Community Investments
Volume 10; No. 3; Summer 1998
Qualified Investments
How to Make Investing in Your Communities Really Count!
By Cynthia Burnett, Community Investment Specialist, Federal Reserve
Bank of San Francisco
Editor’s Note: Since the implementation of the new Community Reivestment
Act (CRA) regulation, bankers have expressed concern about their ability
to find qualified investments. Beyond finding them, bankers worry that
examiners won’t recognize their investment as qualified under the new
CRA. For some banks, the issue of defining qualified investments remains
elusive and has too many gray areas. For others who have a firm grasp
on the regulatory definition, many still face the problem of finding deals
in which their banks want to invest. Several savvy bankers have resorted
to creating their own investment initiatives which address the unique
needs of their communities and ensure strong performance under the investment
test (some of which will be highlighted in future issues in Community
Investments). Community Affairs staff often recommend that banks read
CRA public evaluations of similarly situated financial institutions to
understand what other banks are doing to comply with the CRA. Specifically
for qualified investments, the public evaluations provide insight into
what banks are investing in and what level of CRA consideration they are
receiving. Recently, Community Affairs staff reviewed a total of 45 public
evaluations and strategic plans from the 12th District from the four regulatory
agencies and compiled a list of the types of investments banks are making.
To keep things in context, the list also includes asset size, investment
test rating and overall CRA rating. The document was first distributed
at the American Bankers Association’s National Compliance Conference in
San Diego in May 1998. Since then, many bankers and community groups who
reviewed the document have called with technical questions about what
qualifies as an investment under the CRA. The following article sets out
to answer these questions by reiterating the regulatory definition of
qualified investments and highlighting the process that examiners use
to determine whether an investment will receive CRA consideration.
Investing in disenfranchised communities can infuse life back into decaying
neighborhoods. Through redevelopment bonds, loan pool certificates, equity
investments in local community banks, and grants to local nonprofits,
bank investors can reap social benefits, earn returns on their investments,
and meet their CRA goals. But meeting CRA goals implies an understanding
of what qualifies as an investment. To gain that understanding, consider
the background information examiners use to identify and rate qualified
investments.
Identifying Qualified Investments
When determining investments, examiners look at four broad categories
of investments including lawful investments, membership shares, deposits,
and grants. Within these categories, investments are evaluated by considering
their purpose and geography.
Purpose
Qualified investments must have community development as their
primary purpose, which means invested funds must be used for any one of
the following:
- Affordable housing for low- and moderate-income (LMI) persons;
- Community services targeted to LMI persons;
- Promoting economic development
1
by financing small businesses or farms;2
or,
- Revitalizing or stabilizing LMI areas.
3
If a majority of the dollars or beneficiaries of an investment falls
into one of the above categories, then the “express purpose” of an investment
is considered to be community development. If there is no clear majority,
examiners determine if an investment meets any one of the following criteria:
- The express “bona fide” intent of the investment is for community
development;
- The investment is specifically structured to achieve the express community
development purpose; or,
- It is reasonably certain that the investment will accomplish the stated
community development purpose.
Keep in mind that it is each institution’s responsibility to demonstrate
that an investment is a lawful investment, deposit, membership share,
or grant that has community development as its primary purpose.
Once the primary purpose is established, examiners assess the degree
of innovation and complexity of investments. To do this, examiners rely
on qualitative information, such as comparing qualified investments to
typical investments in an institution’s portfolio and to types of investments
made by an institution’s peers. Most importantly, examiners look at what
types of investments are most common in a bank’s assessment area.
Geography
When evaluating potential qualified investments, examiners also determine
if an institution’s assessment area benefits from these investments. A
qualified investment must benefit an institution’s assessment area(s)
or a broader statewide or regional area inclusive of the assessment area.
According to the CRA, “the fundamental determination that an examiner
must make in regard to an investment is the extent to which it contributes
to a bank’s overall record of helping to meet the credit needs in its
assessment area.”4
To ensure that an investment meets the geographic criterion, examiners
consider the following:
- Who benefits from the investment;
- Whether the investment responds to credit and community development
needs; and,
- Whether private investors routinely provide this type of investment,
and if there are any other unmet investment needs in an assessment area.
Rating Qualified Investments
Examiners assess total qualified investment level in comparison to an
institution’s total investment portfolio; percentage ratios of previous
examinations are often compared to ratios for current examinations to
assess percentage increases or decreases over time.
Banks must receive at least a “low satisfactory” on the lending test
to achieve a “satisfactory” or better composite rating. Institutions with
“high satisfactory” ratings in the lending test can effectively raise
their assigned composite CRA rating to “outstanding” with a “high satisfactory”
or “outstanding” rating in the investment test, depending on the service
test score.
Institutions may receive favorable CRA credit under both the lending
and investment test for a single qualified investment. For example, institutions
that make qualified investments in third party community development organizations
that, in turn, use the investments to make community development loans
can receive favorable consideration under both the investment and lending
tests for their pro-rata share of the loans made by the third party.
Conclusion
This article offers some basic information on identifying and developing
qualified investments. A successful strategy should address the credit
needs in an institution’s assessment area in a manner that is integrated
with and integral to the institution’s overarching investment plan. CI
TEN MOST COMMON QUALIFIED INVESTMENTS
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JULY ’97oMARCH ’98
This list of qualified investments is presented in the order of
frequency from the most (1)to the least (10)frequently reported
investments for which institutions have received CRA consideration.
1. Grants to nonprofit organizations providing services to low-and
moderate- income people and communities
2. Grants to nonprofit affordable housing developers
3. Donations to charitable organizations,specifically involved
in education, health care,nutrition,and welfare-to-work programs
for low-and moderate- income people and communities
4. Purchases of housing finance bonds targeted to low-and moderate-income
communities
5. Purchases of low-income housing tax credits
6. Purchases of certificates of deposit and equity investments
in community development banks and community development credit
unions
7. Investments in community development corporations
8. Purchases of municipal redevelopment bonds targeted to low-and
moderate- income communities
9. Investments in other community development financial institutions
10. Purchases of multifamily affordable housing revenue bonds
Community Affairs staff prepared a list of all qualified investments
that had received CRA consideration from July 1,1997 through March
15,1998. Data was gathered from completed performance valuations
from all four regulatory agencies.These performance valuations were
based on data from large financial institutions, small financial
institutions that had opted to have investments reviewed, and limited
purpose and wholesale banks, all located within the Federal Reserve’s
Twelfth District. All strategic plans were also included.
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1 Economic development is promoted if the activity
supports permanent job creation, retention, and/or improvement for persons
who are currently LMI, or in LMI geographies targeted for redevelopment
by the federal, state, local, or tribal government.
2 The CRA regulation defines small businesses and
farms as those with gross annual revenues of $1 million or less. The regulation
also recognizes the Small Business Administration’s and Small Business
Investment Company program’s definition of small businesses as legitimate,
although different, for the purpose of determining CRA credit. See publication,
Federal Register/Vol. 62, No. 193/October 6, 1997.
3 Community development activities that revitalize
or stabilize LMI areas include community or tribal-based child care, educational,
health, or social services targeted to LMI persons.
4 Interagency Interpretation Letter dated June
26, 1995.
About the Author
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Cynthia Burnett
is a community affairs specialist at the Federal Reserve Bank
of San Francisco, which she joined in 1997. Her work focuses on
issues of welfare reform, specifically, welfare-to-work and regional
job creation initiatives related to the Community Reinvestment
Act. She is currently researching local and national asset accumulation
models for low-income families. Prior to joining the Bank, Ms.
Burnett served ten years in the management of nonprofit affordable
housing, and health and human service organizations in Sacramento
and the San Francisco Bay Area. She holds a bachel | |
