Academic journal article Real Estate Economics

Community Reinvestment and Credit Risk: Evidence from an Affordable-Home-Loan Program

Academic journal article Real Estate Economics

Community Reinvestment and Credit Risk: Evidence from an Affordable-Home-Loan Program

Article excerpt

Recent years have witnessed broad national initiatives and targeted local programs aimed at increasing the supply of mortgage credit to low- and moderate-income households and residents of lower-income neighborhoods, particularly in central cities. Often, these initiatives have been associated with efforts by banks and other depository institutions to comply with community reinvestment regulations? Also, the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 directed the Department of Housing and Urban Development (HUD) to establish annual goals for Fannie Mae and Freddie Mac with respect to the purchase of mortgages extended to low- and moderate-income families, and these institutions subsequently initiated special affordable-home-loan programs designed to broaden the availability of mortgage credit.

Because these lending initiatives typically incorporate flexible underwriting standards along with enhanced risk-mitigation activities, questions arise regarding their credit-risk implications. In particular, what gradations of credit risk are associated with particular aspects of such programs? In this study, we address this issue with a unique data set that allows us to identify credit risk attributable to specific borrower and neighborhood factors. Our study is the first multivariate analysis of affordable-home-loan performance to assess the relationship between delinquency risk and credit history scores, which is an issue of special importance given the increased use of credit scores in affordable-home-lending contexts.

The study examines the performance of home purchase loans originated by a major depository institution in Philadelphia (henceforth referred to as BANK) under a long-established, portfolio-based, flexible lending program known as the Delaware Valley Mortgage Plan (DVMP).(2) Using a database of over 2,000 conventional mortgages originated between 1988 and 1994, we conduct a multivariate analysis of factors related to long-term delinquency. Further, we assess relationships between credit risk factors and long-term delinquency by means of simulations based on the multivariate analysis.

Although a large empirical literature examines factors related to mortgage performance, only a few studies specifically consider the performance of conventional mortgages associated with community reinvestment programs.(3) There has been little systematic study of the relation between mortgage loan performance and credit scores or similar measures of borrower credit history, due to a lack of data. Available evidence on performance of affordable home loans is from largely proprietary studies conducted by Fannie Mae, Freddie Mac and private mortgage insurance companies? Reported results from these studies concern the relation of a few specific underwriting flexibilities to delinquency risk in nationwide aggregate samples, where the loans are relatively recent in origin.(5)

Our study has several distinguishing features. We focus on one bank's portfolio-based, flexible-lending program, in one city. Hence, difficulties associated with aggregation across metropolitan areas and loan servicing institutions do not arise.(6) We are able to analyze the relationship between the performance of a portfolio of seasoned and new affordable home loans and (with controls) credit scores. Our analysis yields new evidence on the relation between relaxed underwriting standards and loan delinquency. We also document relationships between housing market variables and loan delinquency that support the view that credit risk is affected by factors potentially related to appraisal risk.

The paper is organized as follows. In the next section, we describe the DVMP program and its greater than proportionate share of loans originated in low- and moderate-income areas of Philadelphia. In the third section, we describe the loan performance data obtained from BANK. The fourth section presents our basic multivariate analysis. …

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