WORD ON THE STREET: Over the past two-plus years, the Community Reinvestment Act (CRA) has been under unfair assault by those who wish to shift the blame for the financial meltdown from Wall Street to low-income neighborhoods and people. The truth, however, stands in direct contrast to those assertions. Defaults on subprime lending are widely recognized as the one of the most significant underlying causes of the financial meltdown.
Research by the Federal Reserve Bank of San Francisco found that loans issued in California by banks subject to CRA were half as likely to end up in foreclosure as loans issued by independent mortgage companies not covered by CRA. A 2008 analysis by the Board of Governors of the Federal Reserve System further found that only 6% of all higher-priced loans in 2006 (peak of the subprime origination) were made by CRA-covered institutions or their affiliates to lower-income borrowers or neighborhoods in their assessment areas.
In addition, a 2010 analysis by the University of North Carolina's Center for Community Capital found that mortgage borrowers obtaining loans through special lending programs (including CRA) targeted to low- and moderate-income (LMI) purchasers were estimated to be 70% less likely to default on their loans than borrowers with subprime loans.
The bottom line is that CRA is essential to the health of our country's low- and moderate-income communities, and banks do quality lending under CRA. From that starting point, we need to look forward and identify how CRA can become a more effective tool to (1) promote direct lending, investments and services in these communities; and (2) forge partnerships with community development financial institutions (CDFIs) to reach deeper into underserved communities. Many of the witnesses today will focus their comments on the former.
The CDFI solution
CRA is the backbone of the CDFI industry's strategy to engage mainstream banks and thrifts in the work we do. Mainstream banks support our lending by providing deposits and loans that we use for re-lending, to borrowers that mainstream banks cannot reach as effectively as CDFIs.
Mainstream banks also provide CDFIs with equity in the form of grants and as shareholders. Without CRA, the CDFI industry today would be a fraction of its current size, and the scale of its lending and impact would correspondingly be reduced. This investment by mainstream banks, in CDFIs has been consistently successful and, in the case of debt, repaid according to its terms. Working with CDFIs has been a win-win strategy for mainstream banks because it provides a way to reach hard-to-serve market niches and support innovation in the community development sector.
Any revisions to CRA need to focus on supporting and encouraging CDFI partnerships. Mainstream banks are also needed as partners with CDFIs on the transactional level. The CDFIs are often the gap financiers, with mainstream banks providing a significant portion of debt on projects. Without CRA, many of these deals would never happen because CDFIs – individually and as an industry – are not big enough to single-handedly address all community development needs.
Conversely, the on-the-ground and programmatic knowledge of CDFIs, as well as our ability to attract government and philanthropic funds, is a critical complement to the funds and expertise mainstream banks bring to these transactions. Thus, a strong CRA is needed to both engage mainstream banks and help CDFIs grow and do more in their communities.
CRA should reward banks that provide concessionary pricing, longer-term support or other favorable terms on deposits and investments in and loans to CDFIs. Similarly, banks that work with CDFIs to develop innovative products and services for low- and moderate-income markets should be recognized more explicitly and strongly in the evaluation process. While the regulations state that ‘innovative or complex’ activities will receive consideration, implementation has not been adequate. CRA implementation is currently strongly focused on measuring the number and dollar amount of transactions.
This focus has the unintended consequence of creating disincentives for mainstream banks to (1) provide longer term financing, which would reduce liquidity risk and asset-liability management challenges for CDFIs with demand for long-term loans, but that only have short-term money to lend or (2) engage in transactions that are highly impactful, but may take years to put together and involve multiple financing sources. Implementation of CRA should be amended to reward mainstream banks for providing support to CDFIs in a manner that enables them to meet customer needs in a financially sustainable manner.
All financial support provided to CDFIs by banks should be explicitly eligible for CRA consideration, regardless of whether a CDFI is located in and/or serves the same service area as its mainstream bank investor(s). As currently implemented, most banks get (1) minimal CRA consideration for CDFI-related activity outside of their designated assessment areas and (2) limited consideration for such activities, even within assessment areas, unless the assessment area receives a full-scope exam.
This treatment dissuades mainstream banks from supporting CDFIs that are not located directly in their markets and/or principally serve the same geography as the bank does. The resultant mismatch means missed opportunities to multiply banks' ability to deliver credit and investments to underserved areas, particularly those whose needs exceed the capacity of local institutions subject to CRA.
CRA should cover all broad geographies in which a bank does significant business. In particular, industrial loan companies and wholesale, investment, credit card or Internet-based banks should not have local assessment areas.
They should be expected to meet community development needs on a national basis, which is more reflective of their actual markets. Given some of the practical limitations on financial institutions that do not have a retail presence in many of the places that are part of their actual markets, regulators should explicitly recognize and give significant weight to investments in and/or partnerships with CDFIs.
What have we learned?
Over the past 24 months, the liquidity crisis within the broader financial services sector has exacerbated and highlighted the long-term challenges of the CDFI industry in managing portfolio liquidity. Unlike the traditional financial services industry, the CDFI field lacks the sufficient institutional infrastructure to manage portfolio liquidity through loan syndications, secondary market sales and other mechanisms. Efforts to sell securities backed by pools of CDFI originated loans to mainstream banks seeking CRA credit have encountered challenges.
For example, examiners have had difficulty determining whether and how to give CRA credit when a bank purchases an interest in a loan pool that may include loans both within and outside of a bank's assessment area. Or, a regulator may give one bank ‘credit’ for a specific loan within a pool but deny another bank credit for the same loan. As purchasers of the pool, both banks have a fractional interest in all loans and should be given CRA consideration in proportion to their investment in the entire pool.
While the regulations permit proportional treatment, implementation both across and within the agencies is inconsistent and often confusing. We urge the regulatory agencies to improve their examiner training and work toward greater consistency.
Among the 862 certified CDFIs nationwide, there are 62 CDFI banks and thrifts that are both subject to CRA examinations and are often recipients of support from other banks seeking CRA consideration. Within this group, 45% have "Outstanding" CRA ratings and 55% have ‘Satisfactory’ ratings. This compares to mainstream banks, of which 16% have an ‘Outstanding’ rating, and 80% have a ‘Satisfactory’ rating. CDFI banks are mission-driven institutions with a strong focus on their low-income communities.
CRA implementation needs to be amended to be more efficient and effective in helping CDFI banks to (1) maximize their service and the dollars deployed into low- and moderate-income communities and (2) support innovation and impact. We strongly encourage greater integration of CRA requirements with the U.S. Treasury Department's CDFI Fund's programs. We believe the regulatory agencies and low- and moderate-income communities could benefit from adopting some of the highly effective strategies used by the CDFI Fund to promote access to capital.
Jeannine Jacokes is CEO of the Community Development Bankers Association and chairwoman of the board of the CDFI Coalition. This article adapted from testimony presented before a recent Federal Financial Institutions Examination Council hearing on proposed revisions to CRA regulations.