Wells Fargo racial disparity case heads to class-action decision

Wells Fargo & Co. faces a decision as soon as this month on whether a lawsuit over its pandemic-era mortgage denials to non-white applicants gets class-action status, a key turning point in a high-profile and potentially costly case.

The bank, which was long the biggest U.S. mortgage lender until a recent pullback under Chief Executive Officer Charlie Scharf, has asked a federal judge in California to deny the motion the plaintiffs filed earlier this year. The case consolidates a number of lawsuits brought before and after Bloomberg News reported in 2022 that Wells Fargo rejected a majority of Black homeowners who applied to refinance mortgages in 2020, the only big bank to deny more Black applicants than it accepted.

At the heart of the case is a dispute over a credit-scoring algorithm that plaintiffs say disparately impacted minority applicants, creating a potential class of at least 119,100 people. All non-white applicants who applied for a refinance, home purchase or home equity line of credit and were initially “approved” by Fannie Mae’s, Freddie Mac’s or Wells Fargo’s own internal underwriting system but ultimately denied from 2018 through 2022, the plaintiffs argue, are entitled to damages.

The plaintiffs say that a proprietary model Wells Fargo uses to assign prospective borrowers to one of four risk groups disproportionately sent Black and Latino applicants to higher-risk classes, subjecting them to more scrutiny from underwriters than applicants in other classes. The model, called Enhanced Credit Score, generates a score measuring each applicant’s likelihood of default, resulting in higher denial rates, they say.

“Wells Fargo discriminated against the minority applicants by subjecting them to its discriminatory loan policies,” Dennis Ellis, the lead class counsel, wrote in an April motion. “The lost opportunities of potential wealth building derived from homeownership and access to favorable financing will, unfortunately, have generational consequences for these families.” He said in an interview that the credit ratings “were treated like a gold star or a scarlet letter.”

Wells Fargo, in a response last month, called the conflation of the firm’s front-end loan platform, internal and external underwriting systems and thousands of additional rules and policies “counterfactual and logically incoherent,” and it said the proposed class was “overbroad and ill-defined.”

In the bank’s telling, the scoring model is a workflow tool and there is no such thing as approval through the Fannie and Freddie underwriting systems or its own — the systems merely indicate whether an applicant’s mortgage would be eligible for purchase by Fannie or Freddie. If so, the application moves on to the underwriting phase, in which Wells Fargo underwriters verify documentation such as an applicant’s income, employment and credit history. The internal model just sorts applicants by the strength of their credit profile, with higher-risk applicants assigned to “more skilled” underwriters.

Document trove

A trove of documents and emails turned over by Wells Fargo in the discovery phase of the case sheds additional light on what happened when the San Francisco-based bank reviewed its mortgage operations in 2022.

One study conducted in February 2022 by the bank’s fair-lending analysts looked at the outcomes for mortgage applicants by race in 2020. It found that Black applicants were approved at less than 90% of the rate of white ones with broadly similar credit profiles, which the analysts said merited further investigation.

Another study done in March of that year found that the credit-scoring model gave disproportionately lower scores to applicants in four out of five classes protected by fair-lending laws because of their race, gender or age. The document did not specify which classes were affected.

The bank’s analysts then zeroed in on which criteria were having the biggest impact, identifying three: the age of an applicant’s other credit lines, signs they had applied for more in the past six months, and any debts that were 90 days delinquent. But the bank concluded that those were legitimate indicators of creditworthiness and kept the system in place.

In its filings, Wells Fargo said that it “uses a simple, race-neutral scoring system” and that its reviews “consistently confirm that minority applicants were denied for legitimate credit-related reasons and consistent with White applicants.” Furthermore, the bank said, its fair-lending team weighed changes to the model, but those either didn’t significantly reduce the “adverse impacts,” introduced new disparities, or “caused unacceptable model performance.” Even then, the model didn’t make approval decisions, the firm wrote.

Whether the judge allows the class certification to proceed will dictate the stakes for a bank that has sought to move past a series of consumer scandals that erupted in 2016. Problems that began in Wells Fargo’s branch network and rapidly multiplied across business lines led to the exits of two CEOs, billions of dollars in fines and settlements, and an unprecedented Federal Reserve cap on the bank’s growth.

Bank retreat

Scharf, who took over in 2019 with a mission to move the bank past its legal and regulatory woes, announced a major pullback in the mortgage business last year. Most big U.S. banks made a similar move more than a decade ago, concluding after the 2008 financial crisis that home lending was too troublesome. Wells Fargo took the opposite approach — for a decade, it doubled down on the business, dominating the industry and at one point churning out one in every three U.S. home loans.

That was the state of play in 2020, when the pandemic hit, interest rates fell to historic lows and borrowers raced to refinance their mortgages. A Bloomberg examination of federal mortgage data published in 2022 showed that 47% of Black homeowners who applied to refinance their mortgage with Wells Fargo that year were approved, compared with 72% of white homeowners. Wells Fargo did not dispute Bloomberg’s findings, but said at the time, and in its opposition to class certification, that “legitimate, credit-related factors” drove the differences.