Subprime lenders suffer credit losses at twice the rate that traditional consumer lenders do and should be required to set aside more capital, said Federal Deposit Insurance Corp. Chairman Donna A. Tanoue.

In perhaps her toughest speech since joining the agency in May 1998, Ms. Tanoue said the FDIC will recommend changing the risk-based capital system to reflect the hazards associated with subprime lending high-rate loans to borrowers with tainted credit histories. She said the FDIC has already asked several subprime lenders to raise capital.

"We are convinced that a well-managed, appropriately capitalized consumer lending program can meet the credit needs of a broad spectrum of borrowers, including those with subprime credit histories, and do so in a safe and sound manner," Ms. Tanoue told 740 bankers attending a Sunday session of the American Bankers Association's annual convention.

"When not expertly managed," she said, "subprime lending has shown itself to be a high-risk activity that poses increased risk to the deposit insurance funds."

Examples of poor management decisions include rapid growth, predatory pricing, and "other questionable practices that do not adequately account and price for risk," Ms. Tanoue said.

Updating the bankers on a topic she raised at last year's convention, Ms. Tanoue said the FDIC will propose changes to risk-based deposit insurance premiums next month.

The FDIC wants to identify well capitalized banks that are taking excessive risks but paying no premiums for deposit insurance, she said. Banks showing rapid growth, high concentrations of certain loans, broad changes in their mix of business, or unusually high-yielding assets, for example, would be contacted by regulators and given an opportunity to improve.

Those failing to do so would be lowered from the best rating on the risk-based premium matrix to one that requires them to pay insurance premiums.

Echoing recent warnings by other regulators, Ms. Tanoue also addressed declining credit quality. She said Camels ratings declined at 734 institutions in the 12 months that ended in June, in many cases because of management problems or deteriorating asset quality. James Sexton, the FDIC's director of supervision, said it was the first time in at least five years that the number of banks and thrifts with falling Camels ratings exceeded the number with rising ratings.

"It is good to see the FDIC responding to subprime concerns," said former ABA president William T. McConnell, chairman of Park National Corp. in Newark, Ohio.

"She is on the right track," said David S. Hickman, chairman and chief executive officer at United Bank and Trust in Tecumseh, Mich.

Privately, however, bankers at the convention bristled at Ms. Tanoue's warning of higher insurance premiums.

Regulators and bankers have long known that subprime loans are riskier than traditional consumer credit. That fact combined with the relatively narrow range of credit options available to high-risk borrowers -- explains why lenders can and do charge more for loans to such borrowers.

In an April bulletin, the Office of the Comptroller of the Currency acknowledged the unique risks associated with subprime lending by urging lenders to boost capital where appropriate. But Ms. Tanoue is the first regulator to recommend permanent revisions to the risk-based capital rules.

Only about 150 banks and thrifts nationwide are engaged in subprime lending, she said. Yet they account for nearly 20% of the approximately 70 so-called "problem" institutions those with Camels ratings of 4 or 5. Moreover, Ms. Tanoue predicted, the number of banks making subprime loans could swell as nonbank subprime lenders, in search of cheaper funding and greater lending leverage, pursue mergers with FDIC-insured institutions.

Regulators' concerns about subprime lending have intensified after the failure of two banks heavily involved in such lending: $1.1 billion-asset First National Bank of Keystone, W.Va., in September, and $314 million-asset BestBank of Boulder, Colo., in July 1998. Ms. Tanoue pegged the estimated cost of cleaning up First National at $750 million.

The two failures have also raised concerns about regulators' ability to detect fraud. First National, for example, is accused of hiding the fact that $515 million of loans it claimed as assets had actually been securitized and sold. The OCC said the bank concealed the loans' sale by doctoring documents provided by their servicer.

Ms. Tanoue said the FDIC is taking several steps to address such fraud.

After First National failed, for example, the agency asked its regional offices to identify all banks that have "securitizable" loans held by third-party servicers. The agency plans to focus special attention on internal controls at those institutions, which number close to 150.

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