Financial Issues Subcommittee Recommendation to the

Federal Communications Commission's

**Advisory Committee on Diversity for Communications in the Digital
Age**

December 10, 2004

**[Recommendation on the Community Reinvestment Act]{.underline}**

BE IT RESOLVED, that the Advisory Committee on Diversity for
Communications in the Digital Age urges the Federal Communications
Commission to seek revisions to the Community Reinvestment Credit Act
regulations to expand the definition of "qualified investments" to
include private equity funds led by minority and women management teams,
and private equity funds that invest in urban and rural communities.

BE IT RESOLVED FURTHER, that the Advisory Committee on Diversity for
Communications in the Digital Age will convene a panel of experts to
provide further expertise and counsel to the Financial Issues
Subcommittee in support of this effort, and that the Subcommittee report
its recommendations within FY 2005.

**White Paper on**

**The Community Reinvestment Act**

**Increasing Access to Capital**

**Presented by the Access to Capital Subcommittee,**

**FCC Advisory Committee on Diversity for Communications in the Digital
Age**

**November 4, 2004**

**Overview**\*

Since July 1, 1997, the joint rule under the Community Reinvestment Act
(the "CRA")[^1] has strongly encouraged large banks[^2] to have a
program of ongoing qualified investment activity in their communities
and regions in order to meet their obligations under CRA. The CRA
regulations present banks with a continuing need to make investments
that qualify for CRA purposes, are permissible under the Glass-Steagall
Act and related regulations, and provide a return consistent with the
safe and sound operations of the bank.[^3]

Investment in a fund licensed as a Small Business Investment Company
("SBIC"), administered by the Small Business Administration, gives a
bank the opportunity to accomplish all three of these objectives. An
investment in an SBIC operating in a bank's community or region is
specifically identified in the Interagency Interpretive Questions and
Answers Regarding Community Reinvestment for the joint rule[^4] as a
type of investment which will be presumed by the regulatory agencies to
be a "qualified investment" for CRA purposes.[^5] Likewise, Federal law
explicitly permits banks to invest in and own SBICs.[^6] Finally, the
banking industry has substantial experience with both independent and
affiliated SBICs.[^7] The data on investment results of existing
bank-affiliated SBICs demonstrate that as an industry, SBICs have
provided returns on invested capital consistent with (or in many cases
higher than) the return on the capital employed by their bank investors
in their principal lines of business. [^8]

-   **Christopher Lane Davis** is a member of the bar of the State of
    New York. He is a private attorney specializing in corporate
    finance, focusing on matters relating to domestic and international
    venture capital and private equity investment, and a consultant to
    the SBA. Permission to reproduce, in whole or in part, is granted to
    the U.S. Government. His work, *The Community Reinvestment Act
    Regulations: An Opportunity for Banks and SBICs,* July 1, 1999, is
    cited in the Overview and Background Sections. Permission to
    reproduce, in whole or in part, is granted to the U.S. Government.

**Background -- The Community Reinvestment Act**

*The CRA.* In 1977, Congress enacted the Community Reinvestment Act to
encourage banks to help meet the credit needs of the local communities
in which they operate.[^9] To implement the CRA, each of the four
federal bank regulatory agencies (the Office of the Comptroller of the
Currency, the Federal Reserve Board, the Federal Deposit Insurance
Corporation, and the Office of Thrift Supervision) promulgated
regulations.[^10]

*The CRA Regulations.* The CRA regulations establish the framework and
criteria that each agency uses to evaluate a bank's performance in
meeting the credit needs of its local community under the CRA. Banks are
examined on a regular basis by their regulating agencies to assess how
well the bank's activity has met the credit needs of its local community
in the areas of lending, service and investment as measured by the
regulatory standards established in the CRA regulations.[^11] The
agencies numerically grade each bank's performance in each of the three
areas specified by the joint rule, and the combined grades for all three
areas determine a bank's overall CRA performance rating.[^12] The agency
evaluation of a bank's CRA performance is a public document, and is
required to include the agency's assessment of the bank's performance in
each area and the overall CRA rating.[^13]

*Regulatory Compliance.* The CRA does not permit the bank regulatory
agencies to require banks to achieve any specified CRA performance
rating.[^14] Banks are strongly motivated to achieve high ratings,
however, because the agencies are expressly authorized by the CRA to
take a bank's CRA performance into account when reviewing an application
by the bank for approval of an activity relating to deposit-taking
facilities (e.g., acquisitions, new branches, and the like).[^15]
Historically, the bank regulatory agencies have made it clear that the
quality of a bank's CRA performance can have a significant impact, both
positive and negative, on obtaining regulatory approvals desired by the
bank, making CRA performance important to the overall operations of the
bank.[^16]

*Other Effects.* A bank's CRA rating can also have effects beyond the
CRA regulations, for example Federal Housing Finance Board regulations
restrict long terms advances by Federal Home Loan Banks to a member bank
unless the member bank has at least a "Satisfactory" CRA rating.[^17]
For many banks, an "Outstanding" CRA rating is also an important aspect
of the bank's corporate image of quality, community involvement and
industry leadership, and has a significance that extends beyond the
bank's relationship with its regulating agency.

**Background -- The CRA Regulations**

*The Joint Rule.* Beginning in 1993, all four federal regulatory
agencies began a collective effort to develop new joint CRA
regulations.[^18] This effort culminated in the promulgation of a joint
rule by all four agencies on May 4, 1995.[^19] That joint rule replaced
the previous CRA regulations in their entirety. The provisions of the
joint rule were phased in over a two-year period, from July 1, 1995, to
July 1, 1997, when all provisions of the joint rule went into
effect.[^20]

*Ongoing Interpretation and Application of the CRA Regulations.* Since
the promulgation of the joint rule, the agencies have continued to
develop their regulatory policy on CRA performance through the
publication of "Interagency Questions and Answers Regarding Community
Reinvestment" that interpret the regulations through responses to
specific frequently asked questions.[^21] The agencies have also
provided guidance on specific questions relating to the application of
the CRA regulations through issuance of Interpretive Letters.[^22] In
addition, the increasing number of publicly available bank CRA
Performance Evaluations sheds some light on how the standards for CRA
performance are being applied by examiners in the field.[^23]

*Scope.* The joint rule applies to substantially all the banks operating
in the U.S.[^24] There are limited exceptions for "special purpose"
banks (such as "banker's banks" and banks that provide only cash
management controlled disbursement services, correspondent banking
services, trust company services, or clearing agent services) and for
certain types of uninsured banks.[^25] There are also special provisions
for "small banks."[^26] The rules specifically apply, however, to
limited purpose banks, wholesale banks and insured Federal or state
branches of foreign banks.[^27]

*The Credit Needs of the Community.* The joint rule generally provides
that each agency will base a bank's CRA rating on an evaluation of the
bank's performance record in meeting the credit needs of its
community.[^28] The concept of a community's credit needs used in the
joint rule explicitly incorporates the concept of community
development.[^29] Community development under the regulations is an
active concept that requires a bank to take affirmative action to
address the needs of its community. This contrasts with the prior CRA
regulations which listed as the first two criteria for evaluating a
bank's CRA performance the activities conducted by the bank to ascertain
the credit needs of the community and the bank's activities to make the
community aware of the credit services that the bank had to offer.[^30]

*The Definition of a Bank's Community.* The joint rule requires a bank
to specify the geographic area that it considers to be the community in
which the bank operates.[^31] This defined community is referred to as
the "assessment area."[^32] In general, a bank's assessment area is
defined in terms of the consolidated metropolitan statistical areas or
other political subdivisions within which the bank's headquarters,
branches and deposit-taking ATM machines are located, as well as any
contiguous surrounding areas in which the bank originated or purchased a
substantial portion of its loans.[^33] In addition to a bank's local
community (defined by its assessment area), a bank can define a larger
statewide or regional area within which it operates. This larger
"region" must include the bank's assessment area or areas, must be
contiguous, and must be defined in terms of political units (such as
states, counties or cities). [^34]

*Evaluating a Bank's CRA Performance.* A bank's overall CRA performance
is rated as "Outstanding," "Satisfactory," "Needs to Improve," or
"Substantial Noncompliance."[^35] To determine a bank's overall CRA
rating, the agencies rate the bank on the basis of its performance in
each of three performance categories: lending, service, and
investment.[^36] In determining the CRA rating, a bank's performance in
each of the three areas is scored separately.[^37] In this regard, the
joint rule specifically provides that activities considered for purposes
of evaluating performance under the lending and service tests may not be
considered when evaluating performance under the investment test.[^38]
Performance in each category is rated numerically, but the three tests
are not all of equal weight. The overall CRA rating is determined by a
matrix, which takes both the individual test scores and the bank's
combined score on all three tests into account in determining the bank's
overall CRA rating.[^39] Subject to some exceptions, the matrix gives
the lending test a 50% weight and each of the service and investment
tests a 25% weight in determining the overall CRA rating.

*Investment and CRA Performance Ratings.* The requirement that
activities evaluated under the lending or service tests cannot be
considered when evaluating performance under the investment test
requires a bank to focus specifically on its investment activity, as
distinct from lending and other banking activities. This emphasis is
reinforced by the scoring methodology used under the joint rule. Scoring
under the joint rule is intentionally structured so that satisfactory
performance in all three performance tests is important to the overall
rating. The performance scoring system in the joint rule is discussed in
the preface to the joint final rule in the adopting release, which
describes the specific intention of the agencies to require that even if
a bank had the maximum score in both lending and one of the other two
areas, at least a "low satisfactory" performance rating in the third
area would be necessary for the bank to receive an overall CRA rating of
"Outstanding."[^40] The effect of investment performance test ratings on
overall bank CRA ratings can be seen by reviewing the publicly available
CRA Performance Evaluations on the agency's Internet web sites.[^41]

**Background -- The Investment Test**

*Effective Date for the Investment Test.* Since July 1, 1997, a bank's
investment activity has been one of the three types of activity that is
evaluated by the regulating agencies to determine a bank's CRA rating.
The joint rule requires the regulating agencies to evaluate a bank's
record of helping meet the credit needs of its assessment area through
qualified investments that benefit its assessment area or a broader
statewide or regional area that includes the bank's assessment
area(s).[^42]

*Criteria for Evaluating Investments.* The joint rule provides four
specific criteria to be used in evaluating a bank's CRA investment
performance: (1) the dollar amount of qualified investments, (2) the
innovativeness or complexity of the investments, (3) the responsiveness
of the investments to credit and community development needs, and (4)
the degree to which such investments are not routinely made by private
investors.[^43] While the dollar amount of an investment is a
quantitative matter, the other three criteria require a qualitative
evaluation of an investment. The 1999 Interagency Questions and Answers
discusses how examiners should combine the quantitative and qualitative
criteria, and indicate that the quantitative evaluation of the amount of
a bank's investments determines a base rating, and the evaluation of the
qualitative aspects of the investments determine whether there is a
basis for a higher rating than would be justified solely by the amount
of the bank's investments.[^44]

*Qualified Investments.* For purposes of evaluating a bank's performance
under the investment test, the joint rule defines the characteristics of
investments which can be considered. These investments are referred to
as "qualified investments." [^45] The joint rule defines qualified
investments as lawful investments that have as their primary purpose
community development. Both "primary purpose" and "community
development" are used as terms of art in the definition of qualified
investment.

*The Definition of Community Development.* The definition of "community
development" in the joint rule[^46] specifically identifies four
activities: (1) affordable housing and community services for low- and
moderate-income people (2) community services to low- and moderate
income people, (3) activities that promote economic development by
financing businesses or farms that meet the size eligibility standards
of the Small Business Administration's Development Company or Small
Business Investment Company programs[^47] and (4) activities which
revitalize or stabilize low- and moderate-income communities. [^48] The
activities listed as items (1), (2) and (4) reflect traditional concepts
of community development. The explicit inclusion of "financing
businesses and farms" in item (3) as a community development activity is
a significant change from the much vaguer language regarding community
development in the old regulations.[^49]

*The Definition of Primary Purpose.* The term "primary purpose" is
critical to determining whether an investment will be a "qualifying
investment." The term, however, is not defined in the regulation and has
been the subject of considerable uncertainty. The 1999 Interagency
Questions and Answers adopted a new question and answer specifically to
clarify the term.[^50] An investment has as its primary purpose
community development when it is "designed for the express purpose" of
accomplishing one of the four activities in the definition of community
development. An investment is viewed as being "designed for the express
purpose" of accomplishing a community development activity if it meets
one of two tests. The first test is whether a majority of the dollars of
the investment are identifiable to one or more of the four community
development activities. If the first test is not met, an investment may
still qualify if (1) the express, [bona fide]{.underline} intent of the
investment is to achieve a community development purpose, (2) the
investment is specifically structured to achieve the community
development purpose, and (3) the investment actually accomplishes or is
reasonably certain to accomplish its community development purpose.

*Investments in Businesses Qualify under CRA.* The joint rule expressly
recognizes investments (distinct from loans) by banks in businesses and
farms as a qualified CRA activity.[^51] Although the language of the
joint rule does not distinguish between "financing businesses and farms"
and the other types of activity listed in the definition of "community
development," the bank regulatory agencies have interpreted the
regulation to require that even if a business meets the size standards
set forth in the definition of community development, an investment in a
business or farm must additionally meet one of the other criteria listed
in the definition in order to be considered a "qualified
investment."[^52]

**Background - SBICs as Qualified Investments**

*SBICs are Permitted Nonbank Investments for Banks.* As discussed above,
bank ownership of SBICs is specifically authorized by statute.[^53]
Equally important, securities owned by an SBIC in nonbank businesses are
[not]{.underline} attributed to a bank which owns an interest in the
SBIC. This non-attribution is the case whether the SBIC is a wholly
owned subsidiary of the bank or the bank is a minority owner of an
independent SBIC. As a result, SBICs avoid a common problem for banks
considering community development activity through investments in
nonbank businesses.

*SBICs are Qualified Investments.* SBICs have a unique favorable
treatment as qualified investments under the CRA regulations and agency
interpretations. The adopting release for the final joint rule
specifically identifies investment in an SBIC as an example of a
qualified investment for CRA purposes.[^54] The status of SBICs as
qualified investments is clarified further in the 1999 Interagency
Questions and Answers, which state that bank examiners will \"presume\"
that an investment in an SBIC promotes economic development and meets
the standard for a \"qualified investment.\"[^55] In addition, the
release for the joint rule clearly contemplates that it is the
investment by the bank in the SBIC itself that is considered for CRA
purposes, not the underlying portfolio investments subsequently made by
the SBIC.[^56]

*SBICs' Comparative Advantage as Qualified Investments*. The presumption
of economic development purpose given to SBICs creates an important
distinction between an SBIC and most other types of investments
(including non-SBIC investment funds) for a potential bank investor. A
bank's investment in an SBIC will be presumed by examiners to be a
qualified investment without further evaluation. In the case of non-SBIC
investment funds, however, examiners will specifically evaluate whether
the primary purpose of the fund is to engage in one or more of the
community development activities specifically enumerated in the
regulations.[^57] In the case of a typical "blind pool" investment fund
planning to invest in businesses, this determination can be difficult to
make.

*Independent and Bank-Affiliated SBICs.* Investments in independent
SBICs and affiliated SBICs are both considered qualified investments
under the joint rule. The joint rule specifically permits a bank to
receive credit for a qualified investment made by an affiliate
(including a bank holding company parent), so long as no other bank is
also claiming CRA credit for that investment.[^58] The provisions of the
joint rule which allow a bank to receive CRA credit for investments by
affiliates allow a bank to take advantage of a broader range of
investment opportunities than it could participate in directly.[^59]
This flexibility provides a bank that wishes to use the SBIC program as
a means of addressing its CRA obligations with a wide range of
alternatives in structuring and managing a qualified investment program.

*Local, State, and Regional Investment.* The investment test under the
joint rule specifically permits consideration of qualified investments
made outside the bank\'s assessment area in a broader surrounding region
that includes the assessment area.[^60] In the case of wholesale and
limited purpose banks (such as credit card banks), the regulations
permit a bank to consider qualified investments on a nationwide
basis.[^61] Permitting a regional investment focus makes it easier for a
bank to determine in advance whether a prospective SBIC will be an
appropriate qualified investment. As a result, allowing an SBIC that has
a regional (and for some banks, national) focus to be considered a
qualified investment makes SBICs much more attractive and practical
investments for CRA oriented bank investors.[^62]

*The Importance of the Regional Investment Focus.* Recognizing
regionally focused SBICs as qualified investments is an important step
in aligning the CRA regulations with the way SBICs actually need to
operate in order to be economically viable investment operations.[^63] A
broad geographic territory is important for the successful operation of
most SBICs, since few individual assessment areas can provide sufficient
deal flow to permit an SBIC to create a diversified portfolio of private
investments.[^64] In addition, because many SBICs (particularly
independent SBICs) are formed as \"blind pools\" with a limited
investment period (normally 2 to 4 years) it is rarely possible to
predict whether a specific locality or community will generate potential
investment opportunities for a particular SBIC.

*Evaluating a Specific Investment for CRA Purposes.* A question
frequently asked by both SBIC managers and bankers is whether a bank
will receive "CRA credit" for a particular investment in an SBIC. The
first issue is whether the SBIC is a "qualified investment" as defined
in the joint rule. For an SBIC, the answer to this question will
normally be yes, because an investment in an SBIC is presumed under the
joint rule to be a qualified investment.[^65] The second issue is
whether the SBIC is relevant to the bank's CRA performance. In the first
instance, the answer to this question depends on whether the SBIC
operates in the bank's region.[^66] This is a factual question and the
answer will depend on the SBICs business plan (does the SBIC explicitly
intend to seek investments and/or invest in the bank's region) and the
SBIC's actual performance.

*Weighing Qualified Investments*. All qualified investments do not
receive equal weight (equal "CRA credit") in the evaluation of a bank's
CRA performance. To the extent information is available, examiners will
assess the needs and opportunities for qualified investments in a bank's
performance context.[^67] Examiners evaluate qualified investments using
the criteria described in the joint rule: taking into account both the
amount of the investment[^68] and any other qualitative factors.[^69]
Finally, since almost all SBICs operate on a regional basis (as opposed
to operating exclusively in a bank's assessment area), examiners will
evaluate the degree to which the SBIC's investment activity is likely to
(or does) benefit the bank's assessment area.[^70] While the 1999
Interagency Questions and Answers are clear that an investment need not
directly benefit a bank's assessment area, it seems equally clear that
the more likely it is that the investment will produce a benefit to the
assessment area, the greater the weight that investment will receive.

**Impact**

The investment performance required by the joint rule has caused many
banks to expand their investment activities in order to maintain the CRA
rating necessary for the smooth operation of their banking business. For
SBICs, the uniquely favorable treatment of bank investments in SBICs
under banking and CRA regulations provides an additional benefit an SBIC
can offer prospective bank investors. For banks, an independent or
affiliated SBIC can provide a qualified investment opportunity with
distinct advantages compared with other types of qualified investments
currently available to banks.

As previously mentioned Subcommittee's report of June 14, the National
Association of Investment Companies ("NAIC") is a trade association of
private equity funds led by minority management teams and who invest in
opportunities led by women and minority entrepreneurs, and/or in
opportunities in underserved markets. Currently, NAIC member funds
manage over \$5 billion. While this is an impressive number, it is
estimated by the National Venture Capital Association that its member
funds currently manage more than \$65 billion. The disparity of
investment capital between NAIC and NVCA member funds is stark. This is
despite the fact that an independent study conducted by the Kauffman
Foundation, *Minorities and Venture Capital: A New Wave of American
Business*, July, 16, 2003, found that the financial returns from NAIC
member funds were comparable to or exceeded majority managed funds.
Clearly, private equity funds that provide investment dollars to
underserved entrepreneurs and markets need greater access to capital. An
amendment to, or revision of, the Community Reinvestment Act to
authorize such investments by banks would provide increased funding
resources for such funds.

**Recommendation**

The Subcommittee on Access to Capital recommends that the Advisory
Committee adopt a resolution as follows:

RESOLVED, that the Advisory Committee on Diversity for Communications in
the Digital Age urges the Federal Communications Commission to seek
revisions to the Community Reinvestment Credit Act regulations to expand
the definition of "qualified investments" to include private equity
funds led by minority and women management teams, and private equity
funds that invest in urban and rural communities.

RESOLVED FURTHER, that the Advisory Committee on Diversity for
Communications in the Digital Age convene a panel of experts to provide
further expertise and counsel to Access to Capital Subcommittee in
support of this effort, and that the Subcommittee report its
recommendations within FY 2005.

\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\--

**Appendix**

**CRA and SBIC Related Resources Available on the Internet**

This Appendix provides directions for locating some of the resource
materials relating to the Community Reinvestment Act and the Small
Business Investment Company Program and a selection of Internet web
sites which have a broad range of information related to the SBIC
program and the CRA regulations. The lists provided in this Appendix are
intended to provide an introduction and quick reference guide, and are
not a comprehensive list of the wide variety of information available
through the Internet.

> **[CONGRESS]{.underline}**
>
> **U.S. Senate**
>
> U.S. Senate Banking Committee

-   [www.senate.gov/banking]{.underline}

> U.S. Senate Small Business Committee

-   [www.senate.gov/smbiz]{.underline}

> **U.S. House of Representatives**
>
> House Banking Committee

-   [www.house.gov/banking]{.underline}

> House Small Business Committee

-   [www.house.gov/smbiz]{.underline}

> **Congressional Record**

-   [www.access.gpo.gov/su_docs/aces/aces150.html](http://www.access.gpo.gov/su_docs/aces/aces150.html)

> **Library of Congress**

-   [www.loc.gov]{.underline}

> **[FEDERAL AGENCIES]{.underline}**
>
> **Board of Governors of the Federal Reserve System**

-   [www.bog.frb.fed.us]{.underline}

> **Federal Deposit Insurance Corporation**

-   [www.fdic.gov](http://www.fdic.gov/)

> **Federal Financial Institutions Examinations Council**

-   [www.ffiec.gov]{.underline}

> **Federal Housing Finance Board**

-   [www.fhfb.gov](http://www.fhfb.gov/)

> **Office of the Comptroller of the Currency**

-   [www.occ.treas.gov](http://www.occ.treas.gov/)

> **Office of Thrift Supervision**

-   [www.ots.treas.gov]{.underline}

> **Small Business Administration**

-   [www.sba.gov](http://www.sba.gov/)

> **SBA Investment Division**

-   [www.sba.gov/INV]{.underline}

> **[COMMUNITY REINVESTMENT ACT MATERIALS]{.underline}**
>
> **Community Reinvestment Act Regulations**

-   [www.occ.treas.gov/craindx.htm](http://www.occ.treas.gov/craindx.htm)

> **Interagency Questions and Answers Regarding Community Reinvestment**

-   [www.ffiec.gov/cra/info](http://www.ffiec.gov/cra/info)

> **Interpretive Letters on CRA issues**

-   [www.ffiec.gov/cra/info]{.underline}

> **Interagency CRA Ratings data base**

-   [www.ffiec.gov/cracf/crarating/main.cfm]{.underline}

> **CRA Performance Evaluations**

-   [www.bog.frb.fed.us/DCCA/CRA/crarate.cfm](http://www.bog.frb.fed.us/DCCA/CRA/crarate.cfm)
    (Banks examined by the Federal Reserve System)

-   [www2.fdic.gov/dcacra/cra_data.cfm]{.underline} (Banks examined by
    the FDIC)

-   [www.ots.treas.gov/cra.html]{.underline}. (Banks examined by the
    OTS)

-   [www.occ.treas.gov/electric.htm](http://www.occ.treas.gov/electric.htm)
    (Banks examined by the OCC)

> **[SMALL BUSINESS INVESTMENT COMPANY PROGRAM MATERIALS]{.underline}**
>
> **Small Business Act**

-   [www.sba.gov/INV]{.underline}

> **Small Business Investment Company Act**

-   [www.sba.gov/INV]{.underline}

> **Small Business Investment Company Regulations (Part 107)**

-   [www.sba.gov/INV]{.underline}

> **Size Standard Regulations for the SBIC Program (Part 121)**

-   [www.sba.gov/INV]{.underline}

> **SBA Forms for the SBIC Program**

-   [www.sba.gov/INV](http://www.sba.gov/INV)

> **SBA Statistical Information on the SBIC Program**

-   [www.sba.gov/INV]{.underline}

> **Directory of SBICs**

-   [www.sba.gov/INV]{.underline}

> **[TRADE ASSOCIATIONS]{.underline}**
>
> **National Association of Small Business Investment Companies**

-   [ww.nasbic.org]{.underline}

> **National Association of State Venture Funds**

-   [www.nasvf.org]{.underline}

> **National Venture Capital Association**

-   [www.nvca.org](http://www.nvca.org/)

[^1]: **[NOTES]{.underline}**

    ^?^ The Community Reinvestment Act (12 U.S.C. §§ 2901 [et
    seq.]{.underline}) was originally adopted in 1977. The Community
    Reinvestment Act applies to all insured depository institutions
    (defined as \"regulated financial institutions\" in the statute).
    Note, however, that the Community Reinvestment Act does
    [not]{.underline} apply to credit unions.

    The current regulations under the CRA were published as a final rule
    on May 4, 1995, at 60 FR 22156 - 22225. The final rule was
    subsequently amended to make technical corrections on December 20,
    1995, at 60 FR 66048-66051, and again on May 10, 1996, at 61 FR
    21362-21364.

    To provide an illustration of the provisions of the joint rule, this
    Memorandum will focus on the version of the joint rule promulgated
    by the Comptroller of the Currency: 12 C.F.R. Part 25, Subparts A
    through D and Appendices A and B. All citations to the joint rule
    will be to the version promulgated by the Comptroller of the
    Currency, unless otherwise indicated.

[^2]: The discussion in this Memorandum focuses primarily on the
    application of the joint rule to larger banks and savings
    associations, those institutions that do not fall under the
    definition of a \"small bank\" (see 12 C.F.R. § 25.12(t)) or a
    \"small savings association\" (see 12 C.F.R. § 563e.11(s)) in the
    joint rule. In this paper, these larger banks and savings
    associations are collectively referred to as "banks."

[^3]: The joint rule requires that all CRA related activity must be
    consistent with the "safe and sound operation of the institution," a
    standard which normally refers to the financial quality of a bank's
    activities. See 12 C.F.R. §§ 25.11(b) and 25.21(b)(4).

    As a matter of practice, however, banks generally do not subject CRA
    related loans and investments to the same standards for profit and
    loss as their other lines of business. CRA investments tend to be
    viewed as [de facto]{.underline} grants or as "soft" money with
    significantly higher risk and lower return expectations than other
    lines of business activity.

[^4]: The purpose of the Interagency Questions and Answers Regarding
    Community Reinvestment, as described in the issuing release for the
    1999 Interagency Questions and Answers (see below), is to "answer
    the most frequently asked questions about community reinvestment"
    and are described as "informal staff guidance for agency personnel,
    financial institutions, and the public." See 64 FR 23618.

    The regulatory agencies promulgated an initial set of \"Interagency
    Questions and Answers Regarding Community Reinvestment,\" published
    October 21, 1996, at 61 FR 54647-54667. The initial Interagency
    Questions and Answers were replaced a year later by a supplemented
    and amended set of \"Interagency Questions and Answers Regarding
    Community Reinvestment,\" published October 6, 1997, at 62 FR
    52105-52128. The 1997 Interagency Questions and Answers were
    superceded by a new restatement of the "Interagency Questions and
    Answers Regarding Community Reinvestment," published May 3, 1999, at
    64 FR 23618-23648 (referred to further below as the "1999
    Interagency Questions and Answers").

[^5]: This position is clearly stated in the 1999 Interagency Questions
    and Answers, in the Answer to Question 1 with regard to 12 CFR
    25.12(h)(3), at 64 FR 23628:

    > "To be considered as 'community development' under \_\_.12(h)(3)
    > and 563e.12(g)(3), a loan, investment or service, whether made
    > directly or through an intermediary must meet both a size test and
    > a purpose test. An activity meets the size requirement if it
    > finances entities that either meet the size eligibility standards
    > of the Small Business Administration's Development Company (SBDC)
    > or Small Business Investment Company (SBIC) programs, or have
    > gross annual revenues of \$1 million of less. To meet the purpose
    > test, the activity must promote economic development. . . . [The
    > agencies will presume that any loan or investment in or to a SBDC
    > or SBIC promotes economic development.]{.underline} \[emphasis
    > added\]"

[^6]: Bank ownership of SBICs is specifically authorized by Section
    302(b) of the Small Business Investment Company Act (15 U.S.C. §
    682(b)).

    The effect of this authorization under the Bank Holding Company Act
    is discussed in detail at 12 C.F.R. § 225.107, which provides that:

    > "Since the shares of a small business investment company are of a
    > kind and amount expressly made eligible for investment by a
    > national bank under the Small Business Investment Act of 1958, it
    > follows, therefore, that the ownership or control of such shares
    > by a bank holding company would be exempt from the prohibitions of
    > section 4 of the Bank Holding Company Act by virtue of the
    > provisions of section 4(c)(4) of that Act. [Accordingly, the
    > ownership or control of such shares by the bank holding company
    > would be exempt from the prohibitions of section 4 of the Bank
    > Holding Company Act]{.underline} \[emphasis added\]."

    See 12 C.F.R. 225.107(c).

    Until recently there was a question as to whether a national bank
    had authority to invest in an applicant for an SBIC license prior to
    the time that the applicant was formally licensed as an SBIC (see
    OCC Interpretive Letter #617, March 4, 1993). This issue was
    recently clarified by the OCC in a letter reconsidering this issue
    (unpublished letter dated June 18, 1998, from Raymond Natter, Acting
    Chief Counsel, Office of the Comptroller of the Currency to
    Christopher Lane Davis), which concluded *inter alia* that " . . .
    it is my opinion that a national bank may invest in an SBIC that is
    in the process of being organized, as well as one that has already
    obtained a license from the SBA."

    Unlike banks, savings and loan associations do not have explicit
    statutory authority to own SBICs, although a holding company for a
    savings and loan association may own an SBIC (just as a bank holding
    company may). This inconsistency in authority between banks and
    savings and loan associations is apparently unintended, and the
    Director of OTS has called attention to this issue and advocated
    corrective legislation in testimony before the House Banking
    Committee. See "Statement of Eileen Seidman, Director, Office of
    Thrift Supervision, Concerning the Financial Regulatory Relief and
    Economic Efficiency Act," before the Committee on Banking, Housing
    and Urban Affairs of the United States Senate, March 10**,** 1998.
    More recently, at the SBA's New Markets Workshop conference in New
    York City on April 12, 1999, Director Seidman stated in her speech
    to the conference that OTS has granted requesting savings
    associations permission to invest directly in SBICs and that OTS
    expects to continue to grant such permission to requesting savings
    associations in the future.

[^7]: Banks are significant participants in the SBIC program. The number
    of bank-owned SBICs has climbed from 64 at the end of fiscal 1992 to
    84 at the end of 1998. As of the end of fiscal 1998 there were 84
    bank-owned SBICs. (Data is not available with respect to bank
    participation as investors in independent SBICs.)

    The table below indicates the size of bank participation in relation
    to the whole SBIC program as of the end of fiscal 1998:

    Licenses Outstanding and SBIC Program Capital Resources

    [Fiscal Year 1998 (\$ in millions)]{.underline}

    > Private Leverage Capital
    >
    > [Fiscal Year 1998]{.underline} [\#]{.underline}
    > [Capital]{.underline} [from SBA]{.underline}
    > [Resources]{.underline}

    # 

    > Bank-Owned Regular SBICs 84 4,005.4 23.5 4,028.9
    >
    > Debenture-Type Regular 92 897.2 704.8 1,602.0
    >
    > Participating Security 69 1,226.9 889.4 2,116.3
    >
    > Specialized SBICs [73]{.underline} [165.9]{.underline}
    > [178.2]{.underline} [344.1]{.underline}
    >
    > **TOTAL** 318 \$6,295.4 \$1,795.9 \$8,091.4

    See [SBIC Program Statistical Package]{.underline}, January 1999,
    Table 36.

[^8]: The SBA statistics on weighted realized rate of return on invested
    capital for the ten year period from fiscal 1989 - 1998 are as
    follows:

    > Weighted Realized Rate of Return on Invested Capital for SBIC
    > Program Licensees
    >
    > [Fiscal Years 1977 to 1998]{.underline}
    >
    > **Bank** Debent- Part. All
    >
    > **Owned** ure Sec. All SBIC
    >
    > Fiscal **Reg** Regular Regular Regular All Program
    >
    > [Year]{.underline} **[SBICs]{.underline}** [SBICs]{.underline}
    > [SBICs]{.underline} [SBICs]{.underline} [SSBICs]{.underline}
    > [Licensees]{.underline}
    >
    > 1989 **8.42** 8.00 \-- 8.32 7.96 8.28
    >
    > 1990 **14.77** 6.39 \-- 12.95 3.23 12.19
    >
    > 1991 **5.31** (4.38) \-- 3.54 (1.38) 3.18
    >
    > 1992 **11.89** 1.50 \-- 10.46 4.34 10.04
    >
    > 1993 **17.01** 14.09 \-- 16.66 0.58 15.70
    >
    > 1994 **16.03** 0.63 \-- 14.32 4.37 13.80
    >
    > 1995 **8.54** 5.41 (15.59) 7.96 4.50 7.80
    >
    > 1996 **14.51** 11.59 (6.70) 13.58 0.83 3.46
    >
    > 1997 **19.78** 10.02 7.32 18.05 8.11 17.59
    >
    > 1998 **21.42** 10.33 7.85 19.36 5.54 18.89

    Realized Rate of Return on Invested Capital was calculated by
    dividing \"Net Income\" by the average of the beginning and ending
    balances of \"Paid‑in Capital Stock & Surplus\" plus \"Partners\'
    Permanent Capital Contributed\" plus \"Undistributed Realized
    Earnings\".

    See [SBIC Program Statistical Package]{.underline}, January 1999,
    Table 23.

[^9]: The statement of purpose of Community Reinvestment Act states, in
    part:

    > "Section 2901. Congressional Findings and Statement of Purpose.

    The Congress finds that --

    > . . . . .
    >
    > \(3\) regulated financial institutions have continuing and
    >
    > affirmative obligation to help meet the credit needs of the local
    >
    > communities in which they are chartered.
    >
    > \(b\) It is the purpose of this chapter to require each
    > appropriate Federal financial
    >
    > supervisory agency to use its authority when examining financial
    > institutions, to encourage such institutions to help meet the
    > credit needs of the local communities in which they are chartered
    > consistent with the safe and sound operation of such
    > institutions."

    See 12 U.S.C. §§ 2901(a)(3), and discussion in Note Error: Reference
    source not found.

[^10]: The CRA separately authorizes each of the Comptroller of the
    Currency, the Federal Reserve Board, the Federal Deposit Insurance
    Corporation, and the Office of Thrift Supervision to promulgate
    regulations under the statutes applicable to that agency. See 12
    U.S.C. §§ 2901(b), 2902(1), and 2905. The parallel provisions of the
    joint rule relating to each agency are found in separate Parts of 12
    C.F.R. The Comptroller of the Currency\'s regulations are in Part
    25, the Federal Reserve Board\'s regulations are in Part 228, the
    Federal Deposit Insurance Corporation\'s regulations are in Part
    345, and the Office of Thrift Supervision\'s regulations are in Part
    563e.

    To avoid confusion the agencies have cooperated in promulgating
    separate regulations which are identical except for those specific
    areas which relate to the different types of banks or savings
    institutions regulated. See the Federal Reserve System regulation 12
    C.F.R. § 228.11(c)(2) *Foreign Bank Acquisitions*, the Federal
    Deposit Insurance Corporation regulation 12 C.F.R. § 345.11(c)(2)
    *Insured State Branches*, and the Office of Thrift Supervision
    regulation 12 C.F.R. § 563e.11(c) *Scope.*

[^11]: Banks are subject to CRA examinations by the bank regulatory
    agencies which produce a written evaluation of the bank's
    performance under the CRA regulations and the bank's CRA rating. See
    12 U.S.C. §§ 2903(a) and 2906.

    CRA examinations take place approximately every 24 months. CRA
    examinations are scheduled one or more quarters in advance, and
    lists of scheduled CRA examinations are available at the agency web
    sites. All CRA Performance Evaluations are available to the public,
    both from the examining agency and from the examined bank. See 12
    C.F.R. § 25.43(a)(3), (c) and (d).

[^12]: This is a very substantial change from the process under the
    prior CRA regulations. Under the prior regulators were directed
    generally to:

    > \"assess the record of performance of the bank in helping to meet
    > the credit needs of its entire community, including low- and
    > moderate-income neighborhoods, consistent with safe and sound
    > operation of the bank.\"
    >
    > See 12 C.F.R. § 25.7, superseded by the current joint rule.

[^13]: See 12 U.S.C. § 2906(b)(1)(A), and 12 C.F.R. § 25.43(a)(2).

[^14]: The Community Reinvestment Act requires the regulatory agencies
    to evaluate and publicly report on bank performance, but it does
    [not]{.underline} authorize the regulating agencies to require banks
    to comply with performance standards or to impose sanctions on a
    bank which fails to meet performance standards. See 12 U.S.C. §§
    2901(b) and 2903(2), and 12 C.F.R. § 25.29.

    As indicated in the May 4, 1995, release, the prior proposed
    versions of the rule provided that the regulatory agencies would
    have enforcement authority with respect to banks found to be in
    \"Substantial Noncompliance,\" however those provisions were deleted
    from the final version of the joint rule. See the discussion of this
    issue at 60 FR 22158 under \"Enforcement Authority.\"

[^15]: Although failure to meet CRA performance standards does not
    expose a bank to regulatory sanctions, the Community Reinvestment
    Act expressly authorizes the agencies to make decisions on granting
    regulatory approval for certain important bank activities based on
    the CRA performance record of the bank. See 12 U.S.C. § 2903(a)(2).

    This statutory authority is reflected in the regulations, which
    provide that a bank\'s record of CRA performance may be the basis
    for denying or conditioning approval of an application to establish
    a domestic branch, relocate a main office or a branch, participate
    in a merger or acquisition with another insured depository
    institution, or convert to a national bank. See 12 C.F.R. § 25.29.

[^16]: The weight agencies give to a bank's CRA performance when
    reviewing an application is discussed in the 1999 Interagency
    Questions and Answers, in Question and Answer 1 to Sec.
    \_\_\_.29(a), at 64 FR 23641. See discussion at 60 FR 22170.

    A \"Satisfactory\" CRA rating may be sufficient to avoid having a
    bank\'s CRA performance becomes a block to obtaining a requested
    regulatory approval. However, an \"Outstanding\" rating is still
    regarded as preferable. While an \"Outstanding\" rating is not a
    \"safe harbor,\" it reduces the possibility that CRA performance
    will delay regulatory approval.

[^17]: Federal Housing Finance Board regulations restrict long term
    advances by Federal Home Loan Banks to a member bank unless the
    member bank has a \"Satisfactory\" CRA rating. See 12 C.F.R. §
    936.5, effective June 1, 1997, promulgated on May 29, 1997, at 62 FR
    28983 - 28991*.*

    While the Federal Housing Finance Board regulation only requires an
    overall CRA rating of \"Satisfactory,\" the impact of this
    regulation is quite broad. As of September 30, 1998, the twelve
    Federal Home Loan Banks comprising the Federal Home Loan Banking
    System had more than 6800 members, and had approximately \$388,394
    million in total assets, of which \$245,659 million were outstanding
    advances to members. (Information from the Internet web site for
    Federal Home Loan Bank Office of Finance at
    [www.fhfb-of.com]{.underline}.)

[^18]: Proposed rules were published for comment on December 21, 1993
    (see 58 FR 67466), and again on October 7, 1994 (see 59 FR 51232).

[^19]: See Notes Error: Reference source not found and Error: Reference
    source not found.

[^20]: See 12 C.F.R. § 25.51, which sets out the transition rules for
    the version of the joint rule promulgated by the Comptroller of the
    Currency. Note that certain provisions of the joint rule became
    effective on January 1, 1996, and additional sections became
    effective January 1, 1997. All sections of the rule became effective
    July 1, 1997.

[^21]: See Note Error: Reference source not found.

[^22]: Interpretive letters regarding CRA questions can be issued by
    each of the regulatory agencies, although in practice most of the
    interpretive letters on CRA issues made publicly available have been
    issued by the Office of the Comptroller of the Currency. These
    interpretive letters are available from the issuing agencies, and
    copies of all the publicly available interpretive letters are posted
    on the Internet at the web sites for the Office of the Comptroller
    of the Currency ([www.occ.treas.gov](http://www.occ.treas.gov/)) and
    the Federal Financial Institutions Examination Council
    ([www.ffiec.gov]{.underline}). In general, however, since the
    publication of the first set of Interagency Questions and Answers
    Regarding Community Reinvestment in 1996, the agencies have tried to
    avoid issuing interpretive letters in favor of addressing issues
    through revisions and expansions of the Interagency Questions and
    Answers.

[^23]: The CRA Performance Evaluation describes the examined
    institution, states its overall CRA rating, and contains an analysis
    of the bank's performance under each of the lending, service and
    investment tests. See 12 C.F.R. § 25.43(a)(3), (c) and (d).

    A searchable database of examined banks showing their CRA
    Performance rating and the date of their last examination is
    available over the Internet at the web site Federal Financial
    Institutions Examination Council
    ([www.ffiec.gov/cracf/crarating/main.cfm]{.underline}.) For more
    detailed information, the full text of many CRA Performance
    Evaluations is available over the Internet at the web sites for each
    regulatory agency. Web sites for other relevant regulatory agencies
    are listed in the Appendix to this paper.

[^24]: See 12 C.F.R. § 25.11(c).

[^25]: See 12 C.F.R. § 25.11(c)(3) that discusses the exception for
    special purpose banks. The definition of the term \"banker\'s bank\"
    used in the rule can be found at 12 C.F.R. § 24 (Seventh).

    See 12 C.F.R. § 25.11(c)(2) that discusses the application of the
    regulations to uninsured banks. See also the Federal Reserve System
    regulation 12 C.F.R. § 228.11(c)(2) *Foreign Bank Acquisitions*, the
    Federal Deposit Insurance Corporation regulation 12 C.F.R. §
    345.11(c)(2) *Insured State Branches*, and the Office of Thrift
    Supervision regulation 12 C.F.R. § 563e.11(c) *Scope*

    The application of the CRA regulations to foreign banks in the
    United States is a source of frequent confusion. As a general
    matter, foreign banks operating in the United States are subject to
    the CRA regulations if they are insured by the FDIC. Some uninsured
    foreign banks are also covered, however, as described in 12 C.F.R. §
    228.11(c)(2). Foreign banks that qualify as special purpose are
    exempted from the CRA regulations under the exemption for special
    purpose banks referred to above.

[^26]: There are more limited performance requirements for institutions
    defined as \"small banks\" under the joint rule: independent banks
    with under \$250 million in total assets or banks with under \$250
    million in total assets that are affiliated with a bank holding
    company with less than \$1 billion in total assets. Small bank
    performance requirements focus on lending, and do not include the
    investment and service tests. See 12 C.F.R. § 25.11(t) for the
    definition of \"small bank\" and 12 C.F.R. § 25.26 for small bank
    performance standards. Also see Note Error: Reference source not
    found.

[^27]: The definition of \"limited purpose bank\" is found at 12 C.F.R.
    § 25(o), of \"wholesale bank\" at 12 C.F.R. § 25.11(w), and of
    \"foreign bank\" at 12 C.F.R. § 228.11(c)(2). See also the
    discussion in the release under \"Scope\" at 60 FR 22158--22159.

[^28]: See 12 C.F.R. § 25.11(b)(1).

[^29]: See 12 C.F.R. § 25.12(h) for the definition of \"community
    development.\"

[^30]: The prior regulation listed twelve factors to be considered in
    assessing a bank's record of performance under the CRA, of which the
    first two are:

    > "(a) Activities conducted by the bank to ascertain the credit
    > needs of its community, including the extent of the bank's efforts
    > to communicate with members of its community regarding the credit
    > services being provided by the bank;
    >
    > "(b) The extent of the bank's marketing and special credit-related
    > programs to make members of the community aware of the credit
    > services offered by the bank;"

    See 12 C.F.R. §§ 25.7(a) and (b) of the prior CRA regulation.

[^31]: The regulating agency does not evaluate the assessment area
    chosen by the bank, as long as the area complies with the criteria
    in 12 C.F.R. § 25.41.

[^32]: See 12 C.F.R. § 25.41(a).

[^33]: See 12 C.F.R. § 25.41(c), (d) and (e).

[^34]: Both the investment test and the service test evaluate the bank's
    activities in both the bank's assessment area and "a broader
    statewide or regional area that includes the bank's assessment
    area(s)." See 12 C.F.R. §§ 25.23(a) and 25.24(b). See Note Error:
    Reference source not found for a more detailed discussion of the
    concept of a "region.")

[^35]: See 12 U.S.C. § 2906(b)(2) and 12 C.F.R. § 25.28.

[^36]: Banks have the option of being evaluated under goals set out in a
    \"strategic plan\" developed by a bank for meeting the credit needs
    of its community. This alternative is intended to provide additional
    flexibility to banks; however, the plan must be framed in terms of
    annual measurable goals for performance in lending, investment and
    service over a period of up to five years. Strategic plans must
    include public participation and are subject to advance approval by
    the regulating agency. A bank operating under an approved strategic
    plan will be evaluated based on the bank\'s performance relative to
    the specific annual goals set forth in the approved plan. See 12
    C.F.R. § 25.27.

[^37]: The Community Reinvestment Act prescribes [four]{.underline}
    ratings for overall CRA performance: outstanding, satisfactory (both
    \"high satisfactory\" and \"low satisfactory\" are combined for
    overall performance scoring), needs to improve, and substantial
    noncompliance. See 12 U.S.C. § 2906(b)(2). Note, however, that the
    CRA regulations provide separately for [five]{.underline} scoring
    levels for each individual performance category: outstanding, high
    satisfactory, low satisfactory, needs to improve, and substantial
    noncompliance. See 12 C.F.R. § 25.28 and Appendix A to Part 25 for
    scoring.

[^38]: See 12 C.F.R. § 25.23(b).

[^39]: See 12 C.F.R. § 25.28, which addresses the principles to be used
    in determining CRA ratings. The basic principles are set forth in 12
    C.F.R. § 25.28(b)(1)-(3):

    > "(1) A bank that receives an 'outstanding' rating on the lending
    > test receives an assigned rating of at least 'satisfactory';
    >
    > "(2) A bank that receives an 'outstanding' rating on both the
    > service test and the investment test and a rating of at least
    > 'high satisfactory' on the lending test receives an assigned
    > rating of 'outstanding'; and
    >
    > "(3) No bank my receive an assigned rating of 'satisfactory' or
    > higher unless it receives a rating of at least 'low satisfactory'
    > on the lending test."

    See 60 FR 22183.

    The issuing release for the joint rule discusses the rationale and
    methodology for determining CRA ratings and sets out the matrix and
    other considerations used to relate scores to performance ratings
    (see 60 FR 22169-22170). The scoring matrix is also set out in the
    1999 Interagency Questions and Answers in Question and Answer 3 to
    Sec. \_\_\_.28(a), at 64 FR 23641.

    The scoring matrices are as follows:

    > **[Individual Performance Tests]{.underline}**

    **Component Test
    RatingsLendingServiceInvestment**Outstanding1266High
    Satisfactory944Low Satisfactory633Needs to Improve311Substantial
    Noncompliance000

    > **[Overall CRA Rating]{.underline}**

    **PointsComposite Assigned Rating**20 or overOutstanding11 through
    19Satisfactory5 through 10Needs to Improve0 through 4Substantial
    Noncompliance

    See the issuing release for the joint rule at 60 FR 22170 and the
    1999 Interagency Questions and Answers at 64 FR 23641.

    In addition to the matrix, the issuing release and the Answer to
    Question 3 notes that there is one exception to the matrix. An
    institution may not receive an overall CRA rating of "Satisfactory"
    unless it has at least a rating of "low satisfactory" on the lending
    test. To achieve this result, an institution's combined score is
    capped at three times its score on the lending test. See the issuing
    release for the joint rule at 60 FR 22170 and the 1999 Interagency
    Questions and Answers, Question and Answer 3 to Sec. \_\_\_.28(a),
    at 64 FR 23641.

    Note that there are modifications to the relevant performance tests
    in the case of banks that fall in the definitions of \"small banks\"
    (see 12 C.F.R. § 25.12(t)) or \"small savings associations\" (see 12
    C.F.R. § 563e.11(s)). \"Small banks\" and \"small savings
    associations\" have separate performance standards that do not
    require performance under the investment and service tests in order
    for a \"small bank\" or a \"small savings association\" to obtain a
    \"satisfactory\" CRA rating (for \"small banks\" see 12 C.F.R. §
    25.26 and 12 C.F.R. Part 25 Appendix A paragraph (d), and for
    \"small savings associations\" see 12 C.F.R. § 563e.26 and 12 C.F.R.
    Part 563e Appendix A paragraph (d)).

    There are separate modifications to the criteria for
    [both]{.underline} a bank\'s assessment area and the relevant
    performance tests in the case of banks which fall in the definitions
    of \"wholesale or limited purpose banks\" (see 12 C.F.R. § 25.12(o)
    and (w)). \"Wholesale\" or \"limited purpose\" banks have separately
    defined performance standards (see 12 C.F.R. § 25.25 and 12 C.F.R.
    Part 25 Appendix A paragraph (c)).

    Both \"small banks\" and \"wholesale or limited purpose banks,\" may
    also elect to be evaluated based on goals set forth in an approved
    strategic plan, as described in Note Error: Reference source not
    found.

[^40]: See 60 FR 22169-22170. A performance score of at least \"low
    satisfactory\" is necessary in order for a bank to obtain an
    \"Outstanding\" CRA rating.

    While at least "low satisfactory" performance on the investment test
    is necessary for an "Outstanding" CRA rating, the effect of poor
    performance on the investment test is more variable for a
    "Satisfactory" rating. If performance scores on the lending and
    service tests are "low satisfactory," a "needs to improve" score on
    the investment test may cause the overall CRA rating to be "Needs to
    Improve." See for example, the Community Reinvestment Act
    Performance Evaluation for Fidelity National Bank, in Norcross,
    Georgia, dated September 9, 1998.

    A bank can, however, achieve a \"Satisfactory\" CRA rating with
    "high satisfactory" score in lending test and a "low satisfactory"
    score on the service test, even if it receives the lowest
    performance rating ("substantial noncompliance") under the
    investment test. As a result, even if a bank fails to make any
    qualified investments it may still receive an overall CRA rating of
    "Satisfactory." See for example, the Community Reinvestment Act
    Performance Evaluation for Community First National Bank, in
    Alliance, Nebraska, dated August 3, 1998.

[^41]: See the Appendix to this paper for a list of Internet web sites
    at which CRA Performance Evaluations are available.

[^42]: See 12 C.F.R. § 25.23(a).

    Note that the provisions of the joint rule relating to investment
    are less relevant for institutions defined as \"small banks\" under
    the joint rule (see Notes Error: Reference source not found and
    Error: Reference source not found). Qualified investments in the
    form of loans can have some positive effects, however, as examiners
    may adjust a small bank\'s loan-to-deposit ratio, if appropriate,
    based on lending-related qualified investments (see 12 C.F.R. §
    25.26(a)(1), and the discussion in footnote 4 in OCC Interpretive
    Letter 763, December 26, 1996). The regulating agencies will also
    evaluate investment activity in the case of a small bank or thrift
    which wishes to obtain an \"Outstanding\" rating (see 12 C.F.R. § 25
    Appendix A paragraph (d)(2) for \"small banks,\" and 12 C.F.R. §
    563e Appendix A paragraph (d)(2) for \"small savings
    associations\"). The importance of investment activity for a small
    bank or small savings association that wishes to obtain an
    \"Outstanding\" rating is also discussed in footnotes in two
    interagency CRA interpretive letters (see CRA Interpretations \--
    footnote 2 in OCC Interpretive Letter 750, September 23, 1996, and
    footnote 4 in OCC Interpretive Letter 763, December 26, 1996).

[^43]: See 12 C.F.R. § 25.23(e). The application of these criteria to
    the CRA ratings is discussed in more detail in 12 C.F.R. Part 25
    Appendix A paragraph (b)(2).

[^44]: The interaction between the examiners' evaluation under the
    quantitative criteria and the evaluation under the qualitative
    criteria is not clearly articulated, and the guidance in the 1999
    Interagency Questions and Answers is difficult to interpret.

    See the 1999 Interagency Questions and Answers, Question and Answer
    2 to Sec. \_\_\_.28, at 64 FR 23640, which states, in relevant part:

    > ". . . Some of these performance criteria are quantitative, such
    > as number and amount, and others, such as the use of innovative or
    > flexible lending practices, the innovativeness or complexity of
    > qualified investments, and the innovativeness or responsiveness of
    > community development services, are qualitative. The performance
    > criteria that deal with these qualitative aspects of performance
    > recognize that these loans, qualified investments, and community
    > development services sometimes require special expertise and
    > effort on the part of the institution and provide a benefit to the
    > community that would not otherwise be possible. As such, the
    > agencies consider the qualitative aspects of an institution's
    > activities when measuring the benefit received by a community. [An
    > institution's performance under these qualitative criteria may
    > augment the consideration given to an institution's performance
    > under the quantitative criteria of the regulations, resulting in a
    > higher level of performance and rating]{.underline} \[emphasis
    > added\]."

    But also see the apparently contrasting guidance on the qualitative
    criteria in the Answer to Question 2 to Sec. \_\_\_23(e), at 64 FR
    23638:

    > "The extent to which qualified investments receive consideration,
    > however, depends on how examiners evaluate the investment under
    > the remaining three criteria \[the qualitative
    > criteria\]---innovativeness and complexity, responsiveness, and
    > degree to which the investment is not routinely provided by
    > private investors."

[^45]: ^?^ See 12 C.F.R. § 25.12(s) for the definition of \"qualified
    Investment.\" The issuing release elaborates this definition, by
    providing specific examples of financial activities that will be
    considered qualified investments under the rule. See 60 FR 22162,
    footnote 3.

[^46]: See 12 C.F.R. § 25.12(h) for the definition of \"community
    development.\"

[^47]: See 12 C.F.R. § 25.12(h)(3).

    The SBA size eligibility standards referred to are set out in 13
    C.F.R. § 121.301(b) and (c), the definition of \"business concern"
    is set out at 13 C.F.R. § 121.105, and the standards for determining
    a business concern\'s \"affiliates\" for purposes of the size
    eligibility standards are set out in 13 C.F.R. § 121.103.

    The size eligibility standard for the SBIC program set out at 13
    C.F.R. § 121.301(c)(1) requires a small business (together with its
    affiliates) to have: \". . . tangible net worth not in excess of
    \$18 million, and average net income after Federal income taxes
    (excluding carry-over losses) for the preceding 2 completed fiscal
    years not in excess of \$6 million. . . .\"

    Note also that in addition to the SBA size standards, Section
    25.12(h) (3) also includes businesses or farms that have gross
    annual revenues of \$1 million or less.

[^48]: The word \"communities\" has been used here colloquially. The
    technical term used in the joint rule here is \"geographies\" rather
    than \"communities.\" Thus this provision reads: \"activities that
    revitalize or stabilize low- or moderate-income
    [geographies]{.underline} \[emphasis added\].\" See 12 C.F.R. §
    25.12(h)(4).

    The term \"geographies\" is specifically defined in the joint rule
    as \"a census tract or block numbering area delineated by the United
    States Bureau of the Census in the most recent decennial census.\"
    See 12 C.F.R. § 25.1(l).

[^49]: By contrast, the prior rule provided a list of twelve factors
    that the regulating agency was directed to take into account in
    assessing a bank\'s performance. Bank investment activity is
    referred to in only one of the twelve factors:

    > \"(h) The bank\'s participation, including investments, in local
    > community development and redevelopment projects or programs;\"

    See 12 C.F.R. § 25.7(a) through (l), superseded by the joint rule.

    Investment activity is referred to under the old rule simply as one
    way that a bank can participate in \"community development and
    redevelopment projects and programs.\" The old rule contemplated
    bank investment in nonprofit community development organizations and
    low- and moderate-income housing projects. It provided little, if
    any, guidance as to what types of commercial investments would be
    considered appropriate community reinvestment activity.

[^50]: See 1999 Interagency Questions and Answers, Question and Answer 7
    under Sec. \_\_-.12(i) and 563e.12(h). This new Question and Answer
    is discussed in the issuing release for the 1999 Interagency
    Questions and Answers at 64 FR 23619.

[^51]: It is necessary to keep in mind, however, that neither the CRA
    nor the joint rule change the existing statutory restrictions on the
    types of lawful investments which a bank, bank holding company or
    other affiliate may make in nonbank businesses. Any investment by a
    bank or bank holding company must comply with applicable banking
    statutes and regulations regarding ownership of securities in
    nonbanking businesses.

[^52]: The interpretation by the regulatory agencies that in order to be
    considered a \"qualified investment,\" an investment in business
    must [both]{.underline} meet the size standard in the definition of
    \"community development\" and also meet one (or more) of the other
    criteria listed in the definition of community development is
    articulated in the 1999 Interagency Questions and Answers in
    Question and Answer 1 under Secs. \_\_\_.12(h)(3) and 563e.12(g)(3):

    > "*Q1. 'Community development' includes activities that promote
    > economic development by financing businesses or farms that meet
    > certain size eligibility standards. Are all activities that
    > finance businesses and farms that meet these size eligibility
    > standards considered to be community development?*
    >
    > "A1. No. To be considered as 'community development' under Secs.
    > \_\_\_.12(h)(3) and 563e.12(g)(3), [a loan, investment or service
    > whether made directly or through an intermediary, must meet both a
    > size test and a purpose test]{.underline} \[emphasis added\]. An
    > activity meets the size requirement if it finances entities that
    > either meet the size eligibility stands of the Small Business
    > Administration's Development Company (SBDC) or Small Business
    > Investment Company (SBIC) programs . . . . [To meet the purpose
    > test, the activity must promote economic development]{.underline}.
    > An activity is considered to promote economic development if it
    > supports permanent job creation, retention, and/or improvement
    > either in low- or moderate-income geographies or in areas targeted
    > for redevelopment by Federal, state, local or tribal governments.
    > [The agencies will presume that any loan to or investment in an
    > SBDC or SBIC promotes economic development]{.underline} \[emphasis
    > added\]. . . ."

[^53]: See Note Error: Reference source not found.

[^54]: See 60 FR 22162, footnote 3.

[^55]: See the emphasized language in the Answer to Question and Answer
    1 to Secs. \_\_\_.12(h)(3) and 563e.12(g)(3) in the 1999 Interagency
    Interpretive Questions and Answers, discussed in Note Error:
    Reference source not found.

[^56]: As a general matter, there is no \"look through\" to an SBIC\'s
    underlying portfolio in connection with determining the amount of an
    investment in an SBIC when it is evaluated in connection with the
    investment test. Examiners may look at an SBIC's portfolio
    investments, however, in their qualitative evaluation of the
    investment. See the discussion of quantitative and qualitative
    criteria in Note Error: Reference source not found.

    Note, however, that in the case of an SBIC engaged in lending, a
    bank would have the alternative of electing to have the lending
    activities of the SBIC evaluated in connection with the bank\'s
    performance under the lending test. Where a bank has elected to have
    an SBIC\'s activities evaluated under the lending test, the agencies
    will look through the SBIC and evaluate its underlying portfolio.
    See, for example, the discussion in OCC Interpretive Letter 727,
    June 27, 1996.

[^57]: The nature of the bank examiners\' evaluation of an investment in
    a non-SBIC fund is discussed in an interpretive letter dated
    September 3, 1997, designated as OCC Interpretive Letter 799:

    > \"Examiners may determine that the Fund \[a non-SBIC fund\]
    > engages in activities primarily intended to revitalize or
    > stabilize low- or moderate-income geographies. They will make this
    > determination based on information provided to them by the
    > investor financial institutions. In evaluating that information,
    > examiners may consider the following factors:
    >
    > \- Whether the express, [bona fide]{.underline} intent of the Fund
    > is to promote the community development purpose of revitalizing or
    > stabilizing a low- or moderate-income geography;
    >
    > \- Whether the Fund is specifically structured to achieve the
    > expressed community development purpose(s); and
    >
    > \- Whether the Fund is reasonably certain to accomplish the
    > expressed community development purpose(s).\"

[^58]: The term \"affiliate\" is defined in terms of common control, see
    12 C.F.R. § 25.12(a), and investments by affiliates is discussed at
    12 C.F.R. § 25.23(c).

[^59]: For example, a bank can claim CRA credit for an equity investment
    in a nonbank business made by an affiliated bank holding company
    which meets the requirements for a qualified investment, even though
    the bank would not be permitted to make such an equity investment
    directly.

[^60]: Any such broader regional area must include the bank\'s
    assessment area (see 12 C.F.R. § 25.23(a)). The status of regionally
    focused investments is discussed specifically in the 1999
    Interagency Questions and Answers, in the Answers to Questions 5 and
    6 under Sec. \_\_\_.25.12(i) at 64 FR 23629:

    > \"*Q5.* *Must there be some immediate or direct benefit to the
    > institution\'s assessment area(s) to satisfy the regulations'
    > requirement that qualified investments and community development
    > loans or services benefit an institution\'s assessment area(s) or
    > a broader statewide or regional area that includes the
    > institution\'s assessment area(s)?*
    >
    > \"A5. No, the regulations, for example, recognize that community
    > development organizations and programs are frequently efficient
    > and effective ways for institutions to promote community
    > development. These organizations and programs often operate on a
    > statewide or even multi-state basis. Therefore, an institution\'s
    > activity is considered a community development loan or service or
    > a qualified investment if it supports an organization or activity
    > that covers an area that is larger than, but includes, the
    > institution\'s assessment area(s). [The institution\'s assessment
    > area need not receive an immediate or direct benefit from the
    > institution\'s specific participation in the broader organization
    > or activity, provided the purpose, mandate, or function of the
    > organization or activity includes serving geographies or
    > individuals located within the institution\'s assessment
    > area]{.underline} \[emphasis added\]. . . .
    >
    > "*Q6. What is meant by a 'regional area' in the requirement that a
    > community development loan must benefit the institution's
    > assessment area(s) or a broader statewide or regional area that
    > includes the institution's assessment area(s)?*
    >
    > "A6. A 'regional area' may be as small as a city or county or as
    > large as a multistate area. For example, the 'mid-Atlantic states'
    > may comprise a regional area. When examiners evaluate community
    > development loans that benefit a regional area that includes the
    > institution's assessment area(s), however, the examiners will
    > consider the institution's assessment area(s). In most cases, the
    > larger the regional area, the more diffuse the benefit will be to
    > the institution's assessment area(s). Examiners may view loans
    > with more direct benefits to an institution's assessment area(s)
    > as more responsive to the credit needs of the area(s) than loans
    > for which the actual benefit to the assessment area(s) is
    > uncertain or for which the benefit is diffused throughout a larger
    > area that includes the assessment area(s)."

[^61]: See 12 C.F.R. §§ 25.12(o) and (w) for the definitions of "limited
    purpose bank" and "wholesale bank."

    If a wholesale or limited purpose bank has "adequately addressed the
    needs of its assessment area(s)," then examiners are directed to
    consider qualified investments "that benefit areas outside the
    bank's assessment areas(s)." See 12 C.F.R. §§ 25.25(e)(2). The 1999
    Interagency Questions and Answers make clear that this means that a
    wholesale or limited purpose bank may make investments on a national
    (as opposed to a more limited regional) basis, in the Answer to
    Question 1 to Sec. \_\_\_.25(e), at 64 FR 23638:

    > "*Q1. How do examiners evaluate a wholesale or limited purpose
    > institution's qualified investment in a fund that invests in
    > projects nationwide and which has a primary purpose of community
    > development, as that is defined in the regulations?*
    >
    > "A1. If examiners find that a wholesale or limited purpose
    > institution has adequately addressed the needs of its assessment
    > areas(s), they will give consideration to qualified investments,
    > as well as community development loans and community development
    > services, by that institution nationwide. In determining whether
    > an institution has adequately addressed the needs of its
    > assessment area(s), examiners will consider qualified investments
    > that benefit a broader statewide or regional area that includes
    > the institution's assessment area(s)."

[^62]: Although an SBIC with a regional investment focus (assuming the
    region includes the bank\'s assessment area) will be presumed a
    qualified investment, how the investment is evaluated under the
    investment test depends on how directly the investment benefits the
    bank\'s assessment area.

    The issue of how benefit to the assessment area should be taken into
    account is discussed in the context of community development loans
    in the 1999 Interagency Questions and Answers, however, the degree
    to which the same analysis is applicable to investments in SBICs is
    not clear. An investment in an SBIC is significantly different than
    a loan to a specific entity. In addition, it is hard to integrate
    the approach described in the 1999 Interagency Questions and
    Answers, at Question and Answer 6 to Sec. \_\_\_.25.12(i) with the
    description of how quantitative and qualitative criteria should be
    applied in evaluating qualified investments set out in Question and
    Answer 2 to Sec. \_\_\_.28. See Notes Error: Reference source not
    found and Error: Reference source not found.

[^63]: For example, in many rural areas, the small size of a community's
    economy makes it necessary to give an SBIC a statewide or regional
    territory to assure that the SBIC will have a territory which can
    provide the volume of investment opportunities necessary for
    financially successful operations. The most likely effect of
    requiring a local, as opposed to a regional, investment focus in
    this situation will be to hinder or prevent the banks in smaller
    communities (or with limited assessment areas) from using the SBIC
    program as a means to increase the amount of equity capital
    available in their region.

    This is illustrated by the case of an SBIC formed in a Midwestern
    state and funded by investments from more than two dozen rural
    community banks throughout the state. Because of the generally small
    size of the communities which the bank investors served, it was not
    possible for the SBIC to provide any bank investor with any
    reasonable assurance that the SBIC would be able to make an
    investment in that bank's assessment area. This is accentuated by
    the comparatively small number of portfolio investments (normally 15
    -- 25) that an SBIC makes during its investment life.

[^64]: The generally accepted view in the venture capital industry is
    that the ratio of business plans reviewed to investments made is on
    the order of 100:1. Thus, a typical SBIC planning a portfolio of
    investments in 15 to 20 businesses over a two to three year period
    will need a market area which can provide a deal flow of
    approximately 1500 to 2000 investment opportunities (which are
    sufficiently developed to support a business plan) over that period.
    If an SBIC\'s market territory is not large enough to provide an
    adequate deal flow, the economic viability of the SBIC will be
    adversely affected, since it will have to either lower its quality
    standards for investments or slow its rate of investment and limit
    the number of the investments in its portfolio.

[^65]: See Note Error: Reference source not found.

[^66]: See Note Error: Reference source not found.

[^67]: The impact and importance of the information that is available
    (and not available) about the "performance context" for a locality
    is often overlooked. This is particularly true for qualifying
    investment activity, since there is relatively little data available
    assessing the capital needs of small businesses on a national,
    regional or local basis. This absence of specific data limits the
    ability of both banks and agencies to evaluate a community's needs
    and opportunities for investment, design programs to address those
    needs and opportunities, and appropriately evaluate performance in
    relation to the needs and opportunities.

    A recent study by the California Research Bureau is a good example
    of a systematic effort to collect data and evaluate the capital
    needs of small businesses in several specific localities. The study
    illustrates the kind of information which both banks and agencies
    need in order to accurately evaluate the performance context for
    qualifying investment activity. See "Business Capital Needs in
    California: Designing a Program," by Gus Koehler, Ph.D. and Rosa
    Maria Moller, Ph.D (CRB-98-005, April 1998), available at the
    California Library Internet web site
    ([www.library.ca.gov/html/statseg2a.cfm]{.underline}).

[^68]: The 1999 Interagency Questions and Answers discuss how the amount
    of a qualified investment is determined in the Answer to Question 2
    to Sec. \_\_\_.25(e), at 64 FR 23638-23639:

    > ". . . examiners will determine the dollar amount of qualified
    > investments by relying on the figures recorded by the institution
    > according to generally accepted accounting principles (GAAP).
    > Although institutions may exercise a range of investment
    > strategies, including short-term investments, long-term
    > investments, investments that are immediately funded, and
    > investments with a binding, up front commitment that are funded
    > over a period of time, institutions making the same dollar amount
    > of investments over the same number of years, all other
    > performance criteria being equal, would receive the same level of
    > consideration."

[^69]: See 12 C.F.R. § 25.21(b) and Notes Error: Reference source not
    found and Error: Reference source not found.

[^70]: See Note Error: Reference source not found.