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Affirmative lending.

Government-required reporting on lending patterns to minorities has a much-overlooked silver lining. Company data on minority loan applications can help mortgage executives pinpoint missed business opportunities. The problem is, if you don't spot them on your own, the government may help you do it.

Mortgage lending to ethnic minorities is under greater scrutiny than ever before. This heightened degree of examination is largely due to the expanded scope of the Home Mortgage Disclosure Act (HMDA). The original act, enacted in 1976, was amended in 1989 and again in 1991. These amendments expanded the reporting requirements for mortgage bankers and require annual reporting of the results to Congress by the federal banking agencies.

The data are being used by the media, public interest groups and now the Department of Justice (DOJ) to describe the nature of discriminatory lending practices.

The purpose of this article is to illustrate the importance of looking at the information derived from the HMDA reporting requirement as a management resource rather than a regulatory burden. The HMDA data tell a lot about an institution's market penetration, geographic lending patterns, branch office productivity, underwriting efficiency, applicant/borrower income profiles and pipeline management efficiency. In this way, HMDA can serve as a valuable business tool, as well as a means to ensure equal accessibility to housing credit for all creditworthy borrowers.

Decatur Federal example

The Department of Justice's investigation of Decatur Federal Savings and Loan Association, based in Decatur, reveals the extent to which the federal government now is willing to attack perceived inequities in the mortgage lending process. The DOJ alleged in a complaint (Civil Action No. 1 92-CV-2198) filed on September 17, 1992, that Decatur Federal's mortgage lending practices violated the Fair Housing Act and the Equal Credit Opportunity Act by implementing a policy and practice of marketing services and products primarily to white residents of the Atlanta area. The complaint, filed in U.S. District Court for the Northern District of Georgia, Atlanta Division, is notable because it focuses heavily on the way that Decatur Federal marketed its mortgage lending services. The allegations in the government's complaint faulted the institution for not aggressively marketing to minorities. Specifically, it alleged that Decatur Federal had only opened branches and regional offices in majority-white areas; nearly all of Decatur's account executives were white and the real estate agents they called on were white; the institution rarely solicited mortgage loans from Black real estate professionals; and the institution did not employ or contract with Black appraisers and all of the institution's staff appraisers were white. The complaint further alleged that the institution rarely used minority media to advertise its products; most of the institution's FHA/VA loans were made to whites rather than Blacks, even though Blacks traditionally have a relatively high participation rate in the FHA/VA program; and Decatur Federal circumscribed its lending area to exclude predominately Black neighborhoods.

Of the business that Decatur Federal brought in, the government found 90 percent of total home mortgage applications taken from 1985 to 1990 were from whites, while only 6 percent were from Blacks; and that ninety-seven percent of loans closed were in predominantly white census tracts in 1989, while only 3 percent were in Black census tracts.

The government also stated that Blacks were rejected at higher rates than whites and that Blacks were subjected to stricter mortgage loan underwriting than whites and were not extended the same flexible underwriting considerations.

Expensive remedy

Rather than go to trial, Decatur Federal opted to settle the case without any admission of wrongdoing. The settlement, however, did not come cheap. Pursuant to the consent degree, Decatur Federal agreed, among other things, to redraw its lending area to include minority neighborhoods; design advertising programs using Black media to target residents of predominately Black neighborhoods; place 960 column inches of advertising detailing the terms of the consent decree in Black-oriented publications; create special point-of-sale materials to attract minority homebuyers; solicit business from Black real estate professionals; revise the loan officer commission structure to create incentives to originate loans of $50,000 or less; require each account executive to maintain a log that indicates the extent of solicitation for loans in Black neighborhoods; reserve at least one account executive whose sole responsibility is to solicit loans geared toward low- and moderate-income neighborhoods; use Decatur's best efforts to develop correspondent relationships with financial institutions serving the Black community; and create a physical presence in Black communities through a regional loan office. There is much more in the Decatur Federal consent decree that we will not cover in this article.

The Decatur Federal case is significant to mortgage banking firms for three reasons. Many mortgage companies possess lending patterns similar to, or even worse than, those alleged by DOJ in the Decatur Federal case, and, in addition, the DOJ used Decatur's own HMDA data to prosecute the institution. The DOJ focused on the failure to market the availability of loans to minorities.

We can expect many more cases to be initiated by the DOJ or the Department of Housing and Urban Development (HUD) in the very near future. We understand that the DOJ is targeting about 200 lenders for similar violations. Fear of liability should be a motivating influence for mortgage bankers in the instances where the larger policy issue of ensuring equal access to mortgage credit fails to produce sufficient corrective measures.

Taking the higher ground

Leading mortgage companies that choose to take the higher ground see the wisdom of thoroughly analyzing their HMDA data with a view toward developing goals and strategies to improve performance. These companies also see the value of knowing where they stand in lending to minorities before the Justice Department and/or banking regulators reach the point of considering drastic measures.

Companies that evaluate, monitor and respond to their HMDA data results take HMDA seriously. In such companies, HMDA data are important at the highest levels of the organization. At these companies, the CEO knows the degree of HMDA compliance and seeks to improve HMDA performance. These companies also tend to be motivated by a genuine desire to exploit economic opportunities in the relatively untapped minority market; a desire to avoid public embarrassment and a negative business image--especially if they are publicly owned; and a desire to avoid restraints on growth as a result of the Community Reinvestment Act (CRA)--HMDA nexus.

Part of the CRA evaluation involves the financial institution's compliance with antidiscrimination laws. The bank/thrift regulators will examine the geographic distribution of the institution's credit extensions, applications and denials to demonstrate the reasonableness of lending patterns inside and out of the institution's delineated community.

Unfortunately, it has become apparent to us that there are still far too many mortgage companies and depository institutions that view HMDA as another meaningless regulatory burden. We find that at these types of institutions, the CEO and other senior managers do not know their specific level of performance with regard to minority lending.

These firms believe that their mission is accomplished once they have sent correct HMDA loan application registers (LAR) to HUD or the banking regulators. These are also the same companies that tend to treat regulatory compliance matters as low-echelon responsibilities unrelated to production and secondary marketing issues. These firms do not see how managing HMDA results proactively can help improve the bottom line and minimize liability.

Case study

The usefulness of HMDA data as a management tool becomes very clear when you consider the following case study. This case study incorporates a HMDA data analysis our firm performed for a California-based mortgage company that we will call, for purposes of this article, the "Fair Lending Mortgage Corporation" (FLMC). The mortgage company operates in 32 counties in California. The company took in nearly 8,000 mortgage applications in 1991 through 22 branch offices. The branches possess a high degree of autonomy regarding branch operations. The branch managers make all hiring decisions, and their compensation is based on the net profit of the branch.

The HMDA analysis was performed by examining data on loan applications and the action taken on the applications. These categories are further broken down by race of the applicant; the county where the applicant resided; the average income of the applicant by race; the average loan amount applied for by race; the action taken by race (i.e., originated |closed~, rejected by customer, denied, withdrawn and incomplete); and the reasons for denial by race. Using these HMDA data fields combined with census demographic information, we were able to generate a series of 15 tables that illustrate minority lending performance. Space limitations will permit us to display only three of the tables.

The three figures that capture the essence of minority lending performance are: the Application Disparity Index, Action Taken by Race and Reasons for Denial.

Figure 1, the Application Disparity Index (ADI), illustrates just how effective FLMC's marketing and sales efforts are in attracting mortgage applications from minorities. The ADI is created as follows:

the percentage minority group population represents in county / the percentage of total applications from that minority group in county

The higher the ADI, the higher the disparity. An ADI of 1.00 means that the lender is attracting applications from a given minority group in direct proportion to the population of the minorities in a given area. An ADI, for example, of 7.18 for Blacks, as is found in our case study for Alameda County, means that something is quite wrong with FLMC's marketing and sales efforts with regard to attracting applications from Blacks in that county. Similar findings are revealed for the other ethnic groups in various counties.

The ADI provides managers with information as to where the company has insufficient market penetration with respect to different ethnic groups. Relatively high ADI numbers may cause management to forge new correspondent relationships with minority originators or establish a branch in a minority community. Moreover, evidence of a high ADI might cause senior management to advise the branch manager to consider hiring more Black, Hispanic or Asian loan officers. Alternatively, the branch manager armed with this information might try to develop minority loan referral sources from minority real estate brokers, attorneys, accountants, churches and other sources.

The ADI also gives senior management something specific to manage. The company can set goals to lower the ADI for a specific minority group in a specific area over time. Employee performance can be evaluated in part on how well they have succeeded in lowering the ADI and their lending territory.

The information from Figure 2, a chart showing Action Taken by Race, tells a different story. While the ADI focuses on bringing minorities through the door, the Action Taken By Race data focus on how minority loan applications are treated once received, relative to how applications from whites are treated. This area has received the most media attention because it highlights the disparity in approval rates of whites relative to minorities. Also, these data can suggest intentional discrimination in the lending process.

In Figure 2, we see that Blacks, Hispanics, Native Americans and Asians were denied loans relative to whites at rates of 2.10 to 1; 1.15 to 1; and 0.73 to 1 and 0.9 to 1, respectively. Thus, FLMC appears to be doing a good job in treating minorities fairly in the lending process. The only exception appears, at least from these numbers, to be in the treatment of Blacks. The firm may want to conduct an audit to determine if Blacks are, in fact, being treated differently in the process. The examinations should focus on whether underwriting flexibilities extended to whites were also extended to Blacks.

The company also may want to examine the reasons it is doing so well with Asians relative to all other groups. One possible explanation is that the FLMC has an Asian branch manager covering several San Francisco Bay area counties and that manager uses his or her "Asian network" to bring in applications from this customer base. Because mortgage companies approve more loans than they deny, increasing applications from Asians influences the average Asian denial rate downward. This explanation also supports the contention that the racial makeup of your loan applicants will reflect the racial makeup of your loan officers and account executives.

Figure 3, the Reasons for Denial analysis, can help managers focus on whether or not there is bias in the underwriting process. The data tell the manager where to investigate. If collateral is cited as a dominate reason for loan denial, the lender will want to reexamine appraisals and perhaps interview the appraiser to solicit his/her justification for the indicated appraisal value.

If credit is cited as a predominant reason, FLMC may want to reevaluate credit reports to determine if the applicant was given full consideration in the proper factual context. FLMC may want to implement a second-level review procedure for rejected minority loans and refer certain borderline cases to a counseling program with the hope that the applicant can qualify for a loan with FLMC in the near future.

If the reason for loan denial was debt-to-income ratios, then the applicant should be directed to come back after he or she has selected a more affordable home. If insufficient cash was cited, the lender will want to investigate whether or not the applicant was placed into the correct program (i.e., maybe FHA/VA instead of conventional). The lender should also ascertain whether or not minority applicants were informed of the secondary market agency 3/2 and community homebuyers programs that allow for lower down payments.

Tailoring your marketing

After carefully reviewing this data, we concluded that FLMC did not appear to have effectively marketed its loan programs to minority groups, especially Blacks and Hispanics. In this regard, it did not meet the DOJ--Decatur Federal test. To reach Blacks that meet FLMC's lending standards, it will need to fashion its marketing efforts to attract middle- and high-income Blacks in L.A., Alameda and San Francisco counties. It should probably set up branches in L.A. and Alameda counties. Additionally it may want to hire minority loan officers in counties where the Black population is greater than 5 percent of the population. Moderate success may be achieved by marketing to Blacks in selected other counties.

Because Hispanic populations appear to be widely dispersed throughout FLMC's lending territory, the company should be able to improve results with this ethnic group. Nevertheless, because of potential cultural and communication barriers, a well-tailored program will have to be fashioned. From the HMDA data, it appears that only modest marketing efforts need to be undertaken to improve the outreach to Asians and Native Americans.

In sum, HMDA can be very useful to senior managers who are willing to slice and dice the data. Those firms that proactively manage their HMDA performance will be in a position to adopt marketing, sales and underwriting strategies to improve profitability. Those who do not may find themselves in predicaments similar to Decatur Federal's.

Michael Taliefero and Maurice Jourdain-Earl are managing directors of Channel Link Capital Partners, a mortgage investment advisory firm with offices in Washington, D.C. and Oakland, California. Dr. Debby A. Lindsey teaches managerial economics at Howard University, Washington, D.C.
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Title Annotation:government requirement on mortgage lending to minorities
Author:Taliefero, Michael; Jourdain-Earl, Maurice; Lindsey, Debby A.
Publication:Mortgage Banking
Article Type:Cover Story
Date:May 1, 1993
Previous Article:Back to the future.
Next Article:Mortgage detectives.

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