The Federal Deposit Insurance Corporation (FDIC) issued a letter to Evergreen Bank alleging potential violations of the Equal Credit Opportunity Act (ECOA). The FDIC's preliminary findings indicate discriminatory lending practices against Hispanic borrowers based on national origin and potentially against unmarried borrowers based on marital status, evidenced by statistically significant disparities in auto loan interest rates. The disparities, found through a statistical analysis of loan data, were deemed significant enough to warrant further investigation and potential referral to the Department of Justice. The bank has 15 days to respond, providing any explanation or evidence to refute the findings.
The information in this case study is based on the provided report and is intended to illustrate Premier Insights, Inc.'s analytical capabilities. The names of the financial institution and market areas have been changed for confidentiality purposes.
Introduction
Premier Insights, Inc. (Premier) was engaged by a regional bank, hereinafter referred to as the “Bank" to conduct a comprehensive analysis of their indirect auto lending program. This analysis was prompted by a preliminary finding by a regulatory agency, the Federal Deposit Insurance Corporation (FDIC), which suggested potential violations of the Equal Credit Opportunity Act (ECOA) related to pricing disparities for Hispanic borrowers and the treatment of joint applicants. The Bank, headquartered in the city of Oakhaven, with branches across the states of Asteria, Bellwether, and Cypress, sought to understand the regulatory findings and to identify potential areas of concern within their lending practices.
Initial Regulatory Findings
The FDIC’s preliminary analysis, as communicated to the Bank, indicated the following:
- Pricing Disparities: Hispanic borrowers appeared to be charged statistically significantly higher interest rates on auto loans compared to non-Hispanic borrowers. This disparity was observed in both the "buy rate" (the rate the Bank agrees with the dealer) and the "contract rate" (the rate the dealer charges the borrower).
- Joint Applicant Treatment: The Bank’s practice of reclassifying unmarried joint applicants as applicant/co-signer based on shared credit or residency status led to less favorable treatment compared to married applicants.
The FDIC identified these issues as potential violations of ECOA, which prohibits discrimination based on national origin and marital status.
Premier Insights' Approach
Premier adopted a multi-faceted approach to investigate the FDIC’s findings and provide the Bank with a comprehensive analysis:
- Data Analysis: Premier worked with a dataset of 10,622 loans originated by the Bank in a year period. The data included information about loan rates, applicant demographics (identified by surname), and other relevant factors.
- Statistical Modeling: Various statistical models were employed to control for factors that could legitimately affect loan pricing. These factors included the Bank's suggested rate (based on FICO score, loan term, and age of collateral), flat fee transactions, regional differences, program type, FICO scores and loan to value ratios.
- Dealer-Level Analysis: Recognizing that dealer discretion plays a role in loan pricing, Premier also examined data at the dealer level. This included the proportion of loans with a markup and the average markup amount.
Key Findings and Results
Premier’s analysis produced several key findings:
- Raw Disparities: Initial analysis, similar to the FDIC, showed a raw disparity of 15 basis points in loan pricing between Hispanic and non-Hispanic borrowers. This initial model, however, had an R squared of essentially zero meaning that being Hispanic has no real predictive power.
- Impact of Controls: The inclusion of controls significantly reduced the observed disparity:
- Controlling for flat fees reduced the disparity to just under 8 basis points.
- Further controlling for regional differences and program type reduced the disparity to just below 5 basis points.
- The addition of controls for FICO scores and an indicator for no score resulted in the disparity dropping to just above 4 basis points, and the difference became statistically insignificant at the 5% level and barely significant at the 10% level.
- Analyzing the dealer level data which included the proportion of loans overall that they markup and the average amount of the markup, dropped the disparity to roughly 8 basis points.
- Including FICO scores, indicators for no score, longer loan terms, and LTV made the disparity statistically insignificant at roughly 5 basis points.
- Dealer Markups: Further analysis revealed that the distribution of Hispanic and non-Hispanic customers was similar for dealers with average markups at or above the overall median. However, Hispanic borrowers were underrepresented among the bottom 25% of dealers with the lowest markups.
- Back End Add-Ons: The raw difference in back-end add-ons was 11 basis points. When this was combined with the raw difference in the markup for Hispanic (15 basis points), the total difference was then 26 basis points for Hispanics, which was statistically insignificant, but which suggested higher transactional fees for Hispanic borrowers overall.
- Alternative Hispanic Proxy: The use of a BISG (Bayesian Improved Surname Geocoding) proxy for identifying Hispanic borrowers was also explored. The BISG proxy can reduce disparities.
Conclusion
Premier Insights, Inc.'s analysis provided Evergreen Bank with a deeper understanding of the potential fair lending issues in its indirect auto lending program. The findings revealed that while raw disparities existed, controlling for legitimate factors like risk, loan terms, and regional differences significantly reduced or eliminated the disparities. Additionally, the use of a BISG proxy for identifying Hispanic borrowers reduced the statistical significance of disparities. Premier‘s work also identified areas for the Bank to improve its monitoring practices, especially at the dealer level, and to reconsider its policies regarding joint applicants. This thorough analysis gave the Bank a more nuanced understanding of their lending practices and allowed them to respond to the regulatory findings.
Premier Insights’ Value
This case study demonstrates Premier’s capabilities in:
- Complex Data Analysis: Applying sophisticated statistical modeling to address regulatory concerns.
- Fair Lending Expertise: Providing deep insights into fair lending practices and potential areas of risk.
- Data-Driven Solutions: Offering actionable recommendations based on rigorous data analysis.
- Regulatory Compliance: Assisting clients in navigating complex regulatory landscapes.
This study illustrates Premier’s commitment to providing valuable data-driven analysis to its clients.