Federal Deposit
Insurance Corporation

{{4-30-96 p.C-3841}}
   [¶11,089] In The Matter of Citizens Bank, Sharpsburg, Kentucky, Docket No. FDIC-94-180b (11-14-94).

   Bank to cease and desist from such unsafe or unsound practices as following hazardous lending and lax collection practices; operating with inadequate capital; 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. (This order was terminated by order of the FDIC dated 2-14-96. See ¶16,073.)

   [.1] Management—Qualifications—Review
   [.2] Capital—Tier 1 Capital—Increase/Maintain—Methods
   [.3] Loan Loss Reserve—Establish/Maintain
   [.4] Assets—Adversely Classified—Eliminate/Reduce
   [.5] Loans—Extensions of Credit—Existing Borrowers—Curtail
   [.6] Loan Policy—Written Revision—Minimum Requirements
   [.7] Loan Portfolio—Review and Grading System Required
   [.8] Violations of Law—Eliminate/Correct
   [.9] Bank Operations—Internal Routine and Controls—Written Policy Required
   [.10] Investment Policy—Revision—Minimum Requirements
   [.11] Reports of Condition and Income—Amendment Required
   [.12] Dividends—Restricted

In The Matter of

CITIZENS BANK
SHARPSBURG, KENTUCKY
(Insured State Nonmember Bank)
ORDER TO CEASE AND DESIST
FDIC-94-180b
   Citizens Bank, Sharpsburg, 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 October 6, 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 determined 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:

   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 inadequate capital in relation to the kind and quality of assets held by the Bank;
   (c) operating with a large volume of poor quality loans;
   (d) operating with an inadequate loan valuation reserve;
   (e) operating in violation of 215.4(e), {{4-30-90 p.C-3842}}215.5(d), and 215.8 of Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. §§ 215.4(e), 215.5(d), and 215.8, made applicable to state nonmember banks by section 18(j)(2), 12 U.S.C. § 1828 (j)(2), sections 337.3 of FDIC Rules and Regulations, 12 C.F.R. § 337.3; Parts 323 and 265 of FDIC Rules and Regulations, 12 C.F.R. Parts 323 and 365; and sections 287.215, 287.280, and 360.010 of the Kentucky Revised Statutes, Ky Rev. Stat. Ann §§ 287.215, 287.280, and 360.010 (Michie/Bobbs-Merrill, 1992);
   (f) operating with management whose policies and practices are detrimental to the Bank; and
   (g) 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 lending officer.
   (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 of the 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 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) To ensure both compliance with this ORDER and qualified management for the Bank, the board of directors, within 60 days from the effective date of this ORDER shall develop a written policy ("Management Policy") which shall incorporate an analysis of the Bank's management and staffing requirements and shall, at a minimum address (1) both the number and type of positions needed to properly manage the Bank, (2) a clear and concise description of the needed experience and pay for each job, (3) an evaluation of present management, (4) a plan to recruit, hire or replace personnel with requisite ability and experience, (5) a periodic evaluation of each individual's job performance, and (6) the establishment of procedures to periodically review and update the Management Policy.
   (ii) The Management Policy and any subsequent modification thereto 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 Policy which approval shall be recorded in the minutes of the meeting of the board of directors. Thereafter, the Bank and its directors, officers and employees shall implement and follow the Management Policy and any modifications thereto.

   (e) Within 30 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 ensure compliance with the provisions of this ORDER.
   (f) For the purposes of this ORDER, an "outside director" shall be an individual who is neither an officer nor full-time employee of the Bank.

[.2] 2. (a) Within 60 days from the effective date of this ORDER, the Bank shall have Tier 1 capital equal to or greater than seven (7.0) percent of the Bank's total assets. Thereafter, during the life of this ORDER, the Bank shall maintain Tier 1 {{4-30-96 p.C-3843}}capital equal to or greater than seven (7.0) percent of the Bank's total assets.
   (b) Any increase in Tier 1 capital necessary to meet the ratio required by Paragraph 2(a) of this ORDER may be accomplished by the following:

   (i) The sale of new securities in the form of common stock; or
   (ii) The direct contribution of cash by the directors and/or shareholders; or
   (iii) Any other method acceptable to the FDIC.

   (c) If all or part of the increase in Tier 1 capital required by Paragraph 2(a) of this ORDER is accomplished by the sale of new securities, the board of directors of the Bank shall 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 Bank's securities (including a distribution limited only to the Bank's existing shareholders), the Bank shall prepare offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Bank 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 20 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 Unit, 550 17th Street, N.W., Room F-250, Washington, D.C. 20429 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 Regional Director allows any part of the increase in Tier 1 capital to be provided by the sale of noncumulative perpetual preferred stock, then all terms and conditions of the issue, including but not limited to those terms and conditions relative to the interest rate and any convertibility factor, shall be presented to the Regional Director for prior approval.
   (d) In complying with the provisions of Paragraph 2 of this ORDER, the Bank shall provide to any subscriber and/or purchaser of the Bank's securities 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 Bank securities. The written notice required by this paragraph shall be furnished within 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 Bank's securities who received or was tendered the information contained in the Bank's original offering materials.
   (e) For 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's Rules and Regulations, respectively subsections 325.2(t), and 325.2(v), 12 C.F.R. §§ 325.2(t) and (v) and shall include any adjustments necessary for the loan loss reserve. The "Capital Calculators" schedule on page 4.2 of the FDIC Report of Examination provides the method for determining the ratio of Tier 1 capital to total assets as required by this ORDER.
   (f) The Insured Institution shall not lend funds directly or indirectly, whether secured or unsecured, to any purchaser of insured institution stock or to any investor by any other means for the portion of any increase in Tier 1 capital required herein.

[.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 {{1-31-95 p.C-3844}} 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 $400,000.
   (d) In the event that it is determined in connection with subsequent examinations and/or visitations by the Regional Director and/or the Commissioner that the Bank's valuation reserve for loan and lease losses is inadequate, the Bank shall amend its Consolidated Reports of Condition and Income in accordance with Paragraph 11.
   (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 April 1, 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 60 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 which was classified "Substandard" as of April 11, 1994, and which aggregated $50,000 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.

[.5] 5. (a) Beginning with the effective date of this ORDER, the Bank shall not make any further extension of credit to any borrower whose loans are charged off, in whole or in part, or are adversely classified "Loss" as of April 11, 1994 and remain uncollected.

   (b) Beginning with the effective date of this ORDER, the Bank shall not make any further extension of credit to any borrower thereof whose loans in the aggregate exceed $50,000 and are adversely classified "Substandard" as of April 11, 1994, unless such extension has been approved by a majority of the Bank's board of directors in advance and the Bank's board of directors has detailed in the written minutes of the meeting how it has affirmatively determined all of the following: (i) That the extension of credit is in full compliance with the Bank's loan policy; (ii) that it is necessary to protect the Bank's interest or that the extension of credit is adequately secured; (iii) that based upon credit analysis the customer is deemed to be creditworthy; and (iv) that all necessary loan documentation is on file, including current financial and cash flow information and satisfactory {{1-31-95 p.C-3845}}appraisal, title, insurance and lien documents. The minutes shall also include the following information about the extension of credit: (i) The amount adversely classified as of April 11, 1994; (ii) the current balance; (iii) the amount of credit requested; (iv) a description of the collateral and its value securing the credit; and (v) a full description of the documentation presented to the board of directors including the date of the borrower's most recent financial information and the borrower's current income or cash flow data.
   (c) Beginning with the effective date of this ORDER, the Bank shall not renew any loan without the full collection of interest due. The issuance of separate notes to the borrowing customer or a third party, the proceeds of which pay interest due, shall not satisfy the requirements of this paragraph unless these separate notes receive prior board approval in the same manner as outlined in Paragraph 5(b).

[.7] 7. (a) Within 90 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 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 strength assets identified as problem credits, shall be kept with the minutes of the board of directors.
   (c) 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 aggregated with all other extensions of credit to that borrower, either, directly or indirectly, exceed or would exceed $50,000. 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 conclusions, approvals, denials, recommendations, and reasons for the approval of any credit which does not fully comply with the review requirements set forth in this paragraph. At least monthly, the loan committee shall submit its written minutes to the board of directors. At least two-thirds of the mem- {{1-31-95 p.C-3846}}bers of the loan committee shall be independent, outside directors as defined in Paragraph 1(f) of this ORDER.

   [.9] 9. Within 90 days from the effective date of this ORDER, the Bank shall adopt and implement a written policy for the operation of the Bank in such a manner as to provide internal routine and controls consistent with safe and sound banking practices. Such policy and its implementation shall be satisfactory to the Regional Director and Commissioner as determined at subsequent examinations and/or visitations.

[.10] 10. (a) Within 60 days of the effective date of the ORDER, the Bank shall revise its investment policy to comply with the Federal Financial Institutions Examination Council's Supervisory Policy entitled "Supervisory Policy Statement on Securities Activities" ("Policy Statement") and the revisions shall, as a minimum:

   (i) address the acquisition and retention of mortgage derivative products including Collateralized Mortgage Obligations ("CMOs") and Real Estate Mortgage Investment Conduits ("REMICs");
   (ii) determine, at a time prior to acquisition, whether any CMOs and/or REMICs which are being contemplated for acquisition are "high risk mortgage securities" as specified in the Policy Statement; and
   (iii) determine, on at least an annual basis after acquisition, whether such CMOs and/or REMICs contained in the Bank's investment accounts constitute "high risk mortgage securities" as specified in the Policy Statement.

   (b) Within 30 days of the revision of the policy, the board of directors shall approve the revised policy, which approval shall be recorded in the minutes of the meeting of the board of directors. The policy approved at this Board meeting shall within 10 days of its approval, be submitted to the Regional Director and Commissioner and be implemented by the Bank.

[.11] 11. (a) Within 30 days from the effective date of this ORDER, the Bank shall review all Consolidated Reports of Condition and Income filed with the FDIC on and after December 31, 1993, and shall amend and file with the FDIC amended Consolidated Reports of Condition and Income which accurately reflect the financial condition of the Bank as of the date of each such Report.
   (b) In addition to the above and during the life of this ORDER, the Bank shall file with the FDIC Consolidated Reports of Condition and Income which accurately reflect the financial condition of the Bank as of the reporting period. In particular such Reports shall include any adjustment in the Bank's books made necessary or appropriate as a consequence of any State or FDIC examination of the Bank during that reporting period.