By Robert Brannum
As we find ourselves in the midst of the subprime loan crises, with another year of market pain and personal tragedy forecasted, any positive news would be a welcomed reprieve – like the first robin of spring after a long winter. That robin may, in fact, have arrived: new research on the foreclosure crisis indicates that the Community Reinvestment Act (CRA) is at least one positive takeaway.
The CRA was passed in 1977 by the government to encourage federally insured banking institutions to help meet the credit needs of lower-income communities. It was enacted in response to concerns that banking institutions were, in some situations, failing to adequately meet the credit needs of viable lending prospects in all sections of their communities. CRA influences the behavior of banking institutions primarily by an examination and ratings system, and in the formation of public opinion.
While the intentions of the CRA are clear, there have been arguments against it since its inception. Those discussions mainly lie in the areas that competition and market forces should regulate lending and access to credit, not the government. Other arguments are that regulated lending to higher-risk borrowers would raise overall costs and lead to higher default levels.
However, recently released findings from a study by Manhattan law firm Traiger & Hinkley provide evidence that the CRA likely deterred a significant number of poor lending decisions that would have further exacerbated the current subprime crisis.
Traiger and Hinkley is a boutique law firm specializing in providing guidance on CRA compliance and fair lending regulation to banks and other lenders. In 2004 it began conducting a series of annual studies on the mortgage lending industry, and released its third study, "The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis," in early January 2008. “We wanted to test the hypothesis that the CRA might have limited some of the poor lending practices of banks during that period,” said Warren Traiger, a partner in the law firm.
Findings of the study, based on 2006 loan data reported by the Home Mortgage Disclosure Act, indicate that the CRA likely limited poor lending decisions that might have lead to an increased number of foreclosures in the 15 most populated U.S. metropolitan areas.
The study reports that banks which originated loans in their CRA assessment areas (CRA Banks), “were substantially less likely than other lenders to make the kinds of risky home purchase loans that helped fuel the foreclosure crisis.” CRA Banks have not played a significant role in subprime lending and, where they did make subprime loans, the loans have been on more favorable rates and terms than those made by non-CRA Banks. The four key conclusions made by the study are:
CRA Banks were significantly less likely than other lenders to make high cost loans;
Interest rates on subprime loans made by CRA Banks were appreciably lower than the average interest rates on loans originated by other lenders;
CRA Banks were more than twice as likely to retain loans in their portfolios as other lenders; and
Foreclosure rates were lower in metropolitan areas with high concentrations of bank branches.
Figure 1 (below) illustrates the reduced share of subprime loans made by CRA Banks: while CRA Banks made nearly 23 percent of all loans, they only made 9 percent of subprime loans.
Another key finding relates to observations made by Federal Reserve Chairman Bernanke to Congress last September, that “The originate-to distribute model seems to have contributed to the loosening of underwriting standards in 2005 and 2006. When an originator sells a mortgage and its servicing rights, depending on the terms of the sale, much or all of the risks are passed on to the loan purchaser. Thus, originators who sell loans may have less incentive to undertake careful underwriting than if they kept the loans.”
In other words, those banks that kept their originated loans in their own portfolios would be more strongly incented to ensure that careful underwriting took place. The findings in the Traiger study support that this happened.
In Figure 2 (see below), CRA Banks clearly outpaced non-CRA Banks along three important dimensions: in the proportion of all loans kept in portfolio, the proportion of high cost loans kept in portfolio; and the proportion of loans made to low- and middle-income borrowers kept in portfolio.
The New York metropolitan area, one of the 15 studied in the Traiger research, faired very well against the other areas in several key areas. The data indicated that the New York area was better than most regions in making fewer subprime loans and keeping those it did make in its own portfolio.
Two areas of significant achievement for New York were around the region’s percentage of subprime loans made, and of those made to low- and middle-income borrowers. As Figure 3 (below) illustrates, New York had exceptional relative performance in both areas.
While this survey was undertaken by a law firm advising the banking industry, those directly within the banking industry have supported the survey results. Michael Smith is president and CEO of the New York Bankers Association (NYBA), which is comprised of the commercial banks and thrift institutions that engage in the banking business in New York state. “The independent Traiger study findings were not surprising but were gratifying,” commented Smith. “The report confirms what we knew to be true – banks subject to CRA were more likely to make mortgage loans with favorable rates and terms for consumers. New York banks, with branches in their communities, are more likely to keep mortgages in their portfolios and have significantly lower foreclosure rates.”
Many industry advocates have suggested that these findings – that the CRA has led to improved industry conditions while enabling access to credit to lower-income communities – might be an impetus for an expanded role for the CRA in the industry. Said Smith, “Certainly, the Traiger study demonstrates the need for policy makers to look closely at the role of mortgage lenders and brokers, who are not subject to the same stringent regulations as banks. NYBA will continue to work with banking regulators to ensure that any new laws or regulations plainly distinguish the role CRA banks have played in helping communities, compared to those entities which are largely unregulated and largely the cause of the current crisis.s
Robert Brannum is a freelance writer based in Boston with special expertise in the financial industry.