What Should be Considered in Expanding a Bank’s CRA Assessment Area?

Question.

A small New Jersey bank is considering expanding its assessment area to include a large city in an adjacent county, since it is making a large percentage of its loans there.  Would such an expansion have any negative impacts or if there are any regulatory concerns?

Summary.

The Community Reinvestment Act evaluates a bank’s record in meeting the financial needs of its community, which is to say, within its assessment area. If a small bank makes a majority of its loans outside its CRA assessment area, it will not meet the standards for “Satisfactory” under the lending criterion. In that case, the assessment area should be expanded to cover the areas where it makes a substantial proportion of its loans. If the bank makes most of its loans within its present assessment area, however, the desirability of expanding its assessment area will turn on the effect of the expansion on such factors as the distribution of loans within the assessment area to highly economically disadvantaged areas, low-income individuals, or businesses with gross annual revenues less than $1 million.

ANALYSIS.

Factors to Consider

Under Regulation BB, which gives effect to the Community Reinvestment Act (“CRA”), a small bank is evaluated for CRA performance under a lending test using the following criteria:

• The bank’s loan-to-deposit ratio, adjusted for seasonal variation, and other lending-related activities, such as loan originations for sale to secondary markets, community development loans, or qualified investments.
• The percentage of loans and lending-related activities in the bank’s assessment area.
• The bank’s record of lending to and engaging in other lending-related activities for borrowers of different income levels and businesses of different sizes.
• The geographic distribution of the bank’s loans.
• The bank’s record of taking action, if warranted, in response to written complaints about its performance in helping to meet credit needs in its assessment area. 12 CFR §228.26(b).

The FDIC will take into consideration such factors as the bank’s record of serving the credit needs of highly economically disadvantaged areas in its assessment area, low-income individuals, or businesses with gross annual revenues of $1 million or less. Regulation BB, Appendix A to Part 228.

A “small bank” for CRA purposes is one with $250 million or less in assets as of December 31^st the previous two calendar years.

The bank’s CRA assessment area is the area in which its performance in meeting the credit needs of its community will be evaluated. 12 CFR §228.41. It isn’t the same as the bank’s market or service areas, though it could be. The assessment area is the focus of the bank’s lending and service activities and should demonstrate those activities to best advantage.

The assessment area includes contiguous geographies in which it has its main office, its branches, and its deposit-taking ATMs, but also surrounding geographies in which it has originated or purchased a substantial portion of its loans. 12 CFR §228.41(c)(2). While a number of factors should be considered in the delineation of an assessment area, the loans a bank makes are especially important, especially if the bank has is subject to the small bank performance test

The federal agencies have stated that a bank is not required to make a majority of its loans within its CRA assessment area and that it may still obtain a satisfactory rating in spite of its failure to do so. Lending would simply be one of the criteria considered in the evaluation. Interagency Questions and Answers, §__.26(b)(2)—1, A.1.

Under the small bank lending standards of section 228.26(b) of Regulation BB, however, the FDIC will look to see whether the majority of the bank’s loans are made within its assessment area. If the percentage of loans made in the assessment area is less than a majority, the bank will not meet the standards for “Satisfactory” under this performance criterion. In that case, the FDIC would consider such factors as the bank’s size and financial condition, its branching network, its business strategies, as well as economic conditions and loan demand. FDIC Compliance Manual, January 2014, XI-1.3.

While this analysis may come out in the bank’s favor, it is a very difficult hurdle to cross. If more than half of the bank’s loans are made outside its present assessment area, strong consideration must be given to expanding the assessment area.

Regulation BB does not prescribe a required threshold for community development loans, investments, or services. Instead, the bank may make an assessment of the needs of its assessment area and engage in various activities intended to address those needs. This means, however, that loans made outside the assessment area would not be considered in such a performance evaluation. 12 CFR §228.26(c); Interagency Questions and Answers, §__.26(c)—1, A.1.

In one respect, it doesn’t matter whether the bank makes most of its loans inside or outside of its assessment area. The lending test for small banks includes the loan-to-deposit ratio, and while no specific ratio has been established by regulation or law, federal regulators generally look for 60 percent loans-to-deposits. The loan-to-deposit ratio is calculated in the same manner as for the Uniform Bank Performance Report, by dividing the net loans by the net deposits. Loans will not be segregated as to whether they were made within or outside the bank’s assessment area. For that reason, additional loans will enhance the bank’s performance wherever they are made. 12 CFR 228.26(b); Interagency Questions and Answers, §__.26(b)(1)—3, A.3.

Making a Determination

This brief discussion indicates that determining whether a course of action is desirable from a CRA standpoint requires the balancing of various factors. In doing so, it might be useful to think of CRA compliance as a story the bank must tell to its regulators of the way in which it is helping the people in its assessment area meet their financial needs. If the story is to be persuasive, there must be a compelling narrative with facts and figures to back it up.

In this case, the question the story must answer is whether expansion of the CRA assessment area will enhance the bank’s performance in those aspects valued by CRA.

If the bank makes more than half of its loans outside its present assessment area, the assessment area should be expanded to cover those areas in which it makes a substantial portion of its loans, regardless of any other factors involved. As noted, a bank may still obtain a satisfactory CRA rating even though most of its loans are made outside of its assessment area, but it is very difficult to do so.

If most of the loans made by the bank are within its present assessment area, the bank should consider the following in determining whether the expansion is desirable:

• The effect the proposed expansion will have on the distribution of its loans to low- to moderate-income geographies.
• The effect the proposed expansion will have on the distribution of loans to individuals of different income levels and businesses of different sizes, given the products offered by the bank.
• The effect of the proposed expansion on community development loans.
• The effect of the proposed expansion on loans made to highly economically disadvantaged areas, low-income individuals, or businesses with gross annual revenues of $1 million or less.

Since the bank already makes a substantial proportion of its loans to the area proposed for the expansion, it should be able to develop the information necessary for this comparison.

For example, if the expansion will have the effect of increasing the distribution of loans to low- and moderate-income geographies or to low-income individuals or small businesses within the assessment area, it will be more desirable from a CRA assessment standpoint. It the expansion will have the opposite effect, it will be less desirable.

Any decision the bank makes, however, must be consistent with safe and sound banking practices.

The bank will also need to consider whether the proposed expansion will include contiguous geographies or political subdivisions.

This entry was posted on Friday, July 11th, 2014 at 8:25 pm.