Three Government Agencies Propose Updates to the Community Reinvestment Act
By Nushin Huq
9 min read
What it All Means
In what may be a once in a generation update, three government agencies released joint proposed rules to update The Community Reinvestment Act, or CRA, on how activities qualify for consideration, where those activities are considered and how they are evaluated.
The last time the CRA was updated was in 1999. Since then, banking has transformed, including the expansion of online banking and remote operations. The proposed new rules, released jointly by the Treasury Department, Federal Reserve System and Federal Deposit Insurance Corporation aim to, among other things, adapt to changes in the industry, provide greater clarity and consistency in the application of the regulations and create a consistent regulatory approach that applies to banks regulated by all three agencies.
The Purpose of the Community Reinvestment Act
The CRA’s purpose is to encourage banks to meet the credit needs of the local communities where they are chartered, including low- and moderate-income neighborhoods. The regulations around it establish the criteria used to assess each bank with different evaluation standards for banks of different asset sizes and types.
The CRA rating is important to banks. An adverse CRA rating can impede a bank’s ability to open new branches, close branches. Any new product initiatives or acquisitions would require regulatory approval – a difficult hurdle to overcome.
“A CRA exam is done every two to three years,” Brian Coffee, president of the Affordable Housing Investors Council, says. “So, if you get an adverse rating, for the next two or three years, you’re in a difficult position as a bank. That’s why so many banks are focused on meeting their CRA goals.”
Under the current CRA exam structure, there are three tests – one for lending, one for investment and one for service. The proposed rules eliminate the investment test and reduce the service test to be worth ten percent of the overall score.
Ch-Ch-Changes
For affordable housing developers, one of the most notable changes proposed is around community development in the CRA exam structure. The proposed rules combine all community development activities within a community development test with a separate test for retail activities. Currently, community development activities are then divided among those three activities.
“For example, [current rules] on the lending test, community development lending can get a little lost among the broader activities that include mortgage lending and small business lending and other things,” says Benson “Buzz” Roberts, president and chief operating officer of the National Association of Affordable Housing Lenders. “[The proposal] gives a sharper focus for community development and allows more flexibility to address local community development needs.”
These changes put more focus on the retail side of the bank, says Coffee. He works for a bank that is considered a regional bank, due to asset size, and these changes won’t affect his bank much, but it may be impactful for other banks.
In addition to the change in scoring, the proposed rules also provide more clarity in the application of the regulations, including about which community development activities will get considered. The proposal clarifies that all Low Income Housing Tax Credit financing will count in full, under CRA, Roberts says.
“That’s a big improvement,” Roberts says, “There’s [currently] a lack of clarity with respect to LIHTC deals.”
Roberts says that the agencies not only provided more clarity around LIHTC deals, but more flexibility as well.
On the flip side, the definitions for what qualifies for preservation funds are stricter in the proposed regulations, Coffee says. Essentially, preservation funds would be restricted on both rents and income levels of tenants.
Another purpose of the proposed rule is to adapt to changes in the banking industry. In that respect, another major area of improvement is in geography, Roberts says. Under current rules, banks generally get credit for community development activities in states where they have branches. Under the new proposal, banks would still have to address the community development needs near where they have branches, but they will also get credit for community development activities everywhere in the country.
“So that’s a major improvement,” Roberts says. “It will even out the CRA hotspots and the CRA deserts.”
Impact Factors
In the current affordable housing landscape, some markets have a lot of competition for deals, sometimes an almost excessive level, Roberts explains. In other parts of the country, where there may not be many large and sophisticated banks, it can be very hard to find financing. Even if a developer can find it, it might be at less advantageous prices and terms. The new proposal should go a long way to solving those problems, Roberts says. It should also make it much more administratively feasible to manage regional or national financing funds.
However, there is some concern that community development and equity investments, like LIHTC for example, could be disadvantaged because now there are ways for banks to satisfy community development through lending activities that may be easier to do or less burdensome for banks than investment activities, Roberts says.
“We would like there to be some recognition of the importance and responsiveness of equity investments,” Roberts says.
When a bank makes an equity investment, they have to hold more capital that offsets greater risk, Roberts says. Plus, equity investments are not what banks do in their normal course of business, and they have to utilize special authority to make those investments. That’s why National Association of Affordable Housing Lenders (NAAHL) believes equity investments, such as LIHTC, should get special consideration.
“One of the good things about this proposal overall is a very clear and well-defined desire to identify impact factors that really reflect the responsiveness of community development activities and particularly within local contexts,” Roberts says. “So, it makes sense for one of those factors to reflect the special responses and challenges of making equity investments.”
Overall Ratings
There’s also a larger structural question left outstanding for community development, Roberts says. Even under the proposed rules, unless a bank gets/has an outstanding performance record on the retail side, it really can’t get to an overall outstanding record by doing outstanding work in community development.
“If community development isn’t going to change a bank’s rating, then it’s not clear that banks will pay much attention to community development,” Roberts says. “They’ll have to pay some attention in order to achieve a satisfactory rating, but they may not have much motivation to do especially well in community development. And that’s a major concern.”
While items in the proposed rules around flexibility, geography and the clarity around low-income housing are great, they might not mean much if banks are not motivated to stretch to do community development activities, Roberts says.
“There is this concern that from the Affordable Housing Investors Council’s (AHIC) view, that we may have a number of members decide that investments are not quite as critical and diminish their overall investment activity,” Coffee says.
The proposed changes might diminish some investors’ appetite for LIHTC because its small overall percentage, or conversely some institutions may decide to really focus on just a few giant deals every year to meet the overall requirement, Coffee says.
“It’s hard to anticipate all the outcomes, because on the flip side, some small banks won’t be able to invest in what we call MBS [mortgage-backed securities] and get CRA consideration” Coffee says. “It’s stricter rules for MBS investing. They may decide to be more active in the LIHTC industry, but right now, it’s hard to anticipate all the shakeout.”
Roberts would like to see stronger motivation for banks to excel in community development. The CRA exam has a point structure, and the retail test counts for more than the community development test. Even if a bank has an outstanding score on community development, if it scores a satisfactory rating on retail, it cannot have an outstanding overall rating. About 80 percent of banks have a satisfactory overall rating.
“There’s a very wide range of satisfactory ratings, and it doesn’t matter whether you’re outstanding or satisfactory on community development,” Roberts says. “It’s not going to affect your overall rating, and you don’t have much motivation to be one of the top performers. You’re just motivated not to be one of the worst performers.”
Ideally, the grading structure would change so that doing very well in community development would make a difference in the bank’s overall rating, Roberts says. NAAHL will be urging the agencies to reconsider that.
On the other hand, most banks can’t invest in stocks, can’t typically make equity investments nor purchase many tax advantage products, Coffee says.
“The banks have incentive to stay in LIHTC both from a tax perspective, frankly from the community perspective, and then from CRA,” Coffee says. “I know for our bank, I don’t think we’ll have any change in strategy, but for some others, you might see a big change.”
Joint Ruling Takeaways
While the CRA reforms are trying to address how American banking operates today – more internet banking, more operations that are done remotely, the other takeaway is they’re really encouraging banks to engage in more retail, as well as small business lending now than maybe they have in the past, Coffee says.
“Overall, I think it’s great that the three agencies have come together to issue a joint rule,” Roberts says. “I think this proposal reflects a tremendous amount of work, thought and collaboration on part of the agencies that’s very encouraging. I also think they’ve got a lot of things right, or moving in the right direction, addressing concerns with the current rules. So, in all those regards, I think it’s very encouraging, but we do have this structural concern about community development, and I’m sure there are many areas where we are going to recommend some refinements.”
Comments on the proposed rules are due on or before August 5.
