The Los Angeles Community Development Bank, formed to rebuild neighborhoods ravaged by riots in 1992, is in danger of shutting down unless it can raise more capital, according to a report released last week by the city government.

The city, a primary backer of the nonprofit bank, reported that bad loans and lawsuits by borrowers have depleted loan-loss reserves and other administrative funds. The city is also recommending that the bank outline how it would "phase out" its operations in case it cannot be recapitalized.

The bank said it is no danger of failing but is taking the suggestions seriously. It has promised to tighten up its lending practices and solicit capital from private lenders and investors.

The community development bank was initially financed with $435 million of federal funds intended for lending to businesses in federal "empowerment zones." The zones are generally in poor neighborhoods where would-be commercial borrowers are often shunned by conventional lenders.

However, after about $30 million of loan writeoffs as well as lawsuits by borrowers claiming mismanagement, the bank's loan-loss reserves and administrative funds have dwindled to $10 million. If the plaintiffs in the lawsuits prevail, the verdicts could eat up the remaining $10 million and leave the bank - and the city - on the hook for another $40 million, the city's report stated.

"We have enough reserves to cover any potential losses in our current loan portfolio, which is approximately $118 million," said William H. Chu, the bank's president and chief executive officer since January. "But we have the lawsuits to contend with at the same time."

One lawsuit involves Summit Industries, which defaulted on a $2.5 million loan. Summit claims that the bank acted in bad faith when it enforced the terms of its loan agreement after agreeing to work with Summit on the company's repayment problems. Though a Los Angeles Superior Court judge has issued a preliminary judgment against the bank for $7.2 million, Mr. Chu said he expects to prevail because Summit also breached the workout terms.

The city community development department, which administers the federal funding, so far has taken a back-seat approach to overseeing the bank. However, in its report to the Los Angeles City Council, the department wrote that it plans to take a more hands-on role in bank operations. The report, which was written in conjunction with the city's administrative officer and its chief legislative analyst, stated that the bank must outline within 90 days how it plans to restructure.

Specifically, the city said it wants to know whether the bank can raise at least $25 million of additional capital, mainly from private sources, which is crucial to the bank's remaining in operation.

As a step toward attracting private capital, Mr. Chu said the bank is reviewing the structure of federally funded community development banks - like City First Bank of D.C. in Washington - that have operated successfully as full-service, for-profit banks.

"What the ultimate restructure will be, though, is contingent on what will best fit with our bank," Mr. Chu said. "We want to continue with the same mission that we set out to do because we believe that we are making a difference in the community."

The bank will also outline to the city how it plans to cut administrative costs as well as tighten up lending, Mr. Chu added.

The report also called on the bank to formulate a plan to "phase out" operations should it fail to survive. The City Council is to discuss the report this month.

Related Link:

Editor's Note: This link opens a new browser window. We do not control its content or availability of the site.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.