Credit Scoring Amd Fair Mortgage Lending

Ihe Second Inslalkmenl aF a Five I Filial I men I aeries by ihe Fed-ern! Reserve System's Mo-rtgoge Credii PaMnerihip Credii

Scoring Commiflee #

Credit scoring is an underwriting tool used to evaluate the creditworthiness of prospective borrowers. Utilized for several decades in granting certain forms of consumer credit, scoring has come into common use in the mortgage lending industry only within the last 10 years. Scoring brings a high level of efficiency to the underwriting process, but it also has raised concerns about fair lending with regard to historically underserved populations.

To explore the potential impact of credit scoring on mortgage applicants, the Federal Reserve System's Mortgage Credit Partnership Credit Scoring Committee has produced a five-installment series of articles. This is the second. An important goal of the series is to provide the industry and concerned groups and individuals with the opportunity to comment on issues surrounding credit scoring.

This installment incorporates statements requested from representatives of three organizations, who were selected because of their interest in and differing perspectives on credit scoring and fair lending.

JAMES WHEATON

Neighborhood Housing Services of Chicago

Mr. Wheaton has worked for and with nonprofit community development organizations since the mid 1970s. He now serves as the associate director of Neighborhood Housing Services of Chicago, Inc. (NHS), a position he has held since 1993. Mr. Wheaton's responsibilities include administration of NHS's home-improvement and purchase/ rehab lending programs, as well as new program and product development. NHS of Chicago was established in 1975 as a nonprofit corporation that partners with financial institutions, community residents, city government, and Chicago businesses. NHS of Chicago has citywide lending programs as well as targeted neighborhood programs operating in 11 of Chicago's neighborhoods. NHS also recently created a program for victims of predatory lending. NHS of Chicago originates 500 loans annually, totaling $15 million.

THOMAS P. FITZGIBBON, JR.

Manufacturers Bank

Mr. Fitzgibbon is a senior vice president and chief retail banking officer for Manufacturers Bank, and is the president of Manufacturers Community Development Corporation. Mr. Fitzgibbon is a 30-year veteran of the banking industry, having served as a principal banking officer in lending and retail banking operations for institutions in Washington, D.C., and Minnesota prior to moving to Chicago in 1990. He has served on the Steering Committee of the Mortgage Credit Access Partnership and the Small Enterprise Capital Access Partnership for the Federal Reserve Bank of Chicago since 1995. Currently, Fitzgibbon is on the boards of directors for Bethany Hospital, DevCorp

North, NHS of Chicago, the Northwest Housing Partnership and Regional Redevelopment Corp., and the Woodstock Institute. Manufacturers Bank, a $1.4 billion community bank with 13 offices, is ranked as the 100th leading small-business lender in the nation (American Banker) and the third leading small-business lender in low- and moderate-income markets in Cook County, IL. Manufacturers Community Development Corporation is a six-year-old subsidiary of the bank, managing more than $40 million in direct-equity investments and loans in real-estate and small-business ventures.

ALEX STRICKER

Fannie Mae

Dr. Stricker is an economist for credit policy at Fannie Mae. He has worked on development of Fannie Mae's automated underwriting models for the past two years, with emphasis on fair-lending implications. Prior to joining Fannie Mae, Striker pursued doctoral studies at Syracuse University specializing in urban economics and housing discrimination. Fannie Mae is a stockholder-owned corporation chartered by Congress to create a continuous flow of funds to mortgage lenders in support of homeownership and rental housing. It serves as a secondary market for mortgage loans by purchasing mortgages from lenders across the country, aggregating groups of loans into mortgage-backed securities, and selling the securities to investors.

Each representative for this article received a request to comment on the following text:

Lending institutions face various pressures in the course of their credit operations. They must consistently achieve and increase profitability, comply with a complex regulatory framework, and contend with new sources of competition.

An institution's loan underwriting policy, and, in particular, its credit-scoring model, reflect the institution's appetite for risk, targets for profitability, and role in serving the credit needs of its market.

Credit-scoring models have predictive power; they give lenders the ability to expeditiously assess the likelihood of borrower default. There is general agreement that to retain their predictive power, models must be maintained and adjusted to reflect changes in loan performance, market demands and demographics. In addition, observers argue that absent proper maintenance, a lender risks using a model with diminished predictive capability, which may produce an unjustifiable disparate impact on prohibited basis groups.1

From your perspective and experience, what can lenders do to ensure that the credit-scoring models they develop or purchase will accurately predict the performance of their applicant base? What steps might lenders take to effectively update and maintain their models? Finally, what methods should lenders employ to monitor the performance of their credit-scored loans, particularly with respect to the fairness and accuracy of their models?

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