Homegrown Charter One is a Cleveland success story. One of the nation's 30 largest bank holding companies, it trumpets its wealth in its annual report: 419 branches and $33 billion in assets.
Yet there's another side to Charter One, contained in figures that won't make the pages of glossy reports. They show the bank's home loan rejection rate for black Clevelanders soaring high above the rate for white applicants. In 1999, the latest figures available, the bank denied low-income blacks refinancing loans at a rate of 73.9 percent. For low-income whites, the rate was just 45 percent. The rejection rate for high-income whites dropped to 12.5 percent; for high-income blacks, it sat at a stunning 42.8 percent.
Ask community reinvestment activist Paul Bellamy, however, and he'll tell you that Charter One's rejection rate isn't even its biggest problem. He points to data indicating that not only does the bank deny loans to large numbers of blacks; it seems to target black neighborhoods with a special division, called Charter One Credit, that offers high-interest loans. These loans can cost the average customer $50,000 more than a regular mortgage over 30 years.
The record is particularly perplexing, considering Charter One's success in taking deposits from minority customers. In Ohio, the bank ranks sixth in total deposits, but it is first in predominantly minority neighborhoods.
That makes Bellamy angry. "They take in community deposits, pull the money out of the cheap-price loans, and come back with high-priced stuff, and that's all. It's the classic separate and unequal treatment. Charter One is the poster child for this phenomena."
For all Bellamy's passion, it's not a sexy issue. Titans of government and media have preferred to focus on the issue of predatory lending, with its made-for-TV drama. The subtleties that separate a good interest rate from a bad one and a black neighborhood from a white one are more insidious than juicy. Consider this statistic: In northern Ohio, Charter One Bank pulled just 2 percent of its customers from heavily minority census tracts. Charter One Credit pulled 14 percent. The disparity might not seem dramatic. Yet to even it out, Charter One Bank would have to service an additional 1,367 minority-tract customers with prime loans.
To Bellamy, the disparity seems like a return to the days of Jim Crow: two water fountains, two mortgage lenders.
"There's always been a separate financial system in this country for the poor and minorities. What Charter One is doing is just the newest version of it," he says. "And surprise, surprise, the black community ends up paying another black tax."
In 1995, Charter One forged an agreement with Mayor Michael White's office. Among other things, the company promised to study the feasibility of putting branches in the northeast and southeast parts of the city. At the time, it had only two East Side branches, compared to seven on the predominantly white West Side. Six years later, the bank has yet to open a new East Side branch.
Charles Bromley, executive director of Cleveland's Metropolitan Strategy Group, pulls a sheaf of maps from his desk and lays them on the table. Some show the city of Cleveland. Others show Greater Cleveland. Census tracts with 40 percent or more racial minorities are striped gray. Areas where Charter One does a high level of home lending are green. Areas where the bank originates few loans are beige, with a full range of shades in the middle.
"We've got green in Westlake and Independence and Solon," he says. "Now look at Bedford Heights and Warrensville Heights." The map shows a high minority presence -- and few Charter One loans.
Maps of the city are even starker. White neighborhoods, like Kamm's Corners, North Collinwood, and Old Brooklyn, show Charter One's high market share. Neighborhoods like South Collinwood, Glenville, and Union-Miles show almost nothing.
Bromley thinks these maps are the key to the case against Charter One. He believes Charter One's record is so abysmal, it rises to the sins of the Chevy Chase Federal Savings Bank during the 1980s and early '90s. At that time, the Maryland bank received less than 6 percent of its applications from African American neighborhoods. In 1992, the U.S. Department of Justice charged it with a practice known as redlining, in which banks refuse to make loans in certain areas. Chevy Chase agreed to provide about $140 million in special financing for minority neighborhoods and to open branches within them.
The government's case set a precedent. For the first time, a bank was targeted not for rejecting blacks, but for failing to market to them. "To shun an entire community because of its racial makeup is just as wrong as to reject an applicant because they are African American," Attorney General Janet Reno said at the time. "Some neighborhood banks may turn away blacks because of their race, but other neighborhoods may not even have banks to which blacks can turn."
The Department of Justice website still includes maps from the case. Bromley's maps for Charter One in Cleveland look nearly identical: Branches are concentrated in white neighborhoods, with the exception of the integrated Slavic Village. Mortgage and refinancing market shares drop in nearly every census tract with a strong minority presence. "It's the same issue as Chevy Chase," Bromley says. "The maps even look the same."
But Bromley notes one key difference. "In Chevy Chase, they basically ignored the black neighborhoods. With Charter One, they serve them with Charter One Credit and through the brokers. It's a new twist to what's going on. They're saying, 'Okay, we have to serve these people, but we'll do it with the extra fees and the premiums for the brokers.'"
Charter One officials declined to be interviewed for this story, but in letters and published reports, they have conceded that Charter One Credit customers have credit ratings almost equal to conventional customers. They also confirmed that brokers for the high-interest division charge extra fees for their work.
Bromley is especially rankled that subprime loans are going to "A-" borrowers. "These are not people with huge credit problems," he says. "You could do these loans through the main branch without sending them to brokers."
The system that banks use to rate applicants looks like an elementary school report card. Good customers who never miss payments and rack up high scores on various lending tests are deemed "A" borrowers. Customers who accumulate debt, liens, and bankruptcies are "F" borrowers. In between is a range of B's and C's, pluses and minuses. The difference between banking and elementary school is that schools pass "C" students. Even in the recent past, banks did not. Customers who didn't get an A were usually out of luck.
That changed in the 1990s with the explosion of subprime lending. A company called Green Tree Financial found huge success by taking its CEO's experience in the used-car business and applying those tactics to home financing. The mortgage market would never be the same, says Scott Moore, an assistant professor of finance at John Carroll University.
"Green Tree became fabulously successful at targeting people with low-quality credit," Moore says. "The company made a lot of money. And when your profit margin is that high, you attract attention."
Green Tree offered high-interest loans to customers with poor credit histories. Rather than offer a $100,000 mortgage at 7 percent and collect $139,000 in interest over 30 years, the company ratcheted rates up to 10, 12, and 15 percent to cover the higher risk.
With a 10 percent loan, the company's earnings on the same house soar to $215,000; with 15 percent, they rise to $355,000. If customers make payments, the lender earns huge profits. If they fail, the loss is still manageable. After all, the lender owns the home, which it can always resell.
Others took note. Soon, a fleet of financiers specializing in high-rate, high-risk loans flooded the market, pushing products on television, through mass mailings, and via phone banks. Subprime lending increased 241 percent in Ohio between 1995 and 1999, according to a study by the Washington, D.C.-based National Community Reinvestment Coalition. It didn't take banks long to realize they were missing out. The B and C customers they rejected were tripling revenues for other companies. Many banks responded by opening subprime affiliates of their own. KeyCorp established Champion Mortgage. First Union opened the Money Store. National City opened Altegra Credit and the Loan Zone. Charter One, the biggest home mortgage lender in northern Ohio, was no different.
The bank's expansion in the 1980s and '90s -- with mergers that shored up its Ohio dominance and acquisitions of a broad swath of turf in Michigan, New York, Vermont, Massachusetts, and Illinois -- came with a push for higher and higher profit margins. Like so many banks, that meant embracing subprime lending. Executive Vice President John D. Koch spoke of the new division, Equity One Credit, as an "attractive alternative for asset growth" in a 1996 Plain Dealer interview. Koch said he hoped to capture "an emerging growth market comprised of customers who wouldn't ordinarily come to a bank for a loan."
Equity One got off to a fast start. In one year, the division grew from 2 to 112 employees and spread to 13 states. It loaned $139 million in 1997 and about $300 million in 1998, changing its name to Charter One Credit in the process. With a focus on A- and B customers, the division handled 940 loans in northern Ohio in 1999 alone. Charter One Credit actually did more refinancing loans in the city of Cleveland that year than Charter One Bank.
The company's earnings blossomed. Charter One Financial Inc. increased its profits 95 percent from 1998 to 2000. In a Plain Dealer interview in June, John Koch's brother, CEO Charles "Bud" Koch, cited four reasons: acquisitions, branches in grocery stores, an increase in fee income, and "higher-profit" products, like subprime lending.
Melissa Marquez has seen Charter One Credit in action. The neighborhood credit union she manages in Rochester, New York, has a large minority membership. Two years ago, the lender was running credit reports on nearly the entire credit union, Marquez says. "They seemed to be doing a lot of business here."
Marquez didn't realize the implications until she spoke with a young single mother. The woman excitedly told Marquez that she had saved almost $4,000 to buy a house. Her mortgage was ready to go.
Marquez was pleased when the woman told her the loan was through Charter One. "I said, 'I'm so glad you're getting it from a bank, not a finance company or a mortgage company, because those can be terrible deals,'" Marquez remembers. A few days later, at Marquez's suggestion, the woman brought in paperwork from the loan she had just signed. Marquez's heart skipped. "I saw the mortgage wasn't with Charter One, it was with Charter One Credit," she says. "I made the assumption that it was a bank; it couldn't be bad. I was wrong. The interest rate was 12.7 percent." Even worse, the contract included a penalty if the woman refinanced the loan or paid it off early.
Saddled with huge interest fees on her modest house, the woman ended up in bankruptcy. "She was only 26, 27 years old," Marquez says. "If she had taken the time to establish a positive payment history, we could have given her a rate of 7.5 percent. Instead, she was stuck with that."
After hearing similar stories, Rochester activists questioned Charter One about its subprime lender. The bank told them not to worry, says activist Ruhi Maker. The division was pulling out of the Rochester market.
The Federal Home Loan Mortgage Corporation -- a.k.a. Freddie Mac -- estimates that 30 percent of subprime loans go to borrowers who should get prime rates. Freddie's sister company, Fannie Mae, puts that number at 50 percent. Moreover, even customers with credit problems don't always receive rates equal to their risk. Experts believe that about one in four mortgages include broker fees paid through an extra point or two on the interest rate. The broker gets a higher commission -- and the customer pays for it through the nose in monthly payments.
The practice may seem unfair, but it has long been considered legal. So have other extras that some subprime loans include, like penalties for prepayment, high origination fees, and costly insurance.
Activists find the extras troubling in light of statistics that show subprime loans going disproportionately to minority customers. A National Community Reinvestment Coalition study found that, in 1999, more than 66 percent of all loans made in minority census tracts were subprime. In white neighborhoods, that total was just 18 percent.
In Greater Cleveland, blacks account for 15 percent of all households, but they receive 30 percent of all subprime loans and just 5 percent of prime loans. Josh Silver, the coalition's vice president of research and policy, worries that minority customers with good credit are a big part of the subprime market. "You can't tell me that two-thirds of minority buyers are not qualified for prime loans."
Silver's case is almost impossible to prove. Researchers have no way to gauge whether a lender has matched the interest rate and risk level. Lenders must record interest rates and broker premiums, but regulators do not consider such numbers public record.
Elizabeth Erickson, an associate professor of economics at the University of Akron, says that weakens any assertions about unfair practices. "Whether or not a spread is risk-based, that you can't tell. It's hard to say what is based on risk and what is discrimination."
Yet lack of data hasn't subdued suspicions -- or stopped critics from taking on banks with subprime divisions. Equity One was a year old in 1998 when it drew its first challenge. Charter One was seeking a merger with Albank Financial Corporation in Albany, New York, but it needed approval from federal regulators. Inner City Press, a Bronx watchdog group, filed a 25-page challenge to the merger, focusing on the banks' treatment of minorities and commitment to the Community Reinvestment Act, or CRA.
The CRA was passed in 1977 to stop redlining, says Ruth Clevenger, community affairs officer for the Fourth Federal Reserve District in Cleveland. At the time, she says, "banks were literally drawing red lines around certain neighborhoods and saying they wouldn't lend there, regardless of the credit worthiness of individuals in those neighborhoods."
The act requires banks to lend in their entire service area, not just in wealthy or white neighborhoods. If banks cannot earn a satisfactory CRA rating, they cannot buy or be bought -- a huge liability in today's rapidly shifting industry.
Yet the law does not require banks to meet certain levels or dollar figures, Clevenger says. Activists use it to force banks into putting greater emphasis on poor neighborhoods, but such discussion is largely limited to the months preceding a CRA evaluation, which happens every two years, and the time allowed for public comment before a merger.
Even then, activists' power lies mostly in the ability to delay, not halt approval. A merger has never been stopped because of activists' concerns, and only a small percentage of banks ever receive CRA ratings below satisfactory. Clevenger says that means banks are doing their part. "If they're making credit available, there's no reason not to give a bank a satisfactory rating. We don't grade on a curve."
Activists disagree. "There really is no standard," says Matthew Lee, Inner City Press's executive director. "If nobody like us comments, that means there are no problems."
Lee's group got involved in the Charter One-Albank merger because of Albank's miserable record. In 1997, the company agreed to set aside $9 million for discounted loans after the federal government accused it of carving out minority enclaves and refusing to make mortgage loans there. The bank never admitted wrongdoing, but the Justice Department considered the agreement a victory.
Lee's group had concerns about Charter One as well. The bank's record of serving minorities seemed weak. And although Equity One was too new for federal regulators to have data on it, Lee knew enough about subprime lenders to be worried.
Vice President Koch flew to New York to meet with the group, Lee says. The summit ended in a deal that Lee still praises as "groundbreaking." Charter One agreed to provide $1 billion in conventional interest loans to low- and moderate-income borrowers over the next three years. Perhaps more important, the bank also promised to develop a plan to send qualified Equity One applicants to Charter One for prime loans.
"They agreed to things the law doesn't require," says Lee. "I don't want to say Charter One is excellent -- it's by no means great. But if you look at CitiGroup or EquiCredit, those two are doing a lot worse."
Armed with the agreement, Lee's group dropped its opposition. The merger went through.
Charter One's subprime affiliate is no longer new. The division, Charter One Credit, has filed reports that didn't exist when Lee first examined the company.
Bellamy, executive director of the Lorain County Reinvestment Coalition, believes that record paints a troubling picture. Foreclosure documents show that the subprime division's rates have soared as high as 12 percent for A- and B borrowers -- a red flag to activists and analysts, who say the rate likely does not match an A- or B credit risk.
Keith T. Gumbinger, vice president at financial publisher HSH Associates in Butler, New Jersey, says there's no exact formula. "A working rule of thumb is that, for each drop in credit grade, add about 2 percent to the interest rate." That means an A- borrower would get an 8 percent rate; a B borrower, about 9 percent, though occasionally as high as 10.
Of 11 Charter One Credit foreclosures Scene surveyed in Lorain and Cuyahoga counties, nine had interest rates of 10.7 or higher. One was as high as 12 percent. "That discrepancy between risk and price is what's causing the subprime industry to explode at the phenomenal rate that it is," Bellamy says. "We're talking a huge profit."
He and Bromley both belong to the Ohio Community Reinvestment Project. The group contacted Charter One in March, soon after the announcement of its proposed merger with Alliance Bancorp of Illinois. Members hoped to use the threat of a merger delay to challenge Charter One's record and push for a commitment to do better.
The group fired off a letter April 13 to the Office of Thrift Supervision detailing Charter One's record with charts, maps, and statistics. Three days later, Bromley faxed over his analogy to the Chevy Chase case.
Charter One responded with a rebuttal. "While there is always room for improvement in any undertaking no matter how successful the results, Charter One is proud of its record of and commitment to fair lending and its successful role in designing and providing lending and other products and services meeting the needs of its delineated communities -- including low- and moderate-income and minority individuals, organizations and neighborhoods," Senior Vice President Richard Powers wrote. Powers cited the bank's "Second Look" program, which refers minority and low- and moderate-income applications for review after denial.
At a meeting with bank officials, Bellamy asked Charter One to shut down the "Jim Crow" affiliate and handle A- and B customers at the bank without broker premiums. Even Bellamy's cohorts thought he was asking too much. Bill Faith, executive director of the coalition, believes the focus should be on cleaning up, not eliminating, the division. No one was surprised when Charter One said no.
Soon after the meeting, Bellamy sent a letter with 14 questions about Charter One Credit. In his response, Vice President Koch confirmed one of Bellamy's suspicions -- that Charter One Credit purchases loans that contain brokers' fees, though the bank doesn't accept fees of more than 2 percent. "This limitation mirrors what is considered best practices in the industry," Koch wrote.
Yet Bellamy believes fees of any kind amount to outright dishonesty. "How can a system like that, that depends upon rank deception between the broker and borrower, be 'best practices' in this or any other moral universe?" he asks. "Are we to believe that holding it down to two points -- tens of thousands of dollars over the life of a 30-year loan -- is a 'best practice?' It's an industry-wide obscenity."
This, he says, explains why some Charter One Credit customers receive interest rates as high as 12 percent, despite supposedly being A- buyers. Federal regulators, however, seemed unmoved by Bellamy's complaint. The Charter One/Alliance merger was approved.
Officials at the Office of Thrift Supervision declined to discuss the specifics of the merger; nor will they discuss Charter One. But Richard Riese, the agency's director of compliance policy, says the agency tries to take a cooperative approach. "We try to work with institutions to correct their issues, whether they're CRA or safety and soundness concerns. We're not here to set obstacles."
This hands-off sentiment seems to stretch across the regulatory spectrum. Though activists find Charter One's lending data alarming, they can't find a government agency willing to investigate.
Clevenger, the Federal Reserve officer, notes that the case against Charter One may not be as black-and-white as it seems. "Because of the CRA and agreements with groups and the city, banks will tell you they're falling all over each other trying to do a reasonable market share in underserved neighborhoods," she says. "There's a lot of competition, and sometimes brokers are a lot more effective at marketing themselves."
Banks may also feel stuck between a rock and a hard place, Clevenger says. If they market heavily to low-income neighborhoods, they end up denying large numbers of applicants. If they don't market there, they are accused of redlining. "They feel they're damned if they do and damned if they don't."
The U.S. Department of Justice did not return repeated calls. State and local enforcement agencies were no more eager to take on the issue. Stephanie Beougher, a spokeswoman for Attorney General Betty Montgomery, says the state's top lawyers have no jurisdiction over banks. "Even if it's a fair-housing issue, I don't know if they would take that up," she says.
Ohio Civil Rights Commission Public Information Officer Chris Harris says his agency does look at fair-housing issues, but typically after an individual complaint. "For us to take action, a charge has to be filed." The agency has received six fair-housing complaints about Charter One since 1994, but none appear to deal with the larger issue of redlining or subprime lending. State banking regulators say Charter One is federally chartered and therefore out of their jurisdiction.
Congress seems similarly uninterested. Rodney Pulliam, a legislative assistant for Representative Stephanie Tubbs Jones, says the congresswoman has focused on the dramatic abuses of "predatory lending," not the subtle racial patterns of prime and subprime loans.
Ken Silliman, Mayor White's executive assistant for development, believes it's better to work with Charter One than investigate it. "These issues are hard to prove in a court of law," he says. "We have found it's better to focus on the problem, a lack of investment in city neighborhoods, than how it shows up, which may look like redlining."
The only forces pushing Charter One Credit to change may be indirect. In 1996, a suit was filed against the Irwin Mortgage Company, alleging that commissions given to brokers in exchange for their customers' higher interest rates violate federal law. A federal district court dismissed the case. But an appeals court in Atlanta reversed that ruling, calling the premiums "illegal kickbacks." In June, the court granted the suit class-action status, the first on this issue to achieve that distinction.
Experts are predicting dire consequences for the mortgage industry. "We view this as a crisis," the attorney for the National Association of Mortgage Bankers told The Washington Post in July. Others predict that hundreds of additional suits will be filed.
Bellamy believes the class-action case may force brokers to clearly disclose that their interest rate covers such fees.
"It would be a start," he says. "But nothing is going to be as effective as putting out on the table what's really going on. Charter One doesn't want to be seen as discriminatory. If they're exposed, that's going to make them stop doing it."