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Cascade: No. 74, Spring/Summer 2010

Bankers Explain Constraints on CRA Lending and Investing

Editor’s note: Earlier this year, three bankers spoke about investment and lending constraints affecting Community Reinvestment Act-related lending and investing at a Philadelphia Fed Community Affairs Department event in Delaware. The following is a summary of their remarks.

The bankers — Dudley Benoit, senior vice president, intermediaries lending, JPMorgan Chase Bank, New York, NY; Michael Skipper, vice president and community development manager, WSFS Bank, Wilmington, DE; and Paul Marcus, vice president, commercial real estate, Citizens Bank of Pennsylvania, Philadelphia — said that weakness in the real estate market, tighter bank lending standards, and declining availability of public subsidy dollars for community development are presenting new challenges for bank lending and investing to community development financial institutions (CDFIs) and other nonprofits.

Their remarks had several common themes:

  • Banks are re-examining their risk tolerance for all loans, including Community Reinvestment Act (CRA)-related loans and investments, and have an increased emphasis on profitability and credit quality. They are much less willing to make loans on a concessionary basis and are shifting from a transactional focus to a relationship focus.
  • CDFIs are experiencing growing demand for credit and technical assistance and declining funding from banks; therefore, they will need new sources of equity and loans to continue their current levels of lending.
  • Banks seek CDFI/nonprofit customers that have a good management capacity and track record and that have opportunities for profitable business.

WSFS Bank in partnership with Barclays Bank Delaware in Wilmington provided construction financing for the conversion of a commercial building in downtown Wilmington into 16 efficiency apartments. The developer was Connections Community Support Programs, Inc. The Delaware State Housing Authority provided construction and permanent financing and an allocation of low-income housing tax credits.WSFS Bank in partnership with Barclays Bank Delaware in Wilmington provided construction financing for the conversion of a commercial building in downtown Wilmington into 16 efficiency apartments. The developer was Connections Community Support Programs, Inc. The Delaware State Housing Authority provided construction and permanent financing and an allocation of low-income housing tax credits.

Some of the highlights of their respective comments follow.

Dudley Benoit

CDFIs have been key drivers of community revitalization at the community level because they can reach underserved markets, demonstrate innovation in products and services that effectively meet the needs of low- and moderate-income (LMI) individuals and communities, and respond quickly and efficiently to community needs in a way that traditional financial services firms cannot.

The economic downturn and pullbacks by mainstream lenders have increased demands on CDFIs to provide credit and services at several levels:

  • The communities they serve are disproportionately affected by hard times.
  • A large proportion of the projects CDFIs finance depend on federal, state, or local subsidies, all of which are severely strained.
  • CDFI borrowers operate with thin equity cushions and few shock absorbers to cushion bad times.

CDFIs have traditionally funded a large portion of their operating activities through earnings, but those earnings have come under pressure as loan losses have risen, deal volumes have declined, and sources of capital for new activities have become more expensive or unavailable altogether. CDFIs will need new forms of capital and investment to ensure that the gains of the past 20 years are not lost.

Financial institutions face the following challenges in financing CDFIs:

  • CDFI Balance Sheet Strength — Most CDFIs borrow on an unsecured basis and have seen significant balance-sheet growth that has outstripped their equity base. Without additional equity, CDFIs will continue to push up against lender-imposed leverage covenants.
  • Size/Scale — The economics of underwriting loans and banks’ CRA goals give financial institutions incentives to make large loans to large CDFIs.
  • Availability of Subsidized Capital — Many financial institutions have rolled their community development businesses into other mainline businesses. This has changed the focus from concessionary lending and investing to profitability and sustainability. Consolidation in the financial services industry has exacerbated this trend.
  • Business Model/Capitalization — Many CDFIs do not have the capital base or business model that allows them to absorb market-rate debt.
  • Increased Scrutiny — While the historical performance of the CDFI industry is exemplary, the recent credit crisis has caused financial institutions to re-examine their risk tolerance for certain CDFI products. Bank investors are looking for more balance in loan types and geographic diversification.
  • Relationship Banking Model — Another result of “mainstreaming” community development at financial institutions is the focus on relationship banking. Fewer community development divisions are lending-only departments.

Michael Skipper

Real estate constraints. There are presently real estate constraints on banks when making CRA loans and investments involving real estate. In housing developments in LMI communities, below-market rents may strain long-term financial viability. Rehabilitation or construction costs typically exceed the price for which a development can be sold. There is less appetite for federal low-income housing tax credits, and gap or subsidy funds from federal and state governments are shrinking. As a result, the public leverage that triggered private investment is also shrinking.

Market condition constraints. Another set of constraints involves current market conditions. In the recent recession, uncertainty has grown about real estate valuations; as a result, banks have tightened loan-to-value (LTV) ratios. Regulatory agency oversight on credit policy has led to risk aversion, tightened credit standards, heightened pressure on return, and reluctance to delegate authority through participation. Small businesses are also struggling with low revenues, job contraction, andproblems in the real estate market. The Small Business Administration has tightened its lending criteria.

Future collaboration between nonprofits and banks. Nonprofit borrowers will need to share the risk of project financing, be more flexible in their requirements, and expect more active bank oversight. There needs to be greater market efficiency in the allocation of banks’ loan and investment dollars to nonprofit borrowers.

Paul Marcus

Weakness in the markets for retail, office, and other types of real estate is having an impact on all bank and real estate lending. There is widespread attention to real estate portfolio quality, capital adequacy, and profitability. As a result of losses on commercial real estate loans, banks are improving their capital position by shrinking their loan asset base or raising capital.

Under current market conditions, the highest quality transactions will get the limited dollars that are available. Some homebuyers find it challenging to obtain mortgage loans. There is a huge availability of existing homes, so financing may be limited for new affordable housing developments.

CRA loans face a “credit hurdle” within financial institutions because the loans as a group have not always been made to the strongest sponsors when compared with well-capitalized for-profit sponsors. Nonprofit borrowers rely on government sources for equity and have little cushion when markets change. CRA lending policy is becoming less flexible and more conservative in debt service, cash equity, LTV ratios, pricing, and loan term. In the present environment, speculative transactions are becoming more uncommon; for-sale units are pre-sold and commercial transactions are pre-leased.

In a world of limited capital, capital will go to a bank’s best customers. There is more emphasis on profitability and, in turn, on credit quality and loan pricing — the pillars of profitability. Banks must balance their ability to increase CRA lending with their need to generate returns.

In the present climate, there is a shift from a transactional focus to a relationship focus. Large banks find it challenging to originate small transactions and are seeking geographic distribution of their CRA investments. Banks cannot be all things to all people and are looking for long-term partnerships.