WASHINGTON - Banks that originate and sell pools of risky loans would face higher capital requirements under a proposal being formulated by federal bank and thrift regulators.
In a speech Friday to the Conference of State Bank Supervisors, Donna Tanoue, chairman of the Federal Deposit Insurance Corp., said regulators may require banks to take a dollar-for-dollar capital charge for their residual interests in pools of high-risk securitized loans - even if the amount exceeds a current cap limiting the capital charge to 8% of a pool's value.
Banks book those residuals as assets, which Ms. Tanoue said are in many cases "illusory."
She said residuals contributed to the high-cost failures of First National Bank of Keystone (W.Va.) and Pacific Thrift and Loan Co. in California.
"We have a number of institutions on our problem list precisely because of this issue," Ms. Tanoue said. She said the capital requirement is also desirable because there are "a good number of other institutions - that are not on our problem list - but do hold more residual interests in securitized assets than we believe is prudent."
A proposed rule, expected to be issued for comment by July, would define the type of loan pools subject to the increased capital requirement and would cap the amount of residuals a bank could hold as capital.
The proposal would supplement December guidelines cautioning banks to value residual assets conservatively and a February proposal to change the risk-based capital treatment of securitization agreements that give purchasers recourse against the bank in case of losses.
When a bank sells a pool of loans, it typically retains an interest in the loans as a "first-loss position." This means the bank stands last in the line of creditors to be repaid in the event the loan pool does not produce the flow of interest payments the bank expects. The riskier the market perceives the loan pool to be, the larger the portion of the loan the bank has to retain.
For instance, when a bank securitizes a pool of low-risk home mortgage loans, the market may be willing to buy as much as 98% of the pool, leaving the bank with a 2% residual interest. High-risk loan pools are not as attractive, and the market will often leave banks with as much as 15% of the pool.
Current rules cap the amount of capital a bank must carry against residuals at 8% of the pool's value. Regulators would like the cap removed for certain classes of residuals, such as those resulting from pools of subprime loans, Ms. Tanoue said.
The FDIC also plans to crack down on fraud: Ms. Tanoue said the agency's examiners have been instructed to look for certain warning signs and to give fraud investigations high priority.
"As recent failures and recent examinations make clear, technological innovations and the increased liquidity of many bank products have heightened the potential for rapid and large losses from fraud," Ms. Tanoue said.
