CDB Plans to Draw on Private Investors to Remake Itself

In a last-ditch effort to remake itself, the Los Angeles Community Development Bank is proposing to launch a privately funded investment group that would seek out new borrowers in distressed communities.

By drawing on private investment--a minimum of $2 million per participant--the bank hopes to create greater accountability that would result in stronger deals. The private entity would also channel desperately needed funds into the beleaguered institution, which has all but run out of loan loss reserves.

The plan, which will be presented to the City Council for approval, was devised by bank officials as a way to attract new money while protecting that new source of funding from the bank’s mounting legal liabilities.

The federally funded bank--the government’s largest response to the 1992 riots and once a centerpiece for Vice President Al Gore’s Empowerment Zone program--faces lawsuits from early borrowers alleging mismanagement and fraud. One of those cases has resulted in a $10-million judgment that the bank is appealing.

The lawsuits--along with the $24-million default of the bank’s largest loan--have left the community development fund strapped for cash and facing demise if it cannot reinvent itself. It has laid off half its staff and stopped making loans.

The plan to create a private arm--Los Angeles Community Investment Partners--comes in response to a City Council demand that the bank devise a plan to raise the more than $20 million it needs to survive, along with a contingency plan to phase out operations if those efforts fail.

“We think we have a viable plan to recapitalize the bank and get back to lending,” said bank Chief Executive William H. Chu.

The initial vision for the bank included a strong role for private commercial banks, which committed to participate but grew increasingly uncomfortable with the bank’s record. The private capital can be used in more flexible and creative ways than the bank’s federal funding, which is tightly restricted and cannot be rolled back into the institution to make it self-sustaining.

The new incarnation of the bank--if it is successful--could get the institution back on track. “It’s much more closely aligned to what the mayor originally proposed,” said Rockard Delgadillo, deputy mayor for economic development. “Economic forces are going to drive it. . . . We think the Community Development Bank will move forward.”

However, Mayor Richard Riordan is seeking private-sector funds for a separate economic development initiative--Genesis L.A. That effort has garnered significant corporate support and probably would compete with the bank’s proposed plan.

Bank officials will present their plan to the city’s Community Development Department on Thursday, which will make a recommendation to council members.

To raise the funds, the bank hopes to find investors among small commercial banks--particularly subsidiaries of foreign-owned banks. Some of those lenders have a minor presence in the empowerment zone--the federally designated areas where the bank must concentrate its lending efforts--and could earn Community Redevelopment Act credits through their participation.

They would also serve as board members, prescreening loans for the bank. Through their financial involvement, they would have a stronger incentive to see loans succeed than has the bank’s volunteer credit committee, said bank board Chairman Peter Taylor.

“If you’re contributing $2 million, you’re interested in making sure you bring good deals to the table,” said Taylor, a senior vice president at Lehman Bros. who helped craft the new structure.

Of $20 million the bank hopes to raise, $16.4 million would go into a trust fund for loan loss reserves and the remainder would fund the private entity. Replenishing the reserves would allow the bank to resume lending. It has access to $182 million in federal funds, but that money can be used only for loans, not for loss reserves or administrative costs.

Investors would be expected to receive a return on their investment by the end of the fifth year and bank officials are shooting for an internal rate of return of 10% a year.

They would earn the return through dividends on investments the bank would make with the loan loss reserves through investment managers, Chu said. At the end of the five-year period, revenue generated from the deals, returns on the bank’s venture capital investments, and commitments from other private lenders could enable the bank to phase out the private entity and become self-sustaining, Chu said.

Far East National Bank President Robert Oehler, who sits on the community development bank’s board, called the proposal “very exciting and creative, yet practical.”

But whether the bank will be successful in securing investments remains to be seen. One banker said other lenders are unlikely to invest in the private entity until it is staffed and has a track record.

If the City Council rejects the plan it could take over the bank. That is unlikely, however, because of the pending litigation.

The bank won a recent appellate court ruling preventing a borrower from collecting on his $10-million judgment during the bank’s appeal. Collection on judgments is usually halted only if the appellant posts a hefty bond, which the bank could not afford. The unusual decision has given the bank some breathing room to sort out its affairs.

The attorney for the plaintiff, Summit Industries, called the proposed structure “a subterfuge” designed to prevent his client and others from collecting.

“I don’t know how they’re going to tell a court, ‘We’re trying to wipe out a judgment and this is how we’re going to do it,’ ” said Neil Papiano, who is also a City Hall lobbyist. “You go out and incur debts and cause bankruptcies and financial ruin and then decide that it’s all been a joke and you’re going to go on with a new entity?” Neil Papiano said. “That doesn’t sound right.”

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* GENESIS L.A.

Mayor Riordan’s initiative will funnel capital to firms in low-income areas. C2