The Wall Street Journal
Housing Woes Shake Bank In California
FDIC Tells Fremont To Shore Up Capital; Top Subprime Player
By VALERIE BAUERLEIN DAMIAN PALETTA, and DAVID ENRICH
March 29, 2008; Page A1
The financial crisis threatened to claim its first casualty in the U.S.
banking industry, as federal and state regulators gave a rare directive to
Fremont General Corp. to shore up its operations immediately.
While the California lender's woes don't pose a threat to the broader
financial system, its plight marks a new stage in the turmoil that began
last summer. Regulators said the Brea, Calif., company, parent of a once
highly active subprime lender called Fremont Investment & Loan, must raise
new capital within the next 60 days or sell its banking subsidiary.
[Warning]
If it can't comply, Fremont could be subject to seizure by regulators,
making it the biggest U.S. bank failure in 20 years. If regulators felt
Fremont was making progress, they could modify the enforcement action to
give Fremont more time.
For insured depositors, to be sure, no matter what happens to Fremont,
their
accounts would be covered up to $100,000 by the U.S. government's Federal
Deposit Insurance Corp. The FDIC insures certain retirement accounts up to
$250,000.
Fremont's troubles come as regulators over the past several weeks have
started demanding that banks, especially small and midsize ones, get more
aggressive at marking down the value of loans they're holding and that
they
correspondingly beef up their reserves. That is likely to force an
increasing number of banks to raise fresh capital, experts say. At the
same
time, as mounting defaults take a toll on banks, the FDIC and other
regulators say they are bracing for more lenders to fail.
No sizable federally insured bank has been brought to its knees during the
credit squeeze and housing downturn, despite the collapse of many nonbank
mortgage specialists and heavy losses forced on many large commercial and
investment banks. Close scrutiny from regulators and the bread-and-butter
business of collecting inexpensive deposits tend to insulate federally
insured banks. But the tightening noose around Fremont shows how things
can
****ft.
"It's an indication that banks that appeared well-capitalized a year ago
could be in trouble," said Zach Gast, an analyst at the Center for
Financial
Research and Analysis, a forensic-accounting firm that is part of
RiskMetrics Group.
Fremont disclosed Friday that the FDIC had issued a "prompt corrective
action" order on Wednesday requiring it to raise capital or be sold,
according to a filing with the Securities and Exchange Commission. "The
financial condition of Fremont General Cor****ation, the company having
ultimate control over the Bank, continues to deteriorate," the FDIC said
in
the order.
Along with the California Department of Financial Institutions, the FDIC
set
a May 26 deadline to raise the capital. At the same time, the regulators
said the bank can't seek capital by offering depositors higher interest
rates than the rates prevailing in the California market. In addition, the
bank won't be allowed to make capital payments to its parent or an
affiliate, or pay bonuses to bank executives.
In a statement, Fremont said there is "no assurance" it will succeed in
developing a strategy to comply with the directive. A Fremont spokesman
declined further comment.
Fremont doesn't appear likely to attract a federal rescue such as the one
arranged for Bear Stearns Cos. Bear, a major Wall Street investment bank,
had huge, complex exposure to other companies and creditors that could
have
provided a systemic shock to financial markets in the event of its
collapse.
Fremont's exposure is more isolated and contained.
Fremont was founded in 1937 and was long a sleepy Central Valley lender
with
fewer than two dozen branches. But it became an example of a company that
emerged from the shadows during the housing boom and grew into a
substantial
player in subprime loans, those to borrowers with weak credit. At the peak
of the boom, Fremont was one of the top 10 U.S. originators of subprime
loans, thanks to practices that included loose underwriting and aggressive
marketing to brokers.
Fremont was hardly a household name. All of its 22 retail branches were in
California, and it didn't advertise directly to consumers with TV ads or
newspaper pitches. Yet from 2004 to 2006, Fremont made $81 billion in
high-interest-rate loans, fourth-highest among U.S. lenders, according to
a
Wall Street Journal analysis of lending data filed with federal
regulators.
Nearly all of its home mortgages were subprime loans, which then were
bundled into pools, sliced up and sold off to investors.
Fremont aggressively wooed mortgage brokers, the middlemen who are
supposed
to help borrowers get the best deal from lenders. Fremont offered
extremely
flexible loan terms, meaning that approval was easy to get for even shaky
borrowers. What's more, Fremont richly rewarded mortgage brokers who
persuaded borrowers to opt for its most-expensive subprime loans -- in
some
cases, even if the borrowers had good enough credit to qualify for
so-called
prime loans.
According to securities filings, out of 60,000 loans securitized and sold
by
Fremont in 2005 and 2006, about 12% were issued to borrowers with credit
scores of at least 700 -- well within the range that typically qualifies a
borrower for prime terms.
Fremont's lending added fuel to some of the hottest real-estate markets,
from Southern California to New England. But its underwriting practices
and
broker incentives drew sharp criticism from some regulators.
In March 2007, the federal government forced Fremont to stop making
subprime
loans and to cease operating with management whose "policies and practices
are detrimental." The company agreed to the order and sold its subprime
division. Fremont was permitted to keep its commercial real-estate
operations, but the FDIC required the bank to shore up this business line
and improve risk management.
In October, Massachusetts Attorney General Martha Coakley filed a suit
against Fremont General and its banking unit, Fremont Investment & Loan,
alleging that they were offering risky products such as 100% financing and
"no do***entation" loans that were unfair and deceptive.
Fremont denies wrongdoing. In a court filing in November, it said that
without access to its loans -- often requiring a lower standard of proof
of
income, assets and credit history than traditional lenders -- "many
Massachusetts residents who are homeowners today would never have been
able
to purchase homes." Last month, a Massachusetts court issued a preliminary
injunction saying Fremont couldn't foreclose on mortgages in the state
without checking with the attorney general.
Fremont was also a key player in Florida, one of the markets hardest hit
in
the real-estate slump. In 2005, at the housing boom's peak, Fremont made
nearly 5,000 high-rate mortgages in the Miami/Miami Beach/Kendall metro
area, making it the second-biggest subprime lender there.
Fremont submitted a capital-restoration plan last August, but the FDIC
rejected it as "unacceptable," according to regulatory filings. The bank
submitted a new capital-restoration plan on Nov. 9. But on March 17 of
this
year, the company told the FDIC that this plan was "obsolete," according
to
the FDIC.
The company, which hasn't filed financial results since Sept. 30, has been
seeking a buyer for months. It installed a new CEO and executive team in
November and a new board in January.
The FDIC has given "prompt corrective action" notices to only 13 other
banks
since it started releasing public data on these directives in 1993. Six of
those banks failed, some within weeks of the notice. Such notices
typically
only come when a bank has very low capital levels or is at risk of
failure.
(Federal bank regulators often issue less-stringent public and private
enforcement actions against banks.)
There have only been five bank failures since July 2004. But federal
regulators have warned of more potentially insolvent institutions,
particularly banks with high exposures to risky commercial real-estate
loans.
After the savings-and-loan crisis of the late 1980s, Congress passed a law
that required early intervention in problem banks -- known as "prompt
corrective actions" -- to prevent troubled banks from digging themselves
into a deeper hole. The 1991 legislation was called the Federal Deposit
Insurance Cor****ation Improvement Act.
When a bank fails, the FDIC either transfers insured deposits to another
bank or writes the account-holder a check for the insured amount of the
deposit. Fremont's bank currently holds about $7 billion in deposits.
Roughly 80% are federally insured, according to FDIC data. It is possible
for customers with uninsured deposits to recoup a ****tion of their losses,
but there is no federal guarantee on that money. The government's
deposit-insurance system is funded by premiums levied on banks, but
ultimately taxpayers stand behind the fund.
Theodore Kovaleff, a bank and thrift analyst at New York brokerage Sky
Capital, said that in his view, Fremont is unlikely to be able to raise
new
capital because of the uncertainty surrounding the company. "One has
absolutely no idea at all what the value behind the shares is," he said.
"We
don't know what's going to get written off."
The best hope for Fremont might be a federally engineered sale at a
fire-sale price, or a deal structured in a way that cu****ons the buyer
from
some liabilities. For example, the 1983 purchase of Seafirst Corp. by
BankAmerica Corp., a predecessor of Bank of America Corp., included new
nonvoting preferred shares that left Seafirst shareholders bearing the
financial risk of bad loans for five years. Also, Chemical New York Corp.
--
now part of J.P. Morgan Chase & Co. -- was able to spin off problem energy
and real-estate loans into a separate bank when it bought Texas Commerce
Bancshares Inc. in 1987.
Some larger lenders also are trying to bolster depleted capital levels.
Wa****ngton Mutual Inc., the nation's largest savings-and-loan, and
National
City Corp., a Cleveland-based bank, have hired investment bankers to help
them raise cash, say people familiar with the matter. National City is
also
exploring a possible sale of itself. The capital-raising efforts haven't
been successful so far.
-- Rick Brooks and Ruth Simon contributed to this article.
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