WASHINGTON - Banks that make and sell pools of risky loans face higher capital requirements under rules proposed Monday by federal regulators.
The proposal would require banks to hold $1 of capital for each $1 of residual interests in pools of high-risk securitized loans. However, these assets could account for no more than 25% of Tier 1 capital. (The proposal defines residual assets as the interest that an institution keeps after securitizing and selling assets.) Regulators are concerned that banks are overvaluing residual interests.
Office of Thrift Supervision Director Ellen Seidman said the proposal would help stem problems that have caused some bank failures.
"I think this is a really important proposal that responds to the issues that have come up in a couple of failures," she said. "This doesn't say banks cannot do securitizations, but it says the capital on which they rely must be made higher."
The four bank and thrift agencies are attempting to prevent another dramatic failure like the one at First National Bank of Keystone, in Keystone, W.Va., which cost the Bank Insurance Fund more than $750 million.
The Federal Deposit Insurance Corp. said that overvalued residuals accounted for half of the loss to the insurance fund. Keystone's residuals totaled about twice its Tier 1 Capital.
Mark Schmidt, an associate director in the FDIC's division of supervision, said the agency made the issue a priority after the failures of Keystone and Pacific Thrift and Loan in Woodside, Calif., which also had a high concentration of residuals. Pacific Thrift counted $48 million of residuals as capital, most of which was deemed worthless after the thrift's failure.
"Residual valuation is a priority item for us," Mr. Schmidt said. "This is a safety and soundness issue. Generally, the value of these residuals depends on a lot of assumptions, making it a highly volatile asset. We must find a way to protect the industry."
Currently residuals make up more than 25% of Tier 1 capital at 12 institutions, he said. Another 42 banks currently count residuals for at least 5% of their Tier 1 capital, he said. The banks and thrifts cannot be generally defined; he said they vary by size and type.
Monday's proposal picks up where interagency guidelines issued in December left off; those guidelines urged banks to limit their residuals but did not specify any limits.
FDIC Chairman Donna Tanoue warned banks in May that higher capital requirements were in the works. "We have a number of institutions on our problem list precisely because of this issue," Ms. Tanoue said in a speech then. She said the capital requirement is also desirable because there are "a good number of other institutions - that are not on our problem list - but do hold more residual interests in securitized assets than we believe is prudent."
Reaction to the proposal was mixed.
"They are exacting a pretty heavy toll by requiring a dollar-for-dollar capital charge against residual interests," said Gilbert T. Schwartz, a partner with the Schwartz & Ballen law firm in Washington. "It is a pretty conservative and cautious approach that could result in a significant increase in cost of engaging in securitization transactions. Ultimately it could have an effect on the amount of securitizations that are done."
But Karen Shaw Petrou, president of ISD/Shaw, said that many large banks are already prepared for higher capital standards.
"I think the more sophisticated institutions are well enough capitalized because of market capital demands," she said. "I don't think this will have a significant impact on them."
Industry representatives were not too concerned.
"These assets are not typically found on most community banks' balance sheets, so I don't anticipate that the rule will have a wide impact," said Karen Thomas, chief counsel for the Independent Community Bankers of America. "For community banks, its impact will be focused on a few institutions."
Donna Fisher, director of tax and accounting at the American Bankers Association, said that her organization had not had sufficient time to develop a position on the proposal. "We're not surprised that the regulators are taking a look at this, but we need to study the proposal before reacting to it," she said.
Even Mr. Schmidt said the proposal would affect very few banks, but he insisted it is important for supervisors to get ahead of the problem. "This is intended to be preemptive with banks getting into this area, or thinking about it," he said.
The proposal, issued by the FDIC, OTS, Office of the Comptroller of the Currency, and the Federal Reserve Board, is expected to be published soon, with comments due within three months.