February 5, 2018
The Honorable Steven T. Mnuchin
Secretary of the Treasury
Department of the Treasury
1500 Pennsylvania Ave NW
Washington DC, 20220
Dear Secretary Mnuchin,
In February of 2017, President Trump issued an executive order mandating that federal agencies regulate the financial industry consistent with core principles including empowering consumers to make informed financial decisions and build wealth. In June, the Treasury Department responded to this executive order by publishing the first of a series of reports on the financial industry entitled, “A Financial System that Creates Opportunities – Banks and Credit Unions.” This report announced Treasury’s intention to review the Community Reinvestment Act (CRA) with the aim of issuing recommendations for improving its implementation.
The report states, “Treasury plans to review several aspects of the CRA framework, including assessing the need for: improvement in how banks’ CRA investments are measured to improve their benefit to communities; additional harmonization of CRA supervision given the oversight by multiple regulators; changes in the way CRA geographic assessment areas are defined because of the changing nature of technology and other factors; and improvement in the regulatory review and rating assessment process, which would consider the frequency of examinations, the ability of institutions to remediate ratings, and the transparency of how the overall CRA assessment rating is determined.”
Below, we address several of the concerns raised by Treasury through analysis and recommendations regarding assessment areas, enhancing regulatory review and ratings including bolstering efficiency and reducing delays, and improvements to CRA exam methodology. We share Treasury’s objectives that consumers should be empowered to make informed choices and build wealth. By requiring that responsible lending serve all communities, we believe that a revitalized CRA applied broadly and rigorously throughout the financial industry can help achieve the objectives of empowerment and wealth building.
Expansion of CRA to Non-Banks
The Treasury Department has been actively soliciting stakeholders’ views regarding the expansion of CRA to non-bank financial institutions. At the conference of the National Association of Affordable Housing Lenders (NAAHL) in November of 2017, Counselor to the Treasury Secretary Craig Phillips stated that it was “illogical” that CRA was not applied to credit unions. In this vein, we are pleased that the American Bankers Association (ABA) in their recent white paper has endorsed the application of CRA-like requirements to credit unions and financial technology companies (fintechs).
A strong case can be made that CRA must be expanded broadly throughout the financial industry. A broad CRA mandate would level the playing field and require that financial institutions serve all communities, and particularly low- and moderate-income communities, consistent with safety and soundness. Because CRA requires banks to lend responsibly, research has demonstrated that CRA-covered bank lending has considerably lower delinquency and default rates than non-CRA covered lending of independent mortgage companies. Applying CRA broadly throughout the financial industry would encourage institutions to compete by offering responsible and affordable loans with transparent terms and conditions instead of high cost and deceptive loans full of tricks and traps that proliferated in the run-up to the financial crisis. CRA would encourage all financial institutions to improve their performance. For example, NCRC conducted two reports comparing credit unions to banks and found that CRA-covered banks consistently made a higher percentage of loans to low- and moderate-income borrowers and communities than non-CRA covered credit unions.
Regardless of the makeup of Congress or current and future Administrations, the federal government will likely have a large role regulating the financial industry and ensuring its liquidity. During the crisis, non-banks including Bear Stearns and AIG received access to the Federal Reserve Discount Window and received hundreds of billions of dollars of federal loans and subsidies. During future recessions that are not as severe as the Great Recession, it is likely that non-banks as well as banks will continue to have access to the Discount Window and government support. In addition, independent mortgage companies issued approximately 70 percent of government-insured (FHA, VA) lending during 2016, the most recent year for which the Home Mortgage Disclosure Act (HMDA) data is available.Future reform of the Government Sponsored Enterprises will likewise preserve a significant role for government guaranteed mortgage lending. CRA as applied to banks was premised on a quid pro quo of serving all communities in exchange for FDIC deposit insurance. This quid pro quo of government support applies broadly throughout the financial industry.
Federal and state CRA laws and examination regimes provide guidance as to how to apply CRA broadly throughout the financial sector. For example, Massachusetts conducts CRA exams for mortgage companies and credit unions, which use commonsense measures of performance such as the percent of loans to low- and moderate-income borrowers. The federal CRA’s wholesale and limited purpose bank test could be applied to investment banks and scrutinize their level of community development investments such as Small Business Investment Corporations (SBICs) and Low Income Housing Tax Credit (LIHTC). In sum, applying CRA broadly throughout the financial industry is not only desirable, it is feasible.
Congress passed CRA as a means of requiring banks to serve the communities in which they are chartered to do business. When CRA was enacted in 1977, banks financed their loans from deposits made in branches. They made loans locally to the populations served by their branches. Today, the connection between lending, deposit-taking, and branches remains in many cases, but some banks have weakened it. Lending is also financed by secondary market institutions including Fannie Mae, Freddie Mac, and private sector investors. Therefore, banks are not as dependent on deposits as a source of financing and can make loans more easily in geographical areas where they do not have branches. Moreover, financial technology (fintech) companies that do not have branches and that make loans and gather deposits over the internet have applied recently for bank charters.
Currently, CRA exams consider lending in assessment areas that are typically geographical areas containing bank branches. CRA assessment area definitions will need to be updated for both traditional banks that make loans outside of branch networks and fintechs that become banks. Assessment areas need to capture lending where branches are located and lending outside of branch networks.
A recent NCRC report, The Community Reinvestment Act and Geography, maintains that the agencies can apply the existing CRA regulations, their interagency Question and Answer (Q&A) document on CRA, and precedents from CRA exams of non-traditional banks to designate areas outside of branch networks with high volumes of loans as assessment areas (the NCRC study highlights a few CRA exams that evaluated retail lending in areas outside of branch networks). In addition, NCRC has recently commented on the application of Square, a fintech, which is seeking a bank industrial loan charter (ILC). Our comment letter describes how assessment areas would be constructed that would capture substantial volumes of loans.
The NCRC study also concludes that when assessment areas include less than 50 percent of a bank’s loans, the lending test and overall ratings are higher. Higher ratings due only to a minority of loans being scrutinized defeats CRA purpose of holding banks accountable for making responsible loans to low- and moderate-income (LMI) borrowers and communities.
Another issue uncovered by NCRC’s study is the tendency of CRA examiners to designate large numbers of assessment areas as “limited scope” areas subject to only cursory reviews as opposed to the more comprehensive reviews of “full scope” areas. Limited scope areas are more likely to be rural areas as opposed to metropolitan areas. NCRC recommends expanding the number of assessment areas that are full scope and ensuring that rural areas and smaller metropolitan areas are also considered as full scope areas. Applying more full scope designation to rural areas, in particular, will result in banks making more retail loans, community development loans, and qualified investments in rural areas.
Intermediate Small Banks and Thresholds for CRA Exams
The CRA regulations establish different CRA exams of varying degrees of difficulty for banks with different asset levels. Small banks, those with less than $307 million in assets, have the most streamlined exam that consists of a lending test only. Intermediate small banks (ISB), those with assets of $307 million to $1.226 billion, have exams that consist of a lending test and a community development (CD) test. The CD test assesses the level of CD lending and investing for affordable housing, economic development, and community facilities. Large banks, those with assets above $1.226 billion, have the most complex exams consisting of a lending test, an investment test, and a service test. Proposals have been made over the years to qualify more banks as small banks. This would mean that more banks would qualify for the small bank exam that has only the lending test, and fewer would be considered ISB banks.
NCRC recently released a study, Intermediate Small Banks: The Forgotten but Significant Resource for Affordable Housing and Community Development, which documents the significant levels of community development financing of ISB banks and provides several case studies of innovative projects. Using CRA exams conducted in 2016, NCRC documents that ISB banks made $9.3 billion in community development financing over a three-year time period, an amount that rivals major Department of Housing and Urban Development programs like CDBG. The study estimates that if the ISB category was eliminated entirely, at least 50 percent of this CD financing would not occur. Moreover, ISB banks themselves have an interest in retaining the CD test since the study finds that they earn higher ratings on the CD test than the lending test. In other words, the CD test boosts ISB overall ratings. Eliminating or sharply reducing the ISB bank category would be counterproductive for communities and ISB banks.
Exam Delays and Fair Lending Compliance Reviews
NCRC’s study, CRA Exams and Geography, documents that for the 100 largest banks by asset size, 65 percent had CRA exams that occurred during the last three years. The CRA exam cycle is supposed to be a two to three-year time cycle. Therefore, the majority of large banks are being examined in a timely manner. However, the largest banks have the greatest likelihood of being examined in an untimely manner. The top five banks in asset size had exams that ranged from five to seven years old. Thus, while the agencies have made progress over the years in timely execution and release of CRA exams, they need to be more efficient and perhaps devote more staff resources for exams of the largest banks.
Fair lending reviews on CRA exams assess if banks have violated anti-discrimination and consumer protection laws. A bank can experience downgrades in CRA ratings if legal violations are widespread. In NCRC’s study, we found that four of the five largest banks experienced ratings downgrades. Of these four, three were downgraded from Outstanding to Satisfactory and one was downgraded from Outstanding to Needs to Improve.
NCRC’s study found that twelve of the top 100 banks experienced ratings downgrades. Eight of these banks went from Outstanding to Satisfactory ratings and four went from Outstanding or Satisfactory to Needs to Improve ratings. Twice as many banks still passed (Satisfactory ratings) than failed (Needs to Improve ratings) as a result of the downgrades. It would seem that CRA exams are not unduly harsh for fair lending violations, and may be too lenient, if they err in one direction. CRA examiners have discretion regarding the extent of a ratings downgrade due to legal violations. For complex compliance issues, discretion seems appropriate, particularly since the severity and frequency of legal violations will change over the years. Moreover, banks can appeal their CRA ratings if they feel that they have been unjustly judged.
Fair lending reviews are a critical component of CRA exams in that they help assure that banks are fulfilling their obligations under CRA to serve all communities. If banks are engaged in discrimination, they are not serving communities of color. Thus, fair lending reviews must be a rigorous part of the CRA exam. Coordination between the federal bank agencies and the CFPB must be improved and staff resources devoted to fair lending reviews must be augmented to ensure that the fair lending reviews are executed in a timely matter. When fair lending reviews involve complicated compliance issues, some delays might be unavoidable as full and careful investigations need sufficient time. In these instances, CRA exams can be released with a procedure that ratings can be retroactively adjusted, if necessary, based on the findings of the fair lending reviews. Retroactive downgrades should also be applied if non-federal agencies, such as state attorney generals, uncover evidence of widespread discrimination or other illegal activities.
Ideally, CRA and fair lending reviews should be conducted simultaneously. However, when this is not possible, a procedure of retroactive downgrades will be helpful in preventing several year delays in the release of CRA exams. When CRA exams are several years old, they cannot be used effectively in merger application proceedings since they do not reflect recent past performance. Also, CRA cannot effectively hold banks accountable for serving low- and moderate-income communities since banks are being examined infrequently.
Standardizing CRA Exam Methodology and Format
Inconsistencies in CRA exam methodology and performance measures contribute to CRA grade inflation and diminish the objectivity of CRA evaluations. While some flexibility in evaluations can be appropriate, exams that have significantly different approaches within and across agencies impair the ability of the public and even banks themselves to compare and contrast bank performance. For example, on the investment test, agencies use different measures to evaluate CRA-related investments relative to bank capacity. Office of the Comptroller of the Currency (OCC) exams tend to develop a ratio of investments to Tier One capital while the other agency exams tend to use a ratio of investments to assets. These different measures make it impossible to compare banks with similar sizes to each other in order to develop objective scoring on this criterion based on how the banks stack up against each other.
In addition, the investment test often does not sufficiently differentiate among investments with varying degrees of responsiveness to needs and innovation, which are regulatory criteria for judging the effectiveness of investments. For example, investments in equity vehicles highly responsive to local needs for job creation and small business development in areas of high unemployment should generally be judged higher than investments in mortgage-backed securities since a thriving market exists for investing in these securities. Yet, too often the investment test does not make these types of distinctions which would be then reflected in ratings. Better examiner training can help improve the quality of these type of examiner judgments.
The lending and service tests also suffer due to inconsistent measures of performance. On the lending test, the OCC uses market share measures (the percent of total low- and moderate-income (LMI) market captured by the bank compared to the percent of overall market captured by the bank) while the other agencies use portfolio share measures (the percent of a bank’s loans to LMI borrowers compared to all banks’ percent of loans to these borrowers). Both market share and portfolio share measures are reasonable performance measures but comparing banks against each other become difficult if they are examined by different agencies. One solution in this case is for the lending test to consider both measures.
The service test is probably the most subjective of the three tests. While percent of branches in LMI census tracts is a major criterion, it is hard to determine precisely how much weight this has since some CRA exams give out high ratings to banks with low percentages of branches in LMI tracts. In addition, the agencies differ on how much to consider branches in non-LMI tracts that are in close proximity to LMI census tracts (or what close proximity means), making it hard to judge whether percent of branches in LMI tracts is constructed the same way across agencies. Finally, the agencies have adopted a new Q&A about how to measure services offered via non-branch means such as mobile banking. But they have not indicated precisely how they will measure success. Will the measures be the number of accounts to LMI people or the percent of accounts offered to LMI customers? Introducing these types of measures for traditional bank exams would also improve the rigor of their service tests.
Peer comparisons on CRA exams should be conducted in a more transparent manner so that banks and community groups can more accurately respond to examiner conclusions. Often, the lending test compares a bank’s performance to the aggregate (all lenders in the market) while the community development section of the lending test and the investment test have peer comparisons involving specific banks. The rationale for these choices should be better explained by the examiners so all stakeholders can offer more informed opinions about the adequacy of the peer comparisons. We do not support the ABA’s recommendation that banks should designate peers for comparison purposes that the regulators accept. The regulatory agencies are administering the test and as such should make the final decisions.
Weights on CRA exams for component tests must remain standardized in order to facilitate accurate comparisons among bank performance. For example, the large bank exam weights the lending test at 50 percent, the investment test at 25 percent, and the services test at 25 percent. As NCRC’s study, The Community Reinvestment Act and Geography, found the largest 100 banks focus on retail lending so the most weight for the lending test remains appropriate. Ratings schemes that allow for variations of weights for institutions with similar business operations and capacities introduce more subjectivity into the grading system. The former Office of Thrift Supervision (OTS) briefly experimented with a more flexible rating scheme but abandoned this system after only a few years. Currently, weights for component tests are different for different categories of banks (small, intermediate small, large, and wholesale and limited purpose), but within a particularly category, the weights are the same. This approach has stood the test of time.
We agree with the ABA that any guidance or formal or informal examination procedures must be publicly available. We have likewise encountered verbal communications about procedure that are not in any publicly available document. All stakeholders must be privy to all information so that CRA is administered in an unbiased and fair manner that is consistent across the three agencies. In addition, training of examiners should include formalized input and participation of both banks and community organizations during training sessions.
Finally, the agencies took steps in the past to make table formats uniform but more work in this area is needed. Consistent and uniform tables would facilitate comparisons of bank CRA performance.
Definition of Community Development
Community development has a specific regulatory definition that focuses this development on responding to the needs of low- and moderate-income consumers and communities. The CRA regulation has been developed carefully over decades. It focuses on low- and moderate-income communities because these are the communities that experienced redlining and discrimination. Accordingly, community development including community development services like financial education must remain focused on low- and moderate-income consumers.
If the agencies follow the recommendation of the ABA and provide credit for financial education that broadly serves the entire community, it is likely that banks could significantly reduce their efforts to direct this important service to low- and moderate-income people who need it the most because they have been disproportionately left out of the financial mainstream. The Interagency Q&A provides careful exceptions to the focus on low- and moderate-income people such as including mixed-income housing as an example of community development. This is as it should be; exceptions need to be narrowly targeted to promote positive outcomes like integration rather than broad-based which would result in low- and moderate-income communities being neglected in favor of easier-to-serve more affluent communities.
Also, as desirable as it is for bank employees to participate on Habitat for Humanity affordable housing developments, hammering nails is not a community development service which is of or related to the provision of financial services. This type of volunteer service should not be accorded favorable consideration on the CRA service test. Doing so would reduce the amount of financial education provided by banks as they send out their employees to hammer nails instead of providing financial education. It would be a misallocation of talent; bank staff have expertise in financial education whereas the skill and desire to hammer nails is more broadly distributed across the entire population.
The ABA white paper also recommends providing community development consideration for small business lending. Retail small business lending is considered under the retail portion of the lending test and should not be considered as community development. Doing so would double count the small business lending and inflate the lending test rating. We do not take issue with the ABA’s recommendation that a real-estate secured loan to a nonprofit be considered as a community development loan as opposed to a small business loan.
Merger Application Processing
Merger application processing represents a key time for review and enforcement regarding community reinvestment and fair lending obligations. Bank merger law requires that mergers demonstrate a public benefit. The absence of such a requirement could result in anti-competitive impacts and/or disinvestment if merging banks close branches and reduce lending after the merger. An effective and concrete manner to demonstrate public benefits is for the merging banks to commit to community benefits agreements involving community-based organizations. Recent community benefits agreements with KeyBank, Fifth Third, and Huntington total more than $60 billion. These agreements mutually benefit communities and banks through more profitable opportunities for banks and increases in lending and investing in minority and low- and moderate-income neighborhoods. Regulatory agencies can judge the rigor of these agreements by their specificity, quality of performance measures, and responsiveness to needs.
The merger application process needs to be executed carefully in order to ensure that banks are well managed, safe and sound, comply with a wide variety of fair lending and consumer protection law, and demonstrate public benefits. At the same time, the process should not consist of inexplicable delays for either community organizations or banks. For community organizations, undue delays are caused when regulatory agencies do not respond to Freedom of Information Act (FOIA) requests in a timely manner and either provide requested information shortly before public comments on the merger are due or after the expiration of the comment time period, frustrating the purpose of FOIA and public disclosure. We understand that banks become concerned when those with Outstanding CRA ratings experience processing times that seem lengthy. However, NCRC looked at twenty mergers from 2011 through 2016 and found that banks with Outstanding ratings experienced processing time (from submission of application to approval) of approximately one and a half months less than those with Satisfactory ratings. Moreover, a recent Federal Reserve report indicates that the agency has reduced processing time for mergers receiving public comments by about 49 days or almost two months from 2015 to 2016.
Since it appears that processing time is declining, we would caution against any additional action to shorten processing time for banks with Outstanding ratings. Mergers are complicated events with complex and uneven impacts across geography. In addition, even banks with Outstanding ratings can have inconsistent CRA performance across states and metropolitan areas, meaning that the application time period is a critical time for seeking improvements where performance lags. Moreover, the rating can reflect performance from several years ago and more recent performance may be worse or at least different, necessitating analysis of more recent performance. In order for public benefits to be realized in these complex mergers, sufficient time must be allowed for complicated data analysis, including analyses conducted by the federal agencies, and discussions among banks and community organizations. Lastly, in some cases even banks with Outstanding ratings have engaged in discrimination and unfair and deceptive practices during the time period of its CRA exam or after its exam.
When processing time is cut short, investigations of improprieties cannot be completed and mergers are approved with serious and unresolved issues. For example, shortly after Capital One’s acquisition of ING was approved, the Consumer Financial Protection Bureau found Capital One to be in violation of consumer protection law regarding credit card practices and required the bank to refund $140 million to two million customers. NCRC and other commenters had raised unfair and deceptive acts and practices in credit card lending during the merger application proceeding, but these practices were not examined as carefully as they should have been. Further shortening merger time periods is not consistent with attaining public benefits as even more issues would likely be overlooked.
The ABA wants regulators to clarify that “CRA not be used as a general enforcement tool and that an Unsatisfactory CRA rating will not be a de facto bar” in agency approval of activities. Surely, the ABA knows that §25.29, “Effect of CRA performance on applications,” of the CRA regulations implements the statutory provisions that require the agencies to take the bank’s CRA record into account when considering bank applications. This must remain the case since consideration of CRA ratings and performance on applications must remain a powerful incentive for banks to abide by their community reinvestment obligations. Merging with another institution or opening a branch is a privilege, not a right, and only banks abiding by their community reinvestment obligations should be accorded those privileges. Moreover, failing CRA exams remains a rare occurrence (about 2 percent over the last several years) so a bank that fails its CRA exam must not expect approval unless it can demonstrate an overwhelming public benefit of its proposed activity.
The ABA asks that regulatory agencies specify that banks should not be required to enter into an agreement in connection with a strategic plan. For years, the agencies have been indicating in approval orders that agreements are not required by CRA or bank merger law. Regardless, they must change their tone and indicate that while not required, agreements are a concrete and specific means to demonstrate public benefit as required by bank merger law and can also be helpful for strategic plans.
Credit for Community Development Loans and Investments Outside of Assessment Areas
The agencies have longstanding procedures for allowing banks to receive favorable consideration for community development loans and qualified investments outside of their assessment areas. Favorable consideration can be earned if the activity is in the state or regional area comprising the assessment area. Below, are examples from CRA exams of the largest banks demonstrating that they commonly receive favorable consideration for out-of-assessment area activities. The agencies make clear in the Interagency Question and Answer (Q&A) document that banks of all sizes can receive favorable consideration for activity out of their assessment areas. Our suggestions above for expansion of assessment areas to include areas with significant amounts of retail lending outside of branch networks will also facilitate community development lending and investing in additional geographical areas. It seems as though the agencies have developed accepted and regularly used procedures for considering out of assessment area activity.
If the Treasury Department remains concerned, we recommend that the Department consult the agencies and banks themselves about how banks obtain assurances that out of assessment activities will be considered. Is there regular communication about these matters on an ongoing basis between banks, CRA examiners, and the agencies? We are also generally supportive of the ABA recommendation that the agencies develop procedures to respond to bank inquires in a timely manner about whether a particular activity would count as community development. The agencies should also respond in a timely manner to community group inquiries of this nature since community groups are often working in partnership with banks on community development projects.
Here are examples from the largest bank CRA exams of out of assessment area activities being considered favorably.
- JP Morgan Chase – Investment performance was “elevated” to excellent due to significant number of investments in broader statewide and regional areas. Investments in assessment areas were adequate and thus bank could receive credit for investments outside of assessment areas.
- Wells Fargo – “In addition to the investments and grants made in the full- and limited-scope AAs (in California), Wells Fargo made seven grants and investments totaling $83.3 million that benefited the entire state during the evaluation period.”
- Bank of America – “In some rating areas, investments made outside of the bank’s defined assessment areas, but within the state or regional area, enhanced the investment performance of the rating area.”
- Citibank – “The bank originated more than $3.8 billion in community development investments and grants within its various assessment areas and broader regional areas that include its assessment areas during the rating period. This includes broad statewide areas or regional areas that total $1.3 billion in current and prior period investments. These broader regional area investments further support the overall excellent investment performance of the bank.”
The undersigned organizations believe that CRA is integral to increasing access to safe and sound lending, investments, and banking services in underserved organizations. We look forward to continued dialogue with the Treasury Department regarding improving the rigor and implementation of CRA.
This letter was organized by the National Community Reinvestment Coalition (NCRC) and represents the views of our members and allies listed below:
President and CEO of the National Community Reinvestment Coalition