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FDIC Enforcement Decisions and Orders

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{{1-31-97 p.C-3815}}
   [11,077] In The Matter of The Bank Josephine, Prestonsburg, Kentucky, Docket No. FDIC-94-158b (10-18-94).

   Bank to cease and desist from such unsafe or unsound practices as following hazardous lending and lax collection practices; operating with an excessive level of poor quality assets; operating without adequate reserve for loan losses; operating in violation of applicable laws or regulations; operating with management whose policies are detrimental to the Bank; and failing to provide adequate supervision over the Bank's affairs. (Editor's Note: This order was terminated by order of the FDIC dated 11-21-96. See ¶16,133.)

   [.1] Management—Qualifications—Review
   [.2] Management—Management Plan—Minimum Requirements
   [.3] Loan Loss Reserve—Establish/Maintain
   [.4] Assets—Adversely Classified—Eliminate/Reduce
   [.5] Ethics—Policy Required
   [.6] Loan Policy—Written Revision—Minimum Requirements
   [.7] Loan Portfolio—Review and Grading System Required
   [.8] Violations of Law—Eliminate/Correct
   [.9] Dividends—Restricted

In The Matter of
THE BANK JOSEPHINE
PRESTONSBURG, KENTUCKY
(Insured State Nonmember Bank)
ORDER TO CEASE AND DESIST
FDIC-94-158b

   The Bank Josephine, Prestonsburg, Kentucky ("Bank"), having been advised of its right to a Notice of Charges and of Hearing detailing the unsafe or unsound banking practices and violations of law and/or regulations alleged to have been committed by the Bank and of its right to a hearing on the alleged charges under section 8(b)(1) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1818(b)(1), and having waived those rights, entered into a STIPULATION AND CONSENT TO THE ISSUANCE OF AN ORDER TO CEASE AND DESIST ("CONSENT AGREEMENT") with counsel for the Federal Deposit Insurance Corporation ("FDIC"), dated September 27, 1994, whereby solely for the purpose of this proceeding and without admitting or denying the alleged charges of unsafe or unsound banking practices and violations of law and/or regulations, the Bank consented to the issuance of an ORDER TO CEASE AND DESIST ("ORDER") by the FDIC.
   The FDIC considered the matter and de- {{1-31-97 p.C-3816}}termined that it had reason to believe that the Bank had engaged in unsafe or unsound banking practices and had committed violations of law and/or regulations. The FDIC, therefore, accepted the CONSENT AGREEMENT and issued the following:

ORDER TO CEASE AND DESIST

   IT IS HEREBY ORDERED that the Bank, its directors, officers, employees, agents, successors, assigns, and other institution-affiliated parties of the Bank, cease and desist from the following unsafe or unsound banking practices and violations:
   (a) engaging in hazardous lending and lax collection practices;
   (b) operating with a large volume of poor quality loans;
   (c) operating with an inadequate loan valuation reserve;
   (d) operating in violation of Part 323 of the FDIC Rules and Regulations, 12 C.F.R. Part 323;
   (e) operating with management whose policies and practices are detrimental to the Bank; and
   (f) operating with a board of directors which has failed to provide adequate supervision over and direction to the active management of the Bank.
   IT IS FURTHER ORDERED that the Bank take affirmative action as follows:

    [.1] 1. (a) During the life of this ORDER, the Bank shall have management qualified to restore the Bank to a sound condition. Such management shall include a chief executive officer and an experienced senior lending officer responsible for supervising the Bank's overall lending function.
       (b) Present management shall be assessed on its ability to:
         (i) Comply with the requirements of this ORDER;
         (ii) Improve and thereafter maintain the Bank in a safe and sound condition, including asset quality, capital adequacy, liquidity adequacy, and earnings adequacy; and
         (iii) Comply with all applicable State and Federal laws and regulations.
         (c) (i) During the life of this ORDER, the Bank shall notify the Regional Director of the Memphis Regional Office ("Regional Director") and the Commissioner, Department of Financial Institutions for the Commonwealth of Kentucky ("Commissioner") in writing of any resignations and/or terminations of any members of its board of directors and/or any of its senior executive officer(s) within 15 days of the event.
         (ii) The Bank shall comply with section 32 of the Act, 12 U.S.C. § 1831i.
         (d) (i) Within 90 days from the effective date of this ORDER, the board of directors shall prepare and forward, to each shareholder of the Bank, a list of potential candidates for two nominations to the Bank's board of directors at the next meeting of shareholders of the Bank at which directors are to be elected. The list of candidates shall include individuals who are independent with respect to the Bank. The actions taken in identifying potential candidates, including any communication with such individuals, shall be documented and made part of the minutes of the board of directors. Copies of these board minutes shall be provided to the Regional Director and the Commissioner within 120 days from the effective date of this ORDER.
         (ii) Within 150 days from the effective date of this ORDER, the Bank shall hold a meeting of the shareholders of the Bank. At this meeting, at least two outside directors of the Bank are to be elected. At this meeting and each succeeding meeting of the shareholders at which directors are to be elected, the members of the board of directors who are shareholders shall also nominate and support the election of two candidates to the board of directors who are independent with respect to the Bank and who have agreed to stand for election to the board of directors.
       (e) Within 150 days from the effective date of this ORDER, the board of directors shall establish a committee of the board of directors with the responsibility to ensure that the Bank complies with the provisions of this ORDER. At least two-thirds of the members of such committee shall be independent, outside directors as defined herein. The committee shall report monthly to the entire board of directors, and a copy of the report and any discussion relating to the report or the ORDER shall be included in the minutes of the board of directors. Nothing contained herein shall diminish the responsibility of the entire board of directors to {{1-31-97 p.C-3817}}ensure compliance with the provisions of this ORDER.
       (f) For the purposes of this ORDER, an "outside director" shall be an individual:
         (i) Who shall not be employed, in any capacity, by the Bank or its affiliates other than as a director of the Bank or an affiliate;
         (ii) Who shall not own or control more than 5 percent of the voting stock of the Bank or its holding company;
         (iii) Who shall not be indebted to the Bank or any of its affiliates in an amount greater than 5 percent of the Bank's equity capital and reserves;
         (iv) Who shall not be related to any directors, principal shareholders of the Bank or affiliates of the Bank; and
         (v) Who shall be a resident of, or engage in business in, the Bank's trade area.

    [.2] 2. (a) Within 90 days from the date of this ORDER, the board of directors shall review and make a written report ("Management Report") on the Bank's management needs in the lending area. The Management Report shall incorporate an analysis of the Bank's management and staffing requirements and shall, at a minimum:
         (i) Identify both the number and type of positions needed to properly supervise the Bank's lending functions, giving appropriate consideration to the Bank's loan volume, customer base and the number of problem credits.
         (ii) Provide a clear and concise description of the general duties and responsibilities for lending officers and their support staff.
         (iii) Identify the skills, experience and pay required for each position.
         (iv) Provide an evaluation of the Bank's senior management and lending officials, indicating whether bank officials possess the necessary lending and collection experience and qualifications required to adequately perform present and anticipated duties.
         (v) Establish a plan to recruit, hire and/or replace personnel based on ability and experience.
         (vi) Establish a plan providing for periodic evaluation of each individual's job performance.
         (vii) Provide for periodic review of Bank's management and updating of lending policies and procedures.
       (b) The board of directors shall obtain the services of an outside consultant(s), acceptable to the FDIC and the Commissioner, who is knowledgeable in the area of lending, collections and personnel evaluation to assist the board of directors in reviewing the Bank's management needs and preparing the Management Report. The acceptability of the consultant(s) shall be based on the consultant's ability to advise the Bank in each of the areas identified in Paragraph 2(a).
       (c) Within 120 days of the effective date of this ORDER, the board of directors, with the assistance of the outside consultant(s), shall prepare a written plan of implementation ("Plan") addressing the findings of the Management Report. The plan shall specify the actions to be taken by the board of directors and the time frames for each action.
       (d) Within 150 days of the effective date of this ORDER, the board of directors shall prepare a written report ("Written Report") which shall (1) contain a recitation identifying the recommendations made by the outside consultant(s) which have been incorporated in the Management Report and Plan, (2) a recitation identifying the recommendations made by the outside consultant(s) which were not incorporated in the Management Report and Plan and the reasons for not including such recommendations, and (3) a copy of any report(s) prepared by the outside consultant(s).
       (e) A copy of the Management Report, Plan, and Written Report shall be submitted to the Regional Director and the Commissioner for review and comment. Within 30 days from receipt of any comment, and after consideration of such comment, the board of directors shall approve the Management Report and Plan of implementation which approval shall be recorded in the minutes of the meeting of the board of directors. It shall remain the responsibility of the board to fully implement the plan within the specified time frames. In the event the Plan, or any portion thereof, is not implemented, the board shall imme- {{12-31-94 p.C-3818}}diately advise the Regional Director and the Commissioner, in writing, of specific reasons for deviating from the Plan.

       [.3] 3. (a) Within 30 days from the effective date of this Order, the Bank shall establish and shall thereafter maintain, through charges to current operating income, an adequate valuation reserve for loan and lease losses. In determining the adequacy of the valuation reserve for loan and lease losses, the board of directors of the Bank shall at a minimum consider the following:
         (i) Prevailing instructions contained in the Federal Financial Institutions Examination Council booklet entitled "Instructions—Consolidated Reports of Condition and Income";
         (ii) The volume and mix of the existing loan portfolio, including the volume and severity of nonperforming loans and adversely classified credits, as well as an analysis of net charge-offs experienced on previously adversely classified loans;
         (iii) The extent to which loan renewals and extensions are used to maintain loans on a current basis and the degree of risk associated with such loans;
         (iv) The trend in loan growth, including any rapid increase in loan volume within a relatively short time period;
         (v) General and local economic conditions, affecting the collectibility of the bank's loans;
         (vi) Previous loan loss experience by loan type, including the trend of net charge-offs as a percent of average loans over the past several years;
         (vii) Off balance sheet credit risks;
         (viii) The overall risk associated with each concentration of credit together with the degree of risk associated with each related individual borrower; and
         (ix) Any other factors appropriate in determining future valuation reserves.
       (b) Prior to the submission of any Report of Condition or Report of Income, the board of directors of the Bank shall review the adequacy of the Bank's valuation reserve for loan and lease losses. The minutes of the board meetings at which each review is undertaken shall indicate the results of the review, the amount of any increase to the reserve, and the basis for the amount of the valuation reserve. The criteria for the review shall be as set forth in Paragraph 3(a).
       (c) Notwithstanding the provisions of Paragraph 3(a) and 3(b) above, the Bank shall achieve, within 30 days of the effective date of this ORDER, a valuation reserve for loan and lease losses, after charge off of loans classified "Loss" as required in Paragraph 4(a) below, of not less than $2,100,000.
       (d) In the event that the Regional Director and/or the Commissioner determine, at subsequent examinations and/or visitations, that the Bank's valuation reserve for loan and lease losses is inadequate, the Bank shall amend its Consolidated Reports of Condition and Income.
       (e) The requirements of Paragraph 3(c) above are not to be construed as a standard for future operations.

    [.4] 4. (a) Within 10 days from the effective date of this ORDER, the Bank shall eliminate from its books, by charge-off or collection, all assets classified "Loss" as of May 2, 1994, that have not been previously collected or charged off. Reduction of these assets through proceeds of other loans made by the Bank is not considered collection for the purpose of this paragraph.
       (b) Within 90 days from the effective date of this ORDER, the Bank shall formulate and submit to the Regional Director and the Commissioner for review and approval a written plan of action directed at lessening the Bank's risk position in each line of credit and other asset which was classified "Substandard" as of May 2, 1994, and which aggregated $250,000 or more. Such plan shall include but not be limited to, the following:
         (i) Target dollar levels to which the Bank will reduce each line of credit or other asset within three months, six months, and twelve months from the effective date of this ORDER; and
         (ii) Provisions for the submissions of monthly written progress reports under this Paragraph 4 to the Bank's board of directors for review and recordation in the board minutes.
       (c) As used in Paragraph 4 the word "reduce" means (1) to collect, (2) to charge off, or (3) to sufficiently improve the quality of assets adversely classified to warrant removing any adverse classification, as determined by the FDIC.
    {{12-31-94 p.C-3819}}
       (d) Within 90 days from the effective date of this ORDER, the Bank shall formulate and submit to the Regional Director and the Commissioner for review and approval a written plan of action directed at lessening the Bank's risk position in each contingent liability which was classified "Substandard" as of March 31, 1994.

   [.5] 5. Within 60 days from the effective date of this ORDER, the Bank shall develop, adopt and implement a written ethics policy and procedure with regard to the ethical conduct and other standards of conduct and responsibilities for its directors, officers, employees, agents and other persons participating in the conduct of the affairs of the Bank. ("Ethics Program".) At a minimum the Ethics Program shall address the following:
       (a) Ethical and other conduct and responsibilities of individuals in the acceptance of gifts, entertainment, favors and loans; in the case of the use of official information; employment of relatives; use of Bank property; travel expenses; and indebtedness to the Bank or any other financial institution.
       (b) The financial interests and obligations of individuals that appear to conflict with that individual's duties and responsibilities such as:
         (i) Participating in any manner in any transaction or loan in which the individual, his spouse, child, partner, or organization is involved; or in which the individual serves as an officer, director, trustee, partner, or employee, or has a financial interest;
         (ii) Purchasing of Bank property;
         (iii) Providing goods or services to the Bank; and
         (iv) Outside employment and other activities.
       (c) A periodic written method of reporting each individual's compliance with the Ethics Program to an Ethics Counselor and/or committee who shall review compliance with the Ethics Program and report his findings to the board of directors.

   [.6] 6. Within 60 days from the effective date of this ORDER, the Bank shall review its written loan policy and make whatever changes may be necessary to provide for the safe and sound administration of all aspects of the lending function. Proper and adequate loan documentation or evidence thereof as is required by sound banking practices before disbursement of the loan proceeds to borrowers or before renewal or extensions of existing loans shall be part of the review. Such policy shall provide for identification of primary and secondary sources of repayment, the establishment of and adherence to realistic amortization programs, and proper and adequate loan documentation or evidence thereof as is required by sound banking practices before disbursement of the loan proceeds to borrowers or before renewal or extensions of existing loans. Evidence of the review and establishment of procedures to ensure compliance with the loan policy shall be reduced to writing. The policy and its implementation shall be in a form and manner acceptable to the Regional Director and the Commissioner as determined at subsequent examinations and/or visitations.

       [.7] 7. (a) Within 60 days of the effective date of this ORDER, the board shall establish an internal loan review and grading system ("System") to periodically review the Bank's loan portfolio and identify and categorize problem credits. At a minimum the System shall provide for:
         (i) The identification of the overall quality of the loan portfolio;
         (ii) The identification and amount of each delinquent loan;
         (iii) An identification or grouping of loans that warrant the special attention of management;
         (iv) For each loan identified, a statement of the amount and an indication of the degree of risk that the loan will not be fully repaid according to its terms and the reason(s) why the particular loan merits special attention;
         (v) An identification of credit and collateral documentation exceptions;
         (vi) The identification and status of each violation of law, rule or regulation;
         (vii) An identification of loans not in conformance with the Bank's lending policy, and exceptions to the Bank's lending policy;
         (viii) An identification of insider loan transactions; and
         (ix) A mechanism for reporting periodically, no less than quarterly, to the board of directors on the status of each {{12-31-94 p.C-3820}}loan identified and the action(s) taken by management.
       (b) A copy of the reports submitted to the board, as well as documentation of the action taken by the Bank to collect or strengthen assets identified as problem credits, shall be kept with the minutes of the board of directors.
         (c) (i) Within 60 days from the effective date of this ORDER the Bank's board of directors shall establish and appoint a loan committee to review and approve in advance all extensions of credit, and/or renewals that when aggregate with all other extensions of credit to that borrower, either, directly or indirectly, exceed or would exceed $150,000. The review should include financial, income, and cash flow information, collateral values and lien information, repayment terms, past performance by the borrower, the purpose of the extension, and whether the extension complies with the Bank's loan policy and applicable laws, rules and regulations. The loan committee shall meet at least twice monthly and shall maintain written minutes which document its review conclusions, approvals, denials and recommendations. At least monthly, the loan committee shall submit its written minutes to the board of directors.
         (ii) Within 150 days from the effective date of this Order, at least two-thirds of the members of the loan committee shall be independent, outside directors as defined and required in subparagraphs 1(e) and (f) of this ORDER.

   [.8] 8. Within 120 days from the effective date of this ORDER, the Bank shall eliminate and/or correct all violations of law which are set out on pages 8.12-8.13 of the Report of Examination of the Bank as of May 2, 1994. In addition, the Bank shall henceforth comply with all applicable laws and regulations.

       [.9] 9. (a) During the life of the Order, the Bank shall be permitted to pay cash dividends as long as the amount of the dividend shall not exceed fifty (50) percent of the net income of the Bank; and that after payment of such dividends, the ratio of Tier I capital to Part 325 total assets of the Bank will not be less than eight (8.0) percent. Any dividends in excess of this amount, must be made in accordance with applicable State and Federal laws and regulations and must be approved in advance, in writing, by the Regional Director and the Commissioner.
       (b) For purposes of paragraph 9(a) "net income" shall not include (1) gains on sales of securities and (2) net unrealized gains and losses on available-for-sale securities.
   10. On the fifteenth day of the second month following the effective date of this ORDER, and on the fifteenth day of every third month thereafter, the Bank shall furnish written progress reports to the Regional Director and the Commissioner detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. Such reports may be discontinued when the corrections required by this ORDER have been accomplished and the Regional Director has released the Bank in writing from making further reports.
   The provisions of this ORDER shall be binding upon the Bank, its directors, officers, employees, agents, successors, assigns, and other institution-affiliated parties of the Bank.
   This ORDER shall become effective 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: October 18, 1994
   Pursuant to delegated authority.

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