Loan Pools May Be Answer to Meeting CRA Mandate

Hook and Ladder #2, one of the first firehouses in downtown Louisville, was converted into three loft-style apartments, with an art gallery on the first floor. The Downtown Housing Fund provided a 10-year, $45,000 second mortgage with an 8.5 percent interest rate.

Industrial Steel Fabrication in Hazelwood, Mo., used a $170,000 loan from the St. Louis Business Development Loan Fund to support an expanding business environment.

Minimized risk. Community Reinvestment Act (CRA) credit. Community development loan pools provide the opportunity to simultaneously achieve both.

Similar to revolving loan funds, loan pools have gained momentum in recent years. They are seen as a way to help financial institutions efficiently and effectively meet requirements of the CRA investment test. Since the CRA's inception in 1977, financial institutions have struggled with achieving a balance between safety-and-soundness requirements and meeting the needs of their entire community. CRA-qualified community development loans and investments often carry a slightly higher risk, making them less attractive from a safety-and-soundness perspective.

So what makes a community development loan pool different? Because this type of financing comes in a variety of forms, this article will focus on general aspects of loan pools. The characteristics that distinguish loan pools from other forms of community development finance are multiple investors, a targeted focus and less-than-market-rate return to investors. The existence of multiple investors creates a shared-risk environment that allows for more flexible loan criteria than with one financial institution. Community development revolving loan funds with the same characteristics are considered loan pools.

Community development loan pools have been used across the globe to help small businesses get their feet on the ground, to help families achieve home ownership, and to assist nonprofit and for-profit developers with affordable-housing predevelopment costs. Projects previously considered too risky for one financial institution have become funded successes through this shared-risk environment. The central purpose of community development loan pools is to fill financing needs in a community where credit demands are not or cannot be filled by individual conventional financial institutions.

Community development loan pools can be structured in a variety of ways and have very specific purposes directed at an identified community need. Some pools require equal investments from their investors, while others allow investors to decide in what share of the total they want to invest. Many loan pools consist of public, private and individual investments.

Regardless of the structure, financial institutions that make investments may receive CRA investment test credit for their total investment or CRA lending test credit for a percentage of the pool's loans equal to the percentage of their investment. For example, assume ABC Bank's investment is 10 percent of the total pool. (See illustration.) ABC Bank could count 10 percent of the loans to the Jones Family and 123 Housing Developer, as well as every loan made from the pool. In addition, as explained in the Interagency CRA Questions and Answers document, a financial institution may elect to have part of its investment considered under the lending test and the remainder under the investment test.

The real advantage for a large bank with an extensive service area is that a loan pool gives the bank the ability to make a bigger impact at a more localized level. However, what if a small bank wishes to invest in a pool that makes loans statewide, but the bank's service area is only one county? Small banks with this concern usually can ask that their investment be restricted to loans in their service area. According to the Interagency CRA Questions and Answers, an institution's activity also is considered a community development loan or qualified investment if it supports an activity that covers an area that is larger than, but includes, the institution's assessment area.

Probably the most serious concern for investors is who controls the money. Traditionally, funds are administered by a nonprofit organization, a state development finance authority or an economic development agency. Loan decisions are made by a committee of individuals representing the investing organizations. In pools where investors are too numerous for each to have representatives on the loan committee, a smaller committee is appointed to make loan decisions on behalf of the group.

In addition to shared risk and community impact, benefits of loan pools include more flexibility in loan terms and eligibility criteria and a constant source of financing tailored to a community's needs.

Concerns that financing projects through a loan pool might reduce a bank's visibility in the community are mitigated by customers' continuing need for direct financing. Clients usually are directed to a loan pool only when direct bank financing is not possible.

Finally, it's important for those involved in community development to realize loan pools are only one of many community development financing tools. However, they might be the answer for a community with specific and ongoing needs that require financing with an elevated risk.