Sioux Falls, Citibank, and CRA: Do US credit card banks deserve their "outstanding" community...

The US Community Reinvestment Act (CRA) of 1977 turns twenty-five years old this year. Thus, 2002 is an appropriate time to reflect on where it came from, how it works, and the ways it might be improved.1 In this paper, we are specifically interested in how the CRA applies to the seven limited-purpose

The CRA of 1977 establishes two important benchmarks. First, "regulated financial institutions are required by law to demonstrate that their deposit facilities serve the convenience and needs of the community in which they are chartered to do business." Second, financial institutions have "a continuing and affirmative obligation to help meet the credit needs of the entire community in which they are chartered ... consistent with the safe and sound operation of such institutions." An institution's record of meeting credit needs includes low and moderate income neighborhoods. The degree to which banks fulfill these requirements is assessed by the appropriate federal financial supervisory agency when the bank is examined.2

One ironic and likely unanticipated outcome of the CRA is that by requiring all "regulated financial institutions" to comply, even limited-purpose banks that do not take deposits or make mortgage loans fall under its purview. As the name implies, limited-purpose banks are allowed to offer only a narrow product line such as credit card or automobile loans. They must only infrequently offer other types of lending services. Thus, unlike traditional lenders whose CRA performance is evaluated primarily on its mortgage lending patterns and deposit services, regulation and evaluation of limited-purpose banks require a different approach.

Limited-purpose (and wholesale) banks are evaluated about every two years by their respective federal financial regulatory agency using a "community development test." This test takes into consideration three main factors: (1) sufficient community development loans, (2) qualified investments, and (3) adequate provision of community development services within their self-defined assessment area.4 In most cases, limited-purpose banks define the county or MSA where they are located as their assessment area (AA). Following an evaluation, the agency makes a bank's "Community Reinvestment Act performance evaluation (PE)" available at the regulator's web site, by written request, or at each individual institution.

Often while reading these evaluations one finds comments that sound impressive but are vacuous once one realizes there is no metric by which to compare the announced high scores. An example from the Office of the Comptroller of the Currency's (OCC), November 8, 1999, Community Reinvestment Act PE of United Credit National Bank (UCNB) illustrates. "During this evaluation period, the bank's qualified investments and grants totaled $361,077. These dollars represent 2% of the bank's average Tier 1 capital."5 The appeal of a financial ratio-here investments and grants as a share of Tier 1 capital-is that it simplifies an otherwise complicated matter. It gets to the nub of the issue. However, since there is no benchmark ratio to be achieved, or no other banks with whom to compare, the reader is left wondering. Is a limited-purpose bank that invests and loans 2 percent of its Tier 1 capital doing an outstanding job of meeting community development needs? Does UCNB compare favorably to other limited-purpose banks in Sioux Falls with respect to this ratio?

A second and similarly problematic quote comes to us from page 9 of the OCC's CRA PE of Citibank on May 24, 1999. "During this evaluation period, Citibank had a very high level of qualified investments and community development loans, combined they totaled $97 million. We considered the bank's performance strong because: on an annualized basis these dollars represent 3.25 percent of the bank's Tier 1 capital ... and 1.8% of the bank's managed assets" (emphasis ours). Here at least the evaluator is considerate enough to put the ratios on an annualized basis. However, even this second evaluator fails to tell us how the other six limited-purpose banks did with respect to these ratios. Obviously Citibank's investment and loan total are nominally large-huge in fact-as are its assets and Tier 1 capital. However, we cannot tell how Citibank compares with other lenders because no comparison data are given. To be fair and consistent, evaluators need to compare apples to apples. The current evaluation system fails to provide the necessary benchmark ratio or consistent set of ratios to facilitate these comparisons.

We recognize that assessing an institution's community reinvestment performance is a difficult and subjective task. However, we do believe that an empirical benchmark based on the annualized level of qualified investment and loans made within a lender's assessment area (both as a share of assets and as a share of Tier 1 capital) provides a snapshot by which institutions can be compared. Financial economics is full of similar ratio analogies such as a firm's price-to-earnings (P/E), return on equity (ROE), return on assets (ROA), or debt-to-equity (D/E) ratios. None of these are intended to provide a full picture of a firm's finances. However, in comparison with other firms, or to the same firm over time, one can gain insight into how a firm compares and in what direction it is headed. Thus, we suggest that when limited-purpose banks are evaluated, two ratios and a summary measure should be calculated and prominently reported in the evaluation.

The first ratio to be computed is the firm's annualized qualified investment and loans within the assessment area (AA) as a share of assets.6 The second ratio is the firm's annualized qualified investment and loans within the AA as a share of Tier 1 capital.7 Both of the ratios noted above are attempts to see how well a bank does in terms of community development, subject to two different measures (assets and Tier 1 capital) of its ability to pay. By summing these two ratios together, and dividing by two, a new average measure of community development relative to ability to pay is developed.

This new measure, which we refer to as a SOBR (simple outcomes-based ratio) score, could be easily computed by the bank evaluators as part of their routine CRA performance evaluation. As you will see in our analysis in the next section, we computed the ratios with data gleaned entirely from publicly accessible sources. In fact, the best source of data in our analysis was the community reinvestment performance evaluations (PEs) themselves. These are available online from the four federal regulatory agencies or from each individual bank. Where necessary we supplemented this information with call report data from the FDIC. This is also available online for 1998 and later.8 SOBR scores mean little in isolation. To be meaningful, they should be computed for an entire MSA, state, or region. Hopefully, once regulatory agencies adopt this technique, a nationwide list of scores could be posted at the Federal Financial Institutions Examinations Council web page.

To better illustrate how this technique works, we provide an assessment of the seven limited-purpose banks located in Sioux Falls, South Dakota. Sioux Falls is located in the southeast corner of this northern plains state at the intersection of US interstates 29 and 90. In 2000 the MSA consists of all of Minnehaha and Lincoln counties, with a population of 172,412. All seven institutions used this geographical area as their assessment area.9 Because of its absence of usury laws, no corporate or personal income tax, and early legislative moves to allow limited-purpose banks, Sioux Falls has seven limited-purpose banks.

Our Sioux Falls results are summarized in the eight columns of financial and performance information that make up table 1. For ease of exposition, additional information about specific data sources, chartering details, and bank ownership have been excised and are available from the primary author. Banks are listed in rank order of their most recent SOBR score. In the first column is the bank's name. The seven banks analyzed here (in alphabetical order) are Axsys National Bank, Bankfirst, Citibank, Dial Bank, Hurley State Bank, Retailers National Bank, and United Credit National Bank. In the second column we report the bank's latest CRA performance rating (O for outstanding; S for satisfactory). The third and fourth columns show that the limited-purpose banks differ significantly in size. Citibank is the largest with over $14 billion in assets. The smallest is Axsys National Bank with only a little more than $21 million in assets. Similarly, in the fourth column, Tier 1 capital (commonly referred to as core capital for regulatory purposes) ranges from Citibank's high of about $1.5 billion to ANB's approximately $5 million.

Columns 5 through 8 provide the essential part of our analysis. Column 5, headed as "I & L inside AA" reports the levels of qualified investments and loans made within the assessment area on an annualized basis. Annualizing is required since each bank has a different period of time between examinations. Column 6 is titled "% II&L/A" to describe the result of dividing column 5 by column 4. The result is annualized-inside-assessment-area-investment-and-loan-activities divided by the bank's assets. In short, it is community development activities as a share of total assets. Column 7 does the same sort of analysis but uses Tier 1 capital as the denominator instead of assets. Thus, Column 7 reports a measure of community development activities as a share of Tier 1 capital.

The final right hand column provides ranked SOBR (simple, outcomes-based ratio) scores for all seven limited-purpose banks in Sioux Falls. Its main benefit is that it provides an easy to calculate, quantitative measure of community development activity within the assessment area, controlling for the size of the institution. It also allows for easy comparison among the seven institutions. And, fortunately, it appears to have some relationship to the ratings system currently in use. Perhaps regulators are already performing this sort of analysis informally.

Note that the banks with the three highest SOBR scores are also given outstanding ratings. The exception to this observation is Retailers National Bank. What most likely occurred in this case is that RNB's rating was inflated (from our perspective) by investments made outside of the assessment area by one or more of its retail affiliates. The Dayton Hudson Foundation and other affiliates made almost $16 million in grants in Minnesota and South Dakota. Since RNB is the only limited-purpose bank in the corporate hierarchy, it receives all of the credit for the retail empire's corporate generosity. For community groups in Sioux Falls, or others seeking affordable housing in the MSA, this type of community development activity has little or no impact. However, the regulations do allow evaluators to take these types of activities into account. Thus, one can justify the regulator's action. We, of course, can also see that in comparison with other local lenders, RNB itself has low community development ratios with respect to both assets and Tier 1 capital within the assessment area.

Let us return to the two evaluator quotes referred to earlier regarding the community development performance of United Credit National Bank (UCNB) and Citibank. The Kansas City OCC's evaluation of UCNB said that "During this evaluation period, the bank's qualified investments and grants totaled $361,077. These dollars represent 2% of the bank's Tier 1 capital." Despite being factually true, there are at least two problems with this statement. First, the numbers included all qualified investments and loans over the 32 months since it had been last evaluated. Thus, this comparison would be unfair to other lenders who had only 22 months between evaluation periods. To be fair, some common chronological period-we use a year-must be used to make the comparisons consistent. The evaluator, of course, failed to worry about this since there were no other institutions or benchmarks with whom to compare UCNB anyway. Our approach overcomes both of these shortcomings. A quick look at table 1 tells the reader that UCNB's annualized qualified investments and grants totaled not $361,077 and 2 percent of the bank's Tier 1 capital but rather $135,404, or about .75 percent of the bank's Tier 1 capital. We can also see that of the seven limited-purpose banks in Sioux Falls, UCNB ranks fifth in this ratio. It also ranks fifth in terms of its share of qualified investments and grants relative to assets and in terms of an overall SOBR score. Thus, in this light, the evaluator's statement appears to require a bit more caution.

What about Citibank? Its May 1999 evaluation was written by an evaluator from the large-banks division of the OCC based in Washington, DC. The bank's performance was considered strong because "on an annualized basis these dollars represent 3.25 percent of the bank's Tier 1 capital." This evaluator remembered to annualize the data, so the first type of error noted above is avoided. However, the second criticism above continues to hold. There was no group or standard one could compare Citibank's performance with. In addition, a third problem emerges similar to the earlier case of Retailers National Bank. With respect to the quotation, Citibank's evaluators fail to mention what share of the qualified investments and loans were actually made within the assessment area. A careful reader of the evaluation finds insight two pages after the quote. Although all of the loans were in the assessment area, only 25 percent of qualified investments occurred within the assessment area. Thus, it is useful to turn back to table 1. Here we find that Citibank's annualized investments and loans within the assessment area total $21,260,000, or a 1.43 percent share of its Tier 1 capital. We also find that this performance still ranks it as the second best, behind only Axsys by this measure. In terms of assets, Citibank is ranked less favorably. Citibank's community development activities as a share of assets is only .15 percent, leaving it far behind the .41 percent and .40 percent scores of Dial and Axsys respectively.10 Since the SOBR score averages these two ratios, Citibank still ranks second in overall performance.

Despite the improvement SOBR scores give us in evaluating limited-purpose banks, we are still hard pressed to answer the question posed in the subtitle of this paper. Do credit card banks deserve their "outstanding" community reinvestment performance evaluations? In the case of Retailers National Bank, one now has clear empirical support to argue that the answer is "no." Compared with other lenders in the area, RNB's SOBR score and its two component parts trail all but one lender in the city. However, for the other three lenders with outstanding ratings the evaluation of the given rating is a more difficult task.

Axsys National Bank is clearly at the head of the pack in Sioux Falls, but perhaps Sioux Falls is an assessment area where an outstanding rating is cheaper and easier to achieve. Do other cities require higher SOBR score performance in order to receive an outstanding rating? A SOBR score of about .7 percent appears to be the benchmark in Sioux Falls. Do banks in, say, Wilmington, Delaware, need a SOBR score in excess of 1.0 percent to achieve the same rating? One might suspect as much given Sioux Fall's absence of low income census tracts, below average rates of unemployment, and little community reinvestment research or activism. Unfortunately, answering this question will require additional future research or an adoption of a SOBR score or similar method by the federal financial regulatory agencies.

The questions raised in the previous paragraph and the examples above from Retailers National Bank, United Credit National Bank, and Citibank show the shortcomings of the current approach to conducting community reinvestment PEs. Without concrete, easily calculable, and comparable financial ratios, evaluators, lenders, and community groups have little basis by which to discern how lenders are meeting their community development obligations. For an industry that uses financial ratios for decision making on an hourly basis, the absence of such ratios for assessing reinvestment performance is both curious and ripe for change. We urge the federal financial regulatory agencies to adopt the measures noted here or a similar approach when preparing CRA performance evaluations. Bankers, evaluators, and community groups would all benefit by being able to see, albeit imperfectly, how lenders compare in a particular city or region what is likely required for an institution to achieve a particular rating, as well as meaningful trends over time. The twenty-fifth anniversary of the CRA is an apt time to apply these modest regulatory changes.