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12 National CommunityDevelopment LendingSchool

Credit Scoring: Friend or Foe?

A newsletter from the Philadelphia Federal Reserve Bank about consumer credit and community reinvestment

No. 39Spring 1999

Consumers Urged to “Know the

Rules, Use the Tools”

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CONTENTS

Declaring that the attorneygeneral’s office “will not

tolerate credit abuse in Pennsyl-vania,” Mike Fisher, the Common-wealth’s attorney general, kicked offa meeting sponsored by his office inconjunction with the U.S. Food andDrug Administration. The meeting,which was held at the FederalReserve Bank of Philadelphia, waspart of National Consumer Pro-tection Week in February.

At the meeting, representativesfrom city and state government as

well as community organizationsand consumer advocacy groupsexhorted consumers to “know therules, use the tools” and warnedthem of the dangers of credit fraud.

Issues involving credit andcredit fraud generate a largenumber of complaints to the FederalTrade Commission (FTC), thegovernment agency that enforces avariety of consumer protection laws.Consumer discontent also arisesfrom a host of other sources,

Credit scoring, a statistical meth-od used to predict the probabil-

ity that a loan applicant will defaultor become delinquent, was intro-duced in the 1950s and was usedprimarily to evaluate credit card ap-plications. Because of advances intechnology and the increase in thenumber of large banks that can af-ford such technology, the use ofcredit scoring has expanded overthe years and now includes consum-er lending, such as auto, personalunsecured, and home equity loans.More recently, it has been used tohelp evaluate applications for mort-gages and small-business loans,sparking renewed controversy.Supporters see credit scoring as animportant tool in reducing expensesand speeding loan processing. Op-ponents argue that an automated

system will not consider the uniqueneeds of low-income and other non-traditional borrowers. As a result,opponents believe, loan denial rateswill increase.

Creating a Scoring SystemThe first step in developing a

scoring system is to determinewhich pieces of information corre-late with future credit performance.In selecting the factors that will bescored and the points awarded toeach factor, the model builder wantsto find the combination that resultsin final scores that are best correlat-ed with actual credit performance.When a typical application score-card is developed, 50 or 60 factorsmay be identified as having somestand-alone predictive value. How-ever, usually only eight to 12 vari-

Rural HousingDevelopment: ThreeInitiatives in Third District

Ways to Work ProgramGets Help from 12 SouthJersey Banks

Bethlehem NonprofitRenovates, “Deconverts”Houses

ables will be used in the final score-card because they are the fac-tors with the highest predictivevalue.

And while risk weights as-signed to these factors may varyfrom system to system, there arenormally some common elements.Credit history scoring systems,which are based primarily on indi-viduals’ credit histories, considernumber of credit lines, current andhistoric delinquencies, and publicrecords (bankruptcies, foreclosures,or judgments). Application scoringsystems, which look at both creditbureau information and informationsubmitted on an application, consid-er employment stability, debt-to-in-come ratios, assets (particularlycash), and loan-to-value ratios (if theloan is for a mortgage).

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Credit Scoring ...continued from page 1

Consumers Urged to "Know the Rules" ...continued from page 1

AdvantagesProponents of credit scoring cite

several points in its favor. First,credit scoring involves identifyingunderwriting parameters and ap-plying them consistently, which al-lows a level of objectivity. Becauseloan officers differ in their experi-ence and in their views regarding

the relationships between risk andspecific credit characteristics of ap-plicants, an institution cannot becertain that its underwriters are ap-proving all applications that haverisk profiles consistent with the in-stitution’s objectives. By reducingjudgmental review, scoring can pro-mote fair lending by helping lenders

ensure that they are applying thesame underwriting criteria to allborrowers.

Second, scoring decisions differfrom most judgmental decisions inthat scoring has built-in compensa-tory features. Judgmental systemsoften involve a series of “knock-out”rules that may reject an applicant

Dede Myers, Vice President and Community Affairs Officer, FederalReserve Bank of Philadelphia, and Michael Fisher, Attorney General ofthe Commonwealth of Pennsylvania, shown here at the NationalConsumer Protection Week meeting, which was held at the PhiladelphiaFed in February.

including problems with appliances,car sales, and home-improvementcontracts.

But fraud represents one of thebiggest problems. Credit card fraudalone costs the economy $436million a year. When other types offraud are factored in—stockmanipulation, money laundering,and other “white collar” crimes—the figure approaches $1 trillion,according to a 1997 article in thePhiladelphia Inquirer.

Third District states,unfortunately, stand out in this area:Figures compiled by Visa show thatPennsylvania, New Jersey, andDelaware all rank in the top 10states for credit card fraud. Thegood news is that all three statesvigorously prosecute casesinvolving consumer rip-offs.

In the credit fraud game,unscrupulous persons prey not onlyon consumers but also oncompanies. Depository institutionsare often prime targets of those whoengage in fraudulent practices.Check fraud, including counterfeit,altered, forged, or stolen checks,costs the U.S. banking industrymore than $1 billion a year. Fraudinvolving ATMs and identity theftadd to the losses. A recent survey bythe American Bankers Associationstated that in the past few yearsalone, fraudulent checks carried aface value of $4 billion. A 1996

study bythe FederalReserveBoard,reported intheAmericanBanker,claimedthat DFIslost $615million tofraudulentchecks in1995. Thesame studynoted thatthriftssufferedthe greatest losses from bad checks,with banks and credit unions faringonly slightly better.

Community organizationsshould be familiar with the “rulesand tools” so that they can help steertheir clients away from potentialfraud or point them to resourcesshould they fall victim to a ruse.Banks, too, must maintain vigilanceagainst potential scams.

The FTC’s web site(www.ftc.gov) is a good source ofinformation about consumerprotection laws and givesconsumers access to variouspublications and news releases. TheFederal Reserve Bank ofPhiladelphia’s Community and

Consumer Affairs Department alsoresponds to consumers’ complaintsabout the banking and lendingpractices of depository institutionsand nonbank lenders. In addition,Consumer Affairs staff also answerinquiries and advise callers of theircredit rights under variousconsumer banking laws. ThePhiladelphia Fed’s consumerrepresentative is Rose Howe; hernumber is 215-574-6116. The Bankalso publishes several pamphlets onconsumer issues, including “YourCredit Rights” and “Frauds andScams: Protect Yourself and YourMoney.”

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FAIR LENDING ISSUESAnother concern with credit scoring involves fair lending issues. The courts have defined three types of

discrimination. The first, overt or blatant discrimination, means that lending decisions are explicitly made on thebasis of some prohibited factor such as race or gender. Lenders who use credit scoring as the sole basis for theirdecisions have, in essence, a safe harbor from claims of overt discrimination so long as their model does not con-tain any factor that is prohibited per se.

The second, disparate treatment, means that even though there is no explicit use of a prohibited factor,applicants who qualify similarly on the basis of all legitimate factors are nevertheless treated differently in somerespect. But credit-scoring models treat similarly situated applicants the same—by assigning them the same score.

Therefore, any assault on credit scoring would be launched under the third type of discrimination, the so-called effects test or disparate impact doctrine developed under Title VII of the Civil Rights Act of 1964, asamended.

The effects test, as applied to credit scoring, permits discrimination claims based on a credit-scoring sys-tem’s overall disproportionate negative impact on a protected class. The effects test can also be applied to individ-ual factors used in a credit-scoring system. That is, specific scoring factors could be challenged as being substan-tially disadvantageous to protected groups and as hindering their ability to qualify for credit under the overallscoring system.

For example, requiring that applicants have incomes in excess of a certain amount to qualify for an over-draft line of credit could mean that women and minority applicants will be rejected at a higher rate than men andnonminority applicants. If there is a demonstrable relationship between the income requirement and creditwor-thiness for the level of credit involved, however, use of the income standard would likely be permissible.

Cases dealing with the effects test have generally involved a three-step test. The first part of the test re-quires the plaintiff to show that the use of the challenged criterion has a disproportionate impact on a protectedclass.

If the plaintiff meets the burden of showing that a disparate impact exists, the second part of the test shiftsthe burden to the defendant to demonstrate a business justification for the challenged criterion. A credit-scoringmodel makes it easier for the defendant to document the business reason for using a factor that might have a dis-proportionately negative impact on a protected class of applicants. The weights in the model give a measure ofthe relative strength of each factor’s correlation with credit performance, given the other factors contained in themodel. In fact, both the Federal Reserve Board and the Office of the Comptroller of the Currency have supportedcredit-scoring models that have been empirically developed to predict risk as having valid business justificationunder the test for disparate impact.

The third part of the test shifts the burden back to the plaintiff to show that there is an equally effectivebut less discriminatory alternative available and that the defendant has refused to adopt that alternative.

based on only one criterion. Withscoring, a low score on one factorcan be made up in other areas.

Third, credit scoring requiresless time to underwrite and approveloans, resulting in faster service tothe consumer and lower cost to thelender.

Fourth, the reduction in time re-quired to underwrite high-qualityloans allows originators to focustheir underwriting resources on ex-ception credits. This added time,

which can be dedicated to the moremarginal applications, can potential-ly increase the percentage of loansapproved because it enables lendersto better assess default risk and toimplement lending policies de-signed to mitigate potential losses.

DisadvantagesOn the other side of the credit-

scoring debate, opponents point outthat a model’s reliability depends onthe accuracy, completeness, and

timeliness of the information used.If the baseline population used inthe scoring model is not sufficientlydiverse, scores may lack predictivepower for the underrepresented seg-ments of the overall population. Forexample, scoring models may leaveout rent, utility, and other nonstand-ard payment histories, which are of-ten considered an important part ofthe payment record of low- andmoderate-income populations.

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Rural Housing Development

Better Homes of Seaford, Inc., developed a 27-unit project for the elderly and a community center with assistancefrom the Delaware Rural Housing Consortium. Better Homes is developing another 26-unit residence for seniorcitizens. Both projects are in Seaford, Delaware.

The consortium provides its members withincreased access to technical assistance onhousing development, fund-raising foroperations and housing development, strategicplanning, product development, networking,and pre-development funds. This year, theconsortium is seeking to establish anendowment fund to support the housingdevelopment work of its members and plansto campaign for additional state and otherresources for rural housing. It also plans to

Delaware Nonprofits Form Consortium to MeetSpecial Challenges of Rural Housing

Seven nonprofit developers in Delawarehave realized the truth in the saying aboutstrength in numbers.

After discussing the difficulties involved inrural development in Delaware at a roundtablesponsored by NCALL Research in Dover,Delaware, these seven groups discovered thatthey all faced similar barriers in trying todevelop housing in rural areas: lower incomesand a wider affordability gap in the rural partof Delaware, fewer government housing

resources, and a higher rate of substandardhousing. Consequently, the seven formed theDelaware Rural Housing Consortium.

Higher rates of substandard housing, fewer banks, and reduced access to money from foundations andcorporations are just some of the special problems developers of rural housing face. Furthermore, residents ofthese areas often can find only minimum-wage jobs, sometimes rendering even affordable housing unaffordablefor them. In rural Delaware, for example, available employment means work in the service or agriculturalsector, areas not known for high-paying jobs. Such circumstances just add to developers’ frustration levels.

As if these barriers aren’t enough to overcome, recent estimates from the U.S. Census Bureau indicate thatnew home construction in rural areas fell almost 5 percent from 1996 to 1997. Figures for Pennsylvania showthat in 1997 rural areas of the state saw 8,610 new residences go up, while the number in urban areas was nearlythree times higher (24,900).

The three brief articles that follow outline some initiatives currently under way in rural parts ofPennsylvania and Delaware that attempt to solve some of these problems, as well as others, to make affordablehousing more accessible to people who live far beyond the city’s boundaries.

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This 16-unit two-bedroom project for residents 55 and over inMifflinburg, Pennsylvania, was developed using the USDA’sRural Rental Housing Program and the Federal Home LoanBank of Pittsburgh’s Community Investment Program. WestMilton State Bank helped finance the project.

USDA Introduces Two Programs for Rural Housing

The United States Department of Agriculture(USDA) has announced two new tools to help easesome of the problems faced by developers of ruralhousing.

The first, the Rural Direct Loan LeveragingProgram, allows the USDA to offer funding jointlywith lenders of single-family mortgages in rural areas.

Under this new program, participating lendersmay hold and service their portion of the financing, orthey may sell that portion to Fannie Mae. Two sets ofloan documents are required. Loan amounts may notexceed HUD’s maximum mortgage limits for a county,in effect as of September 30, 1998.

USDA has selected two nonprofit organizations inPennsylvania—the Housing Development Corporation(HDC) in Lancaster, Pa., and the Alliance for BetterHousing (ABH) in Kennett Square, Pa.—for a set-asidewithin the leveraging program. USDA will financeabout 75 percent to 80 percent of each loan, with theremainder coming from the bank. The set-aside of$319,000 for HDC and $490,667 for ABH representsadditional funding for the USDA portion of loans.

The two nonprofits are counseling applicants andpackaging loans under this program. HDC is workingwith Fulton Bank, which is providing first mortgages,usually through the Pennsylvania Housing FinanceAgency, and with the Lancaster Housing OpportunityPartnership, which is providing down payment

expand a fund of last resort to help familiesfaced with eviction retain their homes.

Joe L. Myer, executive director of NCALLResearch, a nonprofit housing developer, saidin an interview, “Alone, we have tunnel vision.Together, we think creatively. I find that someof our most creative time is spent in ourmonthly steering committee meetings.” Herecalled that Better Homes of Seafordarticulated the need for additional financing todouble the capacity of a multipurposecommunity center that’s part of an 88-unitproject being developed for the elderly. A fund-raising consultant retained by the consortiumproposed a grant campaign and raised $87,000from two foundations and the GreenwoodTrust Company. Today, the center is thenucleus for a dozen key services to residents.The consultant separately raised $25,000 for ahardship fund for one of the developments inthe project.

Myer explained that a consortium workgroup is studying ways in which rental housingin rural Delaware can be made moreaffordable. One concept under exploration isthat of a rural rental trust in which anendowment would provide a stream ofearnings for operations of selecteddevelopments. Myer said that NCALL haddeveloped a 28-unit complex in Snow Hill,Maryland, employing such a concept.

NCALL Research is the administeringagency for the consortium, which initially wasfunded by a half-dozen Delaware foundations.The consortium members are AppoquiniminkDevelopment, Inc. (ADI), Middletown; NCALLResearch, Inc., Dover; Delmarva RuralMinistries, Inc., Dover; Milford HousingDevelopment Corporation, Milford; BetterHomes of Seaford, Inc., Seaford; MillsboroHousing for Progress (MHP), Millsboro; andthe Interfaith Mission of Sussex County, Inc.,Ocean View. ADI and MHP are all-volunteernonprofits.

For further information, contact Joe L. Myer,Executive Director, NCALL Research, Inc., P.O.Box 1092, Dover, DE 19903; Telephone: (302) 678-9400; web site: www.ncall.org

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assistance through HOME funds. MeschelleSensenig-Roten, director of Home Sales at HDC,estimated that the set-aside would enable five buyersto purchase homes. Using set-aside funds, HDC hasdeveloped and is currently marketing a 98-unittownhouse subdivision in Manheim Township,Lancaster County, Pa.

Alliance for Better Housing, working inpartnership with The Peoples Bank of Oxford, inOxford, Pa., will use the set-aside to assist in homepurchases by seven or eight additional low-incomefirst-time buyers, according to ABH’s president,Howard Porter.

For further information on this USDA program, contactFrank Wetherhold, Single Family Housing ProgramDirector, USDA, Rural Development, One Credit UnionPlace, Suite 330, Harrisburg, PA 17110; Telephone:(717) 237-2279; E-mail: frwether@rdmail.usda.gov

The second new tool from the USDA’s RuralHousing Service attempts to meet the difficultchallenge of developing rental housing in rural areas.The Section 538 Guaranteed Rural Rental HousingProgram allows lenders to underwrite and originate

James Thomas, executive director of the Columbia CountyHousing Authority, congratulates Cathy Gipe, who boughther first house with the assistance of the authority’s downpayment and closing cost program. At far right is VondaLaubach, assistant treasurer of First Columbia Bank andTrust Company.

loans in eligible rural areas, to perform all loan-servicing functions, including asset management andliquidation, and to monitor rent levels. The programprovides lenders with loan guarantees of up to 90percent.

Loans can be used for new construction,moderate or substantial rehabilitation, acquisition ofbuildings that meet special housing needs,combination construction and permanent loans, andconstruction of a wide variety of housing types,including mobile homes and congregate housing.Tenants’ income must be below 115 percent of thearea’s median income at the time of initial occupancy;no income verification is required afterward. Rentsmust not exceed, on average, 30 percent of the area’smedian income, adjusted for family size.

Guarantees may be used in conjunction withother subsidy programs, such as the low-incomehousing tax credit program. Eligible lenders areFHA-, Fannie Mae-, and Freddie Mac-approvedmultifamily lenders and others with multifamilylending experience.

Robert P. Yoder, Sr., vice president of WarriorRun Development Corp., in Turbotville, Pa., said inan interview that he thought the program wouldbecome a key to rural development in the future,especially since federal appropriations for directfunding of rental developments have been steadilydeclining. Yoder expects that banks, which have notbeen very active in rural multifamily development forthe past decade, will show significant interest in theprogram. He observed that banks and mortgagecompanies that previously provided only single-family financing are now taking a look at multifamilylending.

Banks that are members of the Federal HomeLoan Bank System can apply for CommunityInvestment Program (CIP) funds in Section 538-financed projects, thereby controlling their interestrate and credit risk, Yoder said. Both Section 538 andthe CIP can serve residents with up to 115 percent ofarea median income, allowing the two programs to beused harmoniously. CIP funds represent criticalinterest rate savings on project development costsand make it possible to charge lower rents, Yoderexplained.

In fact, Warrior Run is already working withthree different community banks in Pennsylvania on

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developments using the two programs. West MiltonState Bank is helping to finance a 16-unit project forresidents 55 and over in Mifflinburg, Pa. Jersey ShoreState Bank, Williamsport, Pa., is financing an eight-unit family complex in Lock Haven, Pa. ColumbiaCounty Farmers National Bank, Bloomsburg, Pa., isfinancing a 24-unit local complex for residents 55 andover.

For further information on the Section 538Guaranteed Rural Rental Housing Program, contact GaryRothrock, Multi-Family Housing Program Director,USDA, Rural Development, One Credit Union Place,Suite 330, Harrisburg, PA 17110, Telephone: (717) 237-2281; E-mail: grothroc@rurdev.usda.gov

Housing Authority Program in Rural PennsylvaniaAssists First-Time Buyers

An unusual first-time homebuyer programinvolving a local housing authority and communitybanks in Columbia County, Pa., has enabled 105 low-and moderate-income buyers to purchase homes thatthey otherwise could not afford.

The Columbia County Housing Authority (CHA)initiated a down payment and closing cost assistanceprogram in 1991 using its excess funds and grantsfrom the state and from Pennsylvania Power and

Photo shows the interior of one of the townhouses in Manheim Township, Lancaster County, developed by the HousingDevelopment Corporation, Lancaster, Pa.

The program has provided an average of about $5500in deferred-payment second mortgage loans toincome-eligible buyers who have purchased housescosting about $55,000, explained Jim Thomas, theauthority’s executive director. Many times, thesefamilies’ rental expenses are higher than the newmortgage payment.

Buyers obtain financing from area banks ornonbank mortgage companies. The banks have beenvery cooperative in working with the program,Thomas commented. The most active banks since theprogram’s inception, Thomas said, include ColumbiaCounty Farmers National Bank, First Columbia Bank& Trust Co., The First National Bank of Berwick, FirstFederal Bank (based in Hazleton, Pa.), and PNCBank, N.A.

Lenders assist applicants in completing theapplication form and forward it and supportingdocumentation to the authority, which reviews theapplication and determines eligibility. The authorityissues a letter of eligibility to applicants and sendscopies to the lender.

Paul E. Reichart, president and chief executiveofficer of the Columbia County Farmers NationalBank in Bloomsburg, Pa., said that the program hasbeen quite successful and that delinquencies are rare.

Light, one of the state’s major utility companies.

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Credit Scoring ...continued from page 2Reichart, who is chairman of CHA, said that theprogram would be substantially funded in the futurewith Act 137 (the Pennsylvania County HousingTrust Fund Program) transfer tax payments to thecounty. Reichart has been a CHA board membersince its founding in 1969.

Enhancements to the program include a homeownership education program that will be institutedthis year and modeled after a home owner instituteoperated by the Union County Housing Authority.Reichart added that one challenge is to increaseawareness of the program among buyers and realestate agents.

Ed Christiano, executive director of theNorthumberland County Housing Authority andpresident of the Eastern Pennsylvania Association ofHousing Authorities, said that Northumberland’swas the only other home buyer assistance programoperated by a housing authority in the 36-memberassociation. That program, which provides closingcosts but not down payment funds, has assisted about

45 families since it was started in 1995.Christiano explained that an increasing number

of housing authorities are looking for additionalfinancial resources and are interested in working inpartnership with banks. For example, theNorthumberland authority is looking to work withbanks that might donate or negotiate sale of defaultedproperties to the authority, which in turn wouldmake repairs and sell them to low- or moderate-income buyers, he said.

For information on the Columbia County program,contact Jim Thomas, Executive Director, Columbia CountyHousing Authority, 700 Sawmill Road, Bloomsburg, PA17815; Phone: (717) 784-9373. For information on theNorthumberland County program, contact Ed Christiano,Executive Director, Northumberland County HousingAuthority, 50 Mahoning Street, Milton, Pa. 17847;Telephone: (570) 742-8797

Keith Rolland wrote this article.

Ways to Work Program Gets Help from Consortium of

Banks in South Jersey

Twelve financial institutions are contributing funds to the Family Service Association’sloan pool and/or operating expenses. Shown (left to right) are Vincent Nolan, VicePresident, First Union National Bank, Camden, N.J.; Peggy Massey, Vice President,The Woodstown National Bank and Trust Company, Salem, N.J.; Dawn Kosko, VicePresident, Summit Bank, Brigantine, N.J.; Theresa Lance, Branch Manager, Fleet Bank,N.A., Absecon, N.J.; Joyce Harley, Senior Vice President and Community DevelopmentOfficer, Fleet Bank, N.A., Newark, N.J.; and Keith Rolland, Community DevelopmentAdvisor, Federal Reserve Bank of Philadelphia.

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Twelve financial institutionsthat serve southern New Jersey haveentered into a ground-breaking con-sortium with Family Service Associ-ation (FSA), a private nonprofitcommunity-based agency headquar-tered in Absecon, New Jersey, to im-plement the Ways to Work FamilyLoan Program.

Ways to Work is an innovativeprogram that has proven to be effec-tive in helping families move fromwelfare to work. In a cooperative ef-fort between the national Alliancefor Children and Families in Mil-waukee, Wisconsin, and the Mc-Knight Foundation of Minneapolis,Minnesota, the successful 14-year-old program is now being replicatedin other sites throughout the nation.

The purpose of the program isto provide small loans to low-in-come parents who are making the

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City of Bethlehem and ABC Join Forces

On the Bethlehem Home Ownership Project

Credit Scoring ...continued from page 3

scoring models report that a model’sperformance deteriorates over timeand that periodic validation is nec-essary. For example, if a lender thatuses scoring increases its applicantpool through mass marketing, thelender must ensure that the newpool of applicants behaves similarlyto the pool on which the model wasbuilt. Indeed, according to the EqualCredit Opportunity Act, a creditscoring system must be “periodical-ly revalidated by the use of appro-priate statistical principles andmethodology and adjusted as neces-sary to maintain predictive ability.”

Another concern is whetherscoring models that were developedduring good times will work if theeconomy takes a turn for the worse.Those who create scoring models ac-knowledge that applicants, as agroup, will tend to score lower be-cause characteristics used in themodel will reflect the change in be-havior brought about by difficulteconomic times. However, theypoint out, the user of a scoring mod-el can adjust the cutoff score. Fur-thermore, regardless of the under-writing process, whether judgmen-tal or scoring, a downturn in theeconomy will result in a greater

Alliance for Building Communi-ties (ABC), a nonprofit organizationbased in Allentown, Pennsylvania,and the City of Bethlehem have

teamed up to renovate and “decon-vert” 15 houses, 10 on Bethlehem’sSouth Side and five on the city’sWest Side. Other partners in the

Bethlehem Home Ownership Projectare the Northampton County Hous-ing Trust Fund, the Community Ac-tion Committee of the Lehigh Val-

Thus, scores for these populationsmay not reliably assess individualrisk.

In addition, the data on whichthe scoring system is based need toinclude both well-performing andpoorly performing loans and mustbe up-to-date. Builders of credit-

number of defaults and denials thanone would expect to experience inrelatively good times. Nevertheless,the concern remains that the modelitself may not be valid in a decliningeconomy.

Who’s Using ItIn spite of the ongoing debate,

credit-scoring models are gaining inpopularity and sophistication. In1995, both the Federal Home LoanMortgage Corporation (FreddieMac) and the Federal NationalMortgage Corporation (Fannie Mae)encouraged mortgage lenders to usecredit scoring. Also in 1995, Fair,Isaac and Company, Inc., a majorprovider of credit-scoring models,introduced its Small Business Scor-ing Service (SBSS).

In 1997, Fair, Isaac and Compa-ny, Inc., and CRI ProServices, Inc.,announced that they would offer acredit analysis tool that would in-crease the speed and efficiency ofunderwriting small-business loansand, ultimately, would enable finan-cial institutions to take advantage ofsmall-business loan securitizationservices, allowing the loans to berated and sold in the secondarymarket.

Despite the enhanced sophisti-cation of the models, many people,including some bankers and com-munity leaders, remain skepticalthat the objectivity in scoring willbenefit low-income individuals.However, surveys of various data-bases conducted by Freddie Mac

and Fair, Isaac show that credit scor-ing, when compared to judgmentalscreening, would have provided asubstantial increase in acceptancerates. Also, three economists at theBoard of Governors of the FederalReserve analyzed a large sample ofmortgage loans and showed that therelationship between a borrower’sincome and loan performance ap-peared to be slight. Credit score and,to a lesser extent, loan-to-value ratioappeared to be much stronger pre-dictors of foreclosure rates. The factremains that people with lowercredit scores pose higher risks tolenders.

*****

Sources used for this article were:Avery, Robert B., Raphael W. Bostic,

Paul S. Calem, and Glenn B. Can-ner. “Credit Risk, Credit Scoringand the Performance of HomeMortgages,” Federal Reserve Bul-letin 82 (July 1996), pp. 621-48.

Fair, Isaac and Company, Inc. “Low toModerate Income and High Mi-nority Area Case Studies,” Dis-cussion Paper (August 26, 1996).

Mester, Loretta. “What’s the Point ofCredit Scoring?” Business Review,Federal Reserve Bank of Philadel-phia (September/October 1997),pp. 3-16.

Don James wrote this article andthe accompanying box on fair lendingissues.

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This house on West 4th Street in Bethlehem, Pennsylvania, was renovated and deconverted through a program sponsored by theAlliance for Building Communities.

have been chopped up into apart-ments, presents its own set of chal-lenges. In addition to the usual reha-bilitation needs—new roof, rewir-ing, paint—contractors must alsocontend with taking out extra kitch-ens and bathrooms, removing divid-ing walls, and restoring utilities toone-household use.

Furthermore, it’s harder to keepcosts to a minimum with deconver-sion projects. For one thing,Pawlowski points out, there’s afixed amount of subsidy per house,so deconversion efforts are oftenmore difficult than other nonprofithousing ventures.

However, deconversion has twoprimary benefits: it cuts down onurban density and provides roomy,but affordable houses for low-in-come people with large families.

Most of the properties acquired

were in bad shape.Pawlowski at-tributes the deterio-ration, at least inpart, to the fact thatmost of them wererental units. He not-ed that cities tend tohave “huge rates ofrenting. In Bethle-hem, the figure isabout 51 percent.”Rates are even high-er in Allentown,where Pawlowskihas completed asimilar project in-volving 12 houses,and they’re higherstill in Reading,where ABC has setits sights for its nextventure. He blamessome of this highrate on the collapse of the housingmarket in the 1980s. Back then, oneway to pay off the mortgage on alarge house was to create severalrental units out of the dwelling.

Consequently, Pawlowski thinks,many people “became reluctantlandlords, and properties deteriorat-ed, either intentionally or uninten-tionally.”

Interior of a house renovated by ABC.

ley, and First Union, Lafayette Am-bassador, and Summit banks.

According to Ed Pawlowski, ex-ecutive director of ABC, deconver-sion, which involves restoring tosingle-family dwellings houses that

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Ways to Work Program ...continued from page 8

Helping ABC finance the costsof the renovations—thereby keepingthese properties affordable for low-income people—are the other part-ners involved in this project. FirstUnion is providing a $500,000 line ofcredit and Lafayette Ambassador a$250,000 line, both collateralizedagainst 80 percent of the value of therehabilitated structures. Lafayettealso sponsored the project’s applica-tion to the Federal Home Loan Bankof Pittsburgh, which contributed a$67,500 grant to reduce the acquisi-tion price of houses purchased forthe program. Summit Bank has sup-

plied a $10,000 grant for home-buy-er counseling. In addition, the Cityof Bethlehem is kicking in a $20,000-per-house subsidy, and theNorthampton County Trust Fund iscontributing an additional subsidyof $2000 per house.

The Community Action Com-mittee of the Lehigh Valley is per-forming energy audits on all theproperties, and all will have updat-ed, efficient energy systems.

Ultimately, Pawlowski ob-served, the project has three mainpurposes: revitalizing the communi-ty, reducing density, and providing

large, affordable living space forlow-income families. He added, “Ifwe concentrate on an eight-blockarea on Bethlehem’s South sidewhere there might be 100 houses,and we re-do 10 or 15 of them, thathas an impact.”

For more information about ABCand its projects, contact Ed Pawlowski,Alliance for Building Communities, 830Hamilton Mall, Allentown, PA 18101;(610) 439-7007.

transition from welfare to work andwho cannot get loans elsewhere. Theloans are designed to help familymembers succeed in their jobs.Loans can be used to pay for cloth-ing, transportation, or unexpectedexpenses that could interfere with afamily member’s ability to keep ajob or stay in school.

The consortium that has beendeveloped in South Jersey, with theassistance of the Federal ReserveBank of Philadelphia, is unique inthat it will serve a larger geographicarea than the other Ways to Worksites. The program is available tofamilies who live in Atlantic, Burl-ington, Camden, Cape May, Cum-berland, Gloucester, and Salemcounties.

The banks that have contributedto the loan pool and to operating ex-penses for the innovative ventureare The Bank of Gloucester County,

Cape Savings Bank, CommerceBank, N.A., Equity Bank, N.A., TheFirst National Bank of Elmer, FirstUnion Foundation, Fleet Bank, N.A.,The Pennsville National Bank, Sum-mit Bank, Sun National Bank, andThe Woodstown National Bank &Trust Company. Also providingsupport for operating expenses arethe Sovereign Bank Foundation; theGold Foundation; the Atlantic CityHilton; Bally’s Park Place, a HiltonCasino Resort; and the ShowboatCasino Hotel.

A 10-year evaluation of pro-gram operations in Minneapolisshowed that transportation in and ofitself was key to helping peoplekeep their jobs and stay in school.Also, while approximately three-fourths of the borrowers were re-ceiving governmental aid at thetime of their loan application, theiruse of public assistance dropped 40

percent within two years. Fewerthan 1 percent of the borrowershave become new users of public as-sistance since getting their loans. Re-payment rates in some areas havereached 90 percent, but the averagein metropolitan areas is about 76percent.

The program is based in FSA’sConsumer Credit Counseling Ser-vice of South Jersey. Successful pro-gram applicants will receive creditand budget counseling.

For more information on the Fami-ly Loan Program, contact JeromeJohnson, President and Chief ExecutiveOfficer, Family Service Association, orTony Marinaccio, Manager, ConsumerCredit Counseling Service of South Jer-sey, 312 E. White Horse Pike, Absecon,NJ 08201; Telephone: (609) 652-2377.

Cascade is published three times yearly by the Community Affairs Depart-ment of the Federal Reserve Bank of Philadelphia.

Editor Sally Burke

Designer Barbara FitzPatrick

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