A California CRA Law Undercuts Itself

Banks Fear Reputational Risk

For the years the Urban Institute examined in its report, 22.5% of all IMB lending in California was in LMI neighborhoods compared to 13.9% for banks. Furthermore, 22% of all IMB lending was in predominantly minority neighborhoods compared to 16.1% for banks. The report was commissioned by the Mortgage Bankers Association (MBA) to compare the lending patterns of entities subject to CRA requirements, like banks and thrifts, with those of lenders not subject to the statute, like IMBs and credit unions.

The MBA, for its part, believes the Urban Institute’s research serves as a caution to federal and state policymakers who think shrinking the IMB market share is a good policy objective on its own and provides more solid evidence that IMBs already lead the mortgage market in sustainable lending to LMI borrowers and communities. The MBA said in a statement that proposals that apply CRA mandates to IMBs are “ineffective and misguided, as IMBs do not have deposits to reinvest and do not have access to direct government support.”

Laurie Goodman, an Urban Institute fellow, founder of the Housing Finance Policy Center, and one of the assessment’s authors, says this performance gap stems in part from banks originating a lower volume of Federal Housing Administration (FHA) loans, which disproportionately go to LMI neighborhoods and borrowers. 

Furthermore, while banks view mortgages as an auxiliary business that complements their front-and-center retail offerings, IMBs are wholly in the mortgage banking business, she says. “I’m not sure nonbanks should be subject to CRA because they’re already doing more, they’re in one line of business. It seems like it’s a solution in search of a problem.” 

Banks, she added, aren’t looking for the same challenges IMBs are. “They basically make loans to anyone that fits within the box. By contrast, the banks are in a lot of different businesses. … The result of that is if there’s one hint of reputational risk, the banks run,” she says. Reputational risk because, Goodman points out, the banks aren’t really bearing the credit risk for government-insured loans – the government is. Banks moderate this risk by raising their lending threshold with tighter credit overlays. Functionally, these overlays act like cat flaps that let in the cat but keep out the dog, erecting barriers to homeownership that disproportionately impact LMI and minority borrowers. 

When it comes to individual borrowers, IMBs still hold the lending edge in California, with 13.4% of their total lending going to LMI borrowers compared to banks’ 7.2%. The gap is slightly narrower with minority borrowers – 57.9% for IMBs and 53.9% for banks. Yet, IMBs are twice as active than their bank counterparts in lending to borrowers who are both LMI and minority, with 8.8% and 4.4% of mortgage lending going to those borrowers, respectively.  

Given the elevated costs of homeownership in the state, more than one-third of all existing homeowners in California fall under the LMI threshold, per the Institute’s analysis. One-fifth of all homeowners in California live in LMI neighborhoods and one-quarter of homeowners live in predominantly minority neighborhoods. 

Though the Urban Institute did not include market-level data for California, a review of 2022 HMDA data compiled by Richie May, a data and business services advisor, shows the lending disparities between banks and nonbanks continuing into 2022, with IMBs originating 51% of all residential mortgages in California compared to banks’ 42% and credit unions’ 7%. 

Government-insured FHA loans that typically go to LMI and minority borrowers comprised 14% of all IMB lending in California in 2022. Though FHA lending comprised only 7% of mortgages originated in the state in 2022, IMBs accounted for 93% of these mortgages – nearly 87,000 loans worth nearly $37 billion, according to Richie May’s data. The average FHA loan amount was $425,000, which speaks to the extremely high cost of housing in the state, given the national average for FHA loan amounts in 2022 was $270,000. 

CRA In The Golden State

The debate over implementing state-level CRA frameworks hinges on whether increased regulation and oversight will actually result in increased lending to LMI and/or minority borrowers. 

Sen. Monique Limón introduced Senate Bill 1176, California Community Reinvestment Act, to the California Legislature in 2022 in an effort to fold nonbank lenders into a state-level, CRA-style mandate. The bill passed the California Senate in mid-2022, but was later amended by the state assembly’s Banking and Finance Committee to remove the community reinvestment mandate and add language to explore whether other states that have enacted laws modeled after the federal CRA statute actually experienced an increase in lending to underserved communities, as compared with states that have not enacted similar laws.

Paulina Gonzalez-Brito, chief executive officer of Rise Economy (formerly the California Reinvestment Coalition), a statewide coalition of housing and community development organizations, says a state-level mandate will add transparency to a historically opaque process for borrowers. “Nonbank mortgage lenders really obscure, or don’t provide as much data on race in terms of who they’re lending to under HMDA. So, it’s really problematic and doesn’t give us a clear picture of how they’re doing in terms of lending to black, indigenous, and people of color, and whether there’s any disparities or any fair lending concerns.”

The revised bill did not pass the California Legislature during the 2022 legislative session, but Gonzalez-Brito and advocates of a state-level CRA for nonbank lenders are planning on bringing the measure before the legislature in 2024. 

Member organizations of Rise Economy are particularly concerned about the prevalence of “steering” – the practice of ushering borrowers into a particular loan product or program that may be more advantageous for the lender than the borrower. Rise Economy released its own report in spring 2023, “Exploring Mortgage Trends In California,” which tracked state-wide lending patterns of banks and nonbanks using the National Community Reinvestment Coalition’s 2018-2020 Fair Lending Tool and 2021 Home Mortgage Disclosure Act data.

For the most part, Rise Economy’s report affirms many of the Urban Institute’s findings, but the report did find that black borrowers in California more often received government-insured loans from mortgage companies, regardless of income. The fact that government-insured loans are associated with higher costs for borrowers and higher profit margins for lenders raises the question of potential steering of conventional loan-qualifying borrowers of color into higher-cost, government-insured loans.

“As they do their housing counseling, for instance, they see people come in who would have qualified for a conventional loan, but were in a government-backed loan,” Gonzalez-Brito says. 

Jamie Buell, a research analyst for Rise Economy and the report’s author, says just because mortgage companies are stepping up to serve LMI borrowers and borrowers of color doesn’t mean these companies are better serving these communities. “Independent mortgage companies, state-chartered banks, if they are well-serving these communities, then they should have no problem with at least being evaluated as a first step of their provisions and service of these communities,” Buell says. 

Consumers Pay Compliance Costs

But, IMBs are heavily regulated already, says Bill Lowman, vice chairman at the Roseville-based American Pacific Mortgage. He worries that a CRA mandate for IMBs could reverse the progress IMBs have made in expanding credit to LMI and minority borrowers. American Pacific Mortgage, which is licensed in 49 states, gets audited separately by all 49 states, he says – in addition to auditing by the FHA, USDA, VA, and CFPB. 

Contrary to Buell, it’s not being evaluated that worries Lowman, but the added compliance expenses that continue to drive up the cost of origination. These costs are passed straight to borrowers in the form of increased mortgage rates and closing costs. 

“I think the very consumers you’re trying to serve with a CRA requirement,” Lowman explains, “I don’t think anybody’s trying to harm these consumers, but the consumers that they’re trying to serve would ultimately be hurt. It would have a reverse effect on them.”

What states are calling “CRA” for nonbanks doesn’t actually track with what the federal statute requires of banks, says Taylor Stork, chief operating officer of Developer’s Mortgage Company and president of the Community Home Lenders of America, a national association of small and mid-sized community-based mortgage lenders. A CRA-like mandate for IMBs is a conflict in terms given IMBs’ general revenue model. 

“The actual content of what they’re calling CRA is not what the federal CRA laws actually created and represent. The federal laws were created in the 70s in order to address certain inequities, but specifically to ensure that when a depository institution took deposits from one community, that they cycled those deposits back into the same community via loans,” Stork points out. “That was fundamentally the purpose … to make sure that the dollars that came out of the Bronx went back into the Bronx. The dollars that came out of Compton went back into Compton. The dollars that came out of Houston went back into Houston.”

IMBs, of course, don’t take deposits. Most IMBs are privately owned and generate loans using privately-raised capital. Selling their loans to depositors and investors provides IMBs with the liquidity they need to continue originating. “The monies that mortgage companies utilize are their own monies that are used,” he continues. “It’s their own capital – that is then used as collateral in some cases – that is used to then borrow monies from depositories to make the loans.”

A CRA-like mandate for IMBs could also conflict with IMBs’ licensing requirements, creating an undue burden for businesses and borrowers. While banks face heavier federal regulations, IMBs are regulated on a state-by-state basis. This means, Stork says, “whether it’s Illinois or New York or somewhere else, IMBs tend to operate in the communities where they serve the borrowers. We do loans where we live and where we work. It’s just the nature of the model.”

Adding operational complexity with layers of redundant regulation only increases origination costs that are passed on to borrowers, says Stork. Besides, he continues, “When you add new legislation or regulatory controls on top of that – particularly when you add regulatory controls to an industry that is already outpacing the controls that are meant to manage them in the first place – when you add those regulatory controls what you’re actually doing is making it more difficult for the IMBs to operate.” 

IMBs’ business model isn’t just built on a profit motive, but what Stork calls an “existence motive.” IMBs help any borrower they can, even higher risk borrowers, because they have to hit production volumes. Imperiling the operations of IMBs also imperils the communities they serve.

“We know that the vast majority of loans to disadvantaged borrowers are done through the FHA loan program through the Department of HUD. We know that factually, we know it mathematically, and we know it statistically,” he says. “We also know that 90% of those loans are made by IMBs. IMBs are by far and away the first lender and the lender of choice for the very borrowers that a new CRA (Community Reinvestment Act) program is intended to support in the first place.” 

No Appetite

The reasons banks have retreated from mortgage lending, especially FHA programs, mostly stem from the 2007-2008 financial crisis, says Clifford Rossi, director of the Smith Enterprise Risk Consortium at the University of Maryland and a former banking industry executive. 

Many banks no longer had an appetite for volatile assets such as mortgage servicing rights, he says. Banks were also getting burned on the origination side through non-traditional mortgages, such as alt-A and subprime loans. But, regulators’ lack of guidance also played a role.

“Another big reason the banks got out,” says Rossi, “particularly around FHA lending, but even more broadly, in the years following the financial crisis there was an awful lot of uproar by banks in terms of the lack of transparency of repurchase demands that were being made by the GSEs [Government Sponsored Enterprises], private mortgage insurance companies, and also by the FHA.” 

Mortgage repurchases occur when buyers of mortgage-backed securities, such as Fannie Mae or Freddie Mac, determine there are defects in how a loan was made, leading them to demand a repurchase by the lender. After such hefty penalties were levied, Rossi noticed a prevailing attitude among banks – that there was a lack of consistency in the way FHA and the agencies audit for defects in the way banks underwrite or value loans from a collateral standpoint.

Goodman echoes Rossi’s assessment, saying that “banks feel like a lot of them received fines as a result of bad lending during the financial crisis, and that the rules of engagement aren’t as clear as they could be, particularly for servicing loans.”

For those lenders that do have an appetite – and an incentive – to lend within LMI and majority-minority communities, Stork says support and structure need to be created for borrowers instead of for loans. 

“I believe that we need to focus on the people instead of the package,” he says. “When we talk about lending to people, we’re talking about lending in a community and helping build the American Dream. When we look at loans, we’re talking about assets. Assets can be problematic on a bank’s balance sheet when they have basis risk and the assets don’t match the deposits and things like Silicon Valley Bank happen.”