In a First, FDIC Warns Banks About Dangers Of Subprime Lending

The Federal Deposit Insurance Corp. has become the first agency to officially warn banks about the risks posed by subprime lending.

In a May 2 letter made public late Friday, FDIC Director of Supervision Nicholas J. Ketcha Jr. said subprime lending had produced "substantial losses that have had a pronounced negative impact on the overall financial condition of some institutions."

His letter to the chief executive officers of 6,300 state-chartered banks defines subprime lending's risks and outlines the controls regulators expect bankers to exercise.

Subprime lending-loans to consumers with incomplete or tarnished credit histories-is burgeoning because it can produce good returns and fat servicing fees. But as Mr. Ketcha reminded the 6,500 state-charted banks he oversees, "this profit potential is accompanied by significant risks."

The No. 1 danger is default, he said.

Foreclosure rates are hitting 30% or more at some financial institutions, Eric Schmidt, an assistant director in the FDIC's supervision division, said Monday. "That's a huge number," he said, noting the concerns that credit card chargeoff rates of 5% have generated.

Mr. Schmidt said roughly a dozen institutions had lost enough money on subprime lending that their Camel performance rating had been downgraded by the agency. The losses are serious enough at a "handful" of institutions that they have been added to the FDIC's problem list, he said.

"We're not saying not do it," he said. "You've just got to be careful."

The FDIC is advising bankers to recognize the additional risk subprime lending poses and price accordingly. Credit-scoring models, the FDIC said, should be continually tested to ensure results mirror projections.

A bank's board of directors should set limits on the total amount of subprime lending the institution can handle, the FDIC said. Staffing is important, too, as an institution will need more people to handle a greater volume of delinquent loans.

The FDIC letter covers not only direct loans to subprime borrowers, but purchasing subprime dealer paper or loans acquired through brokers. Mr. Ketcha also warned banks about lending to finance companies involved in the market, participating in loan syndications that provide credit to these companies, and buying asset-backed securities issued by these firms.

Representatives at the Federal Reserve Board, Office of the Comptroller of the Currency, and the Office of Thrift Supervision said no similar written warnings have been issued by their agencies. None, including the FDIC, has numbers on the growth of subprime lending.

"We've been looking at subprime lending for the last year and a half to two years," said Jeri Gilland, the OCC's assistant chief national bank examiner for credit and management policy. "But it is really hard to quantify. It is not tracked separately and it is not commonly defined right now."

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