A Bank’s Bitter Lesson

There is more riding on the success or failure of the Los Angeles Community Development Bank than city officials seem to realize.

The bank’s loans to struggling businesses are backed by the city’s future federal community development block grants, which might be lost should the bank be unable to repay the federal government.

The bank also is recipient of the largest ever federal funding commitment to a bank of this sort. As such, it can become a national model--or a monument to failure. Those high stakes should have prompted close scrutiny of the bank and its lending by the City Council and Mayor Richard Riordan’s administration, as well as federal authorities. Instead, little attention has been paid.

The nearly 4-year-old bank was a belated but generous federal response to the 1992 Los Angeles riots. The Department of Housing and Urban Development provided a total of $430 million for loans to businesses that had been turned down by commercial lenders and to create jobs in some of the city’s poorest neighborhoods.

There were problems from the start. The bank’s director and its board lacked formal banking and lending expertise. The terrible recession was over by the time the bank was underway, and businesses that would have been prime candidates had become strong enough to get loans from commercial lenders or the Small Business Administration. That left the bank with only the riskiest prospects.

Facing criticism in 1997 and 1998 that the bank was not moving fast enough to make loans, the board and then-director C. Robert Kemp looked for the dream deal that would establish the bank’s credibility. They unwisely chose to finance a South-Central dairy start-up plan. The bank, left largely to its own devices by HUD and the city, ended up throwing nearly one-fourth of the money it has loaned to date at the dairy, a troubled business that has since failed.

Times news coverage and a belated HUD audit this year finally brought the bank’s many problems to light. They include a 32% default rate on its loans, unusually high even for community lenders; poor internal controls; a failure to stay within its own $20-million loan limit, and scant job creation in targeted areas.

The good news is that the bank has a new president and CEO with real banking savvy--William H. Chu, senior vice president and director of retail banking at the $2.1-billion East West Bank. City Councilman Mike Feuer has called for stronger oversight. In 90 days, perhaps, the full City Council will discuss the mandate and performance of the bank in open session for the very first time.

Those moves represent steps in the right direction, but they come late for the bank. The city’s hard lesson is that hundreds of millions of dollars should not be doled out unwatched.