WASHINGTON — Just months before Superior Bank FSB failed, its president urged regulators to withdraw a proposal that would have required higher capital for the very assets that brought down the $2.3 billion-asset Hinsdale, Ill., thrift.
Regulators closed Superior on July 27. Ironically, its collapse — which could cost the Savings Association Insurance Fund more than $500 million — will likely hasten the completion of the rule Superior sought to avoid. Spokesmen for the federal bank and thrift regulators said they expect the final rule to be released in the early fall. In a Dec. 22 comment letter to regulators on behalf of Superior’s board, Neal T. Halleran, the thrift’s president and managing officer, protested a September proposal that would force financial institutions to hold much steeper capital for subprime residual assets — the interest retained after the bundling and sale of a pool of risky loans.
That plan had come in response to the 1999 implosion of the First National Bank of Keystone in West Virginia, whose overreliance on subprime residuals contributed to its downfall.
In the comment letter, Mr. Halleran called the proposal an “overreaction” and argued that though the thrift had a vast amount of subprime residuals, Superior was no Keystone.
“The fact there have been some egregious cases of deficient management of retained interests and securitization programs does not justify subjecting the system as a whole to rules that ignore” our concerns, Mr. Halleran wrote.
“Institutions with proven track records and depth of expertise in securitization activities have a valid and valuable role in the financial marketplace,” he wrote. “At Superior Bank, we have given large numbers of borrowers an opportunity not only to own their own homes, but also to prove they can be credit worthy. And we have done so without taking on undue liquidity, credit, or interest rate risk. We urge the agencies to withdraw the proposal.”
Industry analysts said that the regulators will want to appear responsive to Superior’s failure, and they expect a final rule to be enacted soon.
“I think the combination of the rule having been largely resolved and the impetus for needing a regulatory solution to manifest problems raised by Superior will compel issuance of a rule soon,” said Karen Shaw Petrou, the managing partner of Federal Financial Analytics.
On Sept. 27 regulators proposed requiring banks to hold $1 of capital for each $1 of their residual interest in pools of securitized loans, and limiting banks’ holdings in such assets to no more than 25% of their Tier 1 capital.
But the fact that the final rule has yet to be released almost eight months after its comment deadline passed has caused speculation that it was being delayed to allow the Office of Thrift Supervision to strike a deal with Superior to keep it from failing.
“We believe that the rule has been held up in part to give the OTS flexibility to negotiate with the prior owners of Superior, who had agreed to a recapitalization plan under the current, somewhat more favorable rules,” Federal Financial Analytics wrote in a report released last week. “However, OTS refused to provide the owners with a promise that they would be protected from the more stringent ones on tap.”
But a spokesman for the agency adamantly denied that it had delayed the rule in any way, and several regulatory officials stressed that it was not unusual for the release of a final rule to take this long. Indeed, several sources said the residual rule would be jointly released with a recourse rule that has been in the works for nearly a decade.
They also stressed that the proposal was enormously complicated and had encountered resistance from several large financial companies, including MBNA Corp. and Freddie Mac. Those companies argued that not all subprime residual assets are created equal, and that while some institutions, such as Keystone, used highly volatile ones, others used assets that had a fixed value which were also captured by the rule.
Regardless of why the rule was delayed, releasing it earlier would have likely had a dramatic impact on Superior. If the proposal had been adopted as proposed, Superior would have likely had to significantly increase its capital, unless an exception for earlier residuals were granted.
But an OTS spokesman played down any effects an earlier release of the rule would have had on Superior, which he said had several other problems. “They used overly optimistic portfolio evaluations, did not engage in proper accounting, and even based on the current rules, they had $700 million in residuals, which was many times over their capital level,” he said.
A spokesman for the Pritzker family — who owned half of the thrift’s holding company along with New York developer Alvin Dworman — said in an interview Tuesday that the company was concerned about the proposal, but he said that it was overshadowed by Ernst & Young’s acknowledgement that the residuals had been improperly valued.
“While the proposed regulation was certainly looming in the background, there were issues relating to the bank concerning the change in methodology by the accountants which resulted in an initial writedown of $117 million in the value of the residuals,” the Pritzker spokesman said.
Subprime loans have been a major focus of regulators this year. After issuing the residuals proposal, in January regulators released long-awaited subprime capital guidelines for examiners on subprime loans.