Regulatory Action Putting Squeeze on Some Small Banks

A handful of small Southern California banks and thrifts are feeling the heat of a regulatory crackdown on a complex type of financial arrangement in which institutions package and sell their loans on Wall Street.

The nation’s top bank regulators, led by the Federal Reserve Bank, are paying closer attention to the practice, known as securitization, and have warned institutions that they may need to boost their capital levels to protect against possible loan losses.

The agencies, worried that some financial institutions have underestimated the potential risks of securitization, on Monday plan to propose tighter capital requirements in some instances.

Separately, regulators are considering similar requirements for institutions that make loans to borrowers with poor credit.

But already, some institutions are feeling the pinch.

On Friday, Orange-based BYL Bancorp said it would exit the securitization business entirely after regulators informed company executives last month that they needed to set aside an additional $8 million in capital for the $100 million in commercial real estate loans the bank has packaged and sold on Wall Street.

“It’s going to hurt us,” said Barry Moore, chief operating officer at BYL, parent of Bank of Yorba Linda. Though BYL has enough excess capital to cover the requirement, Moore said it will cancel future securitizations and, instead, keep the loans it makes in its portfolio.

But the new strategy will likely reduce loan growth 30% and cut into profitability this year, he said. The company suspended its fourth-quarter dividend.

Several small financial institutions have been relying on securitizations to fuel their growth in recent years. This strategy allows banks to get loans off their balance sheets and free up capital for other uses, enabling them to make more loans than regulators might otherwise allow.

But regulators are worried that most banks still face losses on securitized loans if defaults are higher than originally expected.

In addition, Robert Storch, chief of accounting for the Federal Deposit Insurance Corp., said regulators have found that several smaller institutions have failed to adequately protect themselves, often because they misinterpreted existing capital rules.

Goleta-based Community West Bancshares said recently that it had to raise more than $11 million in additional capital after regulators warned that it had improperly calculated its capital requirements.

Bank analysts said the crackdown will likely prompt other institutions to reevaluate their practices.

“Regulators are taking a much closer look at securitizations,” said Ed Carpenter, president of Irvine-based Carpenter & Co., an industry consultant. “Banks have two options: raise capital or exit the business.”

Carpenter said he is working with several institutions in Southern California, helping them understand the proposed rules or search for ways to raise capital.

Among those banks and thrifts that have relied on the securitization of loans are Irvine-based Westcorp, parent of Western Financial Bank, and Tustin-based FirstPlus Bank. Officials at those institutions did not return phone calls Friday.