The highly publicized bankruptcy filing last week by First Alliance Corp. of Irvine, Calif., underscores the need for mainstream lenders to scrutinize their business structures as they enter the subprime mortgage business.

Consumer activists said they fear the entry by commercial banks and by the secondary marketing giants Fannie Mae and Freddie Mac will worsen problems - putting these companies in the line of fire of predatory-lending charges - rather than clean up the industry.

Top banks have already taken control of the subprime sector. According to National Mortgage News, eight of the top 10 subprime lenders are owned by conventional banking companies, including Bank of America Corp., First Union Corp., Wells Fargo & Co., Citigroup Inc., and KeyCorp.

The numerous affiliations have led to an ethical gray area of fair lending, posing the question of whether a subprime lender has the responsibility to refer A-credit borrowers that stumble into their shops up to their conventional affiliates.

Critics charge that borrowers who do not qualify for A-rate loans at banks are downstreamed to subprime lenders, but when A-quality borrowers stumble into a subprime shop, they are kept there and sold a loan with a higher rate.

"I certainly think the subprime affiliate has the responsibility to refer up," said Andrew Foster of the Rural Southern Development Initiative. "When you charge someone a higher rate than what they qualify for, you are very close to violating the fair-housing laws." A survey released last week by Mr. Foster's group showed that 30% of subprime borrowers - primarily in Alabama, Arkansas, and South Carolina - pay higher mortgage rates than they should.

Peter J. Wissinger, president and chief operating officer of Norwest Mortgage Inc., which has a subprime subsidiary, Directors Acceptance Corp., said his company conducts several reviews to make sure customers receive the rate for which they qualify. "Charging for risk is not inappropriate," he said, "but if you're a prime customer and you get a subprime rate, that's not fair."

Bank of America and its subprime affiliate, NationsCredit, have yet to fully address the issue, raising the ire of many grassroots activists. A spokeswoman for Bank of America, though acknowledging that there is no referral system in place between NationsCredit and the bank, said a one-year pilot program found that fewer than 1% of applicants to NationsCredit would have been referred up.

First Union and Money Store appear to be close to implementing a system to address the issue. Michael P. Rizer, a senior vice president at First Union, said the companies are aligning products, underwriting, and pricing for home equity loans, so customers have access to the same resources at both First Union and Money Store. The new system, which he said has been in development for more than two years, will offer borrowers the same products, rates, and pricing at both companies to all ranges of credit.

The National Home Equity Mortgage Association has received numerous calls from members asking about the First Union model, said executive director Jeffrey Zelzer, who predicted the pricing system will "sweep the industry."

Champion Mortgage, a subsidiary of KeyCorp, seems to have already worked out the problem. A Champion loan officer suggested that if you can qualify for a loan from a conventional bank, you should do it there because of a better rate. The officer carefully explained that Champion offers loans that are typically a point or two higher than conventional banks, but that it is an option when the A-quality loan isn't offered.

Banks that enter the fray will probably be met with a hostile attitude, regardless of their pricing policies. "Any company that enters the subprime mortgage business is ripping off and exploiting the borrower," said William Brennan, director of the Home Defense Program at the Atlanta Legal Aid Society. "They all overcharge on interest rates and engage in at least one or more abusive lending practice."

Mr. Brennan opposes allowing Fannie Mae and Freddie Mac to purchase subprime loans. "Allowing Fannie Mae and Freddie Mac to buy billions of dollars of subprime loans would be like dropping an atom bomb on rural and inner-city minority communities," he said. "It's wrong, and HUD shouldn't allow it."

Fannie Mae's chairman, Franklin D. Raines, told the National Community Reinvestment Coalition last week that his company would not purchase subprime loans that resulted from abusive lending practices. Peter Skillern, executive director of Community Reinvestment Association of North Carolina, argued that conventional banks said they could clean up the subprime market and couldn't do so. He contended that Fannie and Freddie won't be able to do so, either.

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