Four big questions as CRA proposal nears official release

WASHINGTON — After nearly two years of internal discussions, regulators are finally ready to propose reforms to the Community Reinvestment Act on Dec. 12. Expect the reaction from within the industry and outside it to be swift and loud. When the Office of the Comptroller of the Currency asked the public to weigh in on CRA reform in 2018, it received more than 1,500 comments.

The OCC has said its priorities for CRA reform are built around enhanced “clarity” and “transparency,” such as providing a concrete list of acceptable CRA activity and insight into examiners’ scoring methodologies, as well as ensuring that banks’ footprint — which today may far exceed physical branch networks — corresponds with their CRA compliance.

All of that, in theory, should strengthen bankers’ efforts to invest in the communities they serve and benefit a broader segment of the public. But reality is rarely so tidy.

“Do bankers who do CRA investing expect to see their lives become a whole lot easier with the reform?” said Julie Hill, a professor at the University of Alabama School of Law. “I kind of doubt it. When’s the last time regulatory change outside of Congress implemented a tidal wave of change for banks that made their lives easier? I don’t remember that.”

While a consensus has emerged that CRA needs to be modernized, the stakes are high, and the consequences of any changes will likely reverberate for decades.

Here are key questions about the upcoming proposal.

FDIC Chairman Jelena McWilliams
Whose rule is it anyway?
The federal bank regulators have traditionally been in lockstep when it comes to rules affecting the whole industry. A common set of standards bolsters consistency across different charter types and reduces banks’ incentive to favor one regulator’s charter over another.

The regulatory process takes so long in large part because agencies take so long to iron out differences and agree. In the CRA’s case, past rules and guidance have been issued jointly with agreement from the OCC, Federal Reserve and the Federal Deposit Insurance Corp.

But the OCC’s push for CRA reform this time has bucked that precedent. Comptroller Joseph Otting began focusing on a reform plan soon after he was confirmed in late 2017, suggesting many times the OCC would be willing to propose its own CRA plan. Sure enough, the agency issued a notice without the other agencies last year seeking public comment on CRA reform, yet all the regulators later reviewed the comments.

Since the OCC began work on reform in December 2017, other regulators have spent the better part of the last two years demurring on questions about their own plans for CRA, which was not on the agendas of the FDIC or Fed before Otting’s campaign.

In recent weeks, the OCC and FDIC have signaled they are ready to support the imminent proposal without the Fed. The divide between the agencies reportedly stems from disagreements over how regulators would measure CRA investment and impact in a final plan.

In a statement last month, a Fed spokesperson said it was “unfortunate that these efforts have so far not been successful and that the agencies were unable to reach agreement on metrics that would be tailored to bank size and business model and reflect the different credit needs of the local communities that are at the heart of the statute.”

The FDIC plans a Dec. 12 board meeting to vote on the proposal, all but confirming the agency is on board with the OCC. But as recently as this month, FDIC Chairman Jelena McWilliams said while she was “inclined” to support issuing the proposal, she still had reservations, namely with OCC’s proposed metric system and approach to assessment areas.

If the FDIC chooses to join the OCC’s proposal, regulators have said it will be published Dec. 12 — the same day the FDIC has a board meeting planned. Without the FDIC, regulators have said to expect the rule the day after, on Dec. 13.

Some observers have raised concern about the prospect of disjointed rulemaking, even though McWilliams and Otting have said their agencies combined oversee about 85% of CRA activity.

“The OCC’s approach to this has been to barrel in without building consensus first on how to proceed,” said Jesse Van Tol, CEO of the National Community Reinvestment Coalition. He raised the possibility that the FDIC’s support could be contingent on some kind of carve-out for smaller banks. “It will be telling if the FDIC signs on with a clause to let their banks opt out. Talk about a vote of confidence.”

But others noted that there is nothing stopping the agencies from advancing a plan before there is consensus.

“From a legal perspective, there’s no reason why one agency can’t move forward without the other two,” said Bill Stern, a partner with Goodwin Procter LLP. “But it makes sense to make the changes together. There’s not really a justification from a policy perspective why a national bank should be regulated differently than a state bank, or a nonmember FDIC bank.”

And the issuance of a proposal without support of all three agencies does not preclude their ultimately agreeing on a final rule.

"We are only at the point of whether a notice of proposed rulemaking will go out. We are not at the point of a final rule. And the objective ought to be that at the end all three agencies will join in a final rule," Fed Vice Chairman of Supervision Randal Quarles said at a recent congressional hearing.
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How will regulators thread the needle on assessment areas?
Everyone agrees that the current definition of CRA assessment areas is outdated. But updating it in a manner that meets several objectives will be a difficult balance to strike.

Those objectives include ensuring communities not served by a bank branch or headquarters have access to CRA investments, banks have flexibility to earn CRA credit beyond physical branch networks and current investments in communities with a high CRA need are not diluted.

“If you’re going to be fair to everyone, it’s never going to be simple,” said Eugene Ludwig, founder and CEO of Promontory Financial Group and a former comptroller of the currency who oversaw the CRA’s last round of reform, in the mid-1990s. “There’s a degree of complication that comes with achieving fairness.”

It bears watching how much regulators will maintain geographic branches as a component versus going beyond the branch network, as well as whether they will base a new definition on where deposits originate. Banks exceeding a deposit threshold beyond their current CRA boundaries could possibly have new assessment areas, according to published reports.

“Having some amount of flexibility is really important for innovation, particularly when it comes to CRA,” said Kevin Petrasic, a partner at Davis Wright Tremaine LLP. “This is an opportunity for the banking agencies, who understand what works and what doesn’t work, to show some flexibility and creativity.”

Other observers worry that allowing banks to invest outside of their CRA areas and still earn credit could result in harmful consequences.

“Depending on how it’s done, it could be a free pass for banks to go where they think they’ll make the highest margin on a CRA loan,” said Van Tol. “That could mean cherry-picking high-cost, rapidly gentrifying areas, or a stronger focus on opportunity zones.”

Van Tol said that a new framework would be likely intended to help banks target places that badly need investment but haven’t historically been eligible for CRA credit, such as rural areas or Indian tribal territory.

“But if you don’t have restrictions on where the banks can go, a bank could easily satisfy their obligations and go to places not with the greatest need, but with the greatest moneymaking opportunity,” he said.
Comptroller of the Currency Joseph Otting
How will the agencies make the CRA grading process more objective and transparent?
Bankers have long complained about perceived subjectivity in CRA scoring, pointing to cycles where their institutions fall from an “outstanding” to “satisfactory” rating or worse without a clear explanation as to why.

How the OCC and FDIC’s proposal bolster objective scores — and consistency across institutions — as well as the transparency of their scoring process will be a key area to watch in the proposal.

“Transparent and objective metrics would support more timely regulatory decisions that rely on CRA performance ratings," Otting said in an August 2018 op-ed in American Banker.

A more consistent scoring methodology could potentially specify the amount of credit available for certain activities available to all banks, or establish a basis for scores such as the amount of CRA projects or their dollar value.

Some observers warn that any proposal should not favor a single basis too heavily; for example, they say the amount of units and the dollar value both have merit.

“One very large loan can be very impactful, like financing a large multifamily housing development aimed at low- to moderate-income individuals,” said Stern, the Goodwin Procter partner. “But a lot of small loans can be impactful if they’re well placed, like helping numerous small businesses get off the ground.”
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Will regulators change the definition of 'low to moderate income' communities?
Another area of CRA reform is the regulatory definition of “low to moderate income,” or LMI.

By law, CRA investment should be directed at communities or individuals who need it most, and that determination is based on the median family income of a given geographic area, which is in turn determined by census tract data. LMI is typically defined by anything less than 80% of an area’s median income.

But the cost of living in the U.S. has risen in in the decades since the Community Reinvestment Act was signed, and the nation’s coasts are now considerably more expensive than much of the interior.

That puts banks in a tough spot, particularly when looking for CRA credit with the current framework’s subjective scoring system. Will a low-cost mortgage in an impoverished rural area earn more credit, or a more expensive one in an urban area?

“Put it this way: It’s a conundrum,” said V. Gerard Comizio, a partner at Fried Frank. “There’s just not a perfect solution there.”