FFIEC Community Reinvestment Act Header

Correspondence Date: March 28, 1997

Dear [ ]:

This responds to your January 2, 1997, letter raising questions about an interagency letter (signed by Matthew Roberts of the Office of the Comptroller of the Currency) dated June 27, 1996, that deals with issues under the Community Reinvestment Act (CRA) with respect to financial institution’s purchase of so-called "equity equivalent" investments in a non-profit community development lender. Since the four bank and thrift regulatory agencies have issued substantively identical regulations to implement CRA, staff from each of the agencies have reviewed, and concur in the opinions expressed in, this response to your letter.

In brief, the June 27, 1996, interagency letter noted that non-profit community development lending organizations are not able to issue equity instruments, such as stock, to facilitate investment by financial institutions. The issue addressed in that letter was whether financial institutions that may wish to invest in these entities and receive favorable consideration by CRA examiners for a proportionate share of the community development lending done by the non-profit could do so. Such favorable consideration generally can only be given for a proportionate share of the community development loans made by a third party based on the equity investment in the entity by a financial institution non-profit community development lender was issuing instruments that were the functional investment in the entity by a financial institution. The June 27 letter addressed a situation wherein a non-profit community development lender was issuing instruments that were, in effect, the functional equivalent of equity instruments. The interagency staff indicated its belief that the circumstances were such that the equity equivalent instruments issued by the non-profit community development lender should be afforded the same treatment as more traditional equity instruments issued by a for-profit community development lender and that a financial institution could receive the same consideration in its CRA examination. That is, the financial institution can receive favorable consideration for the investment, as such, or for a proportionate share of the non-profit’s community development loans, or, in certain circumstances, both.

You raised several questions about the interagency letter and the underlying inquiry that prompted it. First, you asked whether the opinion expressed in the June 27 letter applies to all non-profits that issue equity equivalent instruments addressed in that to financial institutions and you ask about the extent to which any other such instruments must adhere to the circumstances addressed in that letter. The position taken in the June 27 letter could apply to any non-profit entity that engages in community development lending, if it issues equity equivalent investment instruments. These instruments would not have to conform precisely to the model addressed in the June 27 letter, however. For example, the instrument addressed in that letter had an initial 10 year year tenor to be rolled back annually to a new 10 year tenor. It may be, however, that shorter or longer periods would also be acceptable for this purpose. It was noted that the investment instrument in the model addressed in the June 27 letter seemed to have characteristics similar to preferred stock in the typical for-profit equity situation. There may be other ways to structure such instruments in ways that also suffice for the purpose, however, provided they have attributes that are characteristic of traditional equity investments.

Second, after noting that the instruments addressed in the June 27 letter carried an interest rate (that was not tied to any income received by the non-profit entity), you asked how much below market rates the interest rate would have to be for the instrument to be considered an equity equivalent. There was no intent to indicate that interest paid on these equivalent instruments had to be at any particular level, and, in particular, no intention to indicate that they must be below market rate. It is the total structure of the instrument, rather than the rate paid, that gives it the quality of an "equity equivalent."

Finally, you indicated that you believe it would be beneficial to have specific guidelines from the agencies regarding equity equivalent investments and that you intend to encourage non-profit entities to use the model discussed in the June 27 letter as guidance for their programmatic activities. You ask whether doing so is appropriate. The interagency staff will consider whether more specific guidance regarding these matters can be appropriately articulated, either as an addition to the interagency question and answer staff commentary or in another medium. In the meantime, it seems appropriate for you to point out the existence of the June 27 letter to those entities that might make use of it and encourage them to structure their activities along the line discussed. However, I would reiterate that there may be other ways to structure their instruments that also suffice for this purpose, so they should not conclude that any deviation from the circumstances discussed in the June 27 letter will disqualify their offerings. They should, however, make sure that their instruments have qualities equivalent to equity instruments offered by for-profit organizations.

I trust this response will be of use to you.


Sincerely,
/s/
Glenn E. Loney
Associate Director
Division of Consumer and Community Affairs
Board of Governors of the Federal Reserve System