CRA credits for banks: an antidote for balance sheet risk

Banks are businesses. Even banks with missions as noble and vital as community banks are businesses. It’s OK to say that. In fact, we should all be saying that more, because the stronger our banks are, the stronger small businesses and communities will be. And that relationship is precisely what we’re here to talk about -- through the lens of the Community Reinvestment Act (CRA).  

Sometimes a program with the best of aims – like the CRA – can be difficult to engage with. The mismatch between the opportunity (CRA credits) and what your institution can handle can put you in a position that risks profitability to pursue compliance. But it doesn’t have to (we’ll get to that in short order).  

As you know, when you lend to a CRA-eligible borrower, the CRA credit attached can force you into a tradeoff scenario.  

The challenges banks face when chasing CRA credits 

It starts this way:  

• You need to earn CRA credits to comply with regulations
• You look at a lending opportunity that would be CRA-eligible 
• Your traditional credit box doesn’t quite fit the transaction
• You can either make exceptions to your credit policy OR start looking for another opportunity
• The other choice to comply with regulations is to purchase qualified loans instead 

But the challenges don’t end there. The credit for loans acquired is limited and the portfolio of purchased loans may fall just outside your bank’s geographic area.   

An additional hurdle is that acquired conventional loans carry indefinite default risk. And while the default risk for purchased SBA 7(a) loans is limited to the unguaranteed portion, acquiring the guaranteed portion of these loans typically requires a significant premium, bruising the transaction’s economics. 

Most of these challenges traditionally led to a lost opportunity. But with some help, there are ways to break through and reactivate -- even if you’re a lender in the SBA database who had stopped lending.  

Community banks finding strength in partnership 

It’s an interesting time to be a bank with brick-and-mortar branches– or a brick-and-mortar business of any kind. With the rise of crypto currency and people relying more and more on digital banking, community banks are leaning on partners to help them evolve and stay profitable. Similarly, community banks have a partner to help them navigate the changes and challenges of CRA credits: non-bank lenders.  

Non-bank lenders have the flexibility to help banks meet their needs as well as the needs of the borrower and loan officer. 

Community banks + non-bank lenders 

So how does a partnership between a bank and non-bank lender work? 

The non-bank lender offers an alternative approach to earning CRA credit. Instead of stretching to lend on an opportunity outside of your comfort zone, your financial institution becomes a specialized referral agent, moving the opportunity to the non-bank lender. For you, this approach eliminates balance sheet risk and the significant expense of a full-service business lending function. 

Here’s an example: Your loan officer identifies an applicant for a CRA-eligible business loan. If the loan isn’t a good fit for your bank, but you want to keep the depository relationship and enjoy the associated CRA credit, you would refer the opportunity to a non-bank lending partner. 

What happens then?

If the applicant meets the non-bank lender’s more flexible, non-bank borrowing criteria, the lender will process, underwrite, close and service the loan.  

Once the loan closes, the portion of the loan guaranteed by the full faith and credit of the US government (up to 75% of the loan balance) is sold to the bank in certificated form at par, eliminating both premium risk and any risk of default. The bank receives a highly attractive, risk-free, ongoing bond equivalent yield¹ while the government-guaranteed portion of the loan remains in the bank’s loan portfolio.

What about the referral fee?

As a component of the transaction, Ready Capital pays the bank a referral fee that more than covers the nominal third-party administrative expense of the transfer. The excess portion of the referral fee can be shared with the loan officer or branch that had originally introduced the client or used for another purpose chosen by the bank. 

What are the limitations of the alternative approach?  

For some, this program may seem almost too good to be true. Every eligible closed loan results in CRA credit and delivers above-market investment yields without balance sheet risk or the deployment of any operational resources. Plus, the economics of the program allow for a referral fee that your bank can use in any way it chooses.  

Limitations: Non-bank lenders have more flexibility than most banks because of their unique investment time horizon, risk budget, and access to capital. That’s why they regularly funds loans for borrowers that are challenging candidates for a bank. That being said, not every opportunity eligible for CRA credit will qualify as a loan that a non-bank can close.  

Which non-bank lenders offer this alternative? 

This kind of alternative to earning CRA credits is not a common offering. Ready Capital has created a blueprint for this.   

What are the program’s other benefits, besides CRA Credit? 

For many institutions, the simplicity of the solution is the most attractive feature of a CRA credit program. But it offers multiple additional benefits. Participating banks can: 
 

• Earn maximum permissible CRA credit for every qualified transaction 
• Expand the lower range of borrower eligibility through creative financing solutions
• Participate in the origination of a loan where the bank’s interest is fully guaranteed by the SBA at par with no premium 
• Hold the loan in certificated form 
• Collect a bond equivalent yield well in excess of short-term Treasury yields  
• Avoid costly mistakes and fund clients faster  
• Offload the origination, closing and servicing of the loan to the non-bank lender 
• Enjoy significant referral fees to incentivize loan officers and branch managers  
• Retain customer bank deposits by partnering with a non-bank lender who cannot take deposits 

Working with Ready Capital 

When banks partner with Ready Capital, this is what the process looks like: 

STEP 1: If your applicant meets Ready Capital’s more flexible, non-bank borrowing criteria, we will process, underwrite, close and service the loan.  

STEP 2: Once the loan closes, the portion of the loan guaranteed by the full faith and credit of the US government (up to 75% of the loan balance) is sold to the bank in certificated form at par, eliminating both premium risk and any risk of default.  

STEP 3: The bank receives a highly attractive, risk-free, ongoing bond equivalent yield while the government-guaranteed portion of the loan remains in the bank’s loan portfolio. As a component of the transaction, Ready Capital pays the bank a referral fee that more than covers the nominal third-party administrative expense of the transfer.  

The excess portion of the referral fee can be shared with the loan officer or branch that had originally introduced the client or used for another purpose chosen by the bank.