Brief Comments Regarding the Proposed CRA Revision by the OCC and FDIC
The FDIC and OCC yesterday released a 239 page proposal for public comment to review the Community Reinvestment Act responsibilities of insured banks under the 1977 CRA Act. The proposal is motivated in large part to modernize the CRA rules in light of technological changes in bank delivery of products in the Internet age, a laudable goal. The proposal is also intended to improve the predictability and consistency of the CRA exam process and generate more lending and investment activity in communities of need.
The proposal is subject to a 60 day comment period.
However, given the complexity of the proposal and the significance of the subject matter area as well as taking into consideration the practical point that there will be a marked slowdown in year end business activity, the proposal ought to be given a 120 day comment period, at a minimum.
The proposal is quite complicated in many respects and it is not clear that it is entirely a simplification in terms of examination processes or regulatory interpretation. In other respects, the proposal is very straightforward and is transparent and likely represents an improvement over the present amalgamation of the statute including as amended multiple times since 1977, the regulatory provisions implemented during the last major regulatory framework in 1995 and the various interagency questions and answers over a generation. Indeed, based upon my read of the proposal, it seems to me that there are significant parts of the proposal that look to incorporate concepts/doctrines from the interagency Q&As into the formal agency regulation.
There are other efforts to capture information potentially only known to the agencies and examiners but not well known to industry or consumer groups because rulings/decisions were made in the context of an individual institution's CRA exam. The proposal tackles that now by putting a permissibility list for CRA in place initially and with the expectation to expand the regulatory list over time and have it reviewed every three years as part of a notice and comment rulemaking. The mantra seems to be let's not leave anything to chance and let's not rely on agency judgment or discretion to make decisions about what counts for CRA. If any entity, regardless of any unique facts and circumstances, gets credit for a CRA related loan or investment, then the current CRA proposal wants that activity/investment on the approved activity regulatory list and presumed to be permissible in any future exam. It is not really clear that will prove to be workable, but the comment period is open to make points on that approach.
The proposal also does not simplify the range of exams to be applied depending on the type of bank involved. Specifically, small banks under $500 million in assets are not required to use or comply with the new rules and instead they can continue to operate under the status quo rules applicable to small banks. That immediately at least doubles the amount of "law" that will need to be kept current by the agencies and adds considerably to the need for additional industry compliance talent and resources. Additionally, a small bank of less than $500 million can opt in to comply with the new rules and not continue with the status quo rules. Again, a need for compliance expertise will follow any such decision.
In addition to the small banks with two potential options, the strategic plan option which is available under current rules and is a specialized CRA exam evaluation process pursued on a customized basis by a bank remains an option under the new proposal. That is a good thing.
Also, beyond those three options, there is a core part of the new proposal which will be applied to large banks provided that generally their assessment areas match up with their deposit sources. These banks will need to focus on the change in the rules directed towards meeting low and moderate income individuals credit needs through the new rules which expand the lending and investment tests using metrics intended to simplify and standardize the examination process. These are the major changes made by the proposal to focus on the number of loans/investments and the amount of same and measure against a related market and distribution metric for evaluating the bank's CRA performance. There also are other incentives under the new rules for banks to provide loans/investments for certain types of activities and receive "extra credit" within the assessment areas as well as further incentives to provide loans/investments to other parts of the country where there may be unmet community needs including in rural areas, Indian country and elsewhere.
Interestingly, in light of the technology changes regarding the acquisition of deposits online without dependence on branches or other physical locations, the proposal is intended to refresh CRA and its application to such new types of online and web only banks. I predict that there will be great disappointment in the fintech community with the proposed rule because the new branchless banks were likely expecting some type of tech solution, or at least some type of updated definition of market assessment which would capture their business model. Sorry, that is not happening under the proposal as presented by the FDIC and OCC.
Instead, the agencies did what regulatory agencies do best in such instances--they expanded the scope of the regulatory framework. Specifically, the jurisdiction of the CRA would extend potentially to include deposit assessment areas for banks that receive more than 50% of their deposits from areas where the bank is not headquartered or has a physical facility. Of such institutions, CRA requirements would be applied in deposit assessment areas where the bank received more than 5% of its retail deposit base. The agency shorthand for this is the 50/5 rule. So, the agencies merely added more assessment areas for CRA community reinvestment evaluation rather than trying to precisely identify and refine what the term community would mean to a nationwide, internet only bank.
So, that now means two other options are possible under the rule which amounts to five different types of CRA rule methodologies to be applied by the pertinent governing agency. To add a bit of additional complexity, there also are state level CRA type rules, for example, in Massachusetts which applies to banks, credit unions and mortgage lenders and does not track the federal law so that state law method adds further compliance complications in the handful of states with separate community investment requirements. There also are further complexities when taking into account bank and nonbank affiliates of a lead bank for a comprehensive CRA exam. Again, it spells out the need for more legal/regulatory compliance to manage a transition to a new regime.
One personal note of great disappointment, but again that is why comments can be made, is that the bank agencies continue to have a simplistic view of how actual investments and loan arrangements may be made and that it is simply one creditor or one investor making one loan or one investment to a single recipient. Of course, there are many commingled funds involved with federal tax credits and other lending funds where banks are one of multiple investors/lenders in a overall community deal.
Tax credits remain as permissible investments for CRA purposes under the proposal. Nonetheless, banks hate this part but partnership agreements under state law require proper documentation to be permissible and binding and that includes mechanisms for a partner to enter and exit the partnership investment fund/vehicle. That will also mean that a resigning partner's share has to be offered to other partners or to a new partner through a process already in place in the governing operating agreement for the partnership in order to avoid liquidation of the partnership.
Banks also hate the fact that the underlying investment in the fund should be "earmarked" or otherwise tracked through to correspond with the CRA assessment area of the investing bank. There can be pro rata investment/lending reflected in the documents but the total of all such pro rata amounts in a fund/partnership needs to add up to 100% and the total in any one assessment area has to correspond to the pro rata share assigned to it. So, if there is an investment worth 20% in the fund then the total CRA credit for that one earmarked assessment area investment cannot exceed 20%. As noted, this is further complicated when a partner leaves the investment position due to an exit from the fund as permitted or as a result of a corporate change such as a merger.
The good thing about the agency CRA proposal is that the use of pro rata shares generally to claim CRA credit seems to be validated under the proposal. So, the additional documentation validating partnership rights is a minor inconvenience to investors and would appear to solidify the standing to claim and obtain CRA credit. Of course, the new proposal might allow some additional credit in other assessment areas outside the traditional assessment area of the investing bank. Some of that is already included in the interagency Q&A guidance, but elevating the principles into the proposed regulation would further bolster those outcomes to make CRA investments permissible on a statewide or broad regional area or nationwide basis outside of the traditional assessment area if CRA needs are already being met there.
To sum up, there are some major policy battles ahead before this CRA proposed rule is finalized. First, when and how will the Fed get onboard with the proposal? Second, can the proposal credibly state that it will be a simpler and more transparent exam process once the transition period to the new requirements is made? Third, the metrics used by the agency proposal to benchmark overall CRA performance can go up or down depending on political dynamics and who is leading an agency and will that undercut the proposal? Fourth, is the proposal workable given the complexity around the number of bank types used and the range of investments/loans potentially to be measured including obtaining CRA credit for commitments? Fifth, as a matter of first principles, will the proposal help to combat redlining, the original purpose of the 1977 law? Sixth, will the proposal help to incentivize banks to make more community reinvestment throughout the country and not just pursue the most profitable type of community reinvestment? Seventh, will the fintech community ever be able to satisfy the CRA requirements as part of a plan to open up a new fintech charter? Eighth, will the proposal help to stem credit for re-gentrification efforts which probably should not have received CRA credit in the past? Ninth, is the proposal a step in the right direction to bring more transparency to CRA examination reviews? Tenth, and in deference to my conversations with former Comptroller Ludwig over the years on this point and his public comments on the same point, is the proposal fair to the underserved populations and do the benefits outweigh the burdens of implementing the proposal?
By Tim McTaggart. 202-412-6610. Former Delaware Bank Commissioner, Counsel to U.S. Senate Banking Committee, private law partner involved with SBIC, LIHTC and other investment funds and other federal/state CRA matters.