Proposed CRA Regulations Greeted with Great Concern: Aggregate Balance Sheet Ratio Could Overwhelm Other Changes

Proposed Community Reinvestment Act (CRA) regulations released Dec. 12 were greeted with great concern by many affordable housing and community development advocates, as they fear many proposed changes will have adverse effects that will greatly overwhelm the positive revisions.

The proposed regulations were released by two of the three agencies that oversee CRA regulation: the Office of the Comptroller of the Currency (OCC) and Federal Deposit Investment Corporation (FDIC). The third agency, the Federal Reserve (Fed), was notably absent.

More particular to the areas this journal covers, the proposal could have a seismic effect on bank investment in low-income housing tax credits (LIHTC), new markets tax credits (NMTC), historic tax credits (HTC), and opportunity zones (OZ), as well as renewable energy tax credits (RETCs). An estimated 85 percent of annual LIHTC investment is made by CRA-motivated banks, as is nearly 100 percent of NMTC investment. The HTC, OZ and RETC incentives likewise benefit under current CRA regulations, as many of these investments are entitled to CRA credit.

Basics of the Proposal

The CRA was enacted in 1977 to ensure that banks address the needs of all communities they serve, particularly low- and moderate-income (LMI) neighborhoods. The OCC oversees banks and thrifts that conduct about 70 percent of CRA activities and the FDIC oversees another 15 percent, so the two agencies involved in the proposed regulations have a large footprint.

The notice of proposed rulemaking is a 239-page document covering a plethora of issues and proposes some sweeping changes, including what activities qualify for CRA credit, how to measure qualifying CRA activity, and the eligible locations of qualifying activity.

The regulations are extensive and for more detail, see our related blog post.

Modest Good News

The proposed CRA regulations include some elements desired by community development advocates–proposals that would seemingly help stabilize and even increase investment in areas where it’s needed.

The proposal expands assessment areas for banks, providing additional areas for financial institutions that receive at least half of their deposits outside their physical branch footprint (specifically, it would add as an assessment area any area in which the bank received at least 5 percent of its deposits).

The proposal also encourages longer-term investments and loans, as the proposed regulations would continuously measure investments and loans held on bank balance sheets, rather than focusing on activity initiated during a large bank’s three-year exam cycle.

The proposal provides double credit for affordable housing equity investment and lending.

The proposal includes long-requested clarity on what activities qualify for CRA credit, giving specific illustrative but not exhaustive examples and requiring the oversight agencies to publish ongoing updates of CRA qualifying activities.

The expansion of assessment areas, emphasis on long-term lending and investments, double credit for affordable housing equity and lending, and inclusion of examples of qualifying activities all meet the desires of those involved in affordable housing and community development.

However, other proposed changes would result in a substantial shift and could easily overwhelm the effect of these positive proposed revisions.

Aggregate Approach

Overshadowing the beneficial proposed changes are a series of revisions that could have a negative impact on the quantity and quality of community development lending and investment. Most notable is the change to an aggregate quantitative balance sheet ratio to measure compliance.

Historically, CRA compliance was implemented through three distinct “tests” that measured large banks’ CRA activities in assessment areas: lending, which counted for 50 percent of the overall CRA examination; services, which counted for 25 percent; and investment, which counted for 25 percent. To receive a strong CRA score, financial institutions needed solid performance in each of the three separate areas.

The new proposal instead calls for an aggregate balance sheet ratio, measuring the number and dollar volume of all CRA-qualifying activity and comparing that figure to the bank’s deposits. That ratio would be calculated for the bank’s entire branch footprint and each assessment area.

While it’s simpler, there’s a potential problem: the new approach could allow banks to meet their CRA standards by focusing on one type of activity, say lending. Banks would no longer be measured separately under the lending, services, and, most notably, investment test.

This provision could present a major blow to equity investment in LIHTCs, NMTCs, HTCs, OZs and RETCs. Bank equity investments generally carry higher internal capital charges than lending activities, which makes investing activities comparatively much less desirable.

The original OCC advanced notice of proposed rulemaking, released in August 2018, floated the idea of a simple mathematical ratio to determine CRA compliance. That proposal created pushback from tax credit and community development advocates for a variety of reasons–but the proposed final regulations still contain a version of it, despite the substantial majority of the 1,500 plus comment letters expressing opposition to it.

Other Concerns

There are other reasons for concern in the proposed regulations.

The regulations expand the list of qualifying activities to include “essential infrastructure.” That could open the door to major infrastructure lending by banks–lending, for instance, in water, wastewater and electrical grid–to count for full CRA credit regardless of the nexus to LMI households, since by definition they will benefit some LMI communities.

Another concern is determining what percentage of deposits is an acceptable level of qualifying CRA activities. The proposed regulations adopt an 11 percent threshold to achieve an “outstanding” review, but the preamble points out that that number is the “initial benchmark”. While banks would be required to meet a separate community development minimum of 2 percent, that minimum could be met entirely through lending. The OCC and FDIC expect to adjust the benchmarks every three years, or sooner if warranted.

The expected periodic adjustment of the benchmarks upward or downward creates notable uncertainty.  Uncertainty further increased by the fact that the Comptroller of the Currency, who leads the OCC, serves at the pleasure of the president, which means the standard could change depending future election results.

With the proposed aggregate balance sheet ratio and a requirement for banks to collect and publish additional data, it was not immediately clear how–or to what extent–banks would change their approach to qualify for CRA credit under the proposed regulations. For many, there is concern that the proposed changes would lessen bank demand for equity investments, leading to a decline in equity pricing for various tax credits, similar to the drop that occurred for LIHTCs after Donald Trump was elected president in late 2016.

However, there is a significant difference.

In 2016, it was widely (and correctly) presumed that a long-term corporate tax rate decrease was coming, so banks reacted accordingly. In this case, even if the proposed CRA regulations are adopted, it will take months for a final rule to be issued and, under the current version of the proposed rule, banks would not begin to be measured under the new regime for at least two years. The wait would be particularly long for banks whose three-year CRA evaluation period under the current CRA examination approach begins during this two-year period. Those banks would not be subject to the proposed changes until that exam cycle ended. That’s a significant wait. During the wait for a bank to be evaluated under the proposed changes, much consideration will be given to the durability of any regulatory changes, particularly if election results in November change control of Congress or the presidency. November 2020 election results could bring further regulatory or statutory changes.

Legal, Regulatory Concerns

There also are some legal concerns.

The Administrative Procedure Act governs how federal agencies develop and issue regulations. In this case, some question whether the proposed regulatory changes properly implement the statutory CRA requirement to “assess the [bank’s] record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods ...” There are questions whether a court might rule that the proposed changes do not adequately determine the credit needs of low- and moderate-income neighborhoods, for purposes of assessing a bank’s record of meeting such needs.

Rise of the Federal Reserve?

The role of the third member of the CRA-regulating trinity also comes into play. What regulations (if any) might the Fed propose and when? Will the Fed’s decision play a significant role in how the OCC and FDIC view finalizing their proposed CRA regulations? At present, the OCC, FDIC and Fed measure CRA compliance under common rules. Now there’s a real potential for a break.

What Now?

With the 60-day clock for comment on the proposed regulations under way, community development advocates must make their voices heard. The advance notice of proposed rulemaking by the OCC resulted in more than 1,500 comments and helped shape this set of proposals. Now is the time for those in community development to again make their voices heard–particularly concerning the issues that have the potential to create a seismic change in investing.

The proposed CRA regulations include some modest good news, but the overarching idea of an aggregate balance sheet ratio greatly overshadows them.