In another instance of the regulators tightening the reins on subprime lending banks, the Office of Thrift Supervision on June 2 informed Life Financial Corp. that its capital levels were not sufficient for risk weighting.

Life Financial is the savings and loan holding company for subsidiary LIFE Bank, which is a subprime lender, according to industry sources.

The announcement of the OTS's notification follows the recent enforcement action issued by the Office of the Comptroller of the Currency on the banking subsidiaries of Advanta Corp.

Several sources have suggested that these recent tightenings represent a change in philosophy by the regulators, where they are no longer willing to wait for a securitization-driven bank to get in trouble before they take an enforcement action.

"If a bank does not have all of the controls in place that the regulators think are necessary the bank will be subject to enforcement action, regardless of the condition of the bank," said a source close to the situation.

Formerly, the regulators would wait until a bank was in trouble before taking definitive action.

"I don't care what they're saying, this is a real message to the industry," the source said. "If they continue, it's going to soup-to-nuts subprime lending and securitization combined. It's what they want. It's what they wish they would have had with [First National Bank of Keystone]."

Keystone's fraud-related failure will cost the Federal Deposit Insurance Corp. up to $800 million. Despite the fraud, residual assets, which are the low-quality, bottom pieces of a securitized loan pool, played a major part in the high-cost Keystone failure, as the bank was reporting the residuals as being worth more than they really were.

In this light, the bank was not holding sufficient capital against the residuals.

"The key to the Advanta enforcement order is that they're asking for 17% capital," the source said. "I have no idea what Advanta's capital level is, but 17% is a heck of a lot more than the core capital requirements."

Under normal requirements, to be considered well capitalized, a bank needs to hold 10% in core capital. If a bank holds more than 10% in core capital, the bank is allowed to accept brokeraged funds.

A brokeraged fund is created by large deposits to funds brokers, which are then placed in multiple banks, providing fully government-insured funds with maximum return on investment.

"Most banks that are into securitization use brokeraged funds as a means to carry inventory until they can securitize," the source explained. "It's the cheapest source of funds available."

Commentary Period on Subprime

Separately, the Federal Financial Institution Examination Counsel (FFIEC) published its revision proposal for the Call Report in the Federal Register on May 31, which includes a section that specifically addresses subprime loan treatment and classification. The commentary period ends on July 31.

Most interesting, the regulators might be moving towards a program-based' approach to subprime loan reporting, where, instead of looking at each individual loan in a lender's portfolio, a bank would consciously have a subprime program, which would require it to adhere to a modified capital risk treatment.

"They should treat it differently," one source said. "Because the servicing is so different than with prime loans."

Currently, the source added, there are many banks that make subprime loans without having subprime programs.

"What the government seems to be after with this proposal is not just, What is subprime?' That's just too difficult," the source said. "What they're after is What is a subprime program?'"

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