Following Advanta Corp.'s $200 million-plus brush with the Office of the Comptroller of the Currency (ASR 6/12/00), subprime banking entities are likely shaking in their boots.
"The regulators are on a rampage," said a source familiar with the incident.
One real-estate asset-backed analyst remarked, "I don't know what this means. Does this mean everyone is going to have to start using these kinds of numbers?"
Complying with a cease-and-desist order, Advanta was made to raise its discount rate to 18% from 15% on its interest-only subordinated assets (residuals), and to use a 15% discount rate on its "contractual mortgage servicing rights." As the discount rate is the rate used on the securitization to calculate the present-value of future cash flow, the revaluation of assets resulted in a $214 million write-down for Advanta. Advanta did not return phone calls.
What is alarming to industry watchers is that a 15% discount rate on subordinated assets is already considered conservative, sources said. Pushing the rate to 18% suggests that the OCC thinks there's considerable risk in the portfolio or, more likely, considerable risk in the subprime securitization market.
"If the OCC thinks that Advanta needs a discount rate of 18%, and Advanta's historic losses on its home-equity and mortgages aren't that high, it tells the market that that's what OCC thinks is an acceptable discount rate," said the source familiar with the incident. "Even if [the OCC] is not going to force others off from 15% to 18%, it might force them to 16%."
The OCC declined to comment on the issue.
"What's interesting is that this used to be an accounting thing," the ABS analyst said. "It used to be the accountants that were on the hook for making reasonable and appropriate estimates for losses, gains and the discount factor. Now it's turned into a regulatory area."
According to industry sources, Advanta will likely increase its securitization activity to meet the capital requirements imposed on it. In a statement issued by Fitch last week, the rating agency announced that it was lowering Advanta's corporate debt rating. The analysts wrote, "Advanta had intended to fund a significant portion of future originations on balance sheet with deposits. As a result of the regulatory restrictions, the company will likely need to fund more of its loan originations with securitizations, which are less cost-effective and market sensitive than deposits."
Further, by selling more assets, the company will effectively be shrinking the bank, one source noted.
"What that does in some respects - which is counter productive from the regulatory perspective - it means they're going to sell their good assets," the source said. "And what's left after you sell your good assets are the ones you can't sell."
Like Fitch, Thomson Financial BankWatch lowered its ratings on Advanta's short- and long-term corporate debt, while Moody's Investors Service placed the company on ratings watch negative.
Though Advanta's exposure to the OCC's regulations is through its banking entities, the change in discount rate will likely affect all its securitization operations, sources said, including the new small-business credit-card line, which grew to $1.4 billion in managed receivables, a 37% year-to-date increase.