WASHINGTON - As word spreads - and anxiety builds - about the Federal Deposit Insurance Corp.'s subprime capital proposal, details of the draft plan are coming into sharper focus.
The proposal, inspired by the recent failure of several heavy subprime lenders, would make banks whose subprime portfolios exceed 25% of Tier 1 capital set aside at least double the usual risk-based capital.
Examples provided in the FDIC's confidential 47-page draft make this clear. For instance, a bank with a portfolio of mortgages made to customers with excellent credit at an annual percentage rate of 9% could continue to hold just 2% Tier 1 capital against the loans. By comparison, a bank issuing 12% mortgages to B-rated borrowers would have to set aside 4% capital.
The plan, which was submitted to fellow regulators for review in December, would affect more than mortgages. Credit card, auto, payday, and even small-business loans could be considered subprime in some circumstances. The draft proposal includes an exhaustive explanation of how the FDIC reached its recommended capital levels.
But the plan's most ambitious and controversial element may be its pioneering attempt to define "subprime." Few words in banking lexicon are more nebulous. To advocates of the Community Reinvestment Act, subprime loans often represent the only credit option for borrowers with poor or no credit history. To some lenders, however, the word smacks of "predatory lending" and is a tag to be avoided.
"We don't make subprime loans," said a nonbank mortgage lender whose firm pitches high interest rate loans to low-income borrowers. The lender cited the company's low delinquency rates as evidence that it is not an excessive risk-taker.
But the FDIC's one-sentence definition of subprime lending focuses on the riskiness of a portfolio of borrowers, regardless of how well it is managed: "Subprime lending is extending credit within a segregated, clearly identified portfolio solicited under a set of underwriting standards that include both a significantly higher risk of default and higher interest rates or fees than traditional bank lending," excluding community development loans.
Appropriate data for assessing risk would include credit or repayment histories, debt-to-income levels, and credit scores. For example, the FDIC wrote, secured mortgages usually pose a higher default risk if the borrower has filed for bankruptcy in the prior five years; was 30 days past due on a first mortgage twice or more in the past year; was 60 or more days past due on non-mortgage installment debt at least once in the past year; or had any chargeoff, judgment, or repossession within the prior two years.
Also considered riskier than normal would be unsecured mortgage borrowers with a credit score of less than 680 who either filed for bankruptcy during the prior three years or had a single chargeoff, judgment, repossession, or 90-days-past-due payment during the prior two years.
Lenders could not avoid higher capital requirements by burying subprime borrowers in a prime portfolio. "Examiners should not have to discover subprime lending by accident," the FDIC wrote. In such cases, "management is simply making lower-quality loans without appropriate controls" and should be subject to adverse classification, exam criticism, and higher loan-loss reserve requirements.