Regulators are giving more banks harsh Community Reinvestment Act ratings, a trend that could impede mergers and acquisitions.
CRA ratings are a critical factor regulators consider when reviewing merger applications, and a negative rating can derail a transaction. As M&A activity heats up, CRA compliance will move to the forefront of the issues banks must consider when making deals.
"It's no longer just something you can put in the back of your mind; it's got to be one of the boxes you check off yourself before submitting" a merger application, said Philip Smith, the president of Gerrish McCreary Smith, a consulting and law firm in Memphis.
Banks evaluated for CRA compliance receive one of four ratings — "outstanding," "satisfactory," "needs to improve" or "substantial noncompliance." The number of banks receiving "needs to improve" or "substantial noncompliance" marks nearly tripled in the past four years. And the proportion of banks with less-than-satisfactory ratings totaled 3.7% in 2010, nearly triple the 2007 figure, according to Trepp LLC's Foresight Analytics.
"Everything is being scrutinized more now than ever before," said John Woloshen, the executive vice president and chief operating officer of RATA Associates, which provides CRA data compliance software and services for banks.
The degree to which regulators have handed out lower ratings has varied by regulator.
The Office of Thrift Supervision seems to have the toughest approach, issuing less-than-satisfactory ratings to 8.8% of the banks it examined last year, compared to 0.5% in 2007.
"The OTS takes a consistent approach to applying the CRA and its regulations," a spokesman said last week. "This has not changed."
The Federal Deposit Insurance Corp. has boosted its "needs to improve" and "substantial noncompliance" ratings, to 3.8% in 2010, from 2.2% in 2007.
The Federal Reserve handed out nine less-than-satisfactory ratings, or 3.4%, in 2010, compared to one in 2007.
The Office of the Comptroller of the Currency seems the most lenient, with 1.3% of banks receiving low ratings.
The Fed declined comment, and FDIC and OCC representatives were not immediately available.
Industry observers said the reasons for the increases are two-fold. Growing momentum for legislative changes to CRA is shining a brighter light on its enforcement. Also, weak loan demand and stricter credit standards are resulting in fewer loans to low- and moderate-income communities.
A bill introduced last year to revamp CRA faces uncertainty now that Republicans control the House. Regulators are also exploring changes and are expected to issue new rules this year.
"Between now and then, nobody wants to look like they're the weak sister," said Randy Dennis, the president of DD&F Consulting in Little Rock, Ark. "They all want to seem like they're tough."
It isn't just M&A that could suffer. A New Jersey thrift last week said it had postponed a mutual-to-stock conversion after its CRA rating was lowered to "needs to improve." Regulators said they could not approve the conversion, catching the bank off guard.
"We've been satisfactory in the past," and "we anticipated being satisfactory again," Bart D'Ambra, the chief operating officer of Clifton Savings Bancorp,
Negative ratings carry a stigma that is hard to shake, especially for banks trying to attract investors or a buyer, said Jeffrey Hare, a partner at DLA Piper in Washington.
None of the half-dozen banks that received downgraded ratings in recent months returned phone calls seeking comment.
Regulators appear to be stingier with "outstanding" ratings. Just 7.8% of banks received the rating in 2010, compared to 11.9% in 2007, based an analysis by Ken Thomas, an independent bank consultant.
Four years ago, regulators handed out seven outstanding ratings for each less-than-satisfactory rating. Today, that ratio is nearly 1:1, Thomas said.
"We have not seen a situation in recent memory where they've been equal," Thomas said. "This is a situation where there's been an across-the-board tightening."
Not that its a bad thing. Josh Silver, the vice president of research and policy at the National Community Reinvestment Coalition, said the change may to be a positive after years of what he called lax enforcement. Silver said underwriting standards have tightened in the wake of the financial crisis, leading to an "undue restraint" in credit, particularly in underserved communities.
Tougher CRA ratings shine light on the problem, but more data is needed, Silver said. For instance, nearly 90% of all banks are rated satisfactory. "What does that really mean?" he asked. "It would be useful to have more ratings, so you really have more gradations in performance. In that clump of 90% satisfactory, it's clear that not all those satisfactory banks are performing equally."
For now, consultants said that acquisition-minded banks will have to take a more-realistic look at CRA, and not take anything for granted. Being comfortable with your CRA compliance and securing a good rating are two different things, Smith said. "In my somewhat cynical view, t doesn't matter what you're doing," he said. "It matters where the bar is set by the regulators. And what we're seeing is, the bar is no longer where it used to be."
