L.A. Community Bank Faces Risk of Collapse

The Los Angeles Community Development Bank, the centerpiece of city efforts to revitalize depressed communities, could be forced to close if a radical restructuring now underway fails, according to a government report and city officials.

The federal government’s largest response to the 1992 riots, the bank has suffered a series of setbacks to its goal of channeling loans to businesses rejected by conventional lenders in the city’s most blighted pockets. Although new management has aggressively worked to turn the bank’s fortunes around, a city report indicates that early mistakes have taken a toll that could jeopardize the bank’s survival.

Battered by litigation and a devastating $24-million loss when its largest loan soured, the bank has nearly depleted its loan loss reserves and administrative funds. To keep making substantial loans, it must reshape itself dramatically to attract at least $25 million in capital, expected to come mainly from private lenders and investors.

The report, which was requested and now awaits approval by the City Council, gives bank officials 90 days to outline its restructuring and provide a detailed accounting of bank finances. It also calls on the bank to draft a plan showing how it would phase out operations if its make-over fails.

The recommendations raise the possibility that the federally funded bank, the keystone of the city’s federal empowerment zone program, could shutter just as empowerment zone initiatives are gaining political steam elsewhere in the country. Empowerment zones offer tax breaks and other incentives to businesses that locate in depressed areas and create jobs for local residents.

“This is a very critical time for the bank,” said City Councilman Mike Hernandez, who helped set up the bank after the riots. “We want to know if the [private banking industry] is going to step up to the plate or not, because without [that commitment] the bank is not going to survive.”

Major commercial banks pledged several hundred million dollars in co-lending commitments when the community development bank was created, but those commitments never materialized, in part because the quality of early deals was poor and the community development bank lacked experience.

The bank’s leadership has changed notably since early this year, however, giving it a greater chance of wooing private capital at a time when inner-city investments are gaining recognition as viable, Hernandez and others said.

Early this year, banker William H. Chu stepped in as chief executive, investment banker Peter Taylor took the reins of the board of directors, and several other bankers joined the board.

The city report, issued by the Community Development Department, the chief legislative analyst and city administrative officer, offers the best glimpse yet of the bank’s financial picture and the challenges it faces. Although the bank still has federal money to lend, the grant money it relies on for loss reserves and administration has dwindled to $10 million.

A $7.2-million judgment against the bank for breach of contract was awarded to a former borrower earlier this year after a five-week trial. That judgment, which the bank plans to appeal, could wipe out much of the remaining funds, and lawsuits filed by other former borrowers bring the bank’s potential liability to more than $50 million, according to the report.

The lawsuits allege that businesses were damaged by erratic, unprofessional treatment from bank officials and improper meddling in day-to-day operations--allegations the bank has denied. The bank has also faced criticism for not creating enough jobs for empowerment zone residents.

The report also lays out a much stronger oversight role for the city, which until now has taken a hands-off approach to the bank’s administration. It recommends that the Community Development Department, which administers the bank’s federal funding and stands to lose future social service grants if the bank fails, be notified of any changes in bank management.

The report also recommends that the city seek proposals from outside firms to come up with alternatives to the bank to deliver much-needed capital to low-income communities, and asks that $100,000 in city funds be set aside to better help the department oversee the bank’s activities.

As part of its reorganization, the bank has already implemented a hiring freeze. Within the next three months, bank officials plan to stop accepting new direct loan applications, identify other cost-cutting measures and consider terminating some existing service contracts, according to the report. Bank officials must also begin reporting detailed financial data to the city within 15 days of the report’s approval.

Chu said the bank could continue to operate for at least two years under the current budget if it makes only micro-loans, pares its administrative budget and is not forced to pay any legal judgments.

His strategy, however, is to explore a new structure for the bank that could attract private capital. One possibility is to become a for-profit entity, like several other federally funded institutions in Louisville, Ky., Colorado and Washington, D.C.

Chu said he is hopeful that the City Council will give the bank some time to accomplish the transition.

“I’m trying to achieve the impossible here, and if I can do it in the next five years I can make a difference in this community,” Chu said. “The community bank will fail only because we walk away.”

Hernandez said the city could assume the responsibilities of the bank if a restructuring fails. But that would not encourage private-sector participation, something he and others said is crucial.

The bank, financed with $435 million in federal funds, has had some successes, making $117 million in loans and investments. Some loans have performed well, which will enable the bank to retire about $30 million in debt later this year, far ahead of schedule.

A spokesman for the Department of Housing and Urban Development, which funds the bank, said HUD wants the city plan “implemented as quickly as possible,” and added that HUD is unlikely to provide a hefty bailout.

But some question whether the bank should continue in its current role, given the existence of other community development lending programs and the willingness of commercial banks to do inner-city deals in a strong economy.