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FDIC Enforcement Decisions and Orders

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   [11,442] In the Matter of Hampton Bank, Hampton, Minnesota, Docket No. FDIC 97-43b (10-3-97).

   A cease and desist order was issued, based on findings by the FDIC that it had reason to believe that respondent had engaged in unsafe and unsound banking practices..(This order was terminated by order of the FDIC dated 5-12-99; see ¶16,620.)

   [.1] Management—Qualifications Specified
   [.2] Loan and Lease Losses—Eliminate/Reduce
   [.3] Loan and Lease Losses—Adequate Allowance Required
   [.4] Capital—Tier 1 Capital—Increase/Maintain
   [.5] Loans—Risk Position—Written Plan Required
   [.6] Loans—Extensions of Credit—Existing Borrowers—Curtail
   [.7] Overdue Loans—Accrual of Interest
   [.8] Loan Policy—Written Revision
   [.9] Loans Policy—Internal Review and Grading—Establish
   [.10] Profit Plan—Develop/Adopt
   [.11] Legal Services—Contracts
   [.12] Loans—Credit Data—Correct
   [.13] Violations of Law—Eliminate/Correct
   [.14] Internal Audit Procedures—Written/Develop
   [.15] Dividends—Restricted
   [.16] Shareholders—Disclosure—Cease and Desist Order
   [.17] Written Progress Reports Required

In the Matter of
HAMPTON BANK
HAMPTON, MINNESOTA

(Insured State Nonmember Bank)
ORDER TO CEASE AND DESIST
FDIC-97-43b

   Hampton Bank, Hampton, Minnesota ("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 such alleged charges under section 8(b) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1818(b), 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 ____, 1997, whereby solely for the purpose of this proceeding and without admitting or denying any unsafe or unsound banking practices or 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 violated laws 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 institution-affiliated parties, as that term is defined in section 3(u) of the Act, 12 U.S.C. § 1813(u), and its successors and assigns cease and desist from the following unsafe and unsound banking practices and violations of law and/or regulations:

       A. operating with an excessive volume of adversely classified assets;
       B. engaging in hazardous lending and lax collection practices, including maintaining an excessive volume of adversely classified loans;
    {{12-31-97 p.C-4410}}
       C. operating with inadequate equity capital and allowance for loan and lease losses for the kind and quality of assets held;
       D. engaging in violations of applicable laws and regulations;
       E. operating with management whose policies and practices are detrimental to the Bank;
       F. operating with deficient or inadequate loan documentation, including but not limited to, current financial statements, insurance coverage, title searches or legal opinions, and cash flow and/or operating information;
       G. engaging in practices which produce inadequate operating income;
       H. failing to provide adequate supervision and direction over the affairs of the Bank to prevent unsafe or unsound practices and violations of law and/or regulations; and
       I. failing to submit Reports of Condition and Income in accordance with prevailing instructions.
   IT IS FURTHER ORDERED, that the Bank, its institution-affiliated parties, and its successors and assigns, take affirmative action as follows:

   [.1] (a)(i) No more than 30 days from the effective date of this ORDER, the Bank shall have and thereafter retain qualified management. Such management shall include a qualified senior lending officer who shall be given stated written authority by the Bank's board of directors, including responsibility for implementing and maintaining the lending policies of the Bank. The senior lending officer shall have an appropriate level of lending, collections, and loan supervision experience to perform the duties assigned to that individual by the Bank's board of directors. The Bank shall promptly notify the Regional Director of the FDIC's Kansas City Regional Office ("Regional Director") of the identity of said senior lending officer. Prior to the addition of any individual to the board of directors or the employment of any individual as a senior executive officer, the Bank shall comply with the requirements of section 32 of the Act, 12 U.S.C. § 1831i, and section 303.14 of the FDIC's Rules and Regulations, 12 C.F.R. § 303.14.
   (ii) The assessment of whether the Bank has "qualified management" shall be based upon management's conduct, both individual and joint, with respect to the Bank in: (A) complying with the requirements of this ORDER; (B) complying with applicable laws and regulations; and (C) not engaging in any unsafe or unsound banking practice which has an adverse effect on the Bank's asset quality, capital adequacy, earnings, liquidity, and sensitivity to market risk.
   (b) Effective the date of this ORDER, the Bank's board of directors shall meet at least monthly. The board shall prepare in advance and shall follow a detailed written agenda at each meeting, which shall include consideration of actions of any committees. Nothing in the foregoing sentence shall preclude the board from considering matters other than those contained in the agenda. Detailed written minutes of all board meetings shall be maintained and recorded on a timely basis.

   [.2] No more than 10 days from the effective date of this ORDER, the Bank: (a) shall eliminate from its records, by charge-off, collection, or other proper entries, all assets or portions of assets classified "Loss" as of January 13, 1997; and (b) shall either (i) eliminate from its records by charge-off, collection, or other proper entries, or (ii) if the asset is an extension of credit or lease, increase its allowance for loan and lease losses by an amount equal to 50 percent of those assets or portions of assets classified "Doubtful" as of January 13, 1997, which have not been previously collected, charged off, or otherwise eliminated by other proper entries. Reduction of these assets through use of proceeds of loans made by the Bank does not constitute collection for the purpose of this paragraph.

   [.3] (a) As used in this ORDER, "allowance for loan and lease losses" ("allowances") means the same as the term in section 325.2(a) of the FDIC's Rules and Regulations, 12 C.F.R. § 325.2(a), and in the Instructions for Preparation of Reports of Condition and Income ("Instructions").
   (b) The Bank shall have and maintain an adequate allowance in accordance with the requirements of the Instructions.
   (c) Reports of Condition and Income required to be submitted by the Bank as of each Report date, as that term is used in the Instructions ("Report date"), between and including March 31, 1997, and the effective date of this ORDER, shall, at a minimum, reflect an allowance maintained in accordance with the Instructions. If necessary to comply with this paragraph, the Bank shall {{12-31-97 p.C-4411}}file amended Reports of Condition and Income within 10 days from the effective date of this ORDER.
   (d) Prior to the submission of any Report of Condition and Income required to be filed by the Bank after the effective date of this ORDER, the board of directors of the Bank shall: (i) review the adequacy of the Bank's allowance, (ii) provide for an adequate allowance, and (iii) accurately report the allowance in any such Report of Condition and Income. The minutes of the board meeting at which such review is undertaken shall indicate the results of the review, including any increases in the allowance, and the basis for determining the amount of allowance provided.

       [.4] 4. (a) As used in this ORDER:
       (i) "Tier 1 or core capital" ("Tier 1 capital") means the same as the term in section 325.2(t) of the FDIC's Rules and Regulations, 12 C.F.R. § 325.2(t).
       (ii) "Noncumulative perpetual preferred stock" means the same as the term in section 325.2(o) of the FDIC's Rules and Regulations, 12 C.F.R. § 325.2(o).
       (iii) "Total assets" means the same as the term in section 325.2(v) of the FDIC's Rules and Regulations, 12 C.F.R. § 325.2(v).
       (iv) "Securities" means common and noncumulative perpetual preferred stock.
   (b) After appropriate entries for an adequate allowance are made in accordance with the requirements of paragraph 3 of this ORDER, but no later than the next Report date following the effective date of this ORDER, the Bank shall have and maintain Tier 1 capital at or in excess of 6 percent of the Bank's total assets ("Tier 1 capital ratio"). From and after the next Report date following the effective date of this ORDER, for purposes of calculating Tier 1 capital ratio, Tier 1 capital and total assets shall be the dollar amount reported in the Bank's most recent Report of Condition and Income.
   (c) During the period this ORDER is in effect, if the Tier 1 capital ratio declines below 6 percent, the Bank shall, within 60 days after the date on which the said ratio so declined, submit a written plan to the Regional Director and the Minnesota Commissioner of Commerce for approval, describing the means and timing by which the Bank shall increase such ratio up to or in excess of 6 percent. Upon receiving written notification of the approval of the plan, the Bank shall increase its Tier 1 capital ratio to equal or exceed 6 percent in accordance with the approved plan and shall thereafter maintain its Tier 1 capital ratio at or in excess of such level while this ORDER is in effect.
   (d) The Bank's board of directors shall maintain in its minutes a written record of all actions taken by the Bank to comply with the capital requirements of paragraphs 4(b) and 4(c) of this ORDER.

   [.5] 5. (a) Within 30 days from the effective date of this ORDER, the board of directors shall develop a written plan of action to lessen the Bank's risk position in each line of credit aggregating $20,000 or more which was classified "Substandard" or "Doubtful" as of January 13, 1997. In developing such plan, the Bank shall, at a minimum:

       (i) review the financial position of each such borrower, including source of repayment, repayment ability, and alternative repayment sources; and
       (ii) evaluate the available collateral for each such credit, including possible actions to improve the Bank's collateral position.
   Based upon such review and evaluation, the written plan of action shall: (A) establish target dollar levels to which the Bank shall reduce the aggregate dollar volume of "Substandard" or "Doubtful" classifications within 6 and 12 months from the effective date of this ORDER; and (B) provide for the submission of written monthly progress reports to the Bank's board of directors for review and notation in the board minutes. As used in this paragraph, "reduce" means to (1) collect, (2) charge off, or (3) improve the quality of such assets so as to warrant removal of any adverse classifications by the FDIC.
   (b) The written plan of action described by paragraph 5(a) and any subsequent modification thereto shall be submitted to the Regional Director and the Minnesota Commissioner of Commerce for review and comment. No more than 30 days after the receipt of any comment from the Regional Director, the board of directors shall approve the written plan of action, which approval shall be recorded in the minutes of the board of directors. Thereafter, the Bank and its institu-
{{12-31-97 p.C-4412}}tion-affiliated parties shall follow the written plan of action and/or any subsequent modification.

   [.6] 6. (a) Except as provided in paragraph 6(b), effective the date of this ORDER, the Bank shall not extend, directly or indirectly, credit to, or for the benefit of, any borrower who has a loan or other extension of credit with the Bank that has been charged off or classified, in whole or in part, "Loss," "Doubtful," or "Substandard," and is uncollected, unless a majority of the Bank's board of directors first (1) determines that such advance is in the best interest of the Bank, (ii) determines that the Bank has satisfied the requirements set out in paragraph 5 of this ORDER as to such borrower, and (iii) approves such advance. A written record of the board of directors' determination and approval of any advance under the terms of this paragraph shall be maintained in the credit file of the affected borrower(s) as well as the minutes of the board of directors. The requirements of this subparagraph do not prohibit the Bank from renewing any credit already extended to the borrower.
   (b) The Bank may extend additional credit to a borrower who has a loan or other extension of credit with the Bank that is classified, in whole or in part, "Substandard," and is uncollected, provided that any such additional extension of credit shall: (i) not exceed $5,000 in the aggregate for each individual borrower, or $25,000 in the aggregate for all such borrowers, and (ii) be approved by the Bank's senior lending officer upon his determination that making such extension of credit serves the best interest of the Bank. A written record of the senior lending officer's justification for and approval of any such additional extensions of credit shall be maintained in the credit file of the affected borrower(s), and submitted to the Bank's board of directors for review and recording in the board's minutes.

   [.7] 7. Effective the date of this ORDER, the Bank shall not accrue interest on any loan that is, or becomes, 90 days or more delinquent as to principal or interest, unless the loan is both well secured and in the process of collection; "well secured" and "in the process of collection" shall have the same meaning as those terms have in the prevailing Instructions. The Bank shall reverse on its books all previously accrued but uncollected interest on any loan that has ceased to accrue interest pursuant to this provision.

   [.8] 8. No more than 30 days from the effective date of this ORDER, the Bank shall revise its written loan policies which revision shall include, among other things, provisions to address the deficiencies described on pages 8.4 through 8.7 of the FDIC's Report of Examination of the Bank as of January 13, 1997. The revised written loan policies and any subsequent modification thereto shall be submitted to the Regional Director and the Minnesota Commissioner of Commerce for review and comment. No more than 30 days after the receipt of any comment from the Regional Director, the board of directors shall approve the written loan policies and/or any subsequent modification thereto which approval shall be recorded in the minutes of the board of directors. Thereafter, the Bank and its institution-affiliated parties shall follow the written loan policies and/or subsequent modification thereto.

   [.9] 9. (a) Within 60 days from the date of this ORDER, the Bank shall establish an internal loan review and grading system ("System") to periodically identify, categorize, and monitor the Bank's potential problem extensions of credit. At a minimum, the System shall provide for:

       (i) assessing the overall quality of the Bank's portfolio of extensions of credit;
       (ii) the identification and amount of each delinquent extension of credit;
       (iii) (A) the identification of each extension of credit warranting the special attention of Bank management, and (B) a statement of the amount and the reason(s) why each extension of credit so identified merits special attention;
       (iv) credit and collateral documentation exceptions;
       (v) the identification and status of each extension of credit in violation of law, rules and regulations;
       (vi) the identification of each extension of credit not in conformity with the Bank's written lending policy, and any exception to such policy; and
       (vii) the identification of each extension of credit to any institution-affiliated party.
   (b) The System shall also include a written procedure which shall require that at least once a month a written report shall be made to the board of directors on the status of each extension of credit identified under the requirements of paragraph 9(a), and any action taken by management with respect to
{{12-31-97 p.C-4413}}each such extension of credit. The System shall also require that each written report submitted to the board of directors, as well as any documentation of any action taken by the Bank with respect to any extension of credit identified under the requirements of paragraph 9(a), including any action to strengthen or collect any such extension of credit, shall be maintained with and made a part of the board of directors' minutes.

   [.10] 10. (a) No more than 30 days from the effective date of this ORDER, the Bank shall develop a written profit plan consisting of goals and strategies for improving the earnings of the Bank, which written profit plan shall include, at a minimum:

       (i) identification of the major areas in, and means by, which the board of directors will seek to improve the Bank's operating performance;
       (ii) realistic and comprehensive budgets;
       (iii) a budget review process to monitor the income and expenses of the Bank to compare actual figures with budgetary projections; and
       (iv) a description of the operating assumptions that form the basis for, and adequately support, major projected income and expense components.
   (b) The written profit plan and any subsequent modification thereto shall be submitted to the Regional Director and the Minnesota Commissioner of Commerce for review and comment. No more than 30 days after the receipt of any comment from the Regional Director, the board of directors shall approve the written profit plan and any subsequent modification thereto, which approval shall be recorded in the minutes of the board of directors. Thereafter, the Bank and its institution-affiliated parties shall follow the written profit plan and/or any subsequent modification thereto.

   [.11] 11. (a) Effective the date of this ORDER, the Bank shall not contract, or in any way obligate itself to pay for, any legal services unless the terms and conditions of such undertaking are detailed in writing, including, without limitation: the nature and extent of the legal services, the person or persons expected to perform the services, the rate or rates charged or to be charged for the services, the method and period for billing the Bank, and a requirement that the provider of such services provide the Bank with written itemized billing statements for services actually provided.
   Effective the date of this ORDER, an insider of the Bank, or of its holding company ("insider"), shall not participate in any manner, including voting as a member of the board of directors, in any transaction involving the Bank and a customer of the Bank if the insider is providing or is engaged to provide professional services to such customer with respect to the same transaction. "Insider" has the same meaning as in section 215.2 of Regulation O of the Board of Governors of the Federal Reserve, 12 C.F.R. § 215.2. In addition, for purposes of this subparagraph (b), the term "professional services" includes, but is not limited to, accounting, appraiser, engineering, insurance, legal, and real estate sales services. Any insider who, pursuant to the requirements of this subparagraph (b), may not participate in a Bank transaction shall state in writing to the Bank's board of directors the reasons why he or she may not participate and the board shall include the written statement in the minutes of the next board meeting immediately following the date of such statement.

   [.12] 12. (a) No more than 60 days from the effective date of this ORDER, the Bank shall correct the credit data and/or collateral documentation exceptions on loans noted on pages 3c.1 through 3c.5 of the FDIC's Report of Examination of the Bank as of January 13, 1997.
   No more than 60 days from the effective date of this ORDER, the Bank shall correct the cited deficiencies in the loans listed for "Special Mention" on pages 3b.1 through 3b.4 of the FDIC's Report of Examination of the Bank as of January 13, 1997.

   [.13] 13. No more than 60 days from the effective date of this ORDER, the Bank shall eliminate and/or correct all violations of law and regulations described on pages 8.14 through 8.17 of the FDIC's Report of Examination of the Bank as of January 13, 1997.

   [.14] 14. (a) No more than 30 days from the effective date of this ORDER, the Bank shall develop a written internal audit procedure to improve internal controls, accounting practices and recording. The procedure shall require, at a minimum:

       (i) a determination that the records of the
    {{12-31-97 p.C-4414}}Bank are complete and adequate, and that transactions are promptly and properly recorded in the accounts;
       (ii) a check for compliance with applicable statutes and regulations;
       (iii) a review for compliance with policies prescribed by management and/or the board of directors, including verification that loans and securities have been properly approved;
       (iv) a review of electronic data processing procedures and controls, as well as reviewing source documents to ensure that sensitive customer master file change requests have supervisory approval;
       (v) an appraisal of the performance of personnel in accomplishing assigned internal control functions and responsibilities, including tracing transactions to final disposition to ensure there are adequate audit trails;
       (vi) an appraisal of the policies and practices for wire transfer activities including dual controls, segregation of duties, and internal audit coverage;
       (vii) the preparation of a proper and complete set of working papers covering each audit; and
       (viii) the establishment and maintenance of an operating manual describing the specific procedures and techniques to be used by the auditor or auditing staff in performing the audit function.
   (b) The written internal auditing procedures and any subsequent modification thereto shall be submitted to the Regional Director and the Minnesota Commissioner of Commerce for review and comment. No more than 30 days from the receipt of comment from the Regional Director, the board of directors shall approve the written internal auditing procedure and any subsequent modification thereto, which approval shall be recorded in the minutes of the board of directors. Thereafter, the Bank shall follow the written internal auditing procedure and/or subsequent modification thereto.

   [.15] 15. The Bank shall not pay or declare any cash dividends without the prior written consent of the Regional Director and the Minnesota Commissioner of Commerce.

   [.16] 16. Following the effective date of this ORDER, the Bank shall send to its shareholders a description of this ORDER, (a) in conjunction with the Bank's next shareholder communication, and also (b) in conjunction with its notice or proxy statement preceding the Bank's next shareholder meeting. The description shall fully describe the ORDER in all material respects. The description and any accompanying communication, statement, or notice shall be sent to the FDIC, Registration and Disclosure Section, 550 - 17th Street, N.W., Washington, D.C., 20429, for review at least 20 days prior to dissemination to shareholders. Any changes requested to be made by the FDIC shall be made prior to dissemination of the description, communication, notice, or statement.

   [.17] 17. The Bank shall furnish written progress reports to the Regional Director and the Minnesota Commissioner of Commerce detailing the form and manner of any action taken to secure compliance with this ORDER and the results thereof every 90 days, beginning 90 days from the effective date of this ORDER. In addition, the Bank shall furnish such reports on request of either the Regional Director or the Minnesota Commissioner of Commerce. All progress reports and other written responses to this ORDER shall be reviewed by the board of directors of the Bank and made a part of the minutes of the board meeting.
   This ORDER shall become effective 10 days from the date of its issuance.
   The provisions of this ORDER shall be binding upon the Bank and its institution-affiliated parties, successors and assigns.
   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.
   Pursuant to delegated authority.
   Dated this 3rd day of October, 1997.

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