Mind the Gap: Single-Family Lending
Regulators and lending institutions have started to address structural barriers in US lending to minorities.
The OCC launched Project REACh (Roundtable for Economic Access and Change) in 2020, to extend financial inclusion to disadvantaged communities. The main barrier to access for credit for minorities remains having sufficient cash for down payments and closing costs. Project REACh will work with financial institutions to develop products which reduce the burden of down-payments without increasing asset risk. As such products are developed and the market opportunities increase, it is becoming ever more important to understand the current lending dynamics to minority borrowers and the scope for extending credit.
In our previous blog, we outlined some ways our clients can utilize Polygon Research apps to look for potential gaps in their lending practices. This week we focus on special purpose credit programs (SPCP), a lightly utilized tool that lenders have at their disposal, which could form part of the larger market solution in increasing credit to minority borrowers.
To recap, lending institutions must comply with the Equal Credit Opportunity Act (ECOA), which prevents them from considering credit transactions on a prohibited basis, such as race, ethnicity or sex. SPCPs are an exception to this prohibition, allowing credit institutions to establish programs that meet certain eligibility requirements. In December 2020, the Consumer Financial Protection Bureau issued an interpretive rule to Regulation B, which implements the ECOA, with the explicit aim to resolve uncertainties surrounding creditors' administration of SPCPs and thus increase their ease of use. Such programs would act as an avenue for lenders to extend credit to protected classes, including minority groups that might otherwise be unable to receive a loan or favorable lending terms when evaluated by an institution’s standard credit underwriting approach. Let’s take a look at the necessary steps to create a special purpose credit program and how Polygon Research can help lenders apply this tool to their market practice if they decide to do so.
Establishing an SPCP requires an explicit written plan addressing two main points.
The first is a description of the analysis undertaken to show how a specific class of applicants would be denied credit or offered less favorable terms if their applications were processed through lenders' customary credit standards. Such analysis can be done with the use of outside sources, such as Polygon Research apps, or with an organization’s own research.
The second is prescriptive measures of the program which include the following:
- the class of persons the program would benefit,
- the amount of time the program would be implemented before it is either extended or re-evaluated, and
- the procedures and underwriting standards the institution would take in its implementation.
At Polygon Research, we are here to help our clients use data to navigate the mortgage lending regulatory compliance landscape. Even though creditors do their own research in terms of how to best address market needs with their product offerings, the data shows that there is great scope for institutions to grow their business by finding underserved markets.
How big are the market opportunities in minority lending?
On a national US scale, we can analyze the pull-through rate from application to origination for minority vs. non-minority borrowers, as well as the average value of these transactions. Once we have accounted for incomplete and withdrawn applications and approved-but-not-accepted loans, we note that 90% of non-minority applications went on to the origination stage in 2019 as compared to only 85% for minority borrowers, a considerable difference of 5%. This equates to around $18.3bn in origination value or 62,000 loans of untapped market potential, as based on the size of current minority originations and the pull-through rate for non-minorities.
A natural next step is to understand the credit factors or underwriting standards that could be keeping the minority origination rate artificially lower than that of non-minorities. With enhanced knowledge of these credit factors, along with demographic, employment, housing, and income level data available from CensusVision, another one of our apps, lenders are better equipped to expand the markets they serve, diversify their income streams and grow their lending portfolios.
Exhibit 1: HMDAVision Snapshot - 2019 Minority vs Non-Minority Originations
Note: 2019 HMDA LAR data modeled and analyzed via HMDAVision®, and filtered for first-lien, closed-end, forward purchase mortgages secured by owner-occupied, site-built, 1-4 units (single-family).
Interestingly, the average value of minority loan originations (about $297k) is higher than that of non-minorities (about $276k), so there is scope for increased minority lending even if the cost base were to increase with adjustments such as changes in underwriting standards or the implementation of a special-purpose credit program.
Exhibit 2: 2019 Average Loan Size
Note: 2019 HMDA LAR data modeled and analyzed via HMDAVision®, and filtered for first-lien, closed-end, forward purchase mortgages secured by owner-occupied, site-built, 1-4 units (single-family).
So how would lenders go about finding market opportunities?
One way to look for target markets is to find where the discrepancy in denial rates is large - who is being denied the most and why? Through HMDAVision®, our clients can understand which factors might be playing a large role in denials to minority borrowers.#nbsp;
To give an example, focusing on a comparison of the denial rate between different races, the data shows that 16% of loans to Black or African Americans were denied in 2019, which is double the 8% denial rate for non-Black applicants. Following similar market sizing methodology as before, we arrive at $5.6bn of potential originations or around 25,000 new loans for black applicants if the origination rate were to increase to 16%.
Exhibit 3: HMDAVision Denials Dashboard Snapshot
Note: 2019 HMDA LAR data modeled and analyzed via HMDAVision®, and filtered for first-lien, closed-end, forward purchase mortgages secured by owner-occupied, site-built, 1-4 units (single-family). Denial rate = originations / net applications. Net applications = originations + approved not accepted + denials.
The qualifying factors for denying a loan include the inability to make a sufficient down-payment, ratios that exceed lenders' caps (loan-to-value, debt-to-income and payment-to-income), and having little or poor credit history, such as low FICO scores or gaps in employment. If lenders chose to establish special purpose credit programs, zeroing in on the reasons for denials allows them to alter the most relevant metrics in their standard underwriting models as applied to specific protected classes.
In the Denial Reasons below chart, a clearer story begins to emerge as to the reasons for denials. We see that credit history is an much more prevalent factor in denials to Black applicants, representing the primary denial reason for 25.2% of black applications as opposed to 17.8% for other applicant groups. Lenders could utilize such information to better understand how to serve this target population.
Exhibit 4: 2019 Denial Reasons
Note: 2019 HMDA LAR data modeled and analyzed via HMDAVision®, and filtered for first-lien, closed-end, forward purchase mortgages secured by owner-occupied, site-built, 1-4 units (single-family).
If lenders were looking to implement an even more targeted SPCP, this analysis could be done for more detailed demographics within minority segments, such as age group or sex, or with regard to specific geographies. Our apps help institutions find pockets of lending opportunities and understand their practices contextually within the markets they serve, as well as on an individual lender basis. We provide users with an easily digestible format for a large amount of data so they can monitor their business profiles and create winning strategies in their pursuit of new markets.
Other Alternatives for Increasing Minority Lending
Although at the national scale we don’t see much of a discrepancy between the number of loan applications received from minority and non-minority borrowers as a percentage of their population sizes, lenders would be wise to examine the geographies in which they operate in more detail. One way to do so is by examining tracts that have large minority populations or a large number of minority denials. To provide a visual representation, below is the depiction of total market denials and population numbers by County and PUMA, respectively, which can also be viewed on an individual lender basis.
Exhibit 5: HMDAVision HMDA+Census Dashboard
Note: 2019 HMDA LAR data modeled and analyzed via HMDAVision®, and filtered for denials - first-lien, closed-end, forward purchase mortgage applications secured by owner-occupied, site-built, 1-4 units (single-family). Focus on minority denials and population.
Finally, lenders also have other tools at their disposal to increase lending to minority borrowers. Under ECOA, it is permissible to undertake “affirmative marketing” campaigns to increase applications from minority groups, specifically lower-income or communities of color. Lenders can also implement programs in which they take a second look at denied applications once enough time has passed or implement “second review” programs to test whether underwriting standards have been consistently applied between minority and non-minority borrowers.
Whatever tools our clients choose to implement, we are always open to feedback in terms of delivering customized solutions that fit users' specific needs. For more information please visit www.polygonresearch.com/apps or sign up for a demo at www.polygonresearch.com/demo.
