An OCC Guide to Forming a CDC
There’s more to banking than the bottom line
In today’s competitive financial services environment, a bank that actively reaches out to all parts of the communities it serves can develop strong, lasting, and mutually profitable relationships. By promoting community self-sufficiency and economic development, a bank can strengthen its own prospects for long-term success.
The formula — community involvement = competitive edge — sounds simple. But of course you can’t just wave a wand and make local economic development happen, particularly in lower-income communities struggling with long-standing problems. Revitalization takes patience, planning, and perseverance. You have to be in it for the long haul. Your bank must work closely with community leaders and residents, and must have a sound structure within which to channel funds and expertise to targeted economic development initiatives that serve lower-income households, small businesses, and community infrastructure needs.
That’s where CDCs — community development corporations — come in.
CDCs are corporate entities that specialize in the development and rehabilitation of real estate, investment in business ventures, and other activities that address the housing, commercial redevelopment, employment, and community facilities needs of low- and moderate-income persons and areas, or other areas targeted by governmental entities for redevelopment. Rooted in, and responsive to, the communities they serve, CDCs have proven highly effective at attracting public funds and private investment capital to traditionally underserved areas (see: “CDCs: ‘Corrective Capitalism’ at Work”).
Many financial institutions have leveraged their resources and expertise by partnering with existing CDCs. Alternatively, a bank may choose to form one or more wholly-owned subsidiary CDCs, typically in areas lacking an experienced CDC, or to promote specific bank-driven economic development strategies. Multi-bank CDCs can also be effective ways for banks to pool resources and work together to spur and support community economic development. Bank CDCs usually undertake relatively long-term projects, generally reinvesting any income in future projects.
Bank CDCs can undertake many kinds of economic development activities. If you are contemplating formation of a CDC, this introductory guide can help you translate planning into action.
What’s in it for your bank?
There can be many advantages to forming a CDC:
Demonstrating commitment: Forming a CDC shows that your bank is committed to addressing community development needs on a long-term, ongoing basis. Struggling neighborhoods almost always have a multiplicity of needs that require a sustained commitment of resources to facilitate revitalization. Acting through a CDC, your bank can initiate and support a variety of community development projects over time, building strong community alliances and generating good. Moreover, such activities can establish a track record of commitment and accomplishment consistent with the goals of the Community Reinvestment Act.
Responding to local needs: Working through a CDC can provide maximum flexibility for making situation-specific community development investments and responding to community needs and project opportunities as they arise. Although some bank CDCs limit themselves to specialized areas, such as affordable housing or small business investment, others are structured to support comprehensive approaches to community development. For example, a subsidiary CDC may be authorized to develop its own projects, form or invest in joint ventures and limited partnerships, invest in small businesses, and provide gap equity and financing for single-purpose community development projects developed by others.
Maximizing expertise: A subsidiary CDC, like a specialized bank lending unit, can provide an organizational focal point within your bank for community development investment activities, enabling the bank to marshal resources and centralize expertise. Attracting, training, and supporting staff with specialized skills in community development finance is crucial. Community development finance in general, and equity investment in particular, are complex activities requiring special expertise in areas such as real estate development, government-assisted housing, community and economic development programs, and community development financing strategies and techniques. Housing such expertise within a CDC can be far more effective than trying to generate it on an as-needed basis from various resources within the bank. A CDC subsidiary can also help bank affiliates design and implement community development finance programs. For example, the bank CDC may provide technical assistance, advisory services, equity investments, or debt financing for such programs.
Managing risk: Forming a subsidiary CDC enables a bank to leverage its capital for community development purposes while limiting its exposure to the inevitable risks associated with investing in economically challenged areas. As a corporate entity, a CDC can leverage its capital with loans and reinvest its income in additional projects. A CDC’s corporate structure also helps shield the parent institution from exposure to potential liabilities associated with real estate development and business ventures.
Attracting new business: Finally, using a CDC to generate a flow of community development activities can create profitable new banking relationships. A bank with a strong presence in a previously underserved neighborhood or community may become the bank of choice for lower-income persons and families moving into mainstream banking as their economic circumstances improve, as well as small-business entrepreneurs who thrive with the CDC’s help, and developers, builders, and homeowners moving into the area. And, by demonstrating its commitment to the community as a whole, the bank will strengthen relationships with established customers and community leaders. Community development is a two-way street: the bank that supports it will be supported by it.
As part of the process of launching a CDC, you will want to consider the following questions:
• How does the regulatory environment affect creation of a bank CDC?
We’ll look at each of these questions in turn.
The Office of the Comptroller of the Currency (OCC) has various responsibilities for supervision of CDCs established by financial institutions. These are spelled out in the Code of Federal Regulations, primarily at 12 CFR Part 24, commonly known as “Part 24.” In general, OCC’s goal is to create a supportive regulatory environment that encourages banks to make investments that benefit low- and moderate-income individuals and communities. With that goal in mind, we have recently revised Part 24 to streamline the process of creating a CDC and obtaining OCC approval for CDC investments. OCC’s Community Development Division and district community affairs officers stand ready to assist national banks with this process.
Bank subsidiary CDCs are permitted to engage in activities that primarily promote the public welfare. These include activities primarily benefiting: (1) low- and moderate-income persons; (2) low- and moderate-income areas; and (3) areas targeted for redevelopment by a government entity. Investments that would receive “qualified investment” consideration under 12 CFR 25.23 (implementing the Community Reinvestment Act) are also permissible activities.
For example, a bank CDC that supports the purchase, rehabilitation, and sale of single-family homes, or the purchase, development, rehabilitation, sale or rental of multifamily housing, would meet the public welfare standard if most of the housing units will be owned or rented by low- and moderate-income families. Similarly, a bank CDC that invests in or otherwise supports businesses or ventures located in low- and moderate-income areas or other targeted redevelopment areas or that produce or retain permanent jobs, most of which are held by low- and moderate-income persons, would meet the public welfare standard. (See 12 CFR 24.6 for other examples of qualifying public welfare activities for CDCs and for a list of previously approved community development investment activities appropriate for bank CDCs.) In general, a bank CDC may also invest in a small business investment company (SBIC), because SBICs are typically considered “qualified investments” under CRA.
A national bank investing in a subsidiary CDC would typically submit a CD-1 form to the OCC under the Part 24 guidelines. Pursuant to 12 CFR 24.5, banks may be eligible to provide an after-the-fact notice to OCC within 10 days after making such an investment.
Because communities, whether urban or rural, usually have multiple needs, selecting an investment focus is an important first step in the process of establishing a CDC. Your bank will want to use its business experience and established community development relationships to help develop investment strategies. Active community outreach, over an extended period of time if necessary, can help identify critical needs and projects, potential target areas, and capital gaps that need to be addressed.
In some cases, institutions participate in formal community planning activities to identify community development needs, priorities, and investment opportunities. But a bank may also opt to create a CDC when conventional loans and banking services are inadequate to meet financing requests from businesses, government agencies, or community groups.
Some banks have chosen to use bank-owned real estate acquired through foreclosure or through the deed-in-lieu-of-foreclosure process. Banks may use these assets with a community development program undertaken by a CDC. However, such CDC activities involving properties carried on the bank’s books as “other real estate owned” require prior OCC approval.
When developing a mission statement or charter for a subsidiary CDC, a bank should have a clear idea not only of its initial objectives, but also of the types of future investment activities it may want to undertake. For example, although its immediate interest may be to invest in one specific low-income housing project in a particular neighborhood, it may also be aware of other community development needs that it will want to address in the future. In that case, the bank might want to structure its proposal to encompass a range of contemplated investment activities that would meet regulatory standards and conditions. OCC encourages banks to write their CDC charters broadly enough to ensure flexibility to engage in a range of activities. However, a bank that broadens its CDC activities beyond those identified in the initial charter may amend the charter, provided that it is consistent with the requirements of Part 24.
Although OCC has no limitations on the geographic scope of a bank CDC’s activities, this question should be considered carefully during the planning process. A bank may contemplate making community development investments in only one neighborhood or community, but find that its CDC’s activities lend themselves to replication in other communities or states, or making services available to affiliate institutions. In that case the bank must ensure that appropriate financial and staffing commitments to the CDC are in place or available.
Part 24 requires bank subsidiary CDCs to operate in a manner that does not expose the bank to liability beyond the amount of the bank’s investment in the CDC. The most common structure that banks have chosen for CDCs is as a separately chartered subsidiary corporation.
With that kind of arrangement, the bank owns the stock of the subsidiary corporation. Owning shares of stock generally gives the right to exercise some control over the corporation’s management, to share in its earnings, and to share in any residual proceeds from the liquidation of assets upon the corporation’s dissolution.
Such a corporation would be chartered through the secretary of state in the CDC’s home state. OCC does not have a standard or “model” CDC charter or articles of incorporation, but most states do, usually available on the Secretary of State’s or Department of Corporations’ Web sites.
Some bank CDCs have chosen to make the “purpose” section of the articles of incorporation very broad, authorizing the CDC to “engage in public welfare activities consistent with 12 USC 24 (Eleventh)” Other banks have adopted narrower language, specifically identifying the community development activities in which the CDC intends to engage (typically drawing from the list of public welfare investment activities in Part 24).
A bank forming a subsidiary CDC should ensure that the CDC maintains a separate corporate identity to protect the bank from the CDC’s debts and liabilities. Failure to do so could expose the bank to litigation. How a bank goes about maintaining separate corporate identities is to some extent determined by state law and the general nature of subsidiary operations. However, certain organizational elements and operating procedures are generally recognized as preserving corporate separateness in the absence of other factors, such as fraudulent purpose on the part of the parent.
Factors that determine the presence or absence of separateness include corporate procedures, financing, business purpose, and disclosure of information. Specific steps to establish and maintain separateness include:
• Maintaining a separate office for the subsidiary’s business.
OCC’s Handbook on Related Organizations (http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/pub-ch-related-orgs.html) contains additional information about the various factors considered by the courts when deciding whether to hold a parent institution liable for the debts of a subsidiary.
There is no single best way to structure a CDC. One important consideration for national banks that are part of a holding company is deciding whether the bank or holding company will own a controlling interest in the CDC. The chart options for structuring a CDC lists some key points for a bank to consider regarding this choice.
The amount of investment capital to commit to a CDC will vary with the nature of the community needs the availability of other resources and partners, the objectives of the parent financial institution, and any limitations imposed by regulatory agencies.
From a regulatory standpoint, the most important objective is that capitalization should be appropriate, both in terms of equity and debt, to the activities being undertaken by the CDC. A CDC can begin with a modest amount of equity capital, which may grow over time as new project opportunities arise.
Bank CDCs may provide debt financing along with equity investments for community development projects. The anticipated maximum amounts, funding options, and structure of such debt financing should be assessed when planning a community development investment program. Examples of debt financing include direct loans to the CDC, purchase of debt securities issued by the CDC or entity, issuance of lines of credit to the CDC, or participation in loans made by the CDC.
As a general rule a bank may invest up to 10 percent of capital and surplus in investments under Part 24, including any investments in its CDC. A bank investing up to 5 percent of capital and surplus in Part 24 investments may do so without prior OCC approval (although the bank is required to notify OCC of the investments as provided under 12 CFR 24.5). Above the 5-percent threshold, prior OCC approval is required.
Given the complexities of the community development investment process, banks and bank holding companies must ensure that CDCs and CDC investments receive effective management and oversight. A bank establishing a CDC should be particularly attentive to the need to match management and staff experience and expertise with the types of activities to be undertaken by the CDC.
For example, a CDC focusing on the purchase, rehabilitation, and resale of affordable housing should have, at the staff and board levels, persons with appropriate, in-depth experience in real estate development and real estate financing. Similarly, CDCs that focus on venture capital investments in small and minority businesses should have staff and board members able to assess the prospects and performance of small businesses, structure appropriate financing packages, and effectively monitor the progress of the businesses assisted. Most CDCs also make use of an investment or loan advisory committee typically of bank officers and other real estate development experts.
A bank can receive profit distributions or dividends from a subsidiary CDC, and OCC places no limits on either the amounts or timing of profits generated from a bank’s CDC activity. The CDC’s profits may also be reinvested, subject to the dollar and percent-of-capital-and-surplus limitations established in the bank’s previous CD-1 filings. Banks should be careful to ensure that when a CDC reinvests its earnings, it does not cause the bank’s investment in the CDC to exceed the statutory 10-percent-of-capital-and-surplus limitation.
OCC does not require national banks to adopt any particular strategy or engage in any specific forms of community involvement as a prerequisite to making community development investments. Long experience with community development suggests, however, that the prospects for success are greatly improved when, starting with the early stages of the planning process, a bank works closely with those most likely to be affected by its CDC’s activities — thereby improving the prospects for responding to genuine community needs and effectively leveraging community resources.
Community development requires the active and ongoing participation of a variety of public and private organizations and people. Efforts to help meet the housing and employment needs of low- and moderate-income persons and economically distressed communities should be based on effective community involvement at each stage of the planning and financing process. Depending on the nature and location of a project, those involved might include neighborhood development organizations, community advocacy groups, local government officials and agencies, small businesses, merchants’ associations, and other business organizations. Active consultation with affected parties can help identify worthwhile projects; establish cooperative working relationships with public agencies, development groups, and potential investors; and successfully market completed projects to those most in need.
Some bank CDCs have established community advisory committees. Others rely on community outreach mechanisms already established by their parent institution. Community representation on the board of directors of a bank CDC can be helpful in maintaining close ties with the community and in resolving contentious issues that may arise in the course of an investment or project.
This guide highlights several bank-CDC success stories. Some involve the revitalization of whole inner-city neighborhoods that not so long ago would have been described as “blighted.” Others have improved the stock of affordable housing in small communities where even the construction of a single home is big news.
The moral is that there’s no one “right” way to do the work of community development. Some of the biggest banks in the United States are doing exemplary work, but so are some of the smallest. The key ingredient, available to all banks regardless of size, is a commitment to the community that the bank serves: all of the community, and all of the people within it.
There’s more at stake than meeting the goals of the Community Reinvestment Act. At its core, the CDC concept recognizes that in the long run, a bank succeeds only when it earns, and keeps, the support of the entire community. That’s a concept as old as banking — and as new as the next neighborhood revitalization project.