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The Community Reinvestment Act business.

New legal requirements to lend in ways that help communities may actually be good business.


Along the once-decaying corridors of inner city Washington, D.C., new hope has been built brick-by-brick, much of it with community development mortgage loans from the city's own American Security Bank. Since 1986, the bank's community investment has climbed to $250 million in profitable loans, according to Karen Kollias, vice president of American Security's community development group, a real estate division.

San Francisco's First Nationwide Bank generated $25 million in community loans in 1989 alone, says Ann Winchester, first vice president for community lending.

In New York, Norstar Mortgage Corporation has originated roughly $100 million in subsidized single-family housing loans in the past two years according to Vice President Lawrence Strauss.

Stories like these have surfaced from coast-to-coast, as aggressive bankers probe the potential of community reinvestment and attempt to convert social responsibilities into a profitable facet of their overall real estate involvement. But the issue facing financial institutions is more serious than the potential development of a profitable, relatively untapped market. Reinvestment in communities is mandatory for lenders today, both from a regulatory and business standpoint.

Reinvest--or else

Much of this activity has been promoted by the Community Reinvestment Act (CRA), passed in 1977. Headlines brought the news of a recent challenge by community groups to the $2.2 billion merger of Virginia's Sovran Financial Corporation and Atlanta's Citizens and Southern Corporation on grounds the institutions hadn't lived up to their CRA obligation.

Further, Jake Lewis, a professional staff members of the House Banking, Finance and Urban Affairs Committee says, "We are still getting a lot of evidence about discriminatory practices in lending...[demonstrating that] the act has not done all it should."

CRA requires banks and thrifts to help meet the credit needs of their communities by participating in programs to assist low- and moderate-income housing, rehabilitation, home improvement, farm lending, community development and commercial lending activities. Institutions are encouraged to describe their efforts and make reports that are reviewed and readily available for public inspection.

Enforcement of CRA regulations has been charged to the Federal Reserve, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision. Historically, these agencies have been slow to show their enforcement fangs. In an unusual instance, Chicago-based, Continental Illinois National Bank was challenged under CRA regulations during its purchase of an Arizona bank. In this rare CRA challenge by federal regulators, the purchasing transaction was denied.

In other cases, however, this seeming lack of attention created an outcry for better enforcement regulations that were written into the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). A group of influential legislators such as Henry B. Gonzalez, chairman of the House Banking, Finance and Urban Affairs Committee, and Donald W. Riegle, Jr., chairman of the Senate Banking, Housing and Urban Affairs Committee, pushed these regulations through as a part of the thrift reform law.

CRA regulators have begun rating financial institutions on their awareness of community credit needs; marketing and types of credit extended to serve those needs; and community development activities. CRA ratings of institutions will be on a scale of one to four--outstanding, satisfactory, needs to improve and substantial noncompliance--in meeting community credit needs. These ratings must be disclosed to the public on or before July 1, 1990.

CRA compliance notices, which all financial institutions must post, now will state that a current "CRA performance evaluation" is available. What's more, ratings will remain in force until a new examination takes place, which could be up to one year or more.

What happens to the institution with the poor CRA showing? Its expansion plans could be denied or delayed by regulators, as was the case with the proposed Sovran and Continental transactions. Regulators assess CRA records when considering permits to open or close branches, to change charters, and to acquire or merge institutions. Third parties can petition the regulatory agencies to deny these applications if the institution has a poor CRA record. Aside from this, the effect of the ensuing poor press and public relations are enough to make most financial institutions tremble.

Hidden opportunities

Compliance with CRA, however, offers some lenders an immediate market. They cannot only sell mortgages, but they can sell their know-how. Soon, every bank and thrift is going to be on the prowl for new community development business, and may even come courting lenders who have developed the expertise for such projects.

Savvy entrepreneurs are not going to be sitting around waiting to be asked. They will use their ability to help CRA lenders meet the criteria and better position themselves to purchase correctly structured products.

Traditionally, smaller mortgage brokers have filled inner-city financial needs to a greater extent than banks. In turn, banks have done a better job than thrifts, according to a survey based on Federal Home Loan Bank and census tract data by the Center for Community Change, Washington, D.C.

Many lenders don't realize that community lending projects can be good for business too. They tend to view them as requiring concessionary rates, breeding high defaults and lacking a secondary market. Often, they are unaware of many of their community's needs. When it comes to results, "Profits are about the same, if not a tad better," says American Security Bank's Kollias. A community lending expert, she has put together more than 6,500 rental projects, 250 ownership units, and two million square feet of commercial/retail and community facilities.

After working with an independent mortgage lender, ASB now functions as its own mortgage banker, using the same officer to handle an entire project. When they close on an acquisition and construction loan, the same officer submits the documents for Fannie Mae or Freddie Mac. This one-stop operation saves on underwriting and other fees.

"There are a lot of dollars out there," says consultant James Vitarello, of Vitarello Development Associates, Washington, D.C. A former OCC community development expert, Vitarello says, "Community groups need a creative mortgage banker."

Although small-town institutions are generally knowledgeable about their own markets, they may not be actively involved in addressing housing and community redevelopment problems. The record also shows that big-city lenders are not necessarily active participants in their community's low- and moderate-income housing and development projects. This was exemplified by newspaper reports in Detroit and Atlanta which alleged redlining and discriminatory lending practices.

Charles E. Riesenberg, managing vice president of First Bank System's highly successful Community Development Corporation in Minneapolis, says, "Many [lenders] have over-looked a good market. Lower income folks, if underwritten properly, make payments better than high-income people. The house means more to them than to people with a lot of money. It's the `American Dream' and mortgage bankers provide that dream."

The tightening up of CRA serves to remind financial institutions of their community responsibilities. But there are more ramifications. Mortgage lenders, for whom CRA regulations do not apply, were never monitored until the Home Mortgage Disclosure Act (HMDA) requirements were extended to them. But the CRA spotlight on lenders will catch mortgage lenders in the glare, and now that HMDA became effective on January 1, 1990, there may be more than glare.

"It's a new ballgame for mortgage bankers," says First Bank System's Riesenberg, who is active on the American Bankers Association's (ABA) subcommittee on community development lending, and author of the manual "Principles and Practices of Community Development Lending."

Fred Manning, vice president and community affairs officer with the Federal Reserve Bank in Atlanta agrees. "Mortgage bankers can expect to have community folks coming at them. They may experience some heat if they show a wide imbalance between low- and moderate-income housing activity with other activity." Manning adds that he sees increased tensions and protests directed at the banking industry, because it is hard to predict what the community interest groups will have on their agenda in what he describes as a "fluid situation."

The CRA examination will concentrate on how institutions assess community needs, their outreach policies and how they develop their action plans. "Lenders will hear questions they have never heard before," Manning says, "and the community groups will measure the best [rated] banks against the others."

Drawing from his OCC experience, Vitarello also believes that mortgage lenders will come under a great deal of scrutiny, causing their involvement in community reinvestment to become practically mandatory to survive in the public's eye.

Many industry leaders believe that what some describe as a threat is truly an opportunity; that CRA should be viewed by lenders as "enlightened self-interest," says John P. La Ware, member of the Board of Governors of the Federal Reserve System. First Nationwide's Ann Winchester puts it bluntly: "When will banks realize that CRA isn't covering their [reputations] but covering their assets?"

CRA start-up

As with any untried market, however, mortgage lenders' initial involvement in community reinvestment is not that simple.

"I remember the first time I was asked to get involved," says Norstar's Strauss. The $100 million of affordable housing funding he put together "took a year of negotiation with investors," he says.

Since 1988, Norstar has made mortgage loans on two dozen housing projects for a total of 1,400 units. Typical mortgage loans are around $70,000. Norstar primarily negotiates with various investors such as Fannie Mae, and the State of New York Mortgage Agency.

Norstar boasts about the success of the Nehemiah Planned Homes project in East Brooklyn. For this project, the company was the site leader for single-family homes selling in the $50,000 to $60,000 range, with $45,000 mortgages. Down payments are city- subsidized, but homeowners must put down 10 percent.

"A marvelous neighborhood now," is the way Strauss describes the current condition of the community's housing. "The change is astronomical. Manicured lawns, no broken glass, no graffiti."

Strauss emphasizes, however, that CRA lending encompasses more than the standard business practices that most lenders would prefer. Expenses must be cut as much as possible, and often profits are shaved to provide a service to the community.

"It's not typical business. It takes a lot more time, effort and follow-up," he says. But Strauss concedes that the business is worth the effort, saying that "[housing] gives people a chance to be in charge of their own destiny."

"Mortgage bankers should actively go out and seek builders who are involved in affordable housing and structure the financing or assist in it, counsel buyers and assist in the mortgage applications. Go out to community organizations and put together packages to sell. It's serving a wonderful purpose, providing a home," says Strauss.

Gaye G. Beasley, president of the Patrician Mortgage Company, Washington, D.C., and chairman of the Mortgage Bankers Association of America's (MBA) task force on homelessness and affordable housing, adds, "It can be slow and agonizing...but for those who do it constantly, it can be very profitable."

CRA extends to every area of the country. Large, multi-city or multi-state lenders are not allowed to satisfy CRA requirements only at the headquarters' institution. Each branch of a bank or thrift must meet local obligations. However, many branches and independents may not have the trained staff needed for the more complicated financing involved. They may not be familiar with credit enhancement sources or low- and moderate-income housing programs in the secondary market. In fact, they may not even be aware of community groups. This offers local lenders the chance to put their knowledge into play in many untapped markets.

Developing communities

Mortgage lenders can determine CRA lenders' needs and discover the gaps in their community lending programs, provide sources for permanent financing and expedite the work with community groups on mutually desired projects.

One of the most promising ways to develop community projects may arise from the technique of putting together groups of lenders for enhanced financing capabilities. For example, in California, the Savings Associations Mortgage Company (SAMCO) a Santa Clara consortium, is one such coalition that has grown from a membership of 11 thrifts to 56, and has closed $150 million worth of loans since 1971.

In smaller cities, such lender pools could be the only way that many projects garner sufficient financing. Also, community groups can form pools of lenders, as did the Central Germantown Council (CGC) in Pennsylvania. A coalition of fifty neighborhood associations, churches and businesses teamed up to rehabilitate a sixteen-unit apartment and four stores, to open new businesses and to revitalize the community's deteriorated downtown. CGC plans further development with a shopping center, mixed-use properties and a boarding house. Funding has come through local bank grants and construction financing from large out-of-town banks. Mortgages have been financed through the Philadelphia Mortgage Plan, and assisted by CGC.

Secondary market involvement

It appears that single-family housing is the most readily solved community reinvestment problem because there is a strong secondary market through Fannie Mae and Freddie Mac.

Since Martin D. Levine became vice president of low- and moderate-income housing at Fannie Mae, enormous strides have been made towards community reinvestment. Levine says that Fannie Mae is "challenging" local and state local groups to work towards the same goals.

Awarding high marks to Fannie Mae for its support, Norstar's Strauss says his company would never have succeeded without it; the liberalization of Fannie Mae's standards was absolutely essential.

Fannie Mae now has $3.5 billion outstanding in specialized financing for low- and moderate-income housing, according to Levine. They are purchasing low down payment loans, typically at 5 percent, with enhancements that allow borrowers to qualify but still protect Fannie Mae. Their most recent move is a joint multifamily rental initiative with the MBA. This $100 million program is currently being test-marketed in five communities. Fannie Mae is providing rapid processing and greater flexibility in qualifying, and hopes to expand after the program is successfully past its experimental stage.

John Carlisi, investment officer with Fannie Mae's Philadelphia regional office adds, "Low income is where mortgage bankers should be looking for participation from state and local governments to provide second mortgages and different kinds of incentives such as shared appreciation and deferred mortgages."

However, many think that Fannie Mae and Freddie mac need to come up with even more creative programs to serve the affordable housing market. Multifamily housing and other developments pose the greatest challenge.

"We've got to solve the credit enhancement and liquidity problems for loans that don't fit into [the Government National Mortgage Corporation (Ginnie Mae)], Fannie Mae and Freddie Mac. We are now at the hand-tooling stage. We need to create an assembly line," says former OCC official Vitarello.

Vitarello wants to see mortgage lenders agree on criteria and then negotiate with insurance companies. "Bring in an investment banker and gain credibility with the insurance companies--this is the way to go for commercial and mixed-use."

With some imagination, Vitarello also believes that it should be possible for Fannie Mae to provide credit enhancement on the residential part of mixed-use loans. "There's no reason why you can't pool housing and, say, retail. It just takes more creativity."

Insurance companies plowed more than $2 billion into urban investment in 1987, half in low- and moderate-income housing. Much of this comes though their social investment programs. Stanley G. Karson, director of the Center for Corporate Public Involvement in Washington, D.C., a social interest response group for the life and health insurance association, acknowledges that the market investment departments could become more involved.

"We're looking at the impediments and seeing how to overcome them," he says, referring to a newly created Housing Finance Task Force, comprised of industry representatives from the business, public and non-profit sectors. The task force is co-chaired by Wayne E. Hedien, chairman and CEO of Allstate Insurance Company, Northbrook, Illinois, and Harry W. Albright, chairman and CEO of the Dime Savings Bank of New York. Gaye G. Beasley serves on the task force as a representative of MBA.

Speaking practically, ASB's Kollias says, "One of the greatest things that could happen would be to get insurance companies to see this as good business. If it is treated as social investment, there [wouldn't] be enough dollars."

Investment strategies

What insurance companies have done so far is to partner some of the active investors in community redevelopment--investors who work in various ways.

One is the Local Initiatives Managed Assets Corporation (LIMAC) established in 1987 by the Local Initiatives Support Corporation (LISC), in New York. LIMAC purchases and securitizes loans from lenders involved with community development including non-profits, coops, individuals and corporations. It will focus on multifamily and mixed-use projects, commercial and industrial real estate and social service facilities. Single-family loans are judged on a case-by-case basis. Non-profit originators include LISC; The Enterprise Foundation, Columbia Maryland; Neighborhood Reinvestment Corporation (NRC) in Washington, D.C.; and the National Trust For Historic Preservation in Washington, D.C.; as well as other regional groups. LIMAC's first issue was for $10.5 million in 10-year bonds, which have been bought by insurance companies and the MacArthur Foundation. Of this, $1.5 million in subordinated debt was purchased by the Ford Foundation. LIMAC will buy both bridge and gap loans and is currently developing a $100 million demonstration program with Freddie Mac. Under this program, LIMAC will purchase and assemble pools that will be swapped for Freddie Mac securities.

American Securities Bank has dipped successfully into non-housing projects such as a mini-shopping center and an office building used by the District of Columbia government that is flanked by a minority-owned supermarket. The latter $18 million project had lenders standing in line for the permanent financing. It's the smaller projects that have trouble finding investors, according to Kollias. ASB holds $4 million of the shopping center's adjustable rate mortgage in its own portfolio for the time being.

Other sources report tremendous needs. Paul T. Knapp, director for Search for Shelter, a Washington, D.C. non-profit center for low-income housing says there is not financing for such things as shared housing, single-room occupancy housing and quadruplex apartments, where a unit is reserved for battered wives or single parents.

"I would like to see mortgage bankers help our teams," Knapp says. "So many projects don't get off the ground because there is no one on the team who understands the complexity of combining local and state funds, the Steward McKinney [Homeless Assistance] Act, and such financing." He believes that community reinvestment can be a profitable, self-sustaining business.

Not everyone will agree with that. Some experts believe that this type of multifamily housing requires grants to make the project work. Knapp acknowledges that the private sector must be involved, and tries to develop these coalitions. So far, Search for Shelter has projects located in 73 cities and expects to initiate another 30 projects in 1990. Search for Shelter is funded by the Washington, D.C.-based American Institute of Architects and the NRC.

NRC was established by Congress in 1978 to revitalize neighborhoods and to expand affordable housing through ownership or long-term rentals. NRC works to develop partnerships among residents, both in public and private groups. Its network -- NeighborWorks -- operates in 140 cities, towns and counties nationwide through three arms: Neighborhood Housing Services, Apartment Improvement Programs and Mutual Housing Associations.

Relying on Community Development Block Grants (CDBG), local businesses, governments and residents themselves, the network depends on commercial lenders and a revolving loan fund supported by social investors and a secondary market created by the Neighborhood Housing Services of America (NHSA).

NHSA, a private, non-profit corporation located in Oakland, California, has bought $40 million in single-family loans from local NHSs; these have been sold to insurance companies and philanthropic organizations at below-market costs.

"We're working in the toughest neighborhoods," says NRC's deputy director, George Knight. In Ithica, New York, NHS rehabilitated 600 homes for low-income owners by selling more than $1 million worth of loans to NHSA. In Kansas City, Missouri, NHSA's purchase of $300,000 worth of loans provided the gap financing for a NHS 47-unit rental housing project for the elderly that cost $2.6 million.

The non-traditional approach

Meanwhile there are other developments that open up the market. One is GE Capital Mortgage Company's community home buyers program. Approaching low- and moderate-income lending with the question: "What has to be changed to penetrate the market," GE Capital, Raleigh, North Carolina arrived at a hybrid loan approach that they test-marketed in five cities. Backed by commitments from Fannie Mae and Freddie Mac to purchase the loans, the half billion dollar program now has 97 mortgage lenders, banks and thrifts participating.

The program provides 30-year, fixed-rate loans with the debt-to-income ratio raised from 28 percent to 33 percent. "We discovered the vast majority [of prospects] were paying more than 28 percent for rent," says GE Capital's Jeannette Bernay, assistant manager of commercial and industrial affairs.

GE Capital decided that because many low-income people lack the traditional strict credit relationships and employment history, the company would use non-traditional credit sources to underwrite the loans.

This may not sound so special, but FBS's Riesenberg, one of the first participants, says, "To this market, it's a huge deal." Credit is being checked through rent receipts, utility payments, consistent employment--whether or not the applicant holds one or several jobs--and even tips. GE Capital also waived the normal two months mortgage payment reserve requirement and subsidized home inspections on these homes to prevent surprise expenses that owners might not be able to handle.

"It's a different market place," Riesenberg points out. "These low- and moderate-income folks are first-time homebuyers and they don't know anything [about buying a home]...they don't know what a Realtor is. This is an opportunity for mortgage bankers to get them into the market."

Under the GE program, applicants must go through a three-evening training course covering the fundamentals of homebuying and ownership. Although mortgage lenders don't have time to sit down for 10 or 15 hours with each applicant, they can assist in administering such classes, Riesenberg says. More creative underwriting is a way to expand the marketplace and develop more relationships and make more loans, Riesenberg believes.

Another little known and utilized source is HUD's 203 (k) program, which handled a mere 474 loans nationwide in 1989, with about half of them through Statewide Funding Corporation in Albany, New York.

Kenneth Crandell, chief architect for HUD's single-family development division, is betting on 2,500 loans in 1990. The 203 (k) program is an all-in-one acquisition, rehabilitation and permanent financing program, available to owners and investors for one- to four-family homes.

Success is limited by the lack of buyers for first mortgages, Crandell says. Statewide Funding holds these loans in their portfolio, then packages the mortgages in $2 million and $3 million pools and sells them to Ginnie Mae.

A creative future

Despite the cuts in federal development funds, and the strict limitations on the CDBG program; despite the difficulties in putting together the layers of credit and the educational process for everyone concerned; and despite the time required to put together these atypical loans, there is a widespread belief that community reinvestment may more than make up for the slack caused by the softness at the top-end of the real estate lending market.

"There's a lot of misconceptions that CRA is a social program or a giveaway," says Glenn E. Loney, assistant director at the Federal Reserve. Loney states simply that community reinvestment "takes an imaginative approach."

For mortgage lenders, participation in community reinvestment programs may offer a unique and profitable opportunity to help other lenders meet their CRA requirements while revitalizing desperate communities, and tackling some of the nation's most difficult social problems.

Jane Moss Snow is a Washington, D.C.-based freelance writer who frequently covers housing and finance issues.
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Author:Snow, Jane Moss
Publication:Mortgage Banking
Date:May 1, 1990
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