Banks Learn the Price of 'Satisfactory' CRA Grades

Watching Michael Phelps, Simone Biles and other U.S. Olympians win multiple gold medals at the Summer Games in Rio de Janeiro reminded us of popular sports catchphrases such as "Winning isn't everything, it's the only thing."

But even though going for the gold drives so many athletes, businesses and other organizations, it is for the most part absent from banks' performance on Community Reinvestment Act exams. Not only have some notable banks received failing "Needs to Improve" CRA grades of late – mostly recently Associated Banc-Corp in Green Bay, Wis. – but over 90% of institutions are happy with a passing "Satisfactory" CRA rating. Fewer than 10% get an "Outstanding" grade – the gold medal of CRA.

In analyzing CRA exam performance, I have found that banks engage in a deliberate strategy of what I call "Satisficing." I have concluded that there are few if any real incentives for banks to go for CRA gold. Bankers tend to be happy with the middle ground along with over 90% of their brethren and indicate sound reasons to get a Satisfactory rating. They say things such as: "When you are at the top, there is only one way to go," or, "An Outstanding rating brings unwanted community groups asking for donations and wanting us to do more."

Just look at the Federal Deposit Insurance Corp.'s recent monthly summary of CRA grades for banks under its watch. In the agency's September list, only three of the 60 banks graded received an "Outstanding" rating. The rest were rated "Satisfactory."

While it appears unlikely that we will see any substantive CRA reforms in the near future, we should consider incentivizing Outstanding CRA performance. I have previously proposed incentives such as tax rebates, reduced FDIC insurance premiums and a longer period until the next exams for banks that receive the highest rating. Each of these would have a quantifiable bottom-line impact to a bank as compared to a press release or local news article announcing the Outstanding rating. Even a monthly press release from the FDIC, Federal Reserve and Office of the Comptroller of the Currency explicitly naming the Outstanding banks and praising their ratings would be a good start to show that the regulators admire and encourage such CRA performance.

An even more powerful incentive to achieve an Outstanding rating is the buffer it provides when a bank is hit with a CRA downgrade. Receiving the highest rating means a future downgrade will only bring the institution down to Satisfactory, versus the reputational problems that arise when an institution is downgraded from Satisfactory to the lower failing rating of "Needs to Improve."

Going down a rung on the ladder became more possible when officials began imposing CRA downgrades for problems with fair lending, violations of the statutory prohibition against "unfair, deceptive, or abusive acts or practices," or other lending violations. Starting out from the highest point of "Outstanding" is what I call "Fair Lending Downgrade Insurance," or FLDI.

Such a buffer helped contain the effects of downgrades for JPMorgan Chase in 2013 and Bank of America in 2014. Because each of these banks had an Outstanding rating to begin with, they were spared the reputational risk and other problems of a failing CRA rating.

But other banks have not been so fortunate. Most recently, Associated Banc-Corp, a $29 billion-asset company, was downgraded to "Needs to Improve" after an alleged Federal Trade Commission violation and a conciliation agreement with the Department of Housing and Urban Development over the bank's mortgage lending activity. The bank had Outstanding ratings in 1994, 1996 and 1999, but fell to Satisfactory ratings in 2003 and 2006.

Recently, Regions Bank and Fifth Third Bank – among the industry's top 50 by deposits – were both downgraded from Satisfactory to Needs to Improve. Putting aside the adverse reputational risk of a failing CRA grade, many of the corporate and expansion plans of banks with such downgrades get put on hold as a result of their low rating.

One recent downgrade to "Needs to Improve" for a large bank was that of the $14 billion-asset BancorpSouth of Tupelo, Miss. In a recent regulatory filing, the bank said the CRA rating – which resulted from alleged fair-lending violations in a joint Department of Justice and Consumer Financial Protection Bureau complaint – means the institution likely "will be unable" to obtain approval for two pending bank acquisitions. Associated Bank likewise expects not only restrictions on branching and M&A activity, but also the loss of expedited processing on various corporate activities.

The corporate and expansion activity restrictions on BancorpSouth and Associated Bank are real dollars-and-cents costs that could have been avoided with an Outstanding CRA rating on their previous exam.

Like BancorpSouth and Associated Bank, roughly half of our top 50 banks with Satisfactory ratings do not have the FLDI that comes with an Outstanding CRA rating. This is also the case for thousands of community banks.

To be clear, this is not a problem for banks that don't mind a failing CRA rating or any of its related restrictions or risks. It is likewise not a problem for banks that feel assured they will not be hit with a fair lending, UDAAP or other lending-related violation that will result in a downgraded rating. But based on the recent increased enforcement actions by DOJ, CFPB and other federal bodies, this is not a safe or sound bet.

The bottom line is banks should follow the lead of our Olympic heroes and try to go for the gold.

Kenneth H. Thomas, president of Miami-based Community Development Fund Advisors LLC, was a lecturer in finance at the University of Pennsylvania's Wharton School for over 40 years.