Housing Woes Shake Bank in California

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. 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 Corporation, 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. 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 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. 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 documentation" 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. 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 Corporation Improvement Act. The best hope for Fremont might be a federally engineered sale at a fire-sale price, or a deal structured in a way that cushions 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. Washington 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.