Pub. 6 2016 Issue 3

Some common investments where both purpose (majority of dollars) and geography (assessment area) can be achieved for qualified CRA investments include: – Single Family MBS – Multifamily MBS – Certain Municipal Securities – Minority and Women Owned Bank Certificates of Deposit – CRA Mutual Funds Single and multifamily MBS are the most common vehicles through which most institutions build their stock of quali- fied investments. That said, a deeper analysis of the nuances of certain municipal securities, certificates of deposits issued by minority and women-owned banks, and military housing bonds shows that they too can fulfill the criteria for the CRA investment test. Municipal Securities Municipalities issue debt to meet the most fundamental needs of their communities – to improve sewers, to build parks, and to finance school buildings. Logically, they should be excellent vehicles through which banks can reinvest in their communities. In our experience, however, municipal bonds are underutilized in meeting most institutions’ CRA investment needs. Undoubtedly, this underutilization stems from uncertainty over precisely what bonds meet the FDIC’s definition for community development, especially when com- pared to asset classes like mortgages where the application to community development is more straightforward. The FDIC initially cautions in its Interagency Q&: 5 “As a general rule… municipal bonds are not qualified in- vestments because they do not have as their primary purpose community development, as defined in the CRA regula- tions.” In the same breath, however, the commission opens the door to CRA consideration for a number of municipal struc- tures and issues: “…municipal bonds designed primarily to finance com- munity development generally are qualified investments. Municipal bonds or other securities with a primary purpose of community development need not be housing related. For example, a bond to fund a community facility or park or to provide sewage services as part of a plan to redevelop a low- income neighborhood is a qualified investment.” Contrary to its initial warning, this statement seems to give space for municipal bonds to qualify for CRA credit, even outside traditional housing bonds. While general purpose debt issued to finance roads, courthouses, or prisons might not qualify, debt for other revitalizing or stabilizing infra- structure or service projects might. 6 Whether a municipal bond satisfies a “community develop- ment,” purpose should be determined after considering two criteria implicit in the regulation: the bond’s specific purpose and the income of the individuals served. Theoretically, those criteria mirror what an institution must examine for every CRA investment. In practice, however, municipal bonds pose a unique challenge in obtaining and documenting both the specific purpose and granular income. Many municipal bond issues, especially at the county and city level, are often distributed under blanket authoriza- tions. Voters approve a block of debt to be issued “for general corporate purposes” and the municipality expends this authorization over a number of years for a variety of projects. The amount, timing, or location of these projects is often not delineated in bond disclosure documents. Moreover, even when the purpose of the project is explicit, its location may not be. To the FDIC’s example, indentures for municipal debt issued to “provide sewer services” rarely define what tracts or houses will be specifically served, obfuscating the income criteria. Refunding deals, which have constituted the major- ity of municipal issuance in each quarter since 2012, present an additional challenge as investors seeking CRA credit must trace dollars back to their original purpose. 7 Even when both the purpose and the income of the individuals served can be easily determined, institutions must ask if the practice is a feasible exercise, especially when competing for scarce, fast moving supply in the secondary market. For these reasons, where institutions do apply municipal bonds towards their investment test, we find that they gener- ally focus on four distinct types of municipal debt whose characteristics make it easy to identify the purpose and income of the individuals served. School District Bonds: Income: Institutions that utilize school district debt to meet their CRA needs generally rely on the percentage of students who participate in the USDA’s National School Lunch Program (NSLP) to determine whether the district or building services low-to-moderate income individuals. Student incomes must fall at 130% and 185% of the federal poverty guidelines to qualify for free and reduced price lunches, respectively. Not only is this data readily available from state department of education websites, it is also specifically mentioned in the FDIC’s CRA compliance manual as a way in which an institu- tion could determine that community services are offered to low-or-moderate income individuals: 8 “The community service is provided to students or their families from a school at which the majority of students qualify for free or reduced-price meals under the U.S. De- partment of Agriculture’s National School Lunch Program” 14 www.azbankers.org CRA w Continued from page 13