Redlining has been a hot topic for financial regulators and enforcement agencies for several years. The Consumer Financial Protection Bureau (CFPB) started discussing redlining as a priority in its Supervisory Highlights in the Fall of 2012, just one year after its formation, and has continued to discuss, examine, and enforce prohibitions on redlining throughout the past several years.
In the fall of 2021, the Department of Justice (DOJ) announced its new Combating Redlining Initiative with the CFPB and the Office of the Comptroller of the Currency (OCC). The initiative is being led by the Housing and Civil Enforcement Section of the DOJ’s Civil Rights Division, in partnership with U.S. attorneys general (USAGs) offices. The intent is to strengthen partnerships with federal financial agencies to increase fair lending violation detection and consequential referrals, and to facilitate additional coordination with state attorneys general (SAGs) while engaging in “strong outreach” to consumer advocates and industry stakeholders. Traditional redlining activities will be scrutinized as well as digital redlining and discriminatory algorithms, according to CFPB Director Rohit Chopra.
Fair lending compliance is about more than just fairness in underwriting and pricing. Regulatory enforcement agencies want to ensure that minority neighborhoods have the same access to mortgage credit as non-minority neighborhoods. An overview of methods for evaluating, identifying, and mitigating redlining risks is provided below.
What Is Redlining and Why Should Bankers Pay Close Attention?
According to the Interagency Fair Lending Examination Procedures, “Redlining is a form of illegal disparate treatment in which a lender provides unequal access to credit, or unequal terms of credit, because of the race, color, national origin, or other prohibited characteristic(s) of the residents of the area in which the credit seeker resides or will reside or in which the residential property to be mortgaged is located.”
Redlining can violate both the Fair Housing Act (FHA) and the Equal Credit Opportunity Act (ECOA). In addition, the CFPB has taken the position that discrimination, which includes redlining, is unfair under prohibitions on Unfair, Deceptive, or Abusive Acts or Practices (UDAAPs). Lender behavior that denies or limits credit in predominantly minority neighborhoods without justification could be considered redlining. There are many ways that access to credit may be denied or restricted to minority areas, including failing to advertise or market to qualified applicants in minority areas; discouraging applicants in minority neighborhoods from applying for a loan; denying credit to applicants who apply for a loan without justification; or granting credit with less favorable terms to applicants in minority versus non-minority neighborhoods.
Identify Your Geographies
The first step is to analyze your footprint. Your geographies will consist of your assessment area, as defined by the Community Reinvestment Act (CRA), and your “reasonably expected market areas” (REMAs). REMAs are also known as “credit markets,” “marketing areas,” or “lending areas” and should be reassessed annually. They are the geographic areas where an institution can reasonably be expected to lend. Typically larger than a CRA assessment area, they can be based on the following factors:
- Marketing/advertising areas
- Service or market areas defined or used in the bank’s strategy
- Areas where loan officers call on potential clients
- Locations of third-party referral sources and lending partners
- Locations of loan applications/originations
- Locations of deposit customers
- Metropolitan statistical area (MSA)/county definitions
- Locations of minority neighborhoods
- Any barriers to lending
- History of mergers and acquisitions
- Complaints related to your service/market areas and/or lending patterns
Determine Which Minority Geographies to Use
Once you have identified your geographies, you will need to determine which minority geographies you should use in your redlining analysis. This can be determined with a few simple steps.
- Determine the market demographics of your CRA assessment area and credit markets by analyzing your lending data. This will provide the areas that should be included in your redlining analysis. For example, if the data indicates that the minority population is mainly comprised of Black and Hispanic applicants, then you may consider analyzing majority-minority census tracts (MMCTs), majority Black and Hispanic census tracts (MBHCTs), majority Black census tracts (MBCTs), and/or majority Hispanic census tracts (MHCTs).
- Evaluate low-to-moderate income census tracts (LMICTs), low-income census tracts (LICT), and moderate-income census tracts (MICTs) for CRA.
Choose Appropriate Peer Groups
Selection of a set of peer lenders for comparison to your lending outcomes is as much of an art as it is a science. Your analysis should focus on lenders with characteristics similar to your financial institution. Areas of similarity may include business strategy, risk appetite, geographic markets, number of loans, asset size, or other factors. The three different approaches that lenders use to select peer groups are described below.
- Market Aggregate: This method compares your lending activity to all lenders in each market area, regardless of the business model or lending type. This provides an aggregate value for all lending activity in the credit area. Because all lending is typically considered in this metric, it can be difficult to meet the standard of the area if your financial institution’s products and business strategies are significantly different than others in the same market. The metric is still important because it can provide the best overall insight into the demand for services in a particular region. If the market aggregate reveals that the opportunity to lend in a credit market is minimal, it can help to explain lower lending volumes. Conversely, if this metric shows that a large demand is present in a credit market, but you and your peers fail to capture that business, regulators may ask why and continue to probe for reasons.
- Adjusted Aggregate (also known as Regulatory Peers): This method typically analyzes lenders with applications and/or originations that are between 50 and 200 percent of the bank’s lending volume.
- True Peers (also known as Custom Peers): This method compares a financial institution’s lending activity to a “custom peer group.” The group can be created by selecting lenders in your credit markets that have a similar business strategy, size, risk appetite, and product offerings. It may be helpful to discuss this concept with your lenders in each market to determine market-specific competitors that may be potential peers.
Create Your Performance Context
A “performance context” document should be created for your institution that describes the range of economic and demographic conditions as well as institution-specific capacities and limitations for each market area. Factors captured in this documentation can include the following:
- Business-justified limitations or constraints on the institution’s ability and capacity to lend, such as extent of branch network, number of loan officers, recent entry into market, etc.
- Product offerings and lending activities of similarly situated lenders
- Lending trends for the entire market
- Extent of competition:
- How much competition is there for each specific lending activity?
- Who are the dominant lenders in the credit markets?
- Your institution’s business strategy
- Distribution channels (e.g., branch locations, use of third parties, digital applications)
- Where are branches in relationship to predominantly minority neighborhoods?
- Lending strategies and product offerings in each market (including special loan programs)
- Market rankings for both deposits and loans
- Marketing and outreach campaigns
- CRA program initiatives, services, and investments, including any community partnerships
The Communities Your Institution Serves
- Targeted markets/communities
- Share of majority-minority census tracts (MMCT) or majority-Black and Hispanic census tracts (MBHCT)
- Demographic characteristics—local compared to county, metropolitan statistical area/metropolitan division (MSA/MD), or state:
- Population size, dispersion, and trend
- Area median income (AMI) and income distribution
- Families below poverty level
- Housing market factors:
- Housing costs (compared to the AMI)
- Median housing value
- Age of housing stock
- Owner-occupied housing versus rental housing
- Foreclosure rate
- Housing permits
- Economic conditions and trends (local compared to county, MSA/MD, or state):
- Unemployment rate
- Designated disaster areas
- Key industries and employers
- Empowerment zones/enterprise zones
- Distance to employment and availability of public transportation
- Intrinsic barriers to lending (university, airport, military base, or parks that cover a substantial amount of a census tract)
Monitor Your Institution’s Performance
Conducting meaningful and appropriate analysis of your lending results is an important part of your redlining review. This discussion provides information on the types of analysis that you may conduct. Be aware that peer comparisons and denials for collateral are only options when evaluating residential real estate lending, and market comparisons are only available when evaluating residential real estate lending or small loans to businesses and farms reported under the CRA.
- Tract Penetration: an analysis of your census tract application and/or origination penetration, comparing your lending performance in minority and LMI geographies to your performance in non-minority and middle-to-upper income (MUI) geographies.
- Denials for Collateral: an analysis comparing denials for collateral in minority and non-minority communities.
- Comparison to Peer Group(s): an analysis to determine how your lending penetration in minority and LMI geographies compares to your peer group(s).
- Comparison to Market: an analysis to determine how your lending compares to the market aggregate (compares your lending to the aggregate of all lenders in each market/region).
- Map-based Analysis: Statistical analysis is usually enhanced with mapping to visually analyze the locations of an institution’s loan applications, originations, and branch locations in relation to predominantly minority census tracts.
Take Action to Improve Performance
The first step in your improvement strategy is to identify and prioritize your highest-risk areas. The second step is to start working on strategies to improve market penetration in the high-risk areas. Provided below are examples of actions that lenders have used to improve their lending penetration in minority areas, which include corrective actions from recent redlining settlements.
- Open branches or other loan production offices in underserved neighborhoods.
- Invest funds into nonprofit homeownership initiatives.
- Create a fund to provide loan subsidies or down payment assistance to applicants meeting certain requirements in underserved neighborhoods.
- Offer financial education programs, either through the bank or in partnership with a home-buyer counseling agency approved by the Department of Housing and Urban Development (HUD). The agency may be in a position to refer qualified applicants to your bank.
- Conduct targeted advertising in underserved areas.
- Conduct additional employee fair lending training.
- Evaluate the loan products offered by your institution to determine if there are gaps in products available for low-to-moderate income applicants.
- Consider offering special products in minority census tracts.
- Consider creating a Special Purpose Credit Program.
- Assess branch and digital strategies.
- If marketing is distributed equitably, then evaluate the content to ensure that you are promoting products that meet neighborhood needs.
- Expand or develop relationships with community advocates or referral sources, such as real estate brokers and agents through loan production offices and third-party originators.
- Increase marketing and outreach to fill lending gaps. The CRA department may be able to assist with an outreach strategy.
- Consider self-testing in areas of limited progress.
- Consider recruiting additional minority sales staff.
- Inform sales management of lending gaps and collaborate with them on solutions.
An assessment of your redlining risk should be viewed as an opportunity to identify new business opportunities and serve historically marginalized communities while reducing regulatory risk and raising your institution’s profile in the community.