Correspondence Date: August 1, 1997

Dear [ ]:

This letter responds to your memorandum dated March 17, 1997 concerning whether investments in the [the Program] of [the Corporation] might receive positive consideration as "qualified investments" under the Community Reinvestment Act (CRA), and whether they might be considered "innovative." Staff from the four regulatory agencies have reviewed your analysis and supporting documentation, and, for the reasons indicated below, concur that the Program meets the definition of a "qualified investment" under the CRA Regulations.1 Whether or not such investments promote "innovative" practices is one of the performance criteria under the investment test that would have to be assessed on a case-by-case basis.

We understand that financial institutions (banks/savings and loans) are to participate in the Program as investors (by purchasing notes backed by mortgages originated under the Program), with the Corporation serving as the mortgagee (i.e., the loans would not appear on the books of the banks). Once an aggregate pledged investment of $8 million is reached, the Corporation will begin originating loans, according to established Program guidelines, by drawing on its $30 million standing line of credit, arranged independently of the Program. The Program offers borrowers fixed rate (6%) financing for purchases and repairs that improve the long term viability of buildings and visibly improve the surrounding neighborhood. Investors in the mortgage backed notes will earn a 5.5% return, with the remaining 0.5% going into a loan loss reserve fund. The Corporation will not charge a servicing fee, but will receive unused loss reserves when all loans are paid off.

You indicate that the Corporation and its banking partners have targeted the Program to two low- and moderate-income Chicago neighborhoods suffering from the effects of disinvestment in large, older multi-family buildings, where poor incentives for building maintenance and declining property values put neighborhood stability and owner confidence at risk. The Program, as you note, is intended to stimulate sufficient rehabilitation activity in qualifying multi-family buildings so as to reverse this downward spiral. You also state that the Program's sponsors and the features of the Program would ensure that post rehab rents will be affordable to low- and moderate-income renters.

As you know, the CRA Regulations define a qualified investment as a "lawful investment...that has as its primary purpose community development."2 Community development is, moreover, defined to mean: "(1) Affordable housing (including multifamily rental housing) for low- or moderate-income individuals; (2) Community services targeted to low- or moderate-income individuals; (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 (13 CFR 121.301) or have gross annual revenues of $1 million or less; or (4) Activities that revitalize or stabilize low- or moderate-income geographies."3 Hence, to the extent that the Program is targeted to neighborhoods that qualify as "low-or moderate-income" under section _.12 of the CRA Regulations,4 that post-rehab rents remain affordable to low- or moderate-income individuals, and that the purpose of the Program is to serve low- and moderate-income people, then investment in the Program would appear to promote "community development" both by stabilizing low- and moderate-income geographies and providing affordable housing, within the meaning of subsections _.12(h)(1) and (4) of the Regulations.5 Changes in the nature or scope of the Program's activities may, however, warrant reevaluating the amount of consideration to be given under the CRA to a financial institution's investment in the Program.

You also indicate that the Program's underwriting departs from standard industry practices by recognizing that consideration of loan-to-value ratios in low- or moderate-income neighborhoods with depressed real estate values often "kills the deal," even when post-rehab rental income is sufficient to support debt service. You note that, under the Program guidelines, the Corporation is prepared to lend, notwithstanding any gap between the amount of loan proceeds needed to purchase and rehabilitate the multifamily property and the appraisal value, so long as net rental income exceeds debt payments by a ratio of no less than 1.2:1. You assess that, currently, even the most flexible lenders in the local rehab market typically hold loans relative to appraisals to prescribed levels (usually 80%), and that the Corporation's Program, therefore, stands to overcome a serious barrier to multifamily lending by putting strict adherence to loan-to-value ratios "to the test." On that basis, you reason that the Program presently offers an innovative means for investors to promote community development in low- to moderate-income neighborhoods, within the meaning of the CRA Regulations.

As you know, in addition to the dollar amount of qualified investments, there are several qualitative performance criteria that are considered in evaluating an institution's performance under the investment test: an investment's innovation6 and complexity, its responsiveness to credit and community development needs, and the degree to which the investment is not otherwise routinely provided in the market.7 Also, depository institutions actively involved in developing a qualified investment would receive greater consideration under the investment test than would passive investors. These criteria are designed to enable recognition of qualitative aspects of investment performance that promote, or catalyze, community development.8 An assessment of any of these qualitative factors will depend on the context in which an institution's CRA performance is evaluated. Since market practices can vary across localities and over time, that assessment would have to be made on a case-by-case basis.

I trust your question has been adequately addressed. If you have any further questions, please contact me at (202) 452-3583 or Anna Rotenberg of this Division's staff at (202) 452-3946.

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

cc: B.J. Norris, FDIC
A. Loikow, FDIC
T. Burniston, OTS
T. Stark, OTS
S. Cross, OCC
M. Bylsma, OCC
M. Hesse, OCC
R. Frierson, FRB

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1 12 C.F.R. Parts 25, 228, 345, and 563e (1996).

2 See 12 C.F.R. §§ 25.12(s), 228.12(s), 345.12(s), and 563e.12(r).

3 See 12 C.F.R. §§ 25.12(h), 228.12(h), 345.12(h), and 563e.12(g).

4 See 12 C.F.R. §§ 25.12(n), 228.12(n), 345.12(n), and 563e.12(m).

5 See12 C.F.R. §§ 25.12(h)(1) & (4), 228.12(h)(1) & (4), 345.12(h)(1) & (4), and 563e.12(g)(1) & (4).

6 In general, an innovative practice is one that enables the credit needs of low- and moderate-income individuals or geographies to be served in new ways, or serves such groups not previously served by an institution 60 FR 22,165 (May 4, 1995).

7 See _.23(e)(2), (3) and (4).

8 Interagency Questions and Answers Regarding Community Reinvestment, Section_.21(a) -- Performance Tests and Standards, 61 FR 54,654 (October 21, 1996).