HUD Criticizes L.A. Over Community Bank

A federal review has found inadequate city oversight of the beleaguered Los Angeles Community Development Bank, whose default rate soared to 32% this year after its largest and most controversial deal went sideways.

The review by the Department of Housing and Urban Development, obtained this week by The Times, has sparked efforts to improve accountability by the city’s Community Development Department, which is legally responsible for monitoring the bulk of the bank’s funding.

The review marks the first federal scrutiny of the bank since it was founded nearly four years ago to create jobs for residents of the city’s poorest pockets by financing businesses there rejected by conventional lenders. The city stands to lose its future social service grants if the bank cannot repay the majority of its $430 million in federal funding.

While the review by HUD found the bank’s underwriting and record keeping to be sound, it revealed numerous gaps in city oversight. Among other findings, the city transferred tens of millions of dollars to the bank without requesting required documentation, and it failed to monitor the bank to ensure that interest earned on federal grants was repaid to the U.S. Treasury as required by law.

The review raised concerns that an outside auditing firm under contract to the bank is not sufficiently independent. It also called on the city to make site visits to the bank, improve monitoring of its loan portfolio, and do more to link residents of the empowerment zone--the blighted areas the bank serves--to jobs created by bank borrowers. Only 20% of the jobs created by borrowers have gone to empowerment zone residents, far short of the 51% required by regulations, the bank’s business plan shows.

Barker Khorasanee, director of the Community Development Department’s financial management division, said the city took an unusually hands-off approach to the bank since its inception because HUD officials had stressed it should be treated as an independent entity.

Now that the bank’s troubles have come to light, HUD has called for heightened city involvement. The review was completed in July, and the city issued a formal response to HUD last month. City officials are now reviewing bank documentation to “verify all the [city grant] money they took from day one,” Khorasanee said. The outside auditor previously contracted by the bank will report to the city to ensure independence. City staff will begin site visits to the bank and review all loans categorized as risky twice a year. And the city has devised forms to track bank spending, the city’s report said.

The city and bank have also launched a pilot program to link unemployed residents in the bank’s target area with training and direct them to openings at borrower companies. Furthermore, the bank has returned about $400,000 in interest income to the U.S. Treasury in the last month, Khorasanee said.

“We are changing a lot of procedures,” he said. “We aren’t going to second-guess [which borrowers] to fund, but as far as financial flow we are going to manage it together.”

The efforts to strengthen accountability come at a critical juncture for the bank, which will pitch its business plan next month to a City Council increasingly concerned that taxpayer money has been placed at risk.

In a unanimously approved motion, City Councilman Mike Feuer has asked city staff to explore a new system of oversight. Feuer was not aware of the HUD review but said he wanted to “ensure that we have explored every oversight option that makes sense regarding the bank,” including restructuring its board of directors, which is thin on financial expertise.

“It has had a very rocky history with limited success and some very significant failures,” Feuer said. “I strongly support [the bank’s] goal. The question for me has not been the motive but execution.”

The bank continues to fall short on its core mandate to create jobs for residents of the empowerment zone. About a third of borrowers reviewed by HUD didn’t meet the national objective of creating jobs, and about half the borrowers created jobs for workers living outside the target area.

The bank also suffered a blow in August when Copeland Beverage Group--its largest borrower--announced it was closing its doors. The loan had ballooned from $6 million to $24 million as the company struggled to stay afloat.

The bank’s interim CEO, Linda Griego, said bank officials hope to learn from the Copeland loan and are cooperating with the Community Development Department to strengthen both internal and external controls.

“Looking at the chronology on Copeland, you can see the bank had internal controls. It just didn’t follow them after a while,” she said.

Although the Copeland loss is damaging to the bank’s fiscal health, in the last year the institution has picked up lending efforts, the business plan shows. Since its inception, the bank has closed $103 million in loans and investments, and programs that previously showed little activity are moving money out the door.

Beginning next year, businesses in the empowerment zone will be eligible for federal tax credits, giving them more incentive to hire local residents, the plan says. And the bank will expand certain loans beyond the zone, making them available to businesses in all low- and moderate-income census tracts in an effort to diversify the portfolio.

The business plan also reveals unanticipated expenses in the past year, including more than half a million dollars spent on litigation. Several former borrowers have sued the bank alleging fraud and micro-managing by loan officers. The bank has vigorously pursued one of those borrowers with a countersuit and has sued others to collect on debts.