Hedge fund activism can benefit banks’ minority customers
Banks targeted by hedge fund activism become more likely to sign off on mortgage loans for minority customers, UNC Charlotte-led research has discovered. The research journal Management Science published the paper “The Color of Hedge Fund Activism” online in late September.
“When banks face pressure from hedge funds to grow profits, they have strong incentive to improve their processes and close the racial gap between home mortgage approvals,” said lead researcher Yongqiang Chu. This pressure can lead to benefits for borrowers, in what could perhaps be viewed as an unintended consequence.
“Banks learn more about their customers and try to better understand their creditworthiness,” Chu said. “Collecting better data means they rely less on race as a signal for lending decisions or as a proxy for risk. Meanwhile, when benefits from the more effective decisions on lending outweigh the costs of obtaining data, the banks are more profitable.”
The impact on potential borrowers from these hedge fund actions is sizeable, said Chu, who is the Childress Klein Distinguished Professor of Real Estate and Urban Economics and professor of finance with the Belk College of Business. “We see a four percentage-point decrease in the denial rate for minority borrowers,” he said. “This amounts to about 20% of the unconditional average denial rate for minority borrowers.”
Historically, hedge funds buy a significant amount of a company’s stock and use that influence to push for changes within that company. When these powerful hedge funds use their muscle to influence how a company is run, they focus on the target companies’ profitability. The activists take into account financial outcomes and also regulatory compliance concerns that increase costs or thwart future plans, such as for selling the company.
“When banks face pressure from hedge funds to grow profits, they have strong incentive to improve their processes and close the racial gap between home mortgage approvals.”
Dr. Yongqiang Chu
Targeted banks take action
The innovative study found that banks targeted by hedge funds had a higher turnover rate of mortgage officers in areas with higher racial gaps in mortgage approval rates, likely because the banks were replacing mortgage officers to address lending discrimination based on personal biases. The banks also opened new branches in those areas and employed more loan officers.
These steps could be to comply with the Community Reinvestment Act to prepare for approval by the Federal Reserve of future mergers or acquisitions, Chu said.
“This regulatory requirement motivates banks to actively reduce any mortgage lending disparities,” he said. “We find that hedge fund activists can enhance banks’ internal processes, and drive greater information acquisition, which can reduce statistical discrimination.”
Banks targeted by hedge fund activism are more likely to be involved in mergers and acquisitions, the study found.
To identify changes in the racial gap in mortgage lending, Chu and co-authors Bo Huang and Chengsi Zhang used the Home Mortgage Disclosure Act data, considered the most comprehensive source of publicly available information on the U.S. mortgage market. They compared the targeted banks with similar banks that were not targeted by hedge funds. In one step, they searched bank regulatory filings for keywords related to lending discrimination, finding that target banks are more likely to address lending discrimination issues in regulatory filings.
Chu, who is director of the Childress Klein Center for Real Estate, conducts research in real estate, corporate finance, and banking and is the lead author of the State of Housing in Charlotte Report. His research has appeared in top finance, real estate and economics journals, including Review of Financial Studies, Journal of Financial Economics, Management Science, Journal of Financial and Quantitative Analysis, Review of Economic Dynamics, and Real Estate Economics.