland against Wells Fargo Bank where two thirds of the foreclosures in that city were in census tracts where African Americans represented 60 percent or more of the population. [4]

It is critically important that the bank consider the consumer protection implications of a program to freeze or cancel HELOCs. Moreover, the business reasons for the decision to proceed with these programs should be well documented to protect against accusations of unfair or illegal lending practices. 

Conclusion 
Tough economic times often call for unusual measures. It is in these times that the goals of safety and soundness run headlong into consumer protections. While programs to reduce or freeze HELOCs can make perfect economic sense, the potential for reputation and or legal risk to the bank can outweigh the benefits.