Current regulatory attention directed by The Office of the Comptroller of the Currency at community banks has placed Goleta National Bank (GNB) in the hot seat.
Community West Bancshares, GNB's parent company, announced recently that it would not only divest Goleta of its existing high loan-to-value loans but also remove securitizations from its business operations.
"We are getting out of the securitization business because it has become painfully obvious that a community bank, in spite of being sophisticated and capable, can be blindsided by the regulatory process as it relates to how securitizations are treated," said Community West Chairman John Markel.
Community West's woes started with a letter from the OCC saying the bank was computing its risk-based capital ratio wrong. The risk-based capital ratio is defined as risk-based capital divided by the risk-weighted assets.
"In the Goleta National Bank's case, we thought our numbers were approximately $20 million in the numerator of risk-based capital divided by approximately $200 million of risk-based assets," Markel said. "This resulted in a risk-based capital ratio of 10%, which defines a well-capitalized institution."
Beginning in mid-1998, the company priced two securitizations using this computation. They were not aware that a 1997 regulation required banks that were holding more than 8% of their securitization on their books as an asset - called the residual asset - had to include the amount of the original securitization into their risk-based asset calculation. The new calculation resulted in a risk-based capital ratio of 5 %, defining Community West as a severely undercapitalized institution, Markel explained.
"The OCC had not told us about it though they were very aware of our securitizations, so we thought we were satisfying all the regulatory requirements. When we did our first two securitizations we were advised to hold 10% of residual assets in our books, which protected the bond holders," said Markel.
The OCC's intense scrutiny was caused by the downfall of First National Bank of Keystone due to fraudulent activity. Because of the Keystone incident, the OCC decided to take a better look at all national banks doing securitization, and to look at all of their regulatory vehicles, explained Markel "We were highly visible at that time because we were in the process of completing a third securitization and we had $150 million in loans in our books," Markel said. "The OCC looked at their regulations and our assets and said, Uh, oh.'"
Community West board of directors had committed $11.2 million in order for Community West to meet capital requirements.
"Goleta National Bank is a unique organization in that we were capable of solving the capitalization issue by providing a significant infusion of cash," Markel said. "I would be very surprised if other community banks would have a board of directors with sufficient net worth and liquid capital of their own.
"If they got hit with the same regulation that we got hit with, it will be a problem because once you're undercapitalized, the OCC has to come in and do a detailed audit of your books. They will look at whatever the organization has in terms of residual assets, and with high probability require that they mark the asset further down just to be conservative," he noted.