Vol. 1, No. 47
Goodwin, Procter & Hoar LLP, a firm of over 350 lawyers, has one of the largest financial services practices in the United States. We have created the Financial Services Alert as a service to advise our clients and other financial services institutions to news of importance to the industry in a timely manner. Some issues of the Alert will principally summarize significant recent developments in financial services law and regulation. Other issues, such as this one, will provide more indepth analysis about specific areas of financial services law. We hope that you will find the Financial Services Alert to be helpful. We welcome your suggestions for future topics of interest.
The Increasing Role of CRA Compliance in Bank Deals
In recent years, both regulators and community activists have placed greater emphasis on Community Reinvestment Act ("CRA") performance in applications for mergers, acquisitions, branch openings and other transactions. The federal banking agencies have repeatedly emphasized that CRA performance is an important, and often decisive factor in the consideration of the convenience and needs of an application under, for example, the Bank Holding Company Act, and that CRA examination reports will be given great weight in the applications process.
Pending applications by major bank holding companies, such as the proposed Citicorp-Travelers merger which has engendered local opposition, illustrate the trend of increasing activist pressure under CRA. To minimize the possibility of delays caused by CRA protests or concerns in connection with an application, every institution covered by the CRA should be proactive in assuring that its CRA record is defensible. While the CRA law itself has remained essentially unchanged since its enactment in 1977, the interagency regulations implementing the act underwent a significant change in 1995 (with the changes fully effective as of July 1, 1997). The new regulations set forth four standards under which an institution's CRA performance may be measured, depending upon the institution's size and activities. Retail banks are measured under the lending, investment and service tests for large retail institutions (generally, those with $250 million or more in assets) or the streamlined evaluation procedure for small retail institutions, which generally measures the institution's lending performance. The remaining two standards are discussed below.
Institutions are finding that meeting the credit, investment and service needs of their communities in traditional ways and complying with CRA can pose challenges for several reasons. There may be intense competition among financial institutions for limited opportunities to make loans and investments that will qualify for favorable CRA treatment. An institution's assessment area may not include low and moderate income geographies, thereby limiting those opportunities even further. An institution's business strategy or charter may also limit its ability to make loans and investments directly. Even institutions with good lending records may have difficulty in finding qualified investment opportunities. These banks and other financial institutions are looking for alternative loans, services and investments that will address the needs of the communities they serve consistent with their business goals and opportunities.
The purpose of this article is to provide guidance as to the types of activities and investments that we have advised clients federal banking regulators have indicated may help an institution obtain a favorable CRA rating.
Programs Approved for Favorable Consideration under CRA
The four federal banking regulators have approved a number of types of loans and investments for favorable CRA consideration. The interagency regulations even require examiners to take into account the innovativeness of a bank's CRA programs and investments. Thus, an institution may have a great deal of flexibility in tailoring its CRA program to correspond with its overall business strategy.
The ability to structure a successful CRA program even in the face of these competitive and other pressures can be enhanced by providing community development loans, qualified investments and community development services, each of which must have as its primary purpose "community development." "Community development" is defined as: (a) affordable housing (including multifamily rental housing) for low- or moderate-income individuals; (b) community services targeted to low- or moderate-income individuals; (c) activities that promote economic development by financing businesses or farms that meet small business investment company (SBIC) size eligibility standards or have gross annual revenues of $1 million or less; or (d) activities that revitalize or stabilize low- or moderate-income geographies. Community development lending programs and qualified investment programs need to be established and operated carefully to meet the technical requirements of the CRA regulations; a thorough discussion of those technical requirements is, however, beyond the scope of this article.
Some activities may obtain favorable CRA consideration under either the community development lending or qualified investment test, depending upon the exact structure of an institution's participation. In one instance, the regulators approved for favorable CRA consideration under either the lending or the investment test bank investments (to the extent otherwise legally permissible) in the preferred stock of an UPREIT engaged in development of storefront retail properties and shopping centers in low- and moderate-income neighborhoods. The developments provided residents of underserved neighborhoods with access to a variety of needed goods and services by bringing in hundreds of new businesses, which in turn created meaningful employment opportunities and helped reduce crime rates, increase real estate and sales tax revenues, attract new residents and generally improve the quality of life in the areas served. Other examples of programs that can assist a bank in obtaining credit under either the community development lending or the investment test include: the purchase of "equity equivalent" instruments offered by a non-profit community development lender for lending or investment credit; the purchase of promissory notes that fund guarantees of loans to microenterprise lenders; the purchase of debentures in a SBIC; and the purchase of obligations from a special purpose vehicle which holds pools of whole loans consisting primarily of affordable housing mortgages. Another option is to buy loans from a financial institution not covered by the CRA, such as a mortgage banker, that originates and sells both whole loans and mortgage backed securities based in part on the loans' value for meeting CRA requirements. The purchasing bank has the ability to obtain loans or investments in specified communities.
On the pure investment side, the regulators have granted favorable CRA consideration to projects as diverse as securities backed by mortgages made to individuals with low- or moderate-incomes in the low- to moderate-income census tracts within an institution's assessment area, on the one hand, and a grant to a project that would help place low- and moderate-income individuals into affordable rental properties, on the other. Other qualified investments include investments in community development banks and community development corporations, as well as grants to non-profit educational foundations or to clinics providing free health care for low-income patients.
Alternatives
Two alternatives are open to institutions unable to meet the standard retail tests. One alternative to consider is a strategic plan, which is available to all institutions. A strategic plan is a contract agreed to by a bank and its primary federal (and, in some cases, state) regulator specifying what the institution must do in order to obtain a satisfactory or even an outstanding CRA rating. The institution must obtain informal and formal public participation in the drafting of the plan, and the final plan must be approved by the institution's banking regulators. The strategic plan is an appealing alternative for institutions that do not fit the traditional bank mold. Even institutions that operate along traditional lines may appreciate the certainty that a strategic plan may introduce into its CRA program. While historically obtaining approval of a strategic plan has been a cumbersome and time-consuming process, the FDIC has recently issued a series of documents to assist institutions in preparing strategic plans, and has also made a commitment to respond quickly to proposed plan submissions.
Another area an institution may wish to explore is whether it could qualify for the alternative community development standard by being designated a wholesale or limited-purpose institution by its primary federal banking regulator. For such institutions, the retail lending, investment or service is replaced by an evaluation of the institution's community development lending, qualified investments or community development services. A limited-purpose institution is one that offers only a narrow product line, such as credit cards or car loans; a wholesale institution does not extend loans to retail customers. Obviously, these are very narrow designations, and do not absolve an institution from its CRA responsibility; however, obtaining a limited-purpose or wholesale designation may enable a bank to meet its CRA obligations in a matter that conforms more closely to its actual method of business.
Conclusion
As discussed above, CRA compliance should be an important focus for any institution that expects to be involved in any type of transactional application. Establishing and maintaining an effective CRA program can require substantial initial and ongoing effort. However, given the increasing importance of CRA to transactions, proactively undertaking the significant effort that a successful CRA program required to minimize CRA concerns is often well worth the price.
If you would like anyone else to receive issues of the Financial Services Alert, would like to receive any past issues, or would like the background materials for any of the matters discussed above, or please contact Greg Lyons.
The contents of this publication are intended for informational purposes only and should not be construed as legal advice or legal opinion, which can be rendered properly only when related to specific facts. This document may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts. (c)GPH LLP 1998
