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Community Reinvestment Act lending: Is it profitable?

Larry Meeker and Forest Myers

Larry Meeker is

Vice President of

Community Affairs.

Forest My ers is an

Economist in the

Policy an d Special

Projects Department .

Both departments are

in the Division of

Bank Supervis ion

and Structure.

1For example, see

Glenn Cann er and

Way ne Passmore,

The Relative Profit-

ability of Commercial

Bank s Active in Lend-ing in Lower-Income

Neighborhoods and

to Lower-Income Bor-

rowers, Proceed-

ings o f the 31s t

Annua l Con fe rence

o n B a n k S t r u c t u r e ,

May 1 996 (Federal

Reserve Bank of Chi-

cago, forthcomin g).

I n t r o d u c t i o n

In 1977, Congress passed the Commu-nity Reinvestment Act (CRA) to encouragefederally insured depository institutionsto lend in low- to moderate-income neigh-

borhoods and to low- to moderate-income

people. Since then, the profitability of themany special lending programs designedto achieve these goals has been questionedon both theoretical and practical grounds.1

Arguments range from if the businesswas profitable you wouldnt have to pres-sure institutions to do it" to we foundnew markets and new profits throughCRA lending. While CRA requires banksand thrifts to help meet the credit needsof communities in which they are char-tered, it further cautions that these effortsshould be consistent with safe and

sound operations of such institutions.Despite the safe and sound caution,questions about the risk and overall prof-itability of CRA lending persist. Many per-ceive CRA lending to be risky business,

with higher losses and lower profits. Anec-dotal evidence, on the other hand, sug-gests that losses on CRA loans may not

be appreciably different than for non-CRAloans, and some institutions report theirCRA lending is profitable.

Being profitable by simply avoiding losses,however, is not enough. The returns onCRA loans must be as great as thosereceived on other products if lenders are tohave a business incentive to extend theseloans. Without such returns, institutions

will be reluctant to make CRA loans and

will be at a competitive disadvantage withlending institutions not subject to CRA.

In this study, our goals were to determineif some lenders have been able to under-take CRA lending in a way that is competi-tively profitable with their conventionallending and, if so, describe how they didit. We focused on home mortgage lending,

which is a relatively standardized, high-volume business, where lenders are likelyto have become proficient. What we learnedabout home mortgage lending likely has

implications for other types of CRA lend-ing and the longer-run profitability ofCRA lending in general. Our findingsalso have implications for other frequentparties to CRA lending including govern-ment, community organizations andregulators.

To conduct the study, we surveyed largehome mortgage lenders. We asked aboutcredit risk, loan terms, processing costs,and overall profitability of single-family

13

Authors Notes: The authors wish to thank Glen Canner and Paul Calem of the Board ofGovernors of the Federal Reserve System; Richard Moore, President of Commerce Mort-gage Company, Kansas City, Mo.; and Joe Egan, Director of the Kansas City RehabilitationLoan Corporation, Kansas City, Mo., for their many helpful comments and suggestions onthe design of the survey, on earlier drafts of this paper, and for their insights regardingmortgage lending.


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residential CRA loans and comparableconventional loans. This informationpermitted a comparison of strategies

among institutions that found single-family residential CRA lending competi-tively profitable with conventionallending and those that did not.

Ba c k g r o u n d

Several pieces of legislation have helpedshape lending to low- and moderate-income individuals and neighborhoods.CRA set out to eliminate the practice ofredlining and encourage insured deposi-tory institutions to reinvest in their com-munities. The Financial Institutions,Reform, Recovery, and Enforcement Actof 1989 (FIRREA) provided for greaterpublic disclosure of lending to low- andmoderate-income borrowers,2hasteningthe development of affordable housinglending programs, 3and increasingcredit available to low-income borrow-ers.4Finally, the Federal Housing Enter-prise Financial Safety and Soundness

Act of 1992 added further support forCRA lending by requiring the Departmentof Housing and Urban Development(HUD) to set purchasing goals for mort-gage loans to low- and moderate-incomefamilies by the Federal National Mort-gage Association (Fannie Mae) and Fed-eral Home Loan Mortgage Corporation(Freddie Mac), thereby strengtheningthe secondary markets for these loans.

These advances in CRA lending, how-ever, have not been without controversy.In the early 1990s, a U.S. Senate taskforce ranked CRA tenth on a Ten WorstRegulations List.5Surveys of bankershave often indicated that CRA is one of

the most costly regulations to complywith. Some have argued that CRA hasforced banks to make loans they wouldnot otherwise make, subjecting them toincreased credit risk and lower profitability.

Data on loan losses and profitability ofCRA loans, although spotty and largelyanecdotal, generally do not show these

loans to be riskier or less profitable thanconventional loans. However, some stud-ies have shown that delinquency rates,

but not default rates, tend to be higheron CRA loans.6Various surveys on over-all profitability indicate some lenders sac-rifice profitability to subsidize their CRAloans, while other lenders make money,expect to make money, or break even ontheir CRA loans.7

Information on mortgage lending gath-ered from round table discussionsacross the country with bankers, com-munity groups, and others are consis-tent with these findings.8For example:

Reviewin g the components of profitability

tran sactions costs, delinquencies an d

default s, and revenues participan ts

generally agreed that, for low -income

neighborhoods, the costs are higher, delin-

quencies (but n ot necessaril y d efau lts)

are more common, a nd revenues ar e

similar to those experienced in other

neighborhoods. There are no signs tha t

the profitabil i ty of lending in low -income

neighborhoods is high.9

On subsidized mortgage lending programswhere the borrower and lender rely onsome form of private or public assistanceor guarantees, round table participantsnoted that low-income, subsidized mort-gage markets yield little return to pri-

vate equity, and they would be smallerin scope if not for subsidies and a needto meet CRA requirements.10

Factors hindering profitability werehigher paperwork costs, the need forstaff with specialized knowledge aboutsubsidy programs, and screening and

monitoring costs required by some pro-grams. Also important in the profitabilityequation were limitations in subsidy pro-grams that discouraged or preventedlenders from pricing for risk.

An interesting observation from round tableparticipants was that smaller community

banks may have transactions cost and

2FIRREA mad e CRA

ratings and perform-

ance evaluations pub-

lic informa tion. See

the companion article

in this issue for more

details on these

changes and other

events that h ave

shaped CRA and its

implementation.3Jonatha n R. Macey

and Geoffry P. Miller,

The Community Rein-

vestment A ct: An Eco-

nomic Analysis,

Virgin ia Law Review,

79, Number 2 (March

1993 ), pp. 300-301.

4Kath ryn Tholin, et al.,Sound Loans fo r

Comm un i t i e s : An

Ana l ys i s o f the Per -

fo rm ance of Com-

mu n i t y Reinvest -

men t Loans, Wood-

stock Inst itute, October

1993 , p. 3. Griff ith L.

Garw ood an d Dolores

S. Smith, Communi ty

Reinvestment Act:

Evolution and Current

Issues, Fede r a l

Reserve Bu l le t i n,

Board of Governors ofthe Federal Reserve

System, April 1993 ,

p. 262. Keith Rolland,

ed., Commu ni ty Rein-

vestment Advocates,

Federal Reserve

Bank of Philadelphia,

July 1 993, pp. 3-40.

Affordable H ome

Loan Programs Seem

to Be Hav ing an

Impact, Ame r i c a n

Banke r , Thursday,

August 10, 1995, p. 13.5

Olaf de SenerpontDomis, Truth -in-

Lending, CRA Makes

10 W orst Rules

List, Ame r i c a n

Banke r , January 31,

1995, p. 3.6Because there is a

lot of publicly a vail-

able information on

mortgage lending by

FINANCIA L INDUSTRY PERSPECTIVES

14


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risk management advantages over largerinstitutions in extending CRA loans. Thesepotential advantages resulted from

smaller lenders knowing their commu-nity residents better and developingstronger borrower relationships over time.

This close tie between borrower andlender allowed more personal monitoringof loans, something that was apparentlydifficult to replicate on a larger scale.

Large lenders, on the other hand, tendedto rely on standardized risk measuresand processes to handle their higherloan volume and to keep costs down.Since CRA loans often dont fit a stand-ard mold, the need to handle these loansindividually may result in higher proces-sing costs. Less direct contact with bor-rowers may also result in greater creditrisks at larger institutions.

The mode l

To evaluate the profitability of single-family residential CRA lending, we askedlenders questions structured around astandard accounting model for analyzingthe profitability of a loan product:

LOAN PROFIT ACCOUNTING MODEL

Interest income

- Interest expense

Net interest income

- Provision for loan losses

- Overhead expenses

+ Other income

Net income

Questions focused on the overall profit-ability of CRA lending (net income) as

well as its component factors, thus pro-

viding an opportunity to explore howsome lenders achieved more profitableCRA lending.

Th e sur vey

The survey was designed to accommodatea lack of cost accounting information onCRA lending at institutions. In particular,

we asked respondents for their judgmentson the profitability of CRA lending relativeto conventional lending at their institutions.

The survey focused on single-family resi-dential lending. The high volume andrelatively standardized terms and under-

writing criteria for this lending contributedboth to lender expertise in making theseloans and to enough consistent data beinggenerated for meaningful observations.

We knew many institutions would havemore than one CRA home mortgage lend-ing program. Where this was the case,

we asked respondents to provide informa-tion about their organizations most impor-tant program or the program that mosttypified their experience with CRA lending.

Our survey asked respondents for gen-eral information about their organizations,their economic environment, and theirCRA lending profitability.11Informationabout the organizations and their envi-ronment centered on the local economy,areas served, institution type, annual vol-ume of CRA and conventional loan origi-nations, and ways CRA lending wasapproached. The questions pertaining toCRA lending profitability focused oncredit risk, transactions costs, loan feesand terms, and profitability. We alsoasked for comments about other mattersthat might affect these factors.

The respond en t s

The intent of the study was to evaluatethe relative profitability of seasoned CRAprograms, describe possible reasons forprofitability differences, and offer insightsfor improving profitability. Since informa-

tion on the maturity of CRA programs wasnot readily available, we surveyed institu-tions that had total assets of $100 mil-lion or more, assuming their size wouldcorrelate with CRA lending experience.

To lessen the effects of location, we onlysurveyed institutions located in metro-politan areas. Further, we only sentquestionnaires to institutions that had

institutions, most

studies on CRA lend-

ing focus on single-

family residential

lending. For example

see, Fritz Elmend orf

and K arin C. Brough,

Afford able Mortgage

Program Study : A

Survey of Bank Mor t -

gage Program s as of

June 30, 1994, Con-sumer Bank ers Asso-

ciation, (Arlin gton,

Virginia: 1994), p. 9.

Also see Rolland ,

Community Reinvest-

ment, p. V. and

Tholin, et. al., Sound

Loans, pp. 9-15.7Ja ret Seiberg, CRA

Lending is Profitable

For Bank, Study

Finds, Ame r i c a n

Banke r , August 26,

1994 , p. 1. Also see

Elmendorf andBrough, p. 5.8These dis cussions

w ere jointly held as a

precursor to the revi-

sion of CRA supervi-

sion by the three

federal banking agen-

cies and t he Office of

Thrift Supervision.9Report t o Congress

on Comm uni ty Devel-

opment Lendin g by

Depository Inst i tu -

t ions, Board of Gover-

nors of the FederalReserve System, Octo

ber 1993, p. 34.10Ibid, p. 35.11A copy of the sur-

vey form can be ob-

tained by contacting

the Public Affairs

Department, Federal

Reserve Bank of Kan -

sas City.

FEDERAL RESERVE BANK OF KANSAS CITY

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concluded it was less profitable orsubstantially less profitable than theirconventional lending.

As noted earlier, many CRA lending pro-grams were put in place after 1989 and,as a consequence, their current profit-ability may not reflect their long-termprofitability. Looking to the future,approximately 31 percent of the respon-dents (29 respondents) to a question onfuture profitability saw their CRA lend-ing being at least as profitable as theirother lending. The remaining 69 percentdid not believe their CRA lending wouldever be as profitable as their conven-tional lending. This suggests that lend-ers in our data set may be well along theCRA lending learning curve, since fewperceived that future profitability wouldchange significantly from current levels.

Besides dollar profitability, institutionsmay receive other, less tangible benefitsthat make CRA lending attractive. Approxi-mately 90 percent of survey respondentssaid there were non-monetary benefits toCRA lending.14These included:

Commun ity image imp roves.

He lps the commun i ty g row and

prosper .

A stronger commun ity equals futu re

prof i tabi l i ty .

Future customers for other produ cts.

[It] pacifies regula tors and commu-

nity groups.

Comments such as these reflect differ-ences in both attitude and approaches

toward CRA lending, both of which mayhave implications for profitability at indi-

vidual institutions.

Since our principal concern was with thelonger run profitability of CRA lendingand how some institutions achieve it, weseparated survey responses into twolender categories: lenders who reported

their CRA lending was at least as profit-able as their conventional lending, andthose who reported it was not. We then

examined income, expenses, and otherrelated information to identify factorsthat may account for CRA lending profit-ability differences between the groups.

Before discussing the comparative results,several observations about the data andthe study methodology are in order. First,despite attempts to identify institutions

with seasoned CRA lending programs,most reported results were from programsof recent vintage. Thus, the results reflecta period during which the U.S. economyperformed well, and may not reflect prof-itability over future business cycles.

Additionally, there may be limitations inextrapolating the results into future

years because of changes in CRA enforce-ment which began in 1996. The surveycovers lending under the earlier periodsprocess oriented approach to CRA en-forcement. Under the new results ori-ented approach15to CRA enforcement,some lenders may be more aggressive intheir CRA lending, absorbing more bor-rower fees and offering lower loan inter-est rates to establish larger CRA loanportfolios. Such behavior would clearlyhave implications for future CRA loanprofitability.

Finally, the analysis we present makessimple bi-variate comparisons betweenthe profitability of an institutions CRAlending and its conventional lending.However, many factors may influenceprofitability simultaneously, making itdifficult to draw conclusions from ourcomparisons. To deal with these influ-

ences, we used the multi-variate statisti-cal models presented in Appendix A tohold constant institutions loan origina-tion volume (a proxy for institution size),economic conditions, CRA program ageand FHA/VA participation. This analysisprovides support for the more simplydrawn observations from the bi-variatecomparisons.

14Ninety institutions

responded to the sur-

vey question Other

than profitabil ity con-

siderations, are there

add itional benefits to

your institution from

mak ing CRA loans?15The new regulation

became effective forsmal l banks in Janu-

ary 1996 and w i l l

become effective for

large banks in July

1997 . It is the product

of both industry and

commun ity pressures

to refocus examina -

tions from pr ocess to

results.


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Pas t pe r f o rm an ce o f CRA l end i ng

p r og ra m s: Revenu e an d expense

compa r i s o n s

Loan fees, down payments, interestrates, debt ratios, and credit historiesare important constraints on home own-ership for all borrowers, but especiallyfor low-income borrowers. The CRAprograms offered by survey respondentsloosen many of these constraints (See

Appendix B). This loosening can haverevenue and expense consequencesand, hence, profitability implications forlenders. In the following sections, weexamine these factors to evaluate theireffect on overall profitability.

Revenue compa risons: Loan fees and

interest rates

Many of the survey respondents CRAloan programs subsidize borrowers byabsorbing some to nearly all of the fees(appraisal, title search, credit check, fil-

ing fees, and other administrative costs)associated with making a residentialloan. This makes home ownership moreaffordable for low- to moderate-income

borrowers but lowers lender revenuesand decreases the relative profitability ofCRA programs. Survey responses showthis may be one reason why some findCRA lending less profitable than others.

Respondents whoseCRA lending was asprofitable as their con-

ventional lending gaveup a smaller portion oftheir fees (23 percenton average) than insti-tutions with less profit-able CRA programs(40 percent).

Reduced interest ratesis another factor thatcan affect the relativeprofitability of CRAlending programs. Ta-

ble 1 shows that thosewith CRA lending pro-

grams as profitable as their conventionallending programs were less likely (5 per-cent versus 39 percent) to lower rates for

borrowers than those with less profitableprograms.

Lower fees and reduced interest rates,however, do not have to lessen profitabil-ity. Various government programs, in-cluding grants and other assistance,may allow institutions to give up feesand charge lower interest rates withoutsacrificing profitability. Indeed, 22 per-cent of those responding to the surveyindicated that various government pro-grams allowed them to offer lower feeson CRA loans. Further, 29 percent saidgovernment programs allowed them tooffer lower interest rates on their CRAloans. However, even with governmentassistance, many respondents suggestedthere is significant lender subsidizationof CRA loans:

Bank a bsorbs al l nonvendor fees

i.e., appraisal , und erw r i t ing, loan ser-

vice, escrow .

We absorbed some of the costs and

providers of serv ices low ered some

costs.

Too man y lenders are subsid iz ing

the CRA loans, el iminat ing th e prof i t .

Interest rates and profitability

Annual percentage ratecharged on CRA loansrelative to similar size

traditional loans

Banks reporting CRA lending to be

As profitable asconventional

lending

Less profitablethan conventional

lending

Higher 9% 9%

Same 86 52

Lower 5 39

Table 1


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Expense compa risons: tran sactions costs

Transactions costs are an important fac-

tor in mortgage lending that may affectthe relative profitability of CRA lending.To help analyze transactions costs, weasked how CRA lending was conducted

within institutions, as well as about origi-nation and servicing costs.

A majority of respondents (62 percent)conducted their CRA operations throughloan officers who did other types oflending as well. The remaining 38 per-cent (35 respondents) indicated theyused a separate department, loan officersspecializing in CRA lending, or someother mechanism for processing theirCRA loans.16

We found that 83 percent of the institu-tions that treated CRA lending as a sepa-rate activity (30 respondents) were in theless profitable group. This result wassomewhat unexpected. Since CRA lend-ing often requires specialized expertise,

we expected that institutions with sepa-rately structured CRA programs might

benefit from the specialization. Indeed,they may have and our results may sim-ply reflect better accounting for CRAloan profitability at institutions thattreat it separately.17

However, there may be more than account-ing differences at work. For example, wefound that institutions with separateCRA lending programs were more likelyto offer special incentives to loan offi-cers for making single-family residentialCRA loans (44 percent of respondents)than those that did not (18 percent).

These incentives can raise the cost of

originating CRA loans, thus reducingtheir profitability.

Our results may also reflect institutionalsize differences. We noted earlier thatlarger institutions, with their stand-ardized systems, may find it more costlythan smaller institutions to make CRAloans. Although we did not collect size

information in our survey in order topreserve respondent anonymity, the resi-dential loan origination information we

did collect can be used as a proxy forsize and suggests that size may be afactor in CRA loan profitability.18Forexample, average total single-family loanoriginations for institutions with com-paratively profitable CRA programs was$26 million during 1994, the year cov-ered in our survey. Average total resi-dential originations for institutions withless profitable CRA programs was $361million.19

Our results may also reflect differencesin aggressiveness among institutions inmaking CRA loans. Institutions with aseparate CRA lending function may bereaching further into the pool of poten-tial borrowers, working with borrowers

who have fewer financial resources andpoorer credit records. Consequently, costadvantages gained through specializa-tion may be offset by the added expenseassociated with working with more mar-ginal borrowers who have more financialproblems to overcome.

To supplement this broader view of CRAlending costs, we asked for specific infor-mation on origination and servicingcosts.20We found that institutions withless profitable CRA programs tended tohave higher origination costs than those

with comparatively profitable programs(see Figure 2). Almost 70 percent of institu-tions with less profitable programs saidorigination costs on their CRA loans

were higher than those on their con-ventional loans. In contrast, approxi-mately 82 percent of the institutions

with CRA lending programs that are as

profitable as their conventional lend-ing indicated that origination costs ontheir CRA and traditional loans werethe same.

Table 2 lists reasons for higher originationcosts given by institutions with less prof-itable CRA programs.21Time spent with

borrower was the most frequently cited

16The other mecha-

nisms included resi-

dential mortgage

departments, special

adm inistrative areas

of the institution, a

mortgage bank ing

subsidiary, and use

of special underw rit-

ers for real estate

mortgages.17For example, some

institutions may treat

CRA lendin g as a sepa-

rate profit center. In

such cases, the center

may be allocated a

portion of the institu-

tions overhead cost.

Where CRA lendin g isnot treated separately,

no such allocation

may have been done,

tending to make the

relative profitabil ity of

those without sepa-

rate CRA programs

appear to be h igher

than those with sepa-

rate programs.18We assumed that

larger institutions

w ould generally report

larger origination

amounts.19The average size

CRA loan for th e as

profitable group w as

approximately

$52,00 0. For the less

profita ble group, the

avera ge size CRA

loan was $ 59,500.

Although the average

size loan amounts dif-

fer, a means differ-

ence test indicat es the

values are not statisti-

cally different.20Origination costs

includ e processing,

underwri t ing, and

closing a loan . Servic-

ing costs includ e col-

lecting month ly

payments, managing

escrow accounts, and

handl ing any del in-

quency an d foreclo-

sure problems tha t


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reason. Developing borrower informationand Paperwork costs were also consid-ered to be important cost factors, as

were Grants or payments made to com-munity groups.

In addition to origination costs, we askedinstitutions about their loan servicingcosts. Once again, institutions with com-paratively profitable CRA programsshowed little difference in servicing costs

between their CRA loans and their con-ventional loans. Figure 3 shows that 95percent of institutions with compara-tively profitable CRA lending programssaid their servicing costs were the sameas on their conventional loans. On theother hand, 48 percent of the institu-tions with less profitable CRA programs

tended to incur higher servicing costs ontheir CRA loans.

Of the 32 respondents who said theirservicing costs were higher, 91 percentattributed that to higher monitoringcosts. A few respondents offered com-ments about these monitoring costs:

[Greater ] contact w ith customers a nd

w ork to keep [them] current on pay -

ments.

More frequent chan ges to insur an ce.

Also more past du es. More phone

calls.

Loan losses and credi t r isk man agement

Another expense area where CRA lend-ing may affect lender profitability isthrough higher loan losses. Many stud-ies of mortgage default rates show that

when home mortgage loan underwritingcriteria are relaxed, default rates rise.22

CRA lending programs often relax keyunderwriting parameters identified aspredictors of loan defaultsuch as loanto value, debt to income ratios, juniorfinancing, maturity, interest rate (see

Appendix B). Therefore, we asked aboutunderwriting standards, risk controlmethods, and manageability of creditrisk for CRA residential loans.

Our questions on underwriting stand-ards (see Appendix C) focused primarilyon the three Cs of credit: character,capacity, and collateral. Institutions withcomparatively profitable CRA programsindicated they relaxed their credit stand-ards, but often not to the same degree asthose with less profitable programs. Forexample, the more profitable CRA lend-ers placed more emphasis on repaymentcapacitybeing less likely to accept higherdebt to income ratiosand on collateralin making CRA loans.

Many of the differences in credit stand-ards between the two groups appear to

be small. Studies show, however, that

loan performance deteriorates signifi-cantly when multiple standards arerelaxed.23As a consequence, small differ-ences in individual factors may translateinto substantial differences in credit risk

when many factors are relaxed. Wenoted that banks with more profitableCRA programs tended to relax fewer oftheir loan underwriting criteria than

might occur w ith a

loan . See Mortgage

Bank ing Per fo rm -

an ce Review: Si ngl e-

Fami ly Res ident ia l

Mortgage Product ionand Servic ing Prof i t -

ab i l i t y 199 0-1993,

Fannie Mae, Volume

1, December 19 94,

pp. 11, 21.21Since only f our

respondents w i th

more profitab le CRA

programs ind icated

that th eir origination

costs on CRA loans

w ere higher, our dis-

cussion of factors

influ encing origination

costs focuses on ins ti-tutions w ith less prof-

itable programs.22Roberto G. Quercia

and Michael A. Steg-

man, Residential

Mortgage Default: A

Review of the Litera-

ture. J ou r n a l o f

Hous in g Resear ch,

Vol. 3, Issue 2, 199 2,

Reasons for higher origination costsLess profitable

Source of higherorigination costs Percent*

Number ofinstitutions

Time spent with borrower 90 44

Developing borrower information 65 32

Paperwork 49 24

Grant or payments madeto community groups 33 16

Incentives paid to loan officers 14 7

Other factors 24 12

* Percentage is based on 49 respondents indicating their servicing costs were higher.

Table 2


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pp.341-379. Snigdha

Prak ash, Clintons

Home Ow nership

Plan a 2-Edged

Sword for Lenders,

Amer ican Bank er,

June 7, 1995, p 1.

Gordon, H. Steinba ch,

Entering a New

World, Mortgage

Bank ing Magaz ine,

June 1995, pp. 36-42.23For example, see

Robert B. Avery, et al

Credit Risk, Credit

Scoring, an d th e Per-

formance of Home

Mortgages. Federa l

Reserve Bu l le t i n,

Vol. 81 (July 19 96),

pp. 683, 644-647.

Figure 2

Figure 3

Loan origination cost comparisons

Loan servicing cost comparisons

0 20 40 60 80 100

Source: Federal Reserve Bank of Kansas City.

Higher cost

Same cost

Lower cost

As profitable

Less profitable

0 20 40 60 80 100

Source: Federal Reserve Bank of Kansas City.

Same cost

Lower cost

Higher cost

As profitable

Less profitable


21


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those with less profitable programs. The 22institutions with more profitable CRA pro-grams relaxed, on an average, 1.3 of five

broadly defined credit and underwritingstandards (debt to income, loan to value,collateral, character and credit history).

Those with less profitable programs relaxedan average of 2.1 of these standards.

Institutions may be comfortable relaxingsome of their credit standards if theyknow there are other mechanisms formanaging credit risk. Consequently, weasked respondents about their reliance ongovernment guarantees, community

groups, and lending consortia tolessen their credit risk exposure (see

Table 3). While both groups made

extensive use of these enhance-ments, especially communitygroups and government guaran-tees, those with the comparativelyprofitable programs were less likelyto use these alternative risk reduc-ing enhancements than institu-tions with less profitable programs.One possible explanation for thisis that extension of an institutionsexisting underwriting standardsto include CRA loans may be opera-tionally less costly than usingexternal risk reducing techniques.

To judge how important theserisk reducing enhancements

were in the lending process, weasked respondents what propor-tion of their loans would not have

been made without them. Theirresponses are presented in Table 4.

As would be expected, institutionswith less profitable CRA programswere less likely to make CRAloans without them. However, ahigh proportion of CRA loans75percent or morewould have

been made by either profitabilitygroup even without enhancements.

In addition to addressing under-writing criteria, the survey askedrespondents to compare the

delinquency and loan loss rates on theirCRA loans relative to their traditionalloans. All respondents, regardless of prof-itability group, indicated that losses ontheir CRA loans were comparable tolosses on their conventional loans.24

They further believed credit risk for theirCRA programs to be manageable; those

with comparatively profitable CRA pro-grams were unanimous in that belief.

Approximately 72 percent (51) of thosewith less profitable programs thoughtcredit risk on CRA lending was man-ageable. Twenty-seven percent (19)thought it was too soon to tell. Only one

Reliance on enhancementsProportion of survey respondents, by profitability group, indicating reliance on govern-ment guarantees, community groups and lending consorita to reduce credit risk

ProfitabilityGroup

Governmentguarantees

Communitygroups

Lendingconsortia

Percent Number Percent Number Percent Number

As profitable 45 10 64 14 27 6

Less profitable 67 47 89 63 57 40

Table 3

Importance of risk reducing enhancements

Profitabilitygroup

Respondents indicating theywould have made 75 percent ormore of their CRA loans withoutgovernment guarantee programs

Respondents indicating theywould have made 75 percent ormore of their CRA loans withoutcommunity group assistance

Percent Number Percent Number

As profitable 81 17 90 20

Less profitable 75 51 75 50

Table 4

24The similarity in loss

rates found in our sur-

vey are consistent w ith

information gleaned

from the survey by

the Federal Reserve

Bank of Philadelphiamentioned earlier.

None of 11 institu-

tions that d iscussed

their loan loss experi-

ence in tha t survey

report ed significant

differences in d efault

rates betw een their

CRA loans an d their

conventional loans.


22


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respondent thought these risks couldnot be managed.

Unlike loss rates, delinquency rates dif-fered between the two CRA profit groups.Institutions with less profitable CRAlending programs reported higher delin-quency rates, perhaps reflecting theirmore lenient underwriting standards onCRA loans. The higher delinquency ratesmay also help explain higher servicingcosts for these institutions. The informa-tion presented in Figure 4 helps clarifyhow more lenient credit standards andhigher delinquency rates may translateinto higher servicing costs.

Op t i ons f or im p r ovi n g CRA l end i ng

p r o f i t s

In addition to asking respondents aboutthe relative profitability of their past CRAlending efforts, we asked for their insightsconcerning ways to improve future CRAloan profits. Forty-three respondentsmade suggestions on ways to improvethe profitability of CRA lending. Sugges-tions invariably focused on ways to recouplost revenue and to reduce CRA loan

transactions costs. The most frequentlymentioned suggestions are summarizedin Table 5. Discussions concerning thesesuggestions are grouped according totheir implications for revenues and costs.

Revenue enha ncements

Survey responses indicated that institu-tions with less profitable CRA programsgive up more fees and, as one respondentput it, are giving away the shop at theexpense of profits. Less willingness to

give away (more rational competition)and more public programs that assistCRA borrowers with loan fees would less-en subsidization by lenders and improvetheir profitability from CRA lending.

Suggestions for removing regulatoryimpediments were less specific. How-ever, two respondents wanted to charge

higher rates for the added risk posed byCRA loans and/or wanted to recovercosts associated with making theseloans. Both voiced concern that Depart-ment of Justice interpretations of fairlending laws and disparate treatmentcould make this difficult.

Expense reductions

The most common suggestion for improv-ing CRA loan profitability was betteraccess to secondary markets. Presum-ably some respondents would like to sellmore of their CRA loans to others athigher prices, passing along the highermonitoring costs (greater credit risk) andlower interest rates. Since higher moni-toring costs and below market rates leadto discounts, higher prices are not pos-sible without more competition from

charitable buyers investing for socialpurposes. Thus, lender actions to improveCRA loan profitability are confined to off-setting higher servicing costs and raisingreturns from these loans.

Respondents offered a number of othercost reducing suggestions. Three of themost frequently mentioned were: more

Suggestions for improving CRA loan profitability

Suggested improvementNumber of

respondentsProfitability

factors affected

Better/more flexible secondary markets 19 Costs

More transaction cost/buyer assistance 10 Revenues

More marketing assistance 6 Costs

More rational competition 5 Revenues

More buyer education 5 Costs

Less regulation 4 Revenues, Costs

Table 5


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M1M0

$ Monitoring costs

$

Loanl

osses

CRA loan delinquency

Conventional loan delinquency

L0

L1

Figure 4

Loan Monitoring Costs and Loan Losses1

1In Figure 4, the two curved lines, labeled Conventional loan delin-quency and CRA loan delinquency," reflect possible trade-offsbetween loan monitoring costs and loan losses. The CRA loan delin-quency line is placed above the conventional loan deliquency line onthe assumption that higher delinquencies would result from morelenient underwriting on CRA loans. M0spent by an institution forloan monitoring would lead to loan losses of L0on its conventionalloans. However, because more leniently underwritten CRA loansrequire greater loan monitoring, spending fixed amount M0on CRAloan monitoring would produce higher loan losses, L1, on theseloans. To keep CRA loan losses similar to those on conventionalloans, an institution would have to spend M1on loan monitoring.This may explain the results reported in the text of comparable

losses but higher delinquencies and servicing costs for some CRAloan programs.


24


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marketing assistance, more buyer educa-tion programs, and less regulation. Thefirst two suggestions rely heavily on part-

nering arrangementsprimarily withcommunity groups and nonprofit organi-zationsto lessen the costs of informingpotential borrowers of available loanprograms, pre-screening applicantsfor financial responsibility, schoolingapplicants on home ownership and

budgeting matters, and dealing with delin-quencies.25These suggestions wouldlower lender costs by shifting costs toother groups.

Only six respondents answered the sur-vey question on transaction cost savingsresulting from assistance provided bypartners. They estimated their CRA loantransaction costs were lowered by approxi-mately 19 percent because of assistancereceived.

Less regulation was another cost savingsuggestion. One respondent advocatedless regulation, specifically, appraisalrequirements which have added timeand cost without improving quality oflower dollar home mortgage transac-tions. Other comments focused moregenerally on reducing CRA regulation

but did not offer specific recommenda-tions for achieving cost savings.

In summary, 43 respondents offeredsuggestions on ways to improve theprofitability of CRA lending. Thesesuggestions focused on reducing thesubsidy on CRA loans by recouping lostrevenues and reducing costs. Better andmore flexible secondary markets forCRA loans, the most frequently sug-gested method, is not likely to offset

higher servicing costs and interestrate concessions made on these loans.

As a result, other suggestions such asmore transactions costs, buyer assis-tance, marketing assistance, and buyereducation programs provided by govern-ment and nonprofit organizations may

be better ways to improve CRA loanprofitability.

Summa r y a n d im p l i c a t i o n s

In this study, we used a survey to explore

profitability differences between CRAand conventional home mortgage lend-ing programs at 97 large institutions.

The survey asked about factors affect-ing the profitability of these programsrevenues, costs, and lossesand askedlenders to compare these factors for theirCRA mortgage loans with their conven-tional mortgage loans.

The survey was not random and was notintended to present a portrait of industrypractices. Only 2 percent of respondentssaid their CRA lending was unprofitable.

Thus, 98 percent saw their CRA homemortgage lending as making money, albeita majority concluded it was not as profit-able as their conventional home mort-gage lending.

In exploring profitability differences atinstitutions, we found that lenders withmore profitable CRA loan programs weremore likely to treat their CRA lending asthey did their conventional lending. Thatis, they gave up a smaller portion of theirfees, were less willing to cut their inter-est rates on CRA loans, and kept theirorigination and servicing costs near thatfor conventional lending.

Nearly all institutions, including thosewith more profitable programs, loosenedtheir credit standards on CRA loans rela-tive to standards on their conventionalloans. These institutions did so withoutappreciable increases in loan losses. Fur-ther, nearly all indicated that credit riskon CRA loans is manageable.

However, we found institutions with lessprofitable CRA programs experiencedhigher delinquencies on their CRA loansthan those with comparably profitableprograms. Since managing delinquenciestranslates into higher transaction costs,

we suspect the higher transactions costsreflect a riskier loan portfolio. Thishigher risk may be an important factor

25Lending consortia

are another means of

partnering to reduce

lender transa ctions

costs. For example,

one respondent notedProfitabil ity w ill not

increase w hen only a

hand ful of customers

qualify for any one

program. Consortia,

by serving as a focal

point for low -volume

lending products can

ju st if y devel opi ng

and maintaining lend-

ing expertise individ-

ual lenders with

smaller potential cus-

tomer bases could not

ju st if y . It is an econo-

mies of scale issue.

How ever, as another

respondent noted,

this may not reduce

costs, if y ou use a

consortium, you a re

stil l incurring higher

costs because you

stil l have to fund that

group.


25


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in explaining lower CRA loan profitabilityat some institutions.

Impl ications

The period covered in this study predatesthe recent change in the regulation usedfor CRA enforcement. In response to

both industry and community pressuresto quantify CRA performance measures,the new performance-based regulation

will likely produce two results: give addedincentive to institutions to offer alter-native lending products, including small

business loans, small farm loans andconsumer loans; and increase the overallpressures on institutions to lend to lower-income people and in lower-incomeneighborhoods.

With respect to alternative lending prod-ucts, there is no reason to believe thatthe risk, rate and transactions costs find-ings in this study would not be applica-

ble to other loan products. Greaterpressure to lend, however, can have seri-ous profit implications because thereare finite limits on bankable loans inany community that can be made with-out increasing credit risk and associatedtransactions costs. Pressure to makemore loans may mean some lendersaccept uncompensated credit risk. Suchpressures also increase incentives forlenders to work in partnership with com-munity organizations and government to

better manage risk and address commu-nity credit needs. Our study findingshave implications for each of these part-ners as well as for regulators.

For lenders, the key to success in CRAlending appears to be lending that fol-

lows a business as usual approach,incorporating CRA lending into the insti-tutions normal operations. In the case ofsome lenders, this involves no specialdepartments, no special rates, limitedconcessions on fees, and only modestrelaxation of credit and underwritingstandards.

For community groups, a key to expand-ing CRA lending appears to lie in helpinglenders reduce their transactions costs.

Pre- and post-purchase counseling pro-grams that help reduce borrower delin-quencies are ways to reduce thesecosts. Assistance with delinquent bor-rowers is another way to keep transac-tions costs down. Help with marketing,putting deals together, and absorbingsome of the paperwork costs with govern-ment programs are additional avenuesfor reducing lender costs.

For government, a key to increased pro-gram use lies in devising borrower pro-grams and regulatory policies that donot add significantly to lender transac-tions costs or lessen lender revenues.Use of low documentation loan programsthat reduce paperwork burdens withoutcompromising credit standards is one

way to keep origination costs down onCRA loans. Programs that help match

borrowers with available resources areanother way to keep a lid on CRA trans-actions costs.

Although regulators are not financialresource partners in CRA lending, theyplay an important role through their en-forcement of the CRA and the fair lend-ing laws. Here they influence two keypolicy areas critical to CRA lending: (1)defining what constitutes satisfactoryCRA performance vis a visprofitabilityand the safety and soundness criteria forlending, and (2) determining what is ac-ceptable with respect to charging cus-tomers for higher risk and/or highertransactions costs.

The first of these regulatory issues relates

to examiner assessments of the creditquality of CRA loans. As with any non-traditional lending effort, examinersmust assess risk in the context of theinstitutions capabilities to manage thatrisk and absorb losses should they occur.

Their goal must not be to eliminate risk,but rather to see that risk is properly


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managed. This approach gives banks lati-tude to create new products, includingCRA loan products, and not have them

criticized simply because they differ frommore traditional products.

The second regulatory influence pertainsto fair lending law concerns that arisefrom charging lower-income people, whoare also more likely to be protected classindividuals (e.g. minorities), higher rateson loans. Higher charges to protectedclass borrowers may be perceived bylenders as well as regulators as violatingthe nations fair lending laws, thus limit-ing options for achieving profitability onCRA loans. In this regard, policy state-ments from regulators and the JusticeDepartment on these issues can helpresolve uncertainties about fair lendinglaw enforcement and clarify options forachieving profitability on CRA loans.

If banks and others are to be major play-ers in community reinvestment effortsand lend to lower-income individualsand neighborhoods beyond levels they per-ceive required by CRA, they must achievecompetitive returns on their CRA lend-ing. The findings in this study suggestthis can be done and offer guidance tolenders and others on what can be doneto achieve more competitive returns.


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There are many factors that can affect CRA lending profitability. These factors often are interre-lated, making profitability analysis difficult. To strip away some of this complexity, we developedfour models to explore various aspects of CRA lending profitability. The first model evaluates fac-

tors that may influence the overall profitability of CRA lending. Subsequent models focus onspecific revenue and expense aspects of profitability and evaluate factors that may affect them.

CRA lend ing profitability

Ninety-seven institutions responded to the survey. All but three of these provided information onthe relative profitability of their CRA lending. Twenty-two institutions said their CRA lending wasas profitable or more profitable than their conventional lending. The remaining 72 said it wasless profitable.1

To evaluate factors that may explain differences in relative profitability among institutions, we esti-mated a logit model where the dependent variable was CRA loan profitability. This variable took thevalue 1" if a surveyed institution reported its CRA lending was as profitable or more profitablethan its conventional lending; it took the value 0" otherwise.

The independent variables used to explain variations in CRA loan profitability, were:2

Residential loansthis variable is the logarithm of the respondents 1994 residential loan origina-tions. We included this variable as a proxy to capture institutional size effects. Since some sug-gest that larger institutions with standardized monitoring systems may be at a disadvantagerelative to smaller institutions with more personalized systems, we hypothesized profitabilitywould be negatively related to size.

Institution type this variable takes the value 1" if the respondent is a bank, the value 0" other-

wise. In our initial analysis of the survey, we noted that approximately 70 percent of those withprofitable CRA programs were banks. Those with less profitable programs were more evenly dis-tributed among institution typessavings and loans, bank holding companies, mortgage bank-ing companies, etc. Because of this, we thought CRA profitability might be positively related tothe survey respondent being a bank.

CRA program agethis variable represents the age in years of the CRA programs reported in oursurvey. Ages were as of year-end 1994. We assumed older programs would be more profitable,if for no other reason than the institutions offering them were well along the learning curve inmaking these programs successful.

FHA/VAthis variable is the percentage of the institutions single family residential CRA loans thatwere FHA or VA loans. These loans carry government guarantees and provide lenders with

access to secondary mortgage markets. We thought guarantees and secondary market accesswould have a positive effect on CRA loan profitability.

Appendix A: CRA lending profitability model

1Only 94 institutions provided information on the profitability of their CRA programs.

2 In other formulations of the profit model, we included the proportion of 1994 CRA loans to 1994 residential loans

as a proxy for the importance of an institutions CRA business. This variable was not significant in explaining

profit differences among CRA programs.


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Economythis variable takes the value 1" if the economy where a respondent operates is averageto strong, the value 0" if the economy is weak. We thought a strong economy would lessenprofitability differences between conventional and CRA loans by lowering delinquencies andlosses, especially on CRA loans.

The model was estimated using multi-variate logitanalysis.3The results from the estimation areshown to the right. All coefficients have the expectedsigns and two of the five variables are significantat at least the 5 percent level or better. The Chi-square statistic is significant at better than the 5percent level, indicating the model has power inexplaining profitability differences among CRAprograms.

These results suggest that both institution sizeand CRA program age are two important determi-

nants of CRA loan program profitability. Larger vol-ume lenders tend to have less profitable CRAprograms and older CRA programs tend to bemore profitable.

To delve further into CRA loan profitability, we ana-lyzed revenue and expense factors that we thoughtcould affect profitability.

Revenue factors

Responses to our survey, as well as surveys by others, indicate that some institutions may subsi-dize CRA borrowers by giving up fees and charging below market interest rates on their CRAloans. To test this proposition, we estimated a revenue equation for survey respondents. Thedependent variable in this ordinary least squares regression equation was the ratio of fees col-lected on a typical single family CRA residential loan to fees collected on a similar size conventionalloan. The independent variables in the equation included the logarithm of residential loan origina-

tions and program age, variables previously used in the profitability model.

In addition, we included the percent of CRA loans retained by an institution as an explanatory vari-

able. We consider this variable to be a proxy for the subsidy given to CRA borrowers. Higher CRAloan retention rates may be indicative of subsidies given to borrowers that make these loans lesssuitable for resale in secondary markets.

Appendix A: CRA lending profitability model (continued)

3When the dependent variable is not continuous, ordinary least squares estimates of the regression coefficients

are not efficient, making logit analysis more appropriate. G.S. Maddala, Introdu ction to Econometrics, 2nd ed.,

(New York: Macmillian Publishing Company, 1992), p. 324.

Dependent variable: CRA loanprofitability

Independent variables Coefficient1

Constant 5.054

Residential loans -.4299

Institution type .7700

CRA program age .0327

FHA/VA .0113

Economy .6111

1Coefficients in bold type are significant at the 5percent level or below. The Chi-square statistic for the

equation is 14.64, also significant at better than the5 percent level.


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The regression results shown in the table below indicate that program age and percentage reten-tion of CRA loans are significant factors in explaining relative fee differences among institutions.

From these results, it appears there is less fee dis-counting as CRA programs age. One interpretationof this result is that fee discounting occurs in theearly stages of programs as lenders attempt tobuild an initial customer base; it could be a market-ing effort to introduce a new product.

The results also show that greater fee discountingis associated with higher CRA loan retention rates.As hypothesized earlier, this may imply less suitabil-ity of these loans for resale in secondary markets,reflecting among other things greater subsidies,such as below market interest rates, to borrowers.

Expenses

Responses to our survey indicate that working withborrowers, developing borrower information, paper-work costs, grants to community groups, andhigher monitoring costs were factors contributingto higher transactions costs on CRA loans. To analyze transactions cost differences, we broke thelending process into two component partsorigination and servicingand reviewed each.

Origination costs

The dependent variable in the origination cost model took the value 1" if survey respondents indi-cated origination costs on their CRA loans were higher than on their conventional loans. It took thevalue 0" otherwise. As before, we included the logarithm of residential loan originations and CRAprogram age variables in the equation to control for institution size and program age. We alsoincluded a CRA lending structure variable. Thisvariable took the value 1" if a respondent conductedits CRA lending in a separate department, the value0" otherwise. We thought that conducting CRAlending from a separate department might be associ-

ated with larger loan volumes, increased specializa-tion, and greater familiarity with nuances of usingCRA programs and working with CRA borrowers.These factors would tend to reduce origination costs

and have a positive effect on CRA loan profitability.

We used logit regression analysis to estimate theorigination cost equation. The results, shown in theadjacent table, indicate that origination costs tendto be higher at larger institutions. These higher costshelp explain the negative relationship between CRA


Dependent variable: CRA loan fees toconventional loan fees


Constant 1.7818

Residential loans2 -.0467


% CRA loans retained -.0047

1Coefficients in bold type are significant at the 5

percent level or better. The F value for the equation is3.82, which is significant at the 5 percent level or bet-

ter. The adjusted R2for the equation is .16.2This variable was significant at the 12 percent level,

just below our 10 percent cutoff.

Dependent variable: Origination costs


Constant -9.2762

Residential loans .5406

CRA program age -.0149

CRA lending structure 2.2328

1Coefficients in bold type are significant at the 5 per-

cent level or better. The Chi-square statistic for theequation is 19.03, also significant at better than the5 percent level.


30


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loan profitability and institution size. This result is also consistent with observations of others thatlarger institutions, with their standardized lending systems, may be at a disadvantage in makingCRA loans relative to smaller institutions that are geared more toward individualized loan analysis.

Additionally, the results indicate that origination costs are higher for institutions where CRA lend-ing is conducted as a separate activity. This relationship is opposite from what we expected, andwe have no definitive reason for this result. Perhaps it simply reflects that separate departments forCRA lending are not cost effective due to lower loan volumes. It may also reflect better cost account-ing data at institutions that conduct CRA lending in a separate department. Finally, as discussedin the text, it may reflect a greater propensity to pay incentives to loan officers on CRA loans or tolend to more marginal borrowers.

Servic ing cost s

The dependent variable in the servicing costs model took on a value of 1" if servicing costs ona respondents CRA lending were higher than on its conventional lending and 0" otherwise.

The independent variables in the model included

the logarithm of residential loan originations andthe factors we held constant in the other models.

We included the delinquency rate on CRA loans asan explanatory variable because we expectedhigher delinquencies would require more borrowercontact and more intense loan monitoring, raisingservicing costs.

The results, shown in the adjacent table, suggest

that institution size and CRA program age are notsignificant factors in explaining differences in CRAservicing costs for survey respondents. The CRAdelinquency rate, however, is significant. HigherCRA loan delinquencies are associated withhigher servicing costs.

In summary, analysis of CRA loan profitability can be exceedingly complex because of the interac-tion among the many factors that can influence profit. The models presented here attempt to hold

some factors constant in order to judge the effects of others. In this regard, we found loan origina-tion volume (our proxy for size) and CRA program age are important CRA loan profitability factors.We found smaller institutions with fewer originations tended to report higher CRA loan profitabilityand older CRA programs tended to be more profitable than newer programs.

Holding these factors constant, we did a more detailed analysis of revenue and expenses associatedwith CRA lending relative to conventional lending. After doing so, we found that more profitableCRA programs tended to subsidized borrowers less, were not generally conducted as a separateactivity of the institution, and usually had lower loan delinquency rates.


Dependent variable: Servicing costs


Constant -5.3912

Residential loans .1809


CRA loan delinquency rate .5347

1Coefficients in bold type are significant at the 5 per-cent level or better. The Chi-square statistic for theequation is 23.11, also significant at better than the

5 percent level.


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The accompanying table presents major features of CRA programs described by survey respon-dents. Some of these programs were initiated by the respondents and others were made availablethrough or in conjunction with state agencies and private institutions. In addition to these pro-grams, a number of respondents noted they used Rural Development, Federal Housing Administra-tion, and Veterans Administration programs. They also used Fannie Maes (Federal NationalMortgage Associations (FNMA)) Community Homebuyers program.

Appendix B: Summary of major features of CRA programs

Program

Loan fees,

closing costs

and points Down payment Rate Front ratio1 Back ratio2 Other

1 1%2 Closing costs

can befinanced

0% 33% 38% Must completeborrowereducationprogram

3 $1,000 feereduction

3% with PMI(privatemortgageinsurance)

1/4% belowmarket rate

33% 38%

4 Bank pays upfront costs

5% with PMI Little easierthan FNMA

Little easierthan FNMA

5 No points,

applicationfees 1/2 ofregularmortgageproducts

10% Fixed first five

years, floatsthereafter

33% 40%

6 Closing costsreduced,points reduced

5% Rate reduced Higher ratiothan regularproducts

Higher ratiothan regularproducts

7 5%, borrowerprovides 3%,bank provides2% (3/2 option)



8 1/4%, 1/2%below marketrate

Dependingupon program,lender paysmortgageinsurance

9 Secondmortgage tofinance part ofclosing costs

Step rate


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Appendix B: Summary of major features of CRA programs (continued)

Program

Loan fees,

closing costs


10 Dependingupon program,1% originationfee or no fee

3% Dependingupon program,fixed rate ofprime rate + 1%

No PrivateMortgageInsurance(PMI)

11 Lower fees Higher loan tovalue ratio

35% 42%

12 0% Expandeddebt to income Expandeddebt to income

13 1/2% docprep fee

3% No PMI

14 $125 40%

15 Many closing costswaived, averagesaving of $750 toborrower

16 3-5% More liberalratio

More liberalratio

No PMI

17 Lower fees Lower rate

18 $300 flat fee,no points, noreserves

3% 33% 41% No PMI

19 5%(3/2 option)

20 3% 33% 38%

21 3-5% FNMAloans

22 33% 42% Borrowereducationprogram

encouraged23 3% or $1,000 33% 40% Borrower

educationprogramencouraged

24 Lower downpayment,comparableto FHA

Lower interestrate

More liberalratio

More liberalratio


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Appendix B: Summary of major features of CRA programs (continued)

Program

Loan fees,

closing costs


25 Discountsbased onincome andfamily size

Lower downpayment

Higher ratio Higher ratio

26 Lower closingcosts,assistanceavailable

5%,assistanceavailable

Market rate

27 5% No PMI28 $500 flat fee,

1 pointcharged

5% 33% 42%

29 All closingcosts andprepaidsfinanced withsecondmortgage

$500

30 Reduced fees,no post

closingreserves,reduced points

5%, only2.5% from

borrower

Reduced rate

31 1 pointoriginationfee

10% 1/4% abovestandard 3year balloonrate

1The front ratio is the ratio of principle, interest, taxes and insurance payments to borrower income. A front ratio of 26 percent is often used as

a guide for conventional loans.2The back ratio adds other debt payments to the computation of the front ratio. A back ratio of 36 percent is often used as a guide for conven-

tional loans.


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If underwriting standards on single family residential CRA loans differ from those for traditionalloans, how do they differ?

Profit group Percent higher/more Percent same Percent lower Total responses

Debt to income ratio



Loan to value ratio



Reliance on collateral



Reliance on character



Reliance on borrower credit history



Appendix C: Underwriting criteria by profitability group


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cra lending primerr

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