CRA Modernization Goes Back to the Drawing Board

Bankers value certainty and consistency when it comes to regulation, but the Community Reinvestment Act currently offers neither.

In May 2020, the Office of the Comptroller of the Currency issued a controversial revision of the decades-old law. The rewrite stirred up a hornet’s nest of controversy not just because of the changes themselves — some of which were long overdue and well received — but because the agency acted on its own after it was unable to reach an agreement with the Federal Reserve and the Federal Deposit Insurance Corp. The OCC’s decision was also significant because national banks account for approximately 70% of all CRA activity, according to the agency.

“I think not having all the regulators on the same page creates a lot of confusion in the industry,” says Michael Marshall, director of regulatory and legal affairs at the Independent Community Bankers of America.

The CRA, which was enacted in 1977 and applies to all federally insured banks and thrifts, was intended to require financial institutions to help meet the credit needs of the communities where they also raised their deposits. However, under the banking industry’s trifurcated federal regulatory system, compliance is monitored by three different agencies – the OCC for national banks, the Fed for state-chartered banks that are members of the Federal Reserve System, and the FDIC for state-chartered, nonmember banks.

Normally, the feds want one rule that applies to all banks regardless of their regulator. The FDIC initially joined the OCC in the CRA overhaul, but FDIC Chair Jelena McWilliams announced in May 2020 that the agency was not ready to finalize the revisions, intimating that she felt banks were too busy dealing with the impact of the pandemic on their borrowers to implement the new rule. The Fed, for its part, had already bowed out of a joint rulemaking process over a disagreement with the approach taken by the other two agencies. In September 2020, the Fed announced its own Advance Notice of Proposed Rulemaking (ANPR) to modernize the CRA and invited public comment on how to accomplish that.

The OCC’s decision to go it alone means there are now two CRA laws in effect — the agency’s revision rule for banks with a national charter and the previous rule for everyone else. Unfortunately, the confusion surrounding the CRA doesn’t end there.

The OCC’s revision was promulgated under former Comptroller of the Currency Joseph Otting, who was appointed by former President Donald Trump. Otting unexpectedly resigned as comptroller shortly after the agency’s CRA rule changes went into effect in May of last year, even though he was only halfway through his five-year term. The agency is now being run by Acting Comptroller Michael Hsu, a former Fed official who was appointed by the Biden Administration.

In July, the OCC announced that it would rescind the CRA revision developed under Otting — even though some parts of the new framework are already in effect, and national banks had already begun to comply with them. In the OCC’s announcement, Hsu said the “disproportionate impacts of the pandemic on low and moderate income communities,” along with comments that had already been provided to the Federal Reserve under its ANPR process and the OCC’s own experience implementing the 2020 revision, convinced him of the need to start over.

While the OCC deserves credit for taking action to modernize the CRA through adoption of the 2020 rule, upon review I believe it was a false start,” Hsu said in a statement. “This is why we will propose rescinding it and facilitating an orderly transition to a new rule.” Hsu also indicated the OCC would work closely with the Fed and FDIC in a joint rulemaking process, which would in effect piggyback off the Fed’s separate rulemaking process that began last September.

One of the biggest complaints about the CRA is that it was written in an era when deposit-gathering activities were almost exclusively branch-based. The industry’s digital transformation in recent years enables institutions — including large banks with national or multi-regional footprints as well as newer, digital-only banks — to raise deposits from anywhere in the country.

“When we thought of banks [in 1977], we thought of big buildings and pillars,” says John Geiringer, a partner and the regulatory section leader in the financial institutions group at Barack Ferrazzano Kirschbaum & Nagelberg. “Now, between our phones and smart watches, each of us is effectively a walking bank branch.”

Geiringer says the regulators are well aware that digital transformation puts traditional, branch-based banks at a disadvantage when it comes to CRA compliance. “I think there is the recognition in the regulatory community that to the extent that fintechs are encroaching upon the business of banking, they should be held to comparable standards,” he says. “There should be one level playing field.”

There was also a degree of ambiguity in the original law about what kinds of activities qualified for CRA consideration, and there could be variations between different examiners and agencies. One welcomed aspect of the OCC’s revised rule is a non-exhaustive, illustrative list of example activities that would qualify for credit. “Before, you had to call somebody,” says Geiringer, who referred to this as “the secret law of CRA.” With its revision, the OCC under Otting tried to provide more clarity around the issue of qualifying activities.

The OCC rule also imposed new data collection requirements that the ICBA’s Marshall says are of concern to smaller banks. But overall, the OCC’s CRA rewrite seemed to be an honest attempt to modernize a law that badly needed it.

So, what happens now?

I think the interagency process is going to continue moving forward, but in a slightly different direction in light of the fact that we now have the Biden Administration in power,” Geiringer says. “We have seen issuances from both the Biden Administration and others calling for more of an inclination toward the unbanked and the underbanked, and similarly … low- and moderate-income areas.”

A permanent comptroller, once one has been installed at the OCC, could pursue a progressive agenda that goes beyond just modernization. Another scenario that could potential impact any CRA reform initiative is the fate of Fed Chair Jerome Powell, whose term ends in February 2022. Powell is a middle-of-the-road Republican who might be expected to have a moderating influence on CRA reform. Should Powell be replaced by a Democrat who leans more to the left on economic policy matters, that could steer CRA reform in a more progressive direction.

Equally unclear is how long a joint rulemaking process — if indeed the three federal agencies commit to that — will take. A unified revision probably won’t be issued until 2022 at the earliest. In the meantime, the industry is left with no clear sense of what that new rule might look like.

The Year Ahead in Banking Regulation

Although it is difficult to predict whether Congress or the federal banking agencies would be willing to address in a meaningful way any banking issues in an election year, the following are some of the areas to watch for in 2020.

Community Reinvestment Act. The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. issued a proposed rule in December 2019 to revise and modernize the Community Reinvestment Act. The rule would change what qualifies for CRA credit, what areas count for CRA purposes, how to measure CRA activity and how to report CRA data. While the analysis of the practical impact on stakeholders is ongoing and could require consideration of facts and circumstances of individual institutions, the proposed rule may warrant particular attention from two groups of stakeholders as it becomes finalized: small banks and de novo applicants.

First, for national and state nonmember banks under $500 million, the proposed rule offers the option of staying with the current CRA regime or opting into the new one. The Federal Reserve Board did not join the OCC and the FDIC in the proposed rule, so CRA changes would not affect state member banks as proposed. As small banks weigh the costs and benefits of opting in, the calculus may be further complicated by political factors beyond the four corners of the rule itself.

Second, a number of changes in the proposed rule could impact deposit insurance applicants seeking de novo bank or ILC charters, including those related to assessment areas and strategic plans.

Brokered Deposits. The FDIC issued a proposed rule in December 2019 to revise brokered deposits regulations. While the proposed rule does not represent a wholesale revamp of the regulatory framework for brokered deposits — which would likely require statutory changes — some of the changes could expand the primary purpose exception in the definition of deposit broker and establish an administrative process for obtaining FDIC determination that the primary purpose exception applies in a particular case. Also, the new administrative process could offer clarity to banks that are unsure about whether to classify certain deposits as brokered.

LIBOR Transition. The London Interbank Offered Rate, a reference rate used throughout the financial system that proved vulnerable to manipulation, may no longer be available after 2021. The U.K.’s Financial Conduct Authority announced in 2017 its intention to no longer compel panel banks to contribute to the determination of LIBOR beyond 2021. In the U.S., the Financial Stability Oversight Council has flagged LIBOR as an issue in its annual Congressional report every year since 2012. Its members stepped up their rhetoric in 2019 to pressure the financial services industry to prepare for transition away from LIBOR to a new reference rate, one of which is the Secured Overnight Financing Rate, or SOFR, that was selected by the Alternative Reference Rates Committee.

For banks in 2020, it is likely that federal bank examiners, whose agency heads are all members of the FSOC, will increasingly incorporate LIBOR preparedness into exams if they have not done so already. In addition, regulators in New York are requiring submission of LIBOR transition plans by March 23, 2020.

The scope of work to effectuate a smooth transition could be significant, depending on the size and complexity of an institution. It ranges from an accurate inventory of all contracts that reference LIBOR to devising a plan and adopting fallback language for different types of obligations (such as bilateral loans, syndicated loans, floating rate notes, derivatives and retail products), not to mention developing strategies to mitigate litigation risk. Despite some concerns about the suitability of SOFR as a LIBOR replacement, including a possible need for a credit spread adjustment as well as developing a term SOFR, which is in progress, LIBOR transition will be an area of regulatory focus in 2020.

Doing an Acquisition? Don’t Forget the CRA Rating


bank-ratings-9-2-15.pngAs we move further away from the recent economic crisis, an increasing number of financial institutions are considering becoming buyers or sellers. It is therefore important that potential acquirers position themselves to be attractive suitors, and sellers demonstrate that they are healthy candidates. Although much of this focus is directed toward an institution’s overall safety and soundness and numerous other factors, one issue that should not be overlooked is its record of meeting the credit needs of its local communities when measured against the requirements of the Community Reinvestment Act.

CRA Primary Factors
There are two relevant factors related to CRA. First, an acquiring institution’s CRA rating can dictate whether a potential deal will receive regulatory approval. Depending on the severity, a potential acquirer with a less than “satisfactory” rating, or even one with more narrow weaknesses in its CRA program, will find it difficult if not impossible to obtain regulatory approval for any transaction until it improves its rating and its internal CRA program. Also, the CRA condition of the seller is significant, and the buyer should determine how that will impact the bank after consummation.

Even an institution with an “outstanding” CRA rating can still face difficulties executing a transaction. The CRA allows individuals and community groups to take an active part in the regulatory application and approval process of a transaction by providing a mechanism for the submission of public comments regarding any perceived CRA compliance weakness or criticism of a party to the transaction. Because the CRA rating is publicly reported, unlike the institution’s other confidential examination ratings, this becomes an easy target. By taking advantage of the publicly available data concerning financial institutions, including CRA ratings, groups located far outside the acquirer’s market area can file comment letters that pass the very low threshold set by regulators to entertain these protests. In some cases, these activist groups have been able to extract significant commitments from acquirers just to get deals done.

Regulatory Approval Process
Most often, these public comments do not, in and of themselves, prevent an otherwise viable transaction from occurring. They can, however, significantly slow down a pending transaction. Under current procedures, written public comments are included as part of the record that the federal agencies review in the evaluation of an application for a transaction. In connection with these public comments, the regulators may make several requests for additional information before ultimately determining whether those public comments will impact their approval of the proposal. This process can take several months, and can even drag on for significantly longer. From deal uncertainty, to the potential that key talent will leave in the wake of a long transition, to the potential for major shifts in the market or rapid economic change, delaying the closing of a transaction while this process unfolds can be quite costly and damaging for the parties involved.

The importance of the CRA comment process to banking M&A has existed for decades, although historically, it generally has been confined to transactions involving very large financial institutions, such as the recent CIT Group-OneWest Bank acquisition. With the current paucity of larger bank transactions, smaller deals are attracting more public scrutiny and suffering significant delays of, in some cases, many months. Discussions and negotiations with the regulators on this issue may be difficult and frustrating. If CRA comments are submitted to regulators for a particular transaction, it is important to quickly develop with legal counsel a clear strategy to address and resolve any issues that have been raised.

Practical Takeaways
To mitigate the CRA risk in M&A transactions, the following are some strategies that an organization should consider, either as a buyer or a seller:

  • Continue to develop a strong CRA program and strategy.
  • Proactively develop or deepen relationships with local community groups.
  • Be extremely careful and consult with legal counsel when deciding whether and how to respond to broad “informational” questionnaires from community groups.
  • Engage with banking regulators early in the transaction process regarding each party’s CRA status, strengths and potential challenges.
  • In the transaction agreement, consider specifically providing for community-based outreach or support programs following the transaction.
  • Provide clear evidence of community support by both parties, pre- and post-transaction, in the deal announcement.
  • Take all protests seriously, and be cognizant that all communication and information may become public.

CRA Comes to Life

WK-CRA-WhitePaper.pngExecutive Summary

The Community Reinvestment Act (CRA) requires that every insured depository institution meet the needs of its entire community. It also requires the periodic evaluation of depository institutions’ records in helping meet the credit needs of their communities. Proactively monitoring CRA performance is important for several reasons. The record is taken into account when considering an institution’s application for deposit facilities, meaning it will directly impact any contemplated acquisitions and/or branch openings. Additionally, the record will be regularly examined by the federal agencies that are responsible for supervising depository institutions and a rating will be assigned. Since the results of the exam and the rating are available to the public—customers, competitors and community groups—an institution’s CRA performance can impact its reputation. Banks must understand the characteristics of their assessment area and regularly monitor their performance to ensure the equal credit extension throughout their entire customer base.

This paper will explain the purpose and requirements of CRA and how as a board member, you can provide oversight regarding your institution’s CRA obligation.