Volume 8; No. 3; Summer 1996
Small Banks Respond: How We Prepared and Fared Under the New CRA Exam
Many small financial institutions have been examined under new CRA rules
that became effective in early 1996. The following is a report from two
of those institutions, Cache Valley Bank (Logan, Utah) and Mid-Peninsula
Bank (Palo Alto, California). The Fed's roving CRA reporter, Shawn
Elliott, asked the two banks how they prepared for those examinations
and whether the preparation was useful. We would like to thank Dennis
Durfee, Vice President and Compliance Officer of Cache Valley Bank and
Susan Black, Executive Vice President and CRA Officer of Mid-Peninsula
Bank for their candid responses to our questions. Also included is commentary
by Gilberto Cooper and Millie Castillo, examiners-in-charge of the CRA/consumer
compliance examinations for those institutions.
Hundreds of small banks have yet to be examined under the new regulation.
If your bank is one of them, read on... we think you'll find the honest
opinions and examination preparation tips most helpful.
Q. In preparing the performance context for your institution, examiners
looked at peer group data. Did bank management define the banks peer group?
If not, why not? If so, did management include credit unions and finance
companies in the peer group? Did management share peer group information
with the examiners? If so, was this a helpful exercise?
Cache Valley Bank: Management compiled two
different peer group comparisons in preparation for the bank's safety
and soundness examination. The first comparison was taken from the Uniform
Bank Performance Report (UBPR) and the second was comprised of information
from three local financial institutions, including a credit union. During
the compliance examination, the analysis was reviewed by examiners; we
are unsure what benefit this analysis provided to the compliance examination
Cache Valley Examiner: As part of the pre-examination
preparation, the financial data of similarly situated banks was reviewed
to help develop the performance context for the bank's CRA examination.
This peer review included banks of similar asset size, structure, and
with similar market characteristics. Cache Valley Bank management had
performed a similar review using banks located in Utah. Discussion with
management regarding the results of its peer analysis and management's
insights regarding the local banking market (i.e., market concentrations
and niches, competition for deposits) was helpful to our staff in developing
the context within which the bank operates.
Mid-Peninsula Bank: Mid-Peninsula Bank defines
its peer group as commercial banks located in the Bay Area with a focus
on business banking. The peer group does not include finance companies
and credit unions. Management tracks and compares the banks performance
to that of the peer group; these comparisons were not discussed with the
examiners. Examiners used a broader approach and identified a state-wide
peer group utilizing the UBPR.
Mid-Peninsula Examiner: As part of the pre-examination
procedures, the UBPR was reviewed to gauge the bank's performance against
its peers. To develop the bank's performance context accurately, we also
reviewed other financial data produced by the Fed; this data was more
relevant since it included local banks that are similarly situated based
on asset size, location and number of branches.
Q. What factors did management consider when developing the banks
assessment area? Although not required, did the bank conduct any kind
of geographic analysis of loan distribution in its efforts to define its
assessment area? If so, were a majority of those loans located within
the anticipated assessment area?
Cache Valley Bank: In establishing the assessment
area, the bank has historically determined the geographic area that we
can logically expect to serve based on customer convenience. Over the
past several compliance examinations, examiners have questioned the bank's
ability to serve some of the outlying areas included in our delineation,
and, as a result, the bank has "pulled in" its boundaries. During
the most recent compliance examination, however, the assessment area was
not questioned and management was not obliged to make any adjustments.
Bank management used a zip code listing of loans to analyze
loan location and determined that 92% of our loans were made within the
Assessment Area. This analysis was informal and somewhat rough, as the
system uses mailing addresses, which does not necessarily reflect the
location of the loan. The analysis did give us some confidence that the
proportion of loans made within the assessment area is reasonable.
Cache Valley Examiner: The results of the bank's
analysis were confirmed by the examiners' analysis which was based on
block numbering areas (BNAs) designated by the Census Bureau. BNA information
is often more useful that zip code information because it includes demographic
data such as income, number of households and population size which are
helpful in determining the banks penetration into areas of various income
Mid-Peninsula Bank: The bank's delineated community
was previously defined as those communities within a seven mile radius
of our three offices. To meet the requirements of the new regulation,
which indicates that an institution's assessment area must include whole
census tracts or BNAs, we expanded our service area to include whole census
tracts within each city we serve. The philosophy of Mid-Peninsula Bank
is to serve the businesses in the communities in which we are located.
As a result, the majority of our loans are within close proximity. Geographic
analysis and mapping of the bank's loan portfolio confirmed that over
70% of our loans were within the assessment area.
Q. If loan data were collected and analyzed, did bank management
identify any "conspicuous gaps" in lending patterns? If so,
how were these addressed?
Cache Valley Bank: No analysis of loan data
was conducted prior to the examination. Management was not aware of any
lending gaps that may have existed.
Cache Valley Examiner: Lending gaps were identified
during the examiners' geographic analysis of a statistical sample of the
banks commercial loans, but were later determined to be reasonable. The
examiners' analysis of the sample found that no loans were extended in
the one low-income BNA within the bank's assessment area. Upon review,
however, it was determined that this BNA is sparsely populated and located
in a national forest. Overall, the bank's distribution of loans by BNA
income level was considered reasonable.
Mid-Peninsula Bank: Loan data is collected,
analyzed and mapped semi-annually. The only conspicuous gaps identified
were in areas with limited business lending opportunities (i.e., residential
census tracts, the airport, a correctional facility, a university campus,
etc.). This information was discussed with the examiners and included
in the report of examination. It was very helpful to have identified and
analyzed this information prior to the examination.
Mid-Peninsula Examiner: Bank examiners noted
several conspicuous gaps in reviewing loan data, which resulted in further
research and clarification by bank management. The bank substantiated
the cause of these lending patterns, which were due primarily to the bank's
focus on business lending and justifiable low level of penetration in
Q. What percentage of the banks loans and, as appropriate, other
lending-related activities did management expect to be originated within
the bank's assessment area to reasonably meet standards? Did (or does)
the bank engage in other lending-related activities? Can you provide examples?
Cache Valley Bank: We intend for a high percentage
of loans to be made within the bank's assessment area, and, as a small
community bank, we believe it is necessary to originate loans in the local
market. These loans strengthen the local economy, help create jobs and
strengthen the banks customer base.
Cache Valley Examiner: The examiners' analysis
of the statistical loan sample confirmed that the majority of the bank's
credit extensions were within the banks assessment area.
Mid-Peninsula Bank: The bank attempts to maintain
at least 70% of its loans within the assessment area. A geographic analysis
of our total loan portfolio confirmed that 71% of all loans fall within
this area. We also participate in a loan consortium, Lenders for Community
Development (LCD), and lend through LCD's two loan pools--one for affordable
housing and one for micro-lending to small businesses. Lenders for Community
Development has just expanded its operating area from Santa Clara County
and East Palo Alto to include all of San Mateo County. We believe this
will enhance our ability to provide additional loans within our assessment
area going forward.
Mid-Peninsula Examiner: The examiners' analysis
of the geographic distribution of small business loans indicated that
an exceptional portion of the bank's credit extensions were made within
the assessment area.
Q. Does management believe that the bank's loan-to-deposit ratio
is reasonable? Did bank management advise examiners of other factors such
as sales to the secondary market and/or seasonal fluctuations which have
an impact on the loan-to-deposit ratio? What specific economic data does
the bank regularly receive/collect in this regard?
Cache Valley Bank: Management's goal is to
maintain a loan-to-deposit ratio in the 70%-85% range. Compliance examiners
determined this range to be "satisfactory" while safety and
soundness examiners have argued that the ratio is substantially above
the peer group level. The bank operates in a market that is experiencing
a strong, growing economy. Loan demand has been good, creating a very
competitive deposit market and producing higher than average loan-to-deposit
ratios. Management monitors loan and deposit growth closely. The bank
has not experienced substantial seasonal fluctuations which would impact
the loan-to-deposit ratios; however, loans are routinely sold to the secondary
market out of economic necessity.
Cache Valley Examiner: The examiners' review
of deposit data for Cache County revealed that branch banks have a sizeable
majority of the area's deposits. As a result, smaller banks face stiff
competition for deposits. Accordingly, a contributing factor to Cache
Valley Banks high loan-to-deposit ratio is the tough competition for deposits
within its assessment area.
Mid-Peninsula Bank: The bank's loan-to-deposit
ratio was 64% at the end of 1995, 69% by the end of February 1996 and
averaged 64% over the last two years. While a higher loan-to-deposit ratio
is desirable, management believes the existing ratio is reasonable.
Mid-Peninsula Examiner: Comparison of the bank's
loan-to-deposit ratio to its peers indicated that the ratio is satisfactory.
During discussions with bank management, it was agreed that given the
banks financial capacity, the ratio could be increased.
Q. Did management conduct any analysis of the income level of borrowers
or size of small businesses prior to the bank's CRA examination? If so,
was this analysis useful? How did the banks analysis compare to that of
Cache Valley Bank: The bank has not conducted
an analysis of the income level of borrowers or the revenue size of small
business borrowers. The bank's community is a rural area dominated by
small businesses. According to 1990 census data, all of the bank's assessment
area falls in the low-to-moderate income category with only one part,
a sparsely populated National Forest, designated as low income. During
the compliance examination, and in follow-up correspondence, the examiners
suggested that the bank may want to capture borrower income and business
revenue data for all of our lending activity.
Cache Valley Examiner: While management did
not review the income level of its borrowers, examiners collected information
regarding the revenue size of the bank's business borrowers as represented
by the statistical loan sample. This information was used to determine
the bank's CRA performance in lending to small businesses, defined as
those with annual revenue of less than $1 million. In this regard, the
bank's level of lending to such businesses met the standards for satisfactory
Mid-Peninsula Bank: As a business lender, revenue
is analyzed as part of the credit decision and monitored by an account
officer. The bank has not separately tracked this information for compliance
purposes. The examiners obtained this information directly from credit
files during the course of the examination.
Mid-Peninsula Examiner: During the examination,
examiners collected information on business revenue size, since Mid-Peninsula
Bank is primarily a small business lender. A review and analysis of the
data indicated that the bank's record of lending to businesses of different
sizes was outstanding.
Q. Did management consider pursuing an outstanding rating? What factors
did management use in reaching this decision?
Cache Valley Bank: Management's goal is to
maintain a satisfactory CRA rating. In a small institution, management's
time is critical, and the effort required to reach an outstanding rating
does not always equal the reward. We believe that time and effort spent
on other bank functions pays greater dividends in the day-to-day operation
of the bank. Our philosophy is: "If we take care of our customers
and manage the bank on sound principals, we will, by necessity, serve
the community--and a reasonable CRA rating should follow."
Cache Valley Examiner: A bank's performance
under the CRA must be managed, as must any regulatory aspect of a bank's
operation. Management's CRA strategy should be revisited periodically
to ensure that the needs of both the bank and its assessment area are
being met. In particular, bank management must ensure that given its present
resources, performance with CRA is at its best.
Mid-Peninsula Bank: Mid-Peninsula Bank received
an outstanding rating in the two previous CRA exams. The CRA program is
an integral part of our business plan and we are committed to continuing
this tradition of excellence. Preparing for the examination was challenging
since many areas of the revised regulation appear to be open to interpretation.
To be considered for an outstanding rating, we prepared information regarding
the bank's qualified investments and services which was not required under
the small institution examination procedures. The examiners were very
helpful in providing clarification and suggestions about the revised regulations.
Mid-Peninsula Examiner: Since the bank has
received an outstanding CRA rating for the past two examinations, we were
asked to evaluate the bank's performance with consideration for an outstanding
rating. Under the revised rules, there are two methods by which a bank
can merit outstanding performance. First, the institution must meet the
requirements for a satisfactory rating under the five performance criteria
and materially exceed the standards in one or more of the criteria. Second,
at the institution's option, the examiners will evaluate its investments
and services. Consequently, strong performance in investments and services
can potentially raise a "satisfactory" CRA rating to "outstanding."
However, this activity cannot raise a "needs to improve" rating
to a "satisfactory" rating.
Examiners determined that the bank met standards for satisfactory
performance in all five performance criteria, and exceeded standards in
the category of geographic distribution of loans. The bank's investments
and services were then evaluated to ascertain whether an outstanding rating
was warranted. Examiners determined that the bank's investments were innovative
and complex, and that the bank's commitment and dedication to Lenders
for Community Development (LCD) and Community Bank of the Bay (CBB) greatly
enhanced the banks ability to maintain an outstanding rating. Moreover,
management was commended for allocating sufficient resources to ensure
that the local community credit needs were met.