Banks Cited For Skirting Capital Rules

WASHINGTON - The Federal Reserve Board is cracking down on 25 banking organizations that underestimated their capital requirements.

The firms - 22 holding companies and 3 state-chartered banks - failed to set aside adequate funds to absorb possible losses on mortgages sold into the secondary market.

Fed to Check for Evasion

William Taylor, the Fed's director of bank supervision, said examiners will review the files of the banking firms to see whether they deliberately evaded capital requirements through "sharp and fast practices," or were simply confused when applying new risk-based capital rules to so-called recourse sales. In such deals, the seller is partly liable if the mortgage goes bad.

According to the Fed, 22 of the 128 holding companies that sold loans with recourse did not set aside enough capital.

The Fed did not name the institutions, nor the amount of capital they would have to raise to comply. It noted, however, that the boost in capital required "could have a significant impact on certain holding companies."

Institutions that intentionally skirted the rules will have to raise capital immediately, the Fed said. Others will have up to 18 months to comply.

As of March 31, banks and bank holding companies had sold - but retained liability for - $68.4 billion in residential mortgages outstanding. The loans were securitized in pools issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corp., and private issuers.

These loans would have to be backed by roughly $2.7 billion in capital, assuming they are subject to a 4% capital requirement under the new risk-based rules. It is not clear how much of the $2.7 billion has actually been set aside.

Handful of Active Companies

Citicorp and a handful of other companies apparently account for the bulk of the industry's mortgage sales with recourse.

As of March 31, Citicorp reported $37.9 billion of sold mortgages outstanding with recourse. Only four other companies reported more than $1 billion of such outstandings, according to an analysis of regulatory data by Ferguson & Co. They are Bank of Boston Corp., First Bank System Inc., Chase Manhattan Corp., and Meridian Bancorp.

It is not known if any of these companies are among the 22 that regulators are investigating. How these companies view recourse for capital purposes could not be determined from the data, and Citicorp officials could not be reached for comment.

Sellers generally use recourse deals to get a better price or to pool loans that do not conform with standards set by the federal mortgage agencies. Because the institutions retain some risk, regulators require them to have capital backing such assets.

Ambiguous language in risk-based capital rules apparently created the loophole. Banks report recourse transactions as sales on their call reports, and some took this to mean that the transferred mortgages were not subject to capital requirements.

At a Fed meeting on Wednesday's, the six governors voted unanimously to amend risk-based capital rules by clarifying that institutions must hold capital against mortgages sold with recourse. But they left the effective date up in the air while they try to bring other federal banking regulators on board with conforming language.

Taylor Calls for Action

Mr. Taylor noted that all five federal bank regulatory agencies have been working for the past 18 months to clarify and standardize the rules on recourse - and will continue to do so. But he said the undercount by banks and holding companies under its jurisdiction should be addressed immediately.

Phil Roosevelt contributed to this article.

PHOTO : Banks Most Exposed to Recourse Agreements

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