Progress on the CRA Front: New Guidance Could Foster LIHTC Investment by Banks Outside Their Assessment Areas

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The federal Community Reinvestment Act (CRA) was enacted in 1977 in the face of furious opposition from the banking industry. One consequence of that opposition was that the text of the proposed statute was severely whittled down in order to gain passage. All that remained was a charge to federal banking regulators that they ensure that banks, “serve the credit needs of their local communities in a safe and sound manner.” In the absence of any further detail the banking agencies were effectively left to figure out what the statute meant and how to implement its provisions by regulation.

The CRA has been amended several times and hundreds of pages of regulations and interpretative guidance have been issued. Currently, national banks are evaluated by federal banking agency CRA examiners once every three years on their performance in making investments and loans and providing services in their assessment areas. These individual measurements (the investment test, loan test, and services test) determine an institution’s overall CRA performance.

Assessment areas, self-determined based on where the bank maintains its physical branches and takes deposits, must generally consist of one or more metropolitan statistical areas or one or more contiguous political subdivisions.

The Influence of Geography

The investment test has been a tremendous boon to the low-income housing tax credit (LIHTC) industry since LIHTC projects are automatically considered to be qualified community development investments. Banks motivated to comply with the CRA’s investment test have become the lifeblood of the LIHTC equity market. However, the administration of this test has proven challenging in several respects. Perhaps most challenging is the question of assessment area geography. In recent years, the location of bank deposits has become an increasingly important determinant of where banks must make their equity investments. As a recent CohnReznick report documents (The Community Reinvestment Act and Its Effect on Housing Tax Credit Pricing), CRA capital for LIHTC developments is much more expensive in major urban markets where bank deposits are highly concentrated. One consequence has been the evolution of a two-tier capital market with highly different pricing based on whether a LIHTC project is located in a “CRA hot” or a “CRA not” area. Housing credit projects typically command much higher credit pricing if they are located in the hottest CRA markets such as New York City and San Francisco.

In recent years there has been an increasing drumbeat in the calls for reforming the CRA regulations particularly as they relate to how assessment areas are determined. The federal banking agencies mounted a CRA reform effort several years ago and published new proposed interpretative guidance – in question-and-answer format – in March 2013. More than 200 organizations submitted comments. As a result of these comments, the banking agencies incorporated some changes in the final version of the guidance published in the Federal Register on November 20. (View at http://tinyurl.com/p8tjy7b)

The most important change potentially relates to how banks are given credit or “positive consideration” under the investment test for their LIHTC investments.

 

The Prior and New Guidance

Under the prior guidance, a bank could make a LIHTC investment outside of one of its assessment areas if the project was located within a “broader statewide or regional area that included its assessment area.” In theory at least, this meant that banks could invest outside their strictly-defined assessment areas and still get full investment test credit. Unfortunately that provision came with a significant limitation. In order to claim credit for a project located within a broader statewide or regional area but outside of its CRA “footprint,” a bank first had to demonstrate that it had adequately addressed the community development needs of its assessment area or areas. Since the phrase “adequately addressed” was not defined, there was no way for bank executives to be certain that their CRA examiner would agree that the bank had adequately addressed those needs. As a result, the broader statewide or regional area exception had little to no practical value. Criticism of that limitation figured prominently in many of the comments submitted to the regulators.

The final guidance now reads, in part, “…examiners will consider [community development activities in broader statewide or regional areas] even if they will not benefit the institution’s assessment area, as long as the institution has been responsive to community development needs and opportunities in its assessment area.”

The new test still has a limiting condition, so it will remain to be seen whether banks embrace the notion of investing outside of their assessment areas. We believe that if a bank, when considering tax credit opportunities within its assessment areas, determines that either (a) there simply are none available, or (b) that there is more than sufficient capital competing to invest in the eligible projects within its assessment areas, it will have the option of investing in LIHTC projects in other areas within the same state or the same region. Thus a bank whose CRA footprint is the five boroughs of New York City that has tried but been unable to find a local LIHTC project (or at least not without paying a huge premium) should now be able to invest in a project in upstate New York without fear of having the investment disallowed as eligible for positive consideration under the CRA. This should allow projects not located in the largest metro areas to attract capital at higher credit pricing than currently. While this is unlikely to reduce credit pricing in CRA hot markets, it may take some of the pressure off banks to bid up the price of housing credits for projects within their footprint. It will now be incumbent on the federal banking regulators to revise their training of CRA examiners, ideally on a uniform basis, for this change to have full effect.

Matt Barcello and Fred Copeman are part of CohnReznick’s Tax Credit Investment Services practice, which focuses on providing due diligence and other advisory services to institutional investors in tax credit projects. Copeman may be reached at 617-648-1411, fred.copeman@cohnreznick.com.