Appeal of ''Needs to Improve'' CRA Rating - (Third Quarter 2000)
A community bank appealed its Community Reinvestment Act (CRA) rating of ''needs to improve'' assigned by the supervisory office. The performance evaluation (PE) stated that lending within the bank's assessment area was lower than the standard for ''satisfactory'' performance. The bank believed the conclusion was inappropriate based on the following:
- The bank's principle line of business had not changed substantially since the previous CRA evaluation that resulted in a ''satisfactory'' rating.
- The bank was following the same business strategy, yet the examiners did not properly consider the performance context issues as was done in the prior examination.
- The bank's business plan and strategy centered on origination of "non-conforming" residential mortgage loans to customers throughout the country. A large number of these loans were made to low- and moderate-income individuals. The appropriateness of the management component rating downgrade from 1 to 2 was also appealed.
As reported in the PE, the bank had a low level of lending within its assessment area. For the two-year evaluation period, the bank originated 79 loans equating to 7 percent of all bank HMDA reportable (one- to four-family purchase, home improvement, and home refinance) loans. The facts were not in dispute. The key issue was whether the bank's low level of lending within its assessment area could result in a satisfactory record of meeting the bank's community credit needs when considering all relevant factors, including the bank's performance context. Banks with assets of less than $250 million are defined as small institutions under the CRA regulation. Small institutions are evaluated under five assessment criteria:
- Loan to deposit ratio;
- Percentage of loans and as appropriate, other lending related activities located in the bank's assessment area (lending in the assessment area);
- Record of lending to borrowers of different income levels and businesses and farms of different sizes;
- Geographic distribution of the bank's loans; and,
- Record of taking action in response to complaints about its performance in helping to meet credit needs in its assessment area.
The PE concluded the bank's performance in all the above criteria was found to be reasonable with the exception of lending in the assessment area. In all CRA evaluations, performance context is an integral component of the analysis. The performance context considers:
- The economic condition and demographics of the assessment area;
- Information about lending, investment, and service opportunities;
- The bank's product offering and business strategy;
- Any limiting factors or constraints;
- Past performance;
- The bank's public file, and
- Any other information deemed relevant by the OCC.
Performance context is especially important to this bank due to their business strategy and non-traditional product delivery systems. The bank's primary lending activity focuses on non-conforming/subprime mortgage secured loans. Management stated that because there was strong competition from several larger institutions in their market area for traditional lending products, that they had identified subprime lending as a viable niche. According to bank management, this strategy and type of lending has affected the bank's ability to generate a significant volume of loans within their assessment area.
The May 3, 1999 FFIEC Community Reinvestment Act; Questions and Answers Regarding Community Reinvestment (Qs & As) states that if the percentage of loans and other lending-related activities in an institution's assessment area is less than a majority, then the institution does not meet the standards for satisfactory performance only under this criterion. However, its effect on the overall performance rating of the institution is considered in light of the performance context. In addition, the Qs & As also state that examiners can consider ''lending-related activities,'' including community development loans when evaluating the first four performance criteria of the small institutions performance tests.
Community development lending provides support on a performance context basis to the degree that a loan benefits a low- or moderate-income individual or is made in a low- or moderate-income geography. Community development is defined as:
- Affordable housing (including multi-family rental housing) for low- or moderate-income individuals;
- Community services targeted to low- or moderate income individuals;
- Activities that promote economic development; or,
- Activities that revitalize or stabilize low- or moderate income geographies.
The performance context under which this bank operates is unique. It is a small bank (under CRA criterion) that has a narrow product offering which has affected its ability to provide a significant level of traditional lending within its assessment area. While the bank is compensated for assuming additional risk, the benefits to the customers include availability of credit, debt consolidation, and opportunity to improve their credit rating. Although performance context allows for consideration of items such as business strategy and past performance when evaluating CRA, in this situation it did not provide the degree of mitigation needed to bridge the unusually low level of lending within the bank's assessment area to reach an overall ''satisfactory'' rating. Therefore, considering the above factors the ombudsman concluded that the bank's performance under the CRA was reflective of a ''needs to improve'' rating. While the bank's community development lending had a positive impact on the assessment area performance, its current level did not bring the bank's performance to an overall ''satisfactory'' level.
Appeal of the Criterion used to Examine a Community Development Focused Bank - (Third Quarter 2000)
A bank with a community development (CD) focus formally appealed the criterion used to examine the bank. The appeal pointed out that, by pursuing the CD focus, which was the bank's mission, the bank was in direct conflict with some of the examination criterion employed by the Office of the Comptroller of the Currency (OCC). In its appeal the bank expressed concern that the OCC's evaluation of some component ratings is not sensitive to the obstacles facing banks with a CD focus. To illustrate this point, the appeal stated that the bank's CD focus works contrary to profit maximization (earnings) by:
- Creating mortgages that are smaller, more labor intensive, and take longer to close than traditional mortgages.
- Financing businesses with smaller loan amounts, and principals lacking the financial sophistication and expertise of traditional borrowers.
- Serving consumers who, on the deposit side, are characterized by having low balances and requiring a great deal more time and attention due to cultural, linguistic, and experiential difficulties, and who, on the loan side, are disadvantaged by nonexistent, inadequate, or unsatisfactory credit histories; in addition, these consumers have earning streams that are inconsistent, small, and/or from non-traditional sources.
The appeal further stated a CD-focused bank's approach to offsetting these inherent disadvantages is to seek available financial assistance from public and private sources supportive of its mission. A significant source of offset comes from within the U.S. Treasury Department in the form of a Bank Enterprise Act (BEA) award. A bank with a
CD focus is entitled to these awards based on accomplishing preset goals consistent with its mission. Despite documentation showing the bank's eligibility for these funds, in this instance the examiners discounted them because of their non-traditional status.
The appellate submission noted that, unlike investors in most banks that are motivated to acquire new capital and accumulate additional capital based solely on maximizing profit; a bank with a CD focus looks for a balance between profits and service to the low- and moderate-income community. As emphasized above in the discussion of earnings, banks with a CD focus have non-traditional means of raising additional capital such as awards or grants from community groups or other banks. Additionally, the appeal stated that management's ability to budget and project financial outcomes for a bank with a CD focus are severely constrained by the unavailability of comparable data. It further notes that by definition, the customers of a bank with a CD focus have not been well served by traditional banks and available data is very limited.
The corporate process and requirements for chartering a bank with a CD focus is subject to the same standard requirements as any other bank. However, there is a special condition that banks with a CD focus must include the nature of its activities in the articles of association. Specifically, the articles must state:
- The business of the association will be designed to primarily promote the public welfare consistent with the requirements for national bank investment in the community development projects pursuant to national banking laws and regulations, including 12 CFR 24 (Eleven) and 12 CFR 24.
- The bank must obtain prior written approval of the OCC before amending its articles of association to alter its business operations from those of a community development focus.
There are no other special provisions or requirements designed for banks with a CD focus.
As the ombudsman considered whether the examination criterion of the OCC represents a conflict for banks with a CD focus, he recognized the ''intrinsically more challenging undertaking" that these institutions face. However, the financial health of any banking organization is critical to fulfilling its obligation to the stockholders and the community it serves. As CD banks pursue a balance between serving low- and moderate-income communities and profitability, the financial health of these institutions becomes increasingly important. Financially stable community development institutions will have longevity, which will allow them to maximize the positive impact on their communities. The ombudsman concluded that the existing safety and soundness criterion contributes to achieving this longevity. In the OCC's evaluation of a bank's performance under the Community Reinvestment Act, a bank with a CD focus receives recognition for their efforts to provide financial services to low- and moderate-income communities.
The OCC is committed to ensuring that its supervisory conclusions consider the uniqueness of each institution in assigning ratings that reflect the safety and soundness of its operation. The ombudsman offered assurance that the agency will continue to evaluate the issues confronting institutions with a community development focus to ensure there is a reasonable chance for their success.
Appeal of a "Satisfactory" CRA rating - (Third Quarter 2000)
A large retail bank filed an appeal concerning its Community Reinvestment Act (CRA) rating of "satisfactory." The bank also appealed the lending test rating of "high satisfactory," the investment test rating of "low satisfactory," and the service test rating of "high satisfactory." The bank's last performance evaluation (PE) rated the bank as having an "outstanding record of helping to meet the community credit needs." The submission noted that even prior to the enactment of CRA; the bank took great pride in delivering its products and services to all individuals and businesses in its trade area. It continued that since the inception of CRA and the rating system, the bank had made every effort to attain and sustain an "outstanding" CRA rating. CRA has become a part of the bank's yearly business plans and a major goal of the bank's management.
The submission detailed the reasons for disagreement on each of the tests and the overall rating, as follows:
- The PE states that the primary reasons for the bank being rated ''satisfactory record of meeting community credit need'' are:
- The bank's lending levels reflect a good responsiveness to the credit needs of its assessment area.
- A substantial majority of the bank's loans are in the assessment area.
- The bank's distribution of small loans to businesses is good. The bank's geographic distribution of small loans to businesses is also good.
- The bank has a good distribution of loans to borrowers of different income levels. The bank's geographic distribution of loans to borrowers of different income levels is satisfactory.
- The level of community development investments and grants is adequate. However, the bank makes extensive use of flexible lending programs to help meet the needs of its assessment area (AA).
- The bank's delivery systems are accessible to geographies and individuals of different income levels. To the extent changes have been made, the bank has improved the accessibility of its delivery systems.
- The institution provides a satisfactory level of community development services.
The bank is an intrastate bank and is the lead bank in a multi-bank holding company. The bank's assets exceed $2 billion with multiple offices located in four counties. Ninety-five percent of the offices are full-service locations. The bank owns and operates a number of automated teller machines (ATMs) in its assessment area (AA). The bank's AA consists of two separate but contiguous areas. One of the bank's AAs is a metropolitan statistical area (MSA), while the other is a non-MSA. The bank's AAs are comprised of 2 percent low-income geographies, 22 percent moderate-income geographies, 61 percent middle income geographies, and 9 percent upper-income geographies. By family income level, 18 percent of the families in the AAs are considered low-income families, 19 percent are moderate-income, 27 percent are middle income, and 36 percent are upper-income. The bank's business strategy is to operate with a community-bank orientation while offering a large-bank range of products. Commercial lending has long been a primary focus of the bank with small business lending considered one of the bank's market niches.
Discussion and Conclusions
The lending test evaluates a bank's performance in terms of the volume of lending, the geographic distribution of loans originated and purchased, the borrower dispersion of loans originated and purchased, the responsiveness to community needs, the level of innovation and flexible products offered, and community development lending activities. The PE concluded:
- The bank had demonstrated a good responsiveness to the credit needs in its assessment areas, taking into account the number and amount of home mortgage, small business, small farm, and consumer loans in its assessment areas.
- A substantial majority of loans were made in the bank's assessment area.
- The bank's record of lending to businesses of different sizes was good. The bank also demonstrated a good geographic distribution of small loans to businesses.
- The bank has a good distribution of loans to individuals of different income levels. The bank's geographic distribution of loans to borrowers of different income levels is satisfactory.
- The level of community development lending is reasonable based on the available opportunities.
- There is a good use of flexible lending practices and programs.
The appellate submission stated that the lending test rating should be ''outstanding'' based on the information contained in the PE because the bank was consistently ranked as the leading provider of CRA-related loans to low- and moderate-income individuals, businesses, and farms in the bank's assessment area.
A review of the bank's lending tables disclosed that the bank extended a high volume of loans for the evaluation period. While the bank had the largest deposit share in its market, its lending activities also reflected dominance. The market share for small business lending, the bank's acknowledged niche, was commensurate with the bank's deposit share in the MSA and exceeded its deposit share in the non-MSA. The bank ranked first in market share for loans to small businesses, home purchase loans, home improvement loans, and multifamily real estate loans - which identified as the most significant credit needs in the community. The bank's market share percentage was significant in these product categories.
Additionally, the substantial majority of the bank's loans were within the designated assessment areas. Therefore, the ombudsman concluded that the bank's level of lending reflected an excellent responsiveness to the area's credit needs.
Small business lending represents a significant portion of the bank's business lending. The bank's strategy emphasized business lending, which has long been considered its strength. Additionally, loans for start-up companies was one of the most frequently cited credit needs in the bank's AA. Therefore, when considering all factors, the ombudsman concluded that at the time of the examination, the primary emphasis should be placed on small business lending. The PE also stated that affordable, first-time homebuyer loans and multifamily real estate loans were identified credit needs. As such, performance in home purchase and multifamily lending was weighted heavier than other housing-related products.
Furthermore, the ombudsman's analysis found the bank's percentage of loans in LMI areas ranged from an adequate to excellent level of performance when evaluated against the percentage of housing units or businesses in those geographies. In addition, the following was considered:
- In the MSA, the bank's 34 percent small business market share in low-income geographies exceeded the overall market share. In addition, the bank's 26 percent small business market share in moderate-income geographies equaled the overall market share. The percentage of the bank's loans to businesses with revenues of $1 million or less did not exceed the percentage of businesses in those areas. Small business lending performance in the MSA's LMI areas was considered good.
- The small business market share in the non-MSA's moderate-income areas exceeded the bank's overall small business market share and the percentage of loans to small businesses in the moderate geographies exceeded the percentage of businesses in those areas. This was considered an excellent level of performance.
- Home purchase lending in the MSA's low-income geographies equaled the percentage of housing units in that area and the market share in the geographies exceeded the bank's overall market share. The performance in the MSA's moderate-income areas was not as strong; however, the MSA's home purchase lending overall was considered good.
- In the non-MSA, the bank's market share in moderate income areas was comparable to its overall market share. The percentage of loans made during this evaluation period was not as comparable to the housing units located in that geography, but overall performance in the non-MSA was also considered good.
- The percentage of multifamily real estate loans in the MSA's moderate-income geographies exceeded the percentage of housing units in that geography and the bank's market share in that geography exceeded its overall market share. Additionally, this lending occurred in an area identified by the city as being in need of revitalization in terms of housing and economic development. Performance in this product relative to geographic distribution was excellent.
As mentioned above, these loan products addressed the identified credit needs of the community, further demonstrating the bank's commitment to help meet community credit needs. Therefore, the ombudsman concluded that the bank's overall geographic distribution of loans was good.
Borrower distribution reflected a strong level of performance measuring borrowers with various income levels and market share measures. The bank's distribution of loans to LMI borrowers ranged from adequate to excellent. Of particular note during this evaluation period was:
- The bank's overall market share of small loans to businesses was 27 percent and ranked first. The bank's market share of loans to businesses with revenues of $1 million or less exceeded its overall market share. The bank made 78 percent of its business loans to businesses with revenue of $1 million or less. This compared very favorably to the overall market's percentage of loans to those businesses. It was also comparable to the percentage of businesses that had revenues of $1 million or less. This was an excellent level of performance in the MSA.
- The performance with small businesses in the non- MSA was quite comparable with the bank's excellent performance in the MSA indicated above.
- In the MSA, home purchase lending to low-income borrowers was significantly lower than the demographic, however, approximately 40 percent of these families have incomes below the poverty level. These families may have difficulty qualifying for housing-related products. Home purchase lending to moderate- income borrowers met the demographic, while the bank ranked first in overall market share. The bank's market share of moderate-income borrowers was comparable to its overall market share. Considering all factors, overall lending performance to LMI borrowers was good in the MSA and non-MSA.
- Consumer loans to LMI households exceeded the demographics, 113 percent and 175 percent, respectively. This represented an excellent level of performance. As with geographic distribution, these loan products addressed the identified credit needs of the community and were appropriately weighted in determining the overall performance for borrower distribution. These facts indicate the bank's response to the needs of small businesses was excellent and performance in home purchase lending was good. Therefore, it was appropriate at the time of the examination to place the most emphasis on these products.
The ombudsman concluded the bank's overall performance in providing credit to borrowers of different income levels was excellent.
Community Development Lending and Innovative or Flexible Lending Programs
There was no disagreement with the assessment that ''the bank's level of community development lending was reasonable based on available opportunities.'' The PE also described several lending programs that were flexible, responsive, and have had a positive impact on the development of the community. These programs utilize standards that make credit available to borrowers that typically have difficulty accessing credit. While some of the programs have been available for several years, the programs continue to generate loans. Therefore, the ombudsman concluded that the bank utilized flexible lending programs, which had a positive impact on the bank's overall rating for the lending test.
Lending Test Overall Conclusion
The bank's volume of lending was significant and substantial within its assessment areas. Therefore, the bank's performance in the geographic and borrower distribution of credit was key to the bank's overall rating for the lending test. The bank's performance in the geographic and borrower distribution of credit noted above reflected a commitment to helping meet the credit needs of the community. This was particularly true considering the identified credit needs, the bank's product niche or emphasis, the operating environment and the extensive use of flexible lending programs. The bank's overall volume of lending was consistent with the CRA guidelines for an ''outstanding'' rating for the lending test.
The bank's performance under the investment test was evaluated in terms of:
- The volume of qualified investment and grants;
- The level of innovation and complexity associated with the investments;
- The degree to which the investments and grants responded to the credit and community development needs of the AA; and,
- The degree to which these investments and activities are not routinely provided by private investors.
The PE concluded:
- The bank's level of community development investments and grants is reasonable, based on the investment opportunities available in the community.
- The bank has taken a leadership role in one significant investment initiative.
The appellate submission stated that the investment test rating of ''low satisfactory'' was not justifiable, given the information in the PE. In addition, the submission stated that management believes their willingness to invest in any economically viable project in their community, coupled with taking the lead in the only limited liability corporation of its kind, in a community where there are limited community development opportunities as noted by the community contacts, should afford the bank a ''high satisfactory'' rating.
No additional information was offered during the processing of the appeal that would increase the level of community development investments noted at the time of the examination. The level of qualified investments noted during the CRA review represented less than 1 percent of the bank's tier one capital and the PE noted only one occasion where the bank assumed a leadership position. The ombudsman agreed that the level of investment identified during the examination was accurately categorized as reasonable, given the bank's size and resources. Therefore, he concluded that the assigned ''low satisfactory'' rating was appropriate for the bank's performance on the investment test.
The bank's performance under the service test was evaluated in terms of retail banking services (the accessibility of delivery systems, changes in branch locations, and the reasonableness of business hours and services to help meet the AA's needs) and the level of community development services provided in the AAs.
The PE concluded:
- The bank's delivery systems are accessible to all portions of its AA;
- To the extent changes have been made, the bank has improved the accessibility of its delivery systems. Since the last CRA evaluation, the bank acquired a full-service branch in a moderate-income census tract;
- Banking services and hours of operation are tailored to meet customer needs;
- The bank is a leader in providing community development services.
The appellate submission stated that the PE supporting information supported an ''outstanding'' rating for the service test, so an upgrade from a ''high satisfactory'' to an ''outstanding'' was requested. The primary focus of the service test is the distribution of full service branches, while still considering alternative delivery systems. The bank's branch distribution in the MSA's LMI areas exceeded the demographic in the low income area, but not in the moderate-income areas. Information provided during the processing of the appeal revealed that the volume of ATM transactions in the MSA for ATMs located in or near LMI areas was significant. However, there are no branches or ATMs distributed in moderate-income areas of the non-MSA. Therefore, the overall branch distribution was good.
The PE noted that the bank opened a full service branch in a moderate-income geography, which did improve the accessibility of banking services in that geography. The bank's performance in opening and closing branches was excellent. Services listed in the PE were considered to determine the reasonableness of the bank's business hours and services. The services listed did not inconvenience any segment of the community. However, the services are not tailored specifically for LMI individuals or geographies and do not represent a significant difference from services offered by other banks.
Considering this, the bank's services were adequate. There was no dispute about the bank's community development services, which was described as excellent. When blending the conclusions of the other tests to determine the overall rating for the service test, the most weight was given to the bank's branch distribution and the community development services. Therefore, the ombudsman concluded an ''outstanding'' rating was appropriate for the bank's performance in the service test.
The ratings in each of the tests contribute to the overall CRA rating. In this case the changing of the rating on the lending test from ''high satisfactory'' to ''outstanding'' positively affected the overall rating on the bank's CRA performance. Therefore, the bank's overall CRA rating was changed to ''outstanding'' and a new PE was prepared to reflect the change.