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   [11,566] In the Matter of The Farmers State Bank, Ludell, Kansas, Docket No. 98-092b (10-22-98)

   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 practices. (This order terminated by order of the FDIC dated 4-18-01; see ¶16,280.)

   [.1] Management—Qualifications Specified
   [.2] Capital—Increase Required
   [.3] Assets—Adversely Classified Assets—Reduction Required
   [.4] Loans—Extensions of Credit—To Borrowers With Existing Adversely Classified Credits
   [.5] Loan Policy—Preparation or Revision of Policy Required
   [.6] Loans—Internal Review Procedure
   [.7] Loans—Concentration of Credit—Reduction Required
   [.8] Loan Loss Reserve—Establishment of or Increase Required
   [.9] Dividends—Dividends Restricted
   [.10] Violations of Law—Correction of Violations Required
   [.11] Profit Plan—Preparation of Plan Required
   [.12] Audit—External Audit, Minimum Procedures Specified

In the Matter of

THE FARMERS STATE BANK
LUDELL, KANSAS
(Insured State Nonmember Bank)
ORDER TO CEASE
AND DESIST

FDIC-98-092b

   The Farmers State Bank, Ludell, Kansas ("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 October 15, 1998, 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 violation of law and/or regulations:

    A. 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;
       B. engaging in management policies and practices which are detrimental to the Bank;
       C. operating with management whose policies and practices are detrimental to the Bank;
       D. operating with an inadequate allowance for loan and lease losses for the volume, kind and quality of loans held;
       E. engaging in hazardous lending and lax collection practices, including, but not limited to, maintaining an excessive volume of adversely classified loans, extending credit which is inadequately secured, extending credit without obtaining/analyzing complete and current financial information, extending credit in the form of overdrafts without adequate controls, and extending credit without adequate diversification of risk;
       F. operating with an excessive volume of adversely classified assets;
       G. operating without adequate internal controls;
       H. operating with deficient or inadequate loan documentation, including, but not limited to, current financial statements, insurance coverage, title searches or legal opinions, cash flow and/or operating information, and obtaining and maintaining adequate records of lien priority on real estate secured loans;
       I. operating with inadequate Tier 1 capital for the kind and quality of assets held;
       J. failing to establish and/or implement an adequate program of internal and external audits;
       K. failing to keep and/or submit accurate records, including, but not limited, to failing to post the general ledger promptly, failing to properly handle and reconcile returned items, failing to reconcile and to post to correspondent bank accounts in a timely manner, and failing to prepare and file accurate Reports of Condition and Income;
       L. engaging in practices which produce inadequate operating income and excessive loan losses; and
       M. engaging in violations of applicable laws and/or regulations.
   IT IS FURTHER ORDERED, that the Bank, its institution-affiliated parties, and its successors and assigns, take affirmative action as follows:

   [.1]1. (a)(i) No more than 60 days from the effective date of this ORDER, the Bank shall have and thereafter retain qualified management. Such management shall include a qualified chief executive officer who shall be given stated written authority by the Bank's board of directors, including responsibility for maintaining and implementing the policies of the Bank. The chief executive officer shall have an appropriate level of experience to perform the duties assigned to that individual by the Bank's board of directors, including, but not limited, to the ability to provide effective leadership to Bank staff. Such management shall also include a 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 for the type and quality of the Bank's loans. If qualified to perform the duties of both the chief executive officer and the senior lending officer, one individual may function in both capacities. The Bank shall promptly notify the Regional Director of the FDIC's Kansas City Regional Office ("Regional Director") and the Kansas State Bank Commissioner ("Commissioner") of the identities of said chief executive officer and 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. §1831(i), 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, or sensitivity to market risk.
   (b) No more than 60 days from the effective date of this ORDER, the board of directors shall develop a written analysis and assessment of the Bank's management and staffing needs ("management plan"), which shall include, at a minimum:

       (i) identification of both the type and number of officer positions needed to manage and supervise properly the affairs of the Bank, including identification of the specific duties and responsibilities for each officer, with special attention given to the positions of chief executive officer and senior lending officer;
       (ii) identification and establishment of such Bank committees as are needed to provide guidance and oversight to active management;
       (iii) evaluation of each Bank officer and staff member to determine whether these individuals possess the ability, experience and other qualifications required to perform present and anticipated duties, including adherence to the Bank's established policies and practices, and maintenance of the Bank in a safe and sound condition;
       (iv) providing the necessary resources to ensure all employees receive the requisite training and supervision to effectively carry out their duties and responsibilities; and
       (v) a plan of action to recruit and hire any additional or replacement personnel with the requisite ability, experience and other qualifications, which the board of directors determines are necessary to fill Bank officer or staff member positions consistent with the board's analysis, evaluation and assessment as provided in paragraphs 1(b)(iii) of this ORDER.
   (c) The written management plan and any subsequent modification thereto shall be submitted to the Regional Director and to the Commissioner for review and comment. No more than 30 days from the receipt of any comment from the Regional Director and/or the Commissioner and after consideration of such comment, the board of directors shall approve the written management plan 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 implement and follow the written management plan and/or any subsequent modification thereto.
   (d) 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]2. (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) No more than 30 days from the effective date of this Order, the Bank shall increase its Tier 1 capital by not less than $102,000. Such increase in Tier 1 capital may be accomplished by:

    (i) the sale of new offerings of common or noncumulative perpetual preferred stock;
       (ii) the sale of outstanding shares by the Bank's shareholders to any investor who has the financial capability to make the additions to the Bank's Tier 1 capital required by this paragraph 2(b);
       (iii) the direct contribution of cash by the shareholders and/or directors of the Bank;
       (iv) the collection of all or part of assets classified "Loss" or "Doubtful" as of June 1, 1998, without loss or liability to the Bank, provided any such collection on a partially charged off asset shall first be applied to that portion of the asset which was not charged off pursuant to paragraph 8 of this ORDER. Collections on loans or leases classified "Loss" or "Doubtful" which have been charged off shall be credited to the Bank's allowance and, if the board of directors' review of the adequacy of the allowance required by paragraph 8 of this ORDER indicates that such allowance has a balance in excess of that required for adequacy, any such excess may only be transferred to Tier 1 capital through the income statement by a negative provision for the allowance;
       (v) the collection in cash of assets previously charged off, except that any collections on previously charged off loans or leases shall be accounted for in accordance with the requirements of the second sentence of paragraph 2(iv) above. "Assets previously charged off" means any asset charged off other than assets classified "Loss" or "Doubtful" as of June 1, 1998;
       (vi) any combination of the above means; or
       (vii) any other means acceptable to the Regional Director.
   (c) If all or part of the increase in Tier 1 capital required under paragraph 2(b) of this ORDER involves an offering, other than an offering deemed not to be a public securities offering pursuant to 17 C.F.R. §230.506 or as hereafter amended, of the Bank's securities (including a distribution limited only to the Bank's existing shareholders), the Bank shall prepare detailed offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Bank and of this ORDER as well as the circumstances giving rise to the offering, and any other material disclosures necessary to comply with the Federal securities laws. Prior to the sale of the securities, and, in any event, not less than 20 days prior to the dissemination of such materials, the materials used in the sale of the securities shall be submitted to the FDIC, Registration and Disclosure Section, 550 17th Street, N.W. (F-6043), Washington, D.C. 20429, for review. Any changes requested in the materials by the FDIC shall be made prior to their dissemination. In addition, any terms and conditions of the issue of new securities shall be submitted to the Regional Director for prior approval.
   (d) In complying with the provisions of paragraph 2(c) of this ORDER, the Bank shall provide to any subscriber and/or purchaser of Bank stock, written notice of any planned or existing development or other change which is 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 (d) shall be furnished within 10 days from the date such material development or change was planned or occurred, whichever is earlier, to every purchaser and/or subscriber of Bank stock who received or was tendered the information contained in the Bank's original offering materials.
   (e) During the period this ORDER is in effect, if the Tier 1 leverage 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 Commissioner 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 leverage capital ratio to equal or exceed 6 percent in accordance with the approved plan and shall thereafter maintain its Tier 1 leverage capital ratio at or in excess of such level while this ORDER is in effect.
   (f) 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 2(b) through 2(e) of this ORDER, including, at a minimum, any action to increase its Tier 1 capital by each of the methods specified in paragraphs 2(b)(i) through 2(b)(vii) of this ORDER.

   [.3]3. Within 60 days from the effective date of this ORDER, the board of directors shall develop and implement a written plan of action to lessen the Bank's risk position in each line of credit aggregating $25,000 or more which was classified "Substandard" or "Doubtful" as of June 1, 1998. 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 and document the value of 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 as of the end of each of the next 8 calendar quarters 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 classification by the FDIC and/or Commissioner.

   [.4]4. 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 (a) determines that such advance is in the best interest of the Bank, (b) determines that the Bank has satisfied the requirements set out in paragraph 3 of this ORDER as to such borrower, and (c) 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.

   [.5]5. (a) No more than 60 days from the effective date of this ORDER, the Bank shall revise its written loan policy which revision shall include, at a minimum:

       (i) the lending authority of each loan officer;
       (ii) the lending authority of a loan or executive committee, if any;
       (iii) the responsibility of the board of directors in reviewing, ratifying and approving loans;
       (iv) the guidelines under which unsecured loans will be granted;
       (v) the guidelines for rates of interest and terms of repayment for unsecured loans and secured loans;
       (vi) with regard to secured loans: (A) limitations on the amount advanced in relation to the value of the collateral, and (B) the documentation required by the Bank for each type of secured loan;
       (vii) the maintenance and review of complete and current credit files on each borrower;
       (viii) appropriate and adequate collection procedures, including, but not limited to, the actions to be taken against borrowers who fail to make timely payments;
       (ix) guidelines establishing limitations on the maximum volume of loans in relation to total assets;
       (x) appropriate limitations on extension of credit through overdrafts and cash items;
       (xi) the determination and documentation of sources and terms of loan repayment;
       (xii) retention of lien searches and appraisals covering personal property and liens on real estate;
       (xiii) maintenance of written, individual loan file comments by officers;
       (xiv) provisions addressing the capitalization if accrued and unpaid interest on loans;
       (xv) procedures regarding designations of nonaccrual loans;
       (xvi) procedures for identifying, supervising, and collecting problem loans; and
       (xvii) periodic review of the overdue, problem and/or adversely-classified or special-mention loans by the directorate, so as to monitor management's administration of such distressed credits, and to provide guidance.
       (xviii) The recommended guidelines discussed on page 26 of the FDIC's Report of Examination of June 1, 1998. (b) The revised written loan policies and any subsequent modification thereto shall be submitted to the Regional Director and the Commissioner for review and comment. No more than 30 days after receipt of any comment from the Regional Director and/or the Commissioner, 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 any subsequent modification thereto.
   (c) No more than 60 days from the effective date of this ORDER, the Bank shall correct the technical exceptions on loans noted on pages 80–82 of the FDIC's Report of Examination of the Bank of June 1, 1998.
   (d) 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 76–79 of the FDIC's Report of Examination of the Bank of June 1, 1998.

   [.6]6. Within 30 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) Identifying 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 reason(s) why the particular loan merits special attention;
       (v) Credit and collateral documentation exceptions;
       (vi) The identification and status of each violation of law, rule or regulation;
       (vii) Loans not in conformance with the Bank's lending policy, and exceptions to the Bank's policy; and
       (viii) A mechanism for reporting periodically to the board of directors on the status of each loan identified and the action(s) taken by management.

   [.7]7. No more than 60 days from the effective date of this ORDER, the Bank shall formulate and implement a plan to reduce all concentrations of credit as noted on pages 83–84 of the FDIC's Report of Examination of the Bank of June 1, 1998, to less than 25 percent of Tier 1 capital.

   [.8]8. (a) As used in this ORDER, "allowance for loan and lease losses" ("allowance") 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 Conditions and Income required to be submitted by the Bank as of each Report date, as that term is used in the Instructions, between and including June 30, 1998, 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 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.

   [.9]9. The Bank shall not pay or declare any cash dividends without the prior written consent of the Regional Director and the Commissioner.

   [.10]10. 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 committed by the Bank as described on pages 39–51 of the FDIC's Report of Examination of the Bank of June 1, 1998.

   [.11]11. (a) No more than 60 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 for 1999;
       (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 Commissioner for review and comment. No more than 30 days after the receipt of any comment from the Regional Director and/or the Commissioner, 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.

   [.12]12. (a) No more than 60 days from the effective date of this ORDER, the Bank shall develop a written external auditing program taking into consideration the applicable provisions of FDIC's Statement of Policy entitled, "Statement of Policy Regarding Independent External Auditing Programs of State Nonmember Banks," reprinted in 2 Federal Deposit Insurance Corporation Law, Regulations and Related Acts (FDIC) at 5299 (June 17, 1996). The written external auditing program shall, at a minimum, provide that the Bank have an annual audit of the Bank's financial statements by an independent public accounting firm beginning in the calendar year 1998.
   (b) The written external auditing program and any subsequent modifications thereto shall be submitted to the Regional Director and the Commissioner for review and comment. Any written comment by the Regional Director and/or the commissioner shall be: (1) reviewed by the Bank's board of directors at its next meeting subsequent to receipt of such comment, and (2) made a part of the minutes of such meeting. No more than 30 days from the receipt of any comment from the Regional Director, and after consideration of such comment, the board of directors shall approve the written auditing procedures 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 auditing procedures and/or any subsequent modification thereto.
   (c) While this ORDER is in effect, the Bank shall provide the Regional Director and the Commissioner with a copy of the auditor's report and any management letter received from the independent public accounting firm. The Bank shall notify the Regional Director and the Commissioner at least 7 days in advance of the time and the date of any meetings between management and the independent public accounting firm at which any auditing findings are to be discussed and/or presented so that a representative of the FDIC and the Commissioner's Office may attend, if they choose to do so. No more than 90 days after receipt of any independent public accounting firm's report and any management letter, the Bank shall provide the Regional Director and the Commissioner with a written statement detailing the form and manner of any action taken by the Bank to correct any deficiencies noted in such report and/or management letter.
   13. The Bank shall furnish written progress reports to the Regional Director and the Commissioner detailing the form and manner of any action taken to secure compliance with this ORDER and the results thereof within 15 days after the end of each quarter, beginning with the quarter that ends nearest the effective date of this ORDER. In addition, the Bank shall furnish such reports on request of either the Regional Director or the Commissioner. 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 meetings.
   14. All technical words or terms used in this ORDER, for which meanings are not specified or otherwise provided for by the provisions of this ORDER, shall, insofar as applicable, have meanings as defined in Chapter 3 of Title 12 of the Code of Federal Regulations or the Act, as such definitions may be amended after the execution of this ORDER, and any such technical words or terms used in this ORDER and undefined in said Code of Federal Regulations of the Act shall have meanings that accord with their best custom and usage in the banking industry.
   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 22nd day of October, 1998.

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