More than two decades after the last major update–and following months of waiting–two of the three agencies that determine whether financial institutions meet Community Reinvestment Act (CRA) requirements issued proposed guidance Dec 12.

Investment in affordable housing and community development–and to a lesser extent, historic preservation and renewable energy–plays a role in whether financial institutions meet their CRA requirements. The proposed guidance–the first major rewrite of how to measure CRA compliance since 1995–has a potentially massive impact.

Background

When the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Investment Corporation (FDIC) released the notice of proposed rulemaking, affordable housing, community development, historic preservation and renewable energy stakeholders took notice.

The OCC and FDIC are crucial to the CRA–an estimated 70 percent of CRA activities are conducted by banks and thrifts that are overseen by the OCC and another 15 percent of CRA-motivated institutions are overseen by the FDIC. The Federal Reserve (Fed), which did not join the Dec. 12 notice of proposed rulemaking, oversees the other 15 percent.

CRA was enacted as part of the Housing and Community Development Act of 1977 and as a reaction to the practice of redlining, where banks avoided making loans to low-income neighborhoods. The legislation required that the three agencies insure that financial institutions sufficiently address the banking needs of all the communities they serve–particularly low- and moderate-income (LMI) communities.

The last major update to CRA regulations was in 1995. In the ensuing 25 years, there were major changes not only in other major financial laws and regulations, but also how banks operate and in the technology they use. Online banking wasn’t plentiful in 1995. Among incentives, the low-income housing tax credit (LIHTC) was still in in its infancy in 1995 and the new markets tax credit (NMTC) didn’t exist. Other incentives, such as opportunity zones, similarly were years from being enacted.

In addition to cultural changes, there were practical reasons for an update. There is concern that a lack of clarity for what qualifies for CRA credit limits investment in underserved areas.

How We Got Here

After years of discussion, Treasury released a memo in April 2018 that directed bank regulators to take action on CRA regulations. The OCC issued an advanced notice of proposed rulemaking in August 2018, one that received tremendous reaction. The OCC received more than 1,500 comments and according to Joseph Otting, the Comptroller of the Currency and head of the OCC, 94 percent of comments stated that the CRA framework lacked objectivity, transparency and fairness. Otting also said that 98 percent of the comments said the CRA is applied inconsistently and 88 percent of comments concluded that the CRA was hard to understand.

The 2018 notice floated the idea of a simple mathematical ratio to determine CRA compliance, a proposal that created pushback from those in the tax credit community and many other community development advocates because of a fear that it could result in CRA activity in high-cost areas counting far more than low-cost areas. Furthermore, a simple ratio does not differentiate between high impact equity investing as opposed to volume purchases of seasoned loans. That could ultimately reduce investment in affordable housing and community development.

The OCC held meetings around the country, reviewed comments and worked with the FDIC on the next proposal. On Dec. 12, 2019, at the conclusion of a FDIC board meeting, the proposed regulations were released.

CRA and Tax Incentives

While the legislation that created the CRA doesn’t mention any tax incentives, the LIHTC, NMTC and HTC all benefit from their ties to CRA credit.

An estimated 85 percent of LIHTC investment is made by CRA-motivated banks, as is nearly 100 percent of NMTC investment, since census tracts that qualify for NMTCs are LMI neighborhoods and the NMTC provides below-market financing. The HTC has no statutory requirement to be invested in LMI areas, but the National Park Service’s most recent report on the economic impact of the federal HTC indicated that 51 percent of 2018 transactions were LMI census tracts and 75 percent were in economically distressed areas, which also make such investments potentially eligible for CRA credit.

The opportunity zones (OZ) incentive also primarily features low-income neighborhoods and low-income individuals, meaning that much OZ investment potentially qualifies for CRA credit. See further details in the December 2019 edition of the Journal of Tax Credits.

When considering how CRA regulatory change affects community development incentive investment, it’s important to remember that the OCC regulates about 20 percent of the nation’s banks, but those banks have more total assets than those regulated by the FDIC or Fed–and OCC banks make a majority of investments in various tax credit programs.

Proposed Regulations

The notice of proposed rulemaking included some sweeping changes, including what qualifies for CRA credit, where that activity counts for a bank, how to measure CRA activity and how banks track data.

(An important detail: The proposed regulations say that lenders with less than $500 million in assets could opt out of the updated guidance and remain under the previous CRA regulations, a group that makes up about 25 percent of the banks overseen by the FDIC. Few if any of those lenders are tax credit investors.)

Some highlights of the proposed regulations follow.

Qualifying Activities: The proposed regulations would clarify what activities qualify for CRA credit. Many of the qualifying activities echo what has historically been encouraged by the CRA (including specific tax incentive activities mentioned later in this column) but there are some new twists, including expanding credit to distressed or underserved communities or “Indian country.”

A significant update is that the proposal would require regulatory agencies to regularly publish a list of examples of qualifying activities, providing a process for stakeholders to determine whether their activities count. The list would be “illustrative,” rather than exhaustive.

Assessment Areas: Under the current regulations, the location of brick-and-mortar banks–including headquarters, branches and facilities where deposits can be made–establish CRA assessment areas, a determination that predates online banking.

The proposed regulations keep that foundation, but expand the focus. Banks that receive half or more of their deposits from outside their current assessment areas would be required to make any area that contributes at least 5 percent of deposits a new assessment area. OCC officials stressed that few banks would see their assessment areas significantly altered by the changes, with Otting saying “at most, about 10 to 15 banks” would be required to step up CRA activity due to this change.

Measurement: This is a major area of change. The current CRA regulations evaluate banks in different ways, based on their level of assets. The new regulations would create a performance standard for all banks that have assets of more than $500 million.

The proposed regulations would compare the bank’s CRA-qualifying activity with its retail deposits in each assessment area, as well as with the overall bank level for retail deposits, giving both localized and general measurements.

One significant change that could affect tax incentives is that banks would be evaluated on both the number of CRA-eligible loans and investments and the total amount of loans and investments to communities. There has been concern that emphasizing the dollar amount could result in deemphasizing LIHTC and NMTC equity investment as compared to lending, because it is much easier for banks to make loans, especially in high-cost areas, than it is to underwrite equity investments.

Banks would be allowed to see published versions of the equations used for CRA measurement under the proposal and CRA investment would be calculated on an ongoing basis, using an average. Under the current regulations, CRA investments initiated outside the three year examination period don’t receive as much consideration for CRA credit as those inside the period.

Data Collection: Under the proposed regulations, banks would be required to collect and report data on loans, with small banks not required to report them. Banks would also be required to collect and report data on their qualifying activities and some on non-qualifying activities.

Reaction

Apropos for a proposal that received more than 1,500 comment letters on the advance notice of proposed rulemaking, there was vociferous reaction to the proposal.

Several civil rights organizations joined to condemn the proposed changes, saying the OCC and FDIC ignored their requests and “invites a return to discrimination against communities of color and low- and moderate-income neighborhoods.” Others welcomed the proposals, citing the clarity. Still more waited for further evaluation of the proposal, which comprised 239 pages on its release.

Sen. Sherrod Brown, D-Ohio, the ranking member of the Senate Banking, Housing and Urban Affairs Committee criticized the proposal, saying the “proposal undermines a basic principle we agreed to in this country nearly 50 years ago–that banks should serve their customers and their communities. In 2019, it is shameful that Trump regulators are ready to cast aside that principle and trample on a fundamental civil rights law, the Community Reinvestment Act, by pushing aside those who most need access to the banking system, including communities of color and rural communities.”

Rep. Maxine Waters, D-Calif., chairwoman of the House Committee on Financial Services, similarly criticized the proposal and was the lead signatory on a letter calling for the comment period to be extended to 120 days.

Others supported the proposal. For instance, Sen. Mike Crapo, R-Idaho, the Senate Banking Committee chairman, said the proposed rules would encourage more investment, lending and services where they are most needed.

Good or Bad?

The potential to use an equation to measure CRA compliance–the aggregate balance sheet ratio–caused the most concern among stakeholders in various tax incentives.

The ratio would take into account the dollar volume and number of investments under the CRA, including a proposal to give double weight to certain activities that include affordable housing and community development investments. The proposed regulations say that double weighting would be used “to provide an incentive for banks to engage in these activities,” but a reasonable question is whether doubling the effect of affordable housing or community development investments would be enough of an incentive to sustain LIHTC and NMTC equity investment at current volumes.

The list of qualifying activities in the proposed regulations included examples in affordable housing, community development, historic preservation and renewable energy. The expectation is that most investors in those incentives will continue to do so. The devil, as always, is in the details.

There’s a 60-day comment period and the shape of the proposed regulations compared to the ANPR released in 2018 show that the opinions of stakeholders matter.

For more analysis on the proposed rule, please see the January 2020 edition of the Journal of Tax Credits.