CRA: Finally Out

The three banking agencies, OCC, FDIC and the FRB, have issued final revisions to the CRA regulation. The changes take effect on September 1, 2005. This short effective date is selected because for the most part the changes provide regulatory relief.

The issues in this rule change may not seem extensive, but there are some interesting and subtle twists to them. These changes and possible interpretations of them take us back to the basic goals of CRA.

These changes reflect both public comments and discussions such as at the Consumer Advisory Council meeting in June 2005. At the core of these rule changes are two goals. One is to reduce regulatory burden. This is largely accomplished by creating a mid-size bank category that is not subject to data collection and reporting but is subject to a simplified version of the large bank tests. The other goal is to adapt CRA to rural as well as urban credit and investment needs. In this respect, the CAC discussed several issues in detail, bringing urban and non-urban consumer and industry views to the table. The final rule reflects much of the content of these discussions.

Three Sizes
It is now official. There are small banks, large banks, and intermediate small banks. The size measurement for small banks remains unchanged. The new intermediate small bank category includes banks having at least $250 million but less than $1 billion in assets. The dates of measurement, December 31 for the two prior calendar years, remain unchanged.

Small bank tests and large bank tests remain unchanged. The new intermediate small bank will undergo a small bank test with added features of the large bank test. As a practical matter, the regulation now provides a transition period as institutions grow. By the time the institution grows to an asset level of $1 billion, they are expected to perform at the large bank level.Data reports remain unchanged for large banks. However, intermediate small banks are not required to collect and report CRA data. This exemption spares the expense of preparing and submitting reports, however these institutions will still be responsible for knowing and demonstrating where and to whom their loans are made.

Economic Development
Concerns about the nature of community development investments were expressed at the FRB's Consumer Advisory Council meeting in June. The CAC members shared consensus in the concern for recognition of projects that support economic development even though projects with a positive economic development impact might not clearly meet the CRA community development definition. Both industry and consumer representatives argued that economic development benefits low- and moderate-income persons and areas even if it is not specifically and measurably targeted to low- and moderate-income locations or populations. Members stated that it is important to recognize poverty in higher-income areas and that it is important to build infrastructure needed for development. Infrastructure projects should not be eliminated by the 51% test that examiners apply.

Perhaps the most interesting aspect of the CAC meeting was the consensus that is emerging with respect to CRA. The interests of consumers, financial institutions, and local jurisdictions are better served when the emphasis is not limited to low-income in an artificial way. Everyone benefits when the attention is directed to economic development and growth.

A significant change in the revised rule is the treatment of community investment. For the first time, investments can be measured not only by the number of low- or moderate-income people or locations they can be tied to, but also by the impact of the investment on the area's economy. Institutions must still make the connection to improving the income of or opportunities for low- and moderate-income but may make more flexible connections than under the existing rule. Examiners will also look not only at location, but at the number of low- and moderate-income persons that benefit from the project. For housing projects, location becomes significantly more flexible as long as the affordable element is present and quantifiable.

Rural v. Urban
Another problem with qualifying community development loans or investments in non-urban areas is the lack of economic segregation and the related problem of identifying economic need. One solution posed was to designate or recognize areas that are "primarily low- and moderate-income," although no formulas or ratios were put forward. Another idea was to recognize a project that is for the entire community including low- and moderate-income.

Many financial institutions have lost recognition of investments or loans that promoted community development because there were not enough low- and moderate-income beneficiaries. Or projects were rejected because the low- and moderate-income persons benefitting from the project could not be identified to the examiner's satisfaction.

The revised rule provides for ways to recognize non-urban community investment needs that are not easily measured by urban techniques. The community development test for intermediate small banks is adopted as proposed, grouping together the community development lending, investment and service concepts. This gives intermediate banks flexibility in how they meet this test. One significant change in this approach is that general services to the community will no longer be measured for intermediate banks. Instead, services will be looked at in the context of community development. To carry weight, intermediate banks will need to demonstrate the connection between services and low- and moderate-income and community development needs.

The regulation actually uses the term "non-metropolitan" rather than rural. This encompasses areas that are outside of metropolitan areas but may or may not be considered rural. To qualify, a non-metropolitan area must also be distressed or under served. Low-income and moderate-income tracts continue to qualify as before, but the rule now adds the distressed and under served areas without limiting those by income levels.

Income Debates
Over the years, a number of methods to calculate median family income have been applied, ranging from the SMSA numbers to county, regional and even statewide income figures. The math and the effect on who is included or excluded is interesting.

If the statewide median is used, the result may be to include more people in non-urban areas. However, the impact will be different on states such as Wyoming, which does not have a high-cost major metropolitan area, and Illinois where the statewide average would be affected by the Chicago income numbers. In states like Wyoming or North Dakota, the statewide income figures would be lower than in a state such as Illinois or Florida where high-cost metropolitan areas would result in a higher median family income. The result would be that rural counties in Florida or Illinois, with the same county income averages as those for counties in Wyoming or North Dakota would have a higher median family income and therefore more qualified borrowers and locations for CRA community development lending and investments.

One of the median income calculation questions is whether the same formula should be used for all states or whether there should be different formulas for states that have and do not have major high-cost metropolitan areas. If different formulas are applied, how should these formulas be developed and allocated? Alternatively, should income numbers be limited to counties?

The final rule deals with this question by providing a list of qualified areas. Locations can be placed on the list using a variety of needs measurements. The agencies will post a list of eligible rural tracts that are distressed or under served. The list will be maintained on the FFIEC website.

Criteria for the list will include an unemployment rate of at least 1.5 times the national average, a poverty rate of 20% or more or a net migration loss of 5% or more. An area may also be designated on the basis of low and dispersed population on the presumption that there is difficulty accessing services and essential community needs.

Consumer Protection
The revised rule incorporates the proposed rules treatment of violations of consumer protection laws. Any such violations will be reflected in the institution's overall CRA rating. The presumption behind this position is that violations of laws that protect consumers are inherently inconsistent with the CRA goals of meeting community credit needs. This should increase the motivation to comply with laws such as Equal Credit Opportunity and Truth in Lending.

ACTION STEPS

No matter what the size of your institution, study these changes. Even if your institution is not directly affected by the changes, evolving interpretations and examination practices will affect you.
Take a hard look at your market. Determine which parts are urban and which are rural. Then look at your CRA loans, services and investments to see whether your program adequately recognizes and provides services to community credit needs.
Review your investment portfolio. Seek diversity in the portfolio to match the urban and non-urban needs of your market.
Never underestimate the service test and the need for customer education. Look for ways to provide customers with valuable information ranging from managing a household budget to preventing identity theft.