LA/CRA’s High Risk Loan Portfolio: It Simply Comes With the Territory

Most of these criticisms concerning the CRA' s loan portfolio emerge from an incomplete understanding of the Agency's essential purpose and how it functions. The Agency's task is to provide the economic wherewithal to jumpstart economic development in areas largely abandoned by private sources of capital. By its nature, this task involves taking risks. 

While the risks are not negligible, the CRA has been able to manage them effectively, achieving a default rate comparable to that experienced by conventional loan institutions. The following remarks elaborate on these issues. 

The CRA's fundamental mission is to revive economically inner-city areas which are in decline. In fulfilling that role, the Agency uses loans to stimulate or assist construction of structures that fulfill public purposes, such as the construction of housing affordable to low and moderate income families, the rehabilitation of dilapidated commercial structures, and the catalyzation of new private sector development.

The high-risk nature of CRA loans should come as no surprise. The CRA exists to serve developers unable to obtain assistance from conventional sources. Low risk loans can be made by commercial banks with which the CRA should not compete. The CRA was created specifically to make development happen where the private sector, acting alone, has decided to retreat. This implies risk. Still, each CRA loan is fully disclosed and publicly debated before it is made, so that the full extent of the risk is clearly understood at the outset and found to be within acceptable limits.

The mission of the CRA explains many aspects of why loans are made and what the real impact of default is.

• First, because the Agency's loans are made primarily to achieve a public purpose under redevelopment law, and not to maximize financial return, the Agency's operations and repayments on bonded indebtedness are not dependent on repayments from these loans. Income not received from loans in default comprises only 1.6 percent of the Agency's annual budget.
• Second, it is critical to understand that the term "default'' rather misleadingly includes both "technical" and "financial" defaults. Many of the CRA's defaults are technical, meaning that the borrower is simply behind schedule in filing a quarterly statement or report rather than abdicating financial responsibility. Generally, technical defaults occur with housing projects which are merely behind in their construction schedule often due to circumstances beyond the borrowers’ control. These technical defaults will typically be rectified in the course of the project with no substantive financial impact. (In any case, even in instances where financial default is threatened, CRA loans are secured by a deed of trust on the real property).
• Third, while it is true that the CRA has a 32 percent total default rate on its amortizable loans, these loans comprise only 14 percent of the total portfolio. The overall portfolio's financial default rate is 8.5 percent. This is comparable to default rates at conventional lending institutions.

The CRA has been criticized as being unduly lenient with its borrowers. Reasons relating both to economics and to the Agency's mission, however, make the CRA reluctant to foreclose. A principal economic reason is that the CRA is not always the first lien holder in a mortgage: in order to leverage a private sector first mortgage, we are usually in second or third position. While this position enhances the leveraging effect, it does give us less control when dealing with borrowers who default.

For us to foreclose, we must be prepared to go to the foreclosure sale with sufficient funds to pay off all liens having a priority higher than ours. In some cases, this does not make economic sense. Under such circumstances, it becomes financially more prudent to pursue other options such as restructuring, urging the current owner to give the deed to a nonprofit entity or merely monitoring the project to see if the economic conditions change.

The purpose of the Agency also militates against foreclosure. The CRA mission—to reestablish economically vital communities—has a humanitarian aspect. It serves no purpose to foreclose on the home of a low-income person or family because of a temporary inability to make loan repayments. Similarly, the CRA has been flexible in dealing with small business persons who have temporary cash flow problems. We give these recipients of loans extra time to catch up on their loan repayments, or we restructure the loans to reflect changed economic circumstances. The amount of the loan does not change; rather, the schedule under which it is repaid is adjusted so that it is more manageable for the borrower. Again, in these respects, the CRA's policies mirror those of banks in the private sector who seek to work with the borrower to ensure repayment rather than leap into foreclosure proceedings. 

We hope that the foregoing provides a better understanding of the CRA's purpose and how it functions and that restores a more accurate image of the Agency’s fiscal responsibility and solvency. After all, the Agency has been in operation almost fifty years and has been fulfilling its essential function—and making the exact same types of loans—for that entire time. In the process, the CRA has engendered billions in private sector matching investment in redevelopment areas.

If questions remain, we urge you to bring them to our attention. Valid criticism is always well received; we should be vigilant for ways to improve in our portfolio management and loan tracking procedures. Improvements are always possible. As the newly appointed Agency Administrator and head of the Agency's governing board, we will be exploring these issues and suggesting helpful steps toward that end.