Earlier today, as I was writing this article the news broke about the regulators deciding they intend to rescind the 2023 CRA rule. My first reaction was to toss this article in the “trash” folder. But upon further reflection I realized that the rescission hasn't been approved yet, and the Agencies will need to go through the formal regulatory approval process before making it official.
There will certainly be an outcry by “progressive” legislators and community activists claiming the retraction of the 2023 CRA rule will be a setback for consumers and the small business community. As a former state senator I can tell you that legislators (and regulators too) will appreciate supportive feedback. The public also needs to be educated about why the 2023 CRA was seriously flawed and needed to be rescinded for their interest as well as that of the banking community. So, I encourage bankers to use some of my detailed criticism (in this article and my previous article CLICK HERE to read about the assessment area debacle, as well as my next to be published article which will be about the rule’s unbelievable complexity) of the serious flaws in the new rule as the basis for testimony they may submit during the “Comment Period” when it is published.
In my March 23 article about the 2023 CRA Rule, I focused on the serious flaws in the CRA assessment area delineation requirements, explaining how they can lead to meaningless and even misleading performance ratings. In this article, I will comment on the serious loan data omitted from the “Retail Lending Test”. The elimination of important types of credit needed by the community constitutes another major flaw in the 2023 CRA rule. The irony is that the Community Reinvestment Act is supposed to be all about “meeting the need for credit services” in the communities served by a bank. The 2023 CRA rule fails to include consideration of some very important types of credit needed by and important to all communities.
So, what important types of credit are overlooked by the 2023 CRA rule?
First, multifamily housing mortgages are omitted from the Lending Test and considered only in the Community Development activities of a bank if a multifamily mortgage includes affordable housing units. Multifamily housing is not only critical to most communities, it is the dominant form of housing in some areas, particularly urban areas where low- and moderate-income families are located.
For example, the five boroughs that constitute New York City contain 3,519,595 housing units, of which 2,158,784 are multifamily (five or more units) residential units, based on the 2024 FFIEC demographics files. In other words, almost two-thirds of the housing relied upon by families in the Big Apple is multifamily housing but will not be evaluated in CRA exams under the new rule.
This is not only a glaring omission, it is a contradiction of 30 years of CRA performance evaluations, which, since 1995, have included all multifamily mortgage lending in the Lending Test.
The 2024 FFIEC demographic data show that only 45.6% of the rental units are affordable in New York City. This means that, even in the Community Development Financing Test, the majority of multifamily housing in New York City will not be accounted for in the 2023 CRA rule measuring how banks are financing the community’s need for housing.
It is understandable to give special consideration in the form of Community Development recognition for multifamily mortgages that include affordable housing. But it is shocking to omit all other forms of multifamily mortgages that finance a large and critical segment of housing, especially in our urban areas.
Another conspicuous form of credit omitted in the 2023 CRA rule is open-end mortgage lending. Home equity loans and home equity lines of credit (“HELOCs”) are used and relied upon by many homeowners who depend on HELOCs to finance college tuition for their children, home improvements, and various forms of consumer consumption. Additionally, many small businesses are financed by their owners, who use HELOCs as the cheapest and most flexible form of financing for their businesses.
In the latest (2023) HMDA national market data, about 20% (1.1 million mortgage originations) of all mortgages extended that year were open-end mortgages. Clearly, open-end mortgages are an important source of financing for millions of families. Once again, how can the agencies exclude such a significant and important form of financing relied upon by millions of mortgage borrowers?
Finally, a common form of financing for many businesses is called “secured revolving lines of credit,” in which a lender accommodates the financial needs of a business borrower in the form of a line of credit secured by a lien on accounts receivable and inventory. These lines of credit are “renewed” (i.e., the credit facility is approved and extended) annually by the lender. However, these “renewals” don’t qualify for recognition under the Community Reinvestment Act because the underlying debt instrument is a demand note.
To meet the definition of a “renewal” under CRA definitions, the maturity date of the underlying debt instrument must be extended. But because a demand loan is callable on demand, the maturity date cannot technically be extended. This process of using demand notes is necessary to protect the continuity—and hence the priority—of a bank’s security interest in the assets securing the loan under Article 9 of the UCC. Prudent banking practices dictate this approach.
A consequence of the disqualification of secured revolving lines of credit for recognition under CRA is that a common form of credit important to many businesses is not included in small business loans recognized under CRA. There is no good reason for not recognizing the annual renewals of secured revolving lines of credit under CRA. A credit decision is made every year, just as it would be for lines of credit that involve the use of time notes or for any extension of credit to a business.
If CRA is all about meeting the need for credit services, what is the best measure of that need? I contend that the best measure of the need for any particular type of credit is the actual lending activity reported under CRA. But when a common form of business borrowing is excluded from the reported data for an arbitrary reason, the true need for that credit service is understated in the CRA-reported small business lending activity. A major benchmark of the community’s need for small business credit is thereby impaired, resulting in a misunderstanding of the “needs of the community.”
A corollary of the understatement of the total small business lending market is the denial of CRA recognition for small business lending by banks that do extend secured revolving lines of credit accommodations. These banks are being shortchanged when they are not given the credit they deserve for their lending to the small business community.
Similar to my conclusions in my first article pertaining to assessment area delineation flaws, the omission of valuable forms of credit in the 2023 CRA rule is very serious and will undermine the confidence anyone can have in the measurement of the credit needs of the community and, consequently, the benchmark data under the new rule and the “conclusions” derived from that data. Ultimately, CRA performance evaluations should include all forms of financing important to the community
Recap
Bankers should submit testimony when the NPR is published citing the critical loan data important to the community but omitted in the 2023 Rule.
- Multifamily Mortgages
- Open-end mortgages
- Secured revolving lines of credit extended to small businesses including renewals of those facilities
All these loan types should have been included in the 2023 CRA rule but were not. Advocates for a strong and effective CRA that is supposed to measure how banks meet the community’s need for credit should also be critical of this major shortcoming in the 2023 CRA rule. Whatever your position on the Community Reinvestment Act, everyone should recognize that the 2023 rule is a failure in many ways.
