Subprime lenders are crying foul over a proposed rule change that they say could needlessly penalize their entire industry.
At issue is a "staff paper" that Federal Deposit Insurance Corp. officials say was leaked before they had an opportunity to hash out the details. The proposal would double capital requirements for institutions whose subprime loans exceeded 25% of their Tier 1 capital. (See related story, page 2.)
An FDIC spokesman said that only about 140 institutions fall in the category, and only 20 to 24 would need to raise additional capital, totaling about $250 million.
But Robert R. Davis, director of government relations for America's Community Bankers in Washington, argued that the change could have a much wider impact.
"The proposal does not adequately describe what a subprime loan is or what constitutes a risky subprime loan," he said. He argued that under the proposed rule, everything but A-quality loans could be considered risky.
Mr. Davis said that though the FDIC must be concerned with the issue, it is "going down the wrong track" by making an industrywide rule.
"The proposal is geared toward day-to-day lending activities of banks, rather than looking at the small number of lending institutions with risk that concerns the regulators," Mr. Davis said. "We don't need a systematic program dealing with subprime lending risk, in an industry that is already overcapitalized, when it's only a few institutions," he said.
The proposal has made many lenders and community bank officials uneasy.
Harold L. Rams, senior vice president of Quaker City Bank of Whittier, Calif., said doubling the capital requirement would cause banks to make fewer loans and ultimately lose customers. "It impedes us from maintaining customer relationships," he said.
Michael McMahon, an analyst for Sandler O'Neill & Partners, said the proposal represents an "unenlightened and draconian approach." Mr. McMahon argued that the change would restrict credit to those who need it most.
FDIC officials, however, argued that the action would be an appropriate way to protect the banking industry and the deposit insurance fund. Mark Schmidt, associate director, division of supervision for the FDIC, said subprime loans are risky and could result in large, unexpected losses if the economy sours.
"The purpose of the FDIC is safety and soundness of the banking industry," Mr. Schmidt said. "We are not about to tell banks not to make subprime loans, but like every other activity, it must be done in a safe and sound manner, and we feel that higher-risk loans require higher capital."
According to the FDIC, the two most noteworthy failures of the last two years - BestBank of Boulder, Colo., and First National Bank of Keystone (W.Va.) - cost the FDIC more than $1 billion. Their failures stemmed from unsound subprime loans.
Konrad Alt, chief public policy officer at Providian Financial Corp. of San Francisco, Calif., said the difference between a good subprime lender and a bad subprime lender is principally a matter of management. "The proposal needs to do a better job at bringing management into the equation," he said.
Several lenders took issue with what they view is a contradiction by the FDIC, which encourages and requires higher-risk loans - through programs such as the Community Reinvestment Act - but which may start penalizing lenders for making them.
Mr. Schmidt countered that the CRA encourages banks to meet the needs of everyone in the community - while maintaining safe and sound banking practices.
Further, lenders feel they should not be penalized because they made the legal choice to be insured, noting that the FDIC has pointed to the higher reserves of uninsured subprime lenders to bolster its proposal. One lending official said, "We put up with a whole raft of burdens to be part of the FDIC [that uninsured institutions do not] to ensure we operate safely and soundly as insured depositors."
The FDIC said that uninsured subprime lenders hold more capital than uninsured lenders that make less-risky loans. "The market requires significantly more capital in subprime lending than prime - another indicator of the elevated risk of this activity," Mr. Schmidt said.
Some lenders feel that raising the capital requirement is needed. Francisco Nebot, who on Feb. 2 took over as president and chief financial officer of First Alliance Corp. of Irvine, Calif., supports the FDIC initiative.
He said thrifts have been "very aggressive" in subprime lending and that the FDIC should examine the risk.
Mr. McMahon said the proposal serves a purpose by putting subprime lenders on notice that they need sound business plans, documented risk management, and profitable results that do not put the FDIC at risk.
Mr. Davis suggested that the agencies develop a screening process to identity banks that raise regulatory concern. He said the FDIC has flagged only about 20 institutions but is enacting a rule for 10,000. "To enact a proposal that blankets the entire industry, as opposed to just the institutions they are concerned with, is wrong," Mr. Davis said.
Mr. Nebot disagreed. He argued that such a screening would entail looking at the underwriting of every bank - "a tremendous task." An industrywide rule is the only realistic option, he said.
Allen Sanborn, president and CEO of Robert Morris Associates of Philadelphia, Pa., said regulators should address allocating capital for lenders' entire loan book, not just a single product line.
"We think regulators ought to go the full step, not only look at subprime, but examine capital so it's allocated correctly across the board," he said.
Mark Schaftlein, who is the president and chief executive officer of Westmark Mortgage Corp. in Boca Raton, Fla., suggested that federal intervention may not be needed.
"In general, the market will work this out," he said. "This industry has a way of adjusting itself to a rapidly changing marketplace."
He said that in an effort to protect taxpayers, regulators could cost the consumer money through higher rates. "There's a delicate balance between proper regulation and the free market, and there is a risk that the consumer could pay more," Mr. Schaftlein said.
Mr. Nebot acknowledged that the rule may affect institutions' ability to make loans. "We'll probably end up with higher rates," he said.