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FDIC Enforcement Decisions and Orders

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{{9-30-97 p.C-2777}}
   [10,654] In the Matter of Freedom Financial Thrift and Loan Association, Docket No. FDIC-92-68b (10-8-92).

   Institution to cease and desist from such unsafe or unsound practices as operating with inadequate management; operating with an excessive level of poor quality assets; operating without adequate reserve for loan losses; following hazardous lending and lax collection practices; operating with inadequate liquidity and funds management policies; operating with hazardous concentrations of credit; operating in such a manner as to produce low earnings; and operating in violation of applicable laws or regulations. (This order was terminated by order of the FDIC dated 7-8-97. See ¶16,175.)

   [.1] Management—Qualifications—Review
   [.2] Board of Directors—Duties—Meeting Frequency
   [.3] Capital—Tier 1 Capital—Increase/Maintain—Methods
   [.4] Assets—Adversely Classified—Eliminate/Reduce
   [.5] Loans—Extensions of Credit—Existing Borrowers—Curtail
{{9-30-97 p.C-2778}}
   [.6] Lending and Collection Policy—Minimum Requirements
   [.7] Loans—Concentrations of Credit—Risk Segmentation Analysis
   [.8] Loan Loss Reserve—Establish/Maintain
   [.9] Thrift Operations—Overhead Expenses—Control
   [.10] Violations of Law—Eliminate/Correct
   [.11] Asset/Liability Management—Written Policy—Minimum Requirements
   [.12] Thrift Operations—Internal Routine and Controls—Written Policy Required
   [.13] Reports of Condition and Income—Amendment Required
   [.14] Dividends—Restricted
   [.15] Compensation—Officers and Directors—Review Required
   [.16] Audit—Internal

In the Matter of

FREEDOM FINANCIAL THRIFT AND
LOAN ASSOCIATION

EL TORO, CALIFORNIA
(Insured State Nonmember Bank)
ORDER TO CEASE AND DESIST
FDIC-92-68b

   The Federal Deposit Insurance Corporation ("FDIC"), on March 12, 1992, issued to Freedom Financial Thrift and Loan Association, El Toro, California ("Thrift"), a NOTICE OF CHARGES AND OF HEARING ("NOTICE"), pursuant to section 8(b)(1) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1818(b)(1). The NOTICE charges the Thrift with having engaged in unsafe or unsound banking practices and violations of law and/or regulations.
   The insured institution and counsel for the FDIC thereafter executed a STIPULATION AND CONSENT TO THE ISSUANCE OF AN ORDER TO CEASE AND DESIST ("CONSENT AGREEMENT"), dated October 2, 1991, whereby, solely for the purpose of this proceeding and without admitting or denying the allegations in the NOTICE, the Thrift consented to the issuance of an ORDER TO CEASE AND DESIST ("ORDER") by the FDIC.
   The FDIC considered the matter and determined that it had reason to believe that the Thrift had engaged in unsafe or unsound banking practices and had committed violations of law and/or regulations as set forth in the FDIC Report of Examination as of September 23, 1991 and the FDIC Report of Examination as of August 10, 1992. The FDIC, therefore, accepted the CONSENT AGREEMENT and issued the following:

ORDER TO CEASE AND DESIST

   IT IS HEREBY ORDERED that the Thrift, and any institution-affiliated party as such term is defined in section 3(u) of the Act, 12 U.S.C. § 1813(u), cease and desist from the following unsafe or unsound banking practices and violations:
   (a) operating with inadequate management;
   (b) operating with a large volume of poor quality loans;
   (c) operating with an inadequate loan valuation reserve;
   (d) following hazardous lending and lax collection practices;
   (e) operating with inadequate provisions for liquidity and funds management;
   (f) operating with loan concentrations that are unsafe or unsound;
   (g) operating in such a manner as to produce low earnings; and
   (h) operating in violation of Part 323 of the FDIC Rules and Regulations, 12 C.F.R. 323; and section 23B of the Federal Reserve Act, 12 U.S.C. § 371c-1, made applicable to state nonmember insured institutions by section 18(j)(1) of the Act, 12 U.S.C. § 1828(j)(1); both as more fully described on pages 6-b and 6-b-1 of the Report of Examination as of September 23, 1991 and 6-b-1 through 6-b-3 of the Report of Examination as of August 10, 1992.
   IT IS FURTHER ORDERED that the Thrift take affirmative action as follows:

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   [.1] 1. The Thrift shall have and retain qualified management.
   (a) Each member of management shall have qualifications and experience commensurate with his or her duties and responsibilities at the Thrift. Management should include a chief executive officer with proven ability in managing a thrift of comparable size, and experience in upgrading a low quality loan portfolio, improving earnings, and other matters needing particular attention. Management should also include a senior lending officer with significant appropriate lending, collection, and loan supervision experience and experience in upgrading a low quality loan portfolio. Each member of management shall be provided appropriate written authority from the Thrift's board of directors to implement the provisions of this ORDER.
   (b) The qualifications of management shall be assessed on its ability to:

       (i) comply with the requirements of this ORDER;
       (ii) operate the Thrift in a safe and sound manner;
       (iii) comply with applicable laws and regulations; and
       (iv) restore all aspects of the Thrift to a safe and sound condition, including asset quality, capital adequacy, earnings, management effectiveness, and liquidity.
   (c) During the life of this ORDER, the Thrift shall notify the Regional Director of the FDIC's San Francisco Regional Office ("Regional Director") in writing when it proposes to add any individual to the Thrift's board of directors or employ any individual as a senior executive officer. The notification must be received at least 30 days before such addition or employment is intended to become effective and should include a description of the background and experience of the individual or individuals to be added or employed.
   (d) The Thrift may not add any individual to its board of directors or employ any individual as a senior executive officer if the Regional Director issues a notice of disapproval pursuant to section 32 of the Act, 12 U.S.C. § 1831i.

   [.2] 2. Within 30 days from the effective date of this ORDER, the board of directors shall increase its participation in the affairs of the Thrift, assuming full responsibility for the formulation of sound policies and objectives and for the supervision of all of the Thrift's activities. This participation shall include meetings to be held no less frequently than monthly, at which, at a minimum, the following areas are reviewed and approved: reports of income and expenses; new, overdue, renewal, insider, charged-off, and recovered loans; investment activity; operating policies; and individual committee actions. Board minutes shall document these reviews and approvals, including the names of any dissenting directors.

[.3] 3. (a) During the life of this Order, the Thrift shall maintain Tier 1 capital in such an amount as to equal or exceed eight and one-half (8.5) percent of the Thrift's adjusted Part 325 total assets.
   (b) Within 60 days from the effective date of this ORDER, the Thrift shall develop and adopt a plan to meet the minimum risk-based capital requirements as described in the FDIC Statement of Policy on Risk-Based Capital contained in Appendix A to Part 325 of the FDIC Rules and Regulations, 12 C.F.R. Part 325, Appendix A. The Plan shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations.
   (c) Any increase in Tier 1 capital necessary to meet the requirements of Paragraph 2 of this ORDER may be accomplished by the following:

       (i) the sale of common stock; or
       (ii) the sale of noncumulative perpetual preferred stock; or
       (iii) the direct contribution of cash by the board of directors, shareholders, and/or parent holding company; or
       (iv) any other means acceptable to the Regional Director; or
       (v) any combination of the above means.
Any increase in Tier 1 capital necessary to meet the requirements of Paragraph 2 of this ORDER may not be accomplished through a deduction from the Thrift's loan loss reserves.
   (d) If all or part of the increase in Tier 1 capital required by Paragraph 2 of this ORDER is accomplished by the sale of new securities, the board of directors shall {{12-31-92 p.C-2780}}forthwith take all necessary steps to adopt and implement a plan for the sale of such additional securities, including the voting of any shares owned or proxies held or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Thrift's securities (including a distribution limited only to the Thrift's existing shareholders), the Thrift shall prepare offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Thrift and the circumstances giving rise to the offering, and any other material disclosures necessary to comply with the Federal securities laws. Prior to the implementation of the plan and, in any event, not less than fifteen (15) days prior to the dissemination of such materials, the plan and any materials used in the sale of the securities shall be submitted to the FDIC, Registration and Disclosure Section, Washington, D.C. 24029, for review. Any changes requested to be made in the plan or materials by the FDIC shall be made prior to their dissemination. If the increase in Tier 1 capital is provided by the sale of non-cumulative perpetual preferred stock, then all terms and conditions of the issue, including but not limited to those terms and conditions relative to interest rate and convertibility factor, shall be presented to the Regional Director for prior approval.
   (e) In complying with the provisions of Paragraph 2 of this ORDER, the Thrift shall provide to any subscriber and/or purchaser of the Thrift's securities, a written notice of any planned or existing development or other changes which are materially different from the information reflected in any offering materials used in connection with the sale of Thrift securities. The written notice required by this paragraph shall be furnished within ten (10) days from the date such material development or change was planned or occurred, whichever is earlier, and shall be furnished to every subscriber and/or purchaser of the Thrift's securities who received or was tendered the information contained in the Thrift's original offering materials.
   (f) For the purposes of this ORDER, the terms "Tier 1 capital" and "total assets" shall have the meanings ascribed to them in Part 325 of the FDIC Rules and Regulations, 12 C.F.R. §§ 325.2(m) and 325.2(n), as amended at 56 Fed. Reg. 10154, effective April 10, 1991.

[.4] 4. (a) Within 10 days from the effective date of this ORDER, the Thrift shall eliminate from its books, by charge-off or collection, all assets classified "Loss" and one-half of the assets classified "Doubtful" in the Report of Examination as of August 10, 1992, that have not been previously collected or charged off. Elimination of these assets through proceeds of other loans made by the Thrift is not considered collection for the purpose of this paragraph.
   (b) Within 90 days from the effective date of this ORDER, the Thrift shall have reduced the assets classified "Substandard" and those assets classified "Doubtful" in the Report of Examination as of August 10, 1992 that have not previously been charged off to not more than $2,500,000.
   (c) Within 180 days from the effective date of this ORDER, the Thrift shall have reduced the assets classified "Substandard" and those assets classified "Doubtful" in the Report of Examination as of August 10, 1992 that have not previously been charged off to not more than $2,000,000.
   (d) Within 270 days from the effective date of this ORDER, the Thrift shall have reduced the assets classified "Substandard" and those assets classified "Doubtful" in the Report of Examination as of August 10, 1992 that have not previously been charged off to not more than $1,500,000.
   (e) Within 360 days from the effective date of this ORDER, the Thrift shall have reduced the assets classified "Substandard" and those assets classified "Doubtful" in the Report of Examination as of August 10, 1992 that have not previously been charged off to not more than $1,000,000.
   (f) The requirements of subparagraphs 4(a), 4(b), 4(c), 4(d) and 4(e) of this ORDER are not to be construed as standards for future operations and, in addition to the foregoing, the Thrift shall eventually reduce the total of all adversely classified assets. Reduction of these assets through proceeds of other loans made by the Thrift to the borrower (or a borrower related to the borrower) whose loan has been ad- {{12-31-92 p.C-2781}}versely classified in not considered collection for the purpose of this paragraph. As used in subparagraphs 4(b), 4(c), 4(d), 4(e) and 4(f) the word "reduce" means:

       (i) to collect;
       (ii) to charge-off; or
       (iii) to sufficiently improve the quality of assets adversely classified to warrant removing any adverse classification, as determined by the FDIC.

   [.5] 5. Beginning with the effective date of this ORDER, the Thrift shall not extend, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Thrift that has been charged off or classified, in whole or in part, "Loss" or "Doubtful" and is uncollected. The requirements of this paragraph shall not prohibit the Thrift from renewing (after collection in cash of interest due from the borrower) any credit already extended to any borrower.

[.6] 6. (a) Within 60 days from the effective date of this ORDER, the Thrift shall revise, adopt, and implement written lending and collection policies to provide effective guidance and control over the Thrift's lending function, which policies shall include specific guidelines for placing loans on a non-accrual basis. In addition, the Thrift shall obtain adequate and current documentation for all loans in the Thrift's loan portfolio. Such policies and their implementation shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.
   (b) The initial revisions to the Thrift's loan policy and practices, required by this paragraph, at a minimum, shall include the following:

       (i) provisions, consistent with FDIC instructions for the preparation of Reports of Condition and Income, under which the accrual of interest income is discontinued and previously accrued interest is reversed on delinquent loans;
       (ii) provisions which prohibit the capitalization of interest or loan related expense unless the board of directors supports in writing and records in the minutes of the corresponding board of directors meeting why an exception thereto is in the best interests of the Thrift;
       (iii) provisions which require complete loan documentation, realistic repayment terms and current credit information adequate to support the outstanding indebtedness of the borrower. Such documentation shall include, where appropriate, current financial information, profit and loss statements or copies of tax returns and cash flow projections;
       (iv) provisions which incorporate limitations on the amount that can be loaned in relation to established collateral values;
       (v) provisions which specify the circumstances and conditions under which real estate appraisals must be conducted by an independent third party;
       (vi) provisions which establish standards for unsecured credit;
       (vii) provisions which establish officer lending limits;
       (viii) provisions which prohibit concentrations of credit in excess of 25 percent of the Thrift's total equity capital and reserves to any borrower and that borrower's related interests;
       (ix) provisions which require the preparation of a loan "watch list" which shall include relevant information on all loans in excess of $25,000 which are classified "Substandard" and "Doubtful" as of August 10, 1992 or by the FDIC in subsequent Reports of Examination and all other loans in excess of $25,000 which warrant individual review and consideration by the board of directors as determined by the loan committee or active management. The loan "watch list" shall be presented to the board of directors for review at least monthly with such review noted in the minutes; and
       (x) the board of directors shall adopt procedures whereby officer compliance with the revised loan policy is monitored and responsibility for exceptions thereto assigned. The procedures adopted shall be reflected in minutes of a board of directors meeting at which all members are present and the vote of each is noted.

   [.7] 7. Within 180 days from the effective date of this ORDER, the Thrift shall perform a risk segmentation analysis with {{12-31-92 p.C-2782}}respect to the Concentrations of Credit listed on Page 2-b of the Report of Examination as of August 10, 1992. Concentrations should be identified by produce type, geographic distribution, underlying collateral or other asset groups which are considered economically related and in the aggregate represent a large portion of the Thrift's capital account. A copy of this analysis shall be provided to the Regional Director and the board agrees to develop a plan to reduce any segment of the portfolio which the Regional Director deems to be an undue concentration of credit in relation to the Thrift's capital account. The plan and its implementation shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.

   [.8] 8. Within 30 days from the effective date of this ORDER, the Thrift shall establish and thereafter maintain an adequate reserve for loan losses.
   Additionally, within 30 days from the effective date of this ORDER, the board of directors shall develop or revise, adopt and implement a comprehensive policy for determining the adequacy of the reserve for loan losses. For the purpose of this determination, the adequacy of the reserve shall be determined after the charge-off of all loans or other items classified "Loss." The policy shall provide for a review of the reserve at least once each calendar quarter. Said review should be completed in sufficient time to ensure that the findings of the board of directors with respect to the loan loss reserve may be properly reported in the quarterly Reports of Condition and Income. The review should focus on the results of the Thrift's internal loan review, loan loss experience, trends of delinquent and non-accrual loans, an estimate of potential loss exposure of significant credits, concentrations of credit, and present and prospective economic conditions. A deficiency in the reserve shall be remedied in the calendar quarter it is discovered, prior to submitting the Report of Condition, by a charge to current operating earnings. The minutes of the board of directors meeting at which such review is undertaken shall indicate the results of the review. Upon completion of the review, the Thrift shall increase and maintain its loss reserve consistent with the loan loss reserve policy established. Such policy and its implementation shall be satisfactory to the Regional Director as determined at subsequent examinations and/or visitations.

   [.9] 9. Within 60 days from the effective date of this ORDER, the Thrift shall develop and adopt a plan to control overhead and other expenses and improve the Thrift's profitability. The plan shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.

   [.10] 10. Within 60 days from the effective date of this ORDER, the Thrift shall eliminate and/or correct all violations of law which are more fully set out on pages 6-b and 6-b-1 of the Report of Examination as of September 23, 1991 and pages 6-b-1 through 6-b-3 of the Report of Examination of the Thrift as of August 10, 1992. In addition, the Thrift shall take all necessary steps to ensure future compliance with all applicable laws and regulations.

   [.11] 11. Within 60 days from the effective date of this ORDER, the board of directors shall develop a comprehensive asset/ liability management policy. Such policy and its implementation shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations. The policy shall establish standards consistent with generally accepted prudent banking operations by giving specific consideration to:

       (i) establishing a range for the Thrift's volatile liability dependency ratio, as computed by the FDIC in its Reports of Examination;
       (ii) establishing a range for short-term investments to potentially volatile liabilities, as those terms are defined by the FDIC in its current edition of "A Users Guide for the Uniform Bank Performance Report";
       (iii) establishing maturity ranges for the Thrift's investment portfolio;
       (iv) establishing acceptable ranges for the Thrift's rate sensitivity and gap ratios; and
       (v) the establishing of an asset/ liability committee, including a description of its responsibilities, how often it will meet, how it will obtain information and guidance from the board of directors, and how its activities will be reported to the board of directors; provided, however, that it is expressly un- {{4-30-94 p.C-2783}}derstood that the board of directors may act as such committee.

   [.12] 12. Within 60 days from the effective date of this ORDER, the Thrift shall adopt and implement a policy for the operation of the Thrift in such a manner as to provide adequate internal routine and control policies consistent with safe and sound banking practices. Such policy shall at a minimum address the deficiencies noted on page 6-c of the Report of Examination of the Thrift as of September 23, 1991 and 6-c of the Report of Examination as of August 10, 1992. Such policy and its implementation shall be satisfactory to the Regional Director as determined at subsequent examinations and/or visitations.

   [.13] 13. Within 10 days after eliminating from its books any asset in compliance with Paragraph 4 of this ORDER, the Thrift shall file with the FDIC amended Consolidated Reports of Condition and Income which shall accurately reflect the financial condition of the Thrift as of June 30, 1992. Thereafter, during the life of this ORDER, the Thrift shall file with the FDIC Consolidated Reports of Condition and Income which accurately reflect the financial condition of the Thrift as of the end of the period for which the Reports are filed, including any adjustment in the Thrift's books made necessary or appropriate as a consequence of any FDIC examination of the Thrift during that reported period.

   [.14] 14. The Thrift shall not pay cash dividends in any amount except as follows:

       (a) such declarations and payments are made in accordance with applicable State and Federal laws and regulations;
       (b) after payment of such dividends, the ratio of Tier 1 capital to total assets of the Thrift will not be less than eight and one half (8.5) percent;
       (c) such declaration and payment of dividends shall have been approved in advance by the board of directors;
       (d) 30 days prior to the payment of any such dividend, the Thrift shall have submitted to the Regional Director a resolution, adopted by the board of directors, verifying that (a) (b) and (c) above are true and that to reach such conclusion, the Thrift relied upon the most recent Report of Condition and Income submitted to the FDIC by the Thrift; and
       (e) such declaration and payment of dividends shall not be made without the prior written consent of the Regional Director, which consent shall not be unreasonably withheld.

   [.15] 15. Within 120 days of the date of this ORDER, the Thrift shall have completed a review and study of the current director and executive officer compensation packages and organizational structure. This review and study shall be acceptable to the Regional Director and shall include the following:
       (a) a critical analysis of each individual's duties and responsibilities, and an appraisal of each individual's performance compared to the present level of compensation;
       (b) a determination of whether the present management team is capable of implementing board directives, operating within the constraints of laws and regulations, and operating the Thrift in a prudent manner;
       (c) the development of comprehensive job descriptions; and
       (d) the development of an organizational chart to delineate formal lines of communication and reporting. A copy of the board's findings and a summary of the conclusions shall be provided to the Regional Director upon completion of the study. For the purpose of this paragraph, "compensation" refers to any and all salaries, bonuses, and other benefits of every kind and nature whatsoever, whether paid directly or indirectly.

   [.16] 16. Within 60 days from the effective date of this ORDER, the Thrift shall develop an internal audit program that establishes procedures to protect the integrity of the Thrift's operational and accounting systems. The program shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.
   17. Within 30 days of the end of the first quarter following the effective date of this ORDER, and within thirty (30) days of the end of each quarter thereafter, the Thrift shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. Such reports shall include a copy of {{4-30-94 p.C-2784}}the Thrift's Report of Condition and the Thrift's Report of Income. Such reports may be discontinued when the corrections required by this ORDER have been accomplished and the Regional Director has released the Thrift in writing from making further reports.
   The provisions of this ORDER shall be binding upon the Thrift and any institution-affiliated party of the Thrift.
   This ORDER shall become effective ten (10) days from the date of its issuance.
   The provisions of this ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provisions of this ORDER shall have been modified, terminated, suspended, or set aside by the FDIC.
   Dated at San Francisco, California, this 8th day of October, 1992.
   Pursuant to delegated authority.

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