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FDIC Enforcement Decisions and Orders

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   [11,952] In the Matter of Western State Bank, Duarte, California, Docket No. 02-110b (7-18-02).

   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.

   [.1] Management—Qualifications Specified

   [.2] Board of Directors—Increase Participation in Bank Affairs Required

   [.3] Capital—Maintain Tier 1 Capital

   [.4] Loan Loss Reserve—Establishment of or Increase Required

   [.5] Assets—Charge-off or Collection

   [.6] Loans—Extensions of Credit—To Borrowers with Existing Adversely Classified Credits

   [.7] Loan Policy—Preparation or Revision of Policy Required

   [.8, .16] Audit—Program Required

   [.9] Strategic Plan—Preparation of Required

   [.10] Budget Plan—Preparation Required

   [.11] Violations of Law—Correction of Violations Required

   [.12] Reports of Condition and Income—Amendment Required

   [.13] Dividends—Dividends Restricted

   [.14] Information Systems—Steering Committee—Minimum Requirements Specified

   [.15] Data Processing—Management Reporting System Required
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   [.17] Information Systems—Board Supervision—Minimum Requirements Specified

   [.18] Security Controls—Improvement Required

   [.19] Shareholders—Disclosure of Cease and Desist Order Required

In the Matter of
WESTERN STATE BANK
DUARTE, CALIFORNIA
(Insured State Nonmember Bank)
ORDER TO CEASE AND DESIST

FDIC-02-110b

   Western State Bank,, Duarte, California ("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 July 17, 2002, 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:

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 regulation:

   (a) operating with inadequate management;

   (b) operating with a board of directors which has failed to provide adequate supervision over and direction to the active management of the Bank;

   (c) engaging in inadequate lending and collection practices;

   (d) operating with inadequate capital in relation to the kind and quality of assets held by the Bank;

   (e) operating with a large volume of poor quality loans;

   (f) operating with an inadequate loan valuation reserve;

   (g) operating with inadequate internal routine and controls policies;

   (h) operating in such a manner as to produce operating losses; and

   (i) operating in violation of section 303.42(b)(3) of the FDIC's Rules and Regulations, 12 C.F.R. §303.42(b)(3), as more fully described on page 20 of the Report of Examination as of January 22, 2002; Part 323 of the FDIC's Rules and Regulations, 12 C.F.R. §323, as more fully described on pages 26-27 of the Report of Examination as of January 22, 2002; Part 364 of the FDIC's Rules and Regulations, 12 C.F.R. §364, as more fully described on pages 24 and 25 of the Report of Examination as of January 22, 2002; Section 3372 of the California Financial Code, as more fully described on pages 20-24 of the Report of Examination as of January 22, 2002; and sections 215.4(a) and 215.4(b) of Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. §§ 215.4(a) and 215.4(b), made applicable to state nonmember institutions by section 18(j)(2) of the Act, 12 U.S.C. §1828(j)(2), as more fully described on pages 20-21 of the Report of Examination as of January 22, 2002;

   (j) operating with inadequate information systems policies and procedures.

   IT IS FURTHER ORDERED, that the Bank, its institution-affiliated parties, and its successors and assigns, take affirmative action as follows:

   [.1]1. The Bank shall have and retain qualified management.

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

   (b) The qualifications of management shall be assessed on its ability to:

       (i) comply with the requirements of this ORDER;

       (ii) operate the Bank in a safe and sound manner;

       (iii) comply with applicable laws and regulations; and

       (iv) restore all aspects of the Bank to a safe and sound condition, including asset quality, capital adequacy, earnings, management effectiveness, and liquidity.

   (c) During the life of this ORDER, the Bank shall notify the Regional Director of the FDIC's San Francisco Regional Office ("Regional Director") in writing when it proposes to add any individual to the Bank's board of directors or employ any individual as a senior executive officer. The notification must be received at least 30 days before such addition or employment is intended to become effective and should include a description of the background and experience of the individual or individuals to be added or employed.

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

   [.3]3. (a) Within 90 days from the effective date of this ORDER, the Bank shall have Tier 1 capital in such an amount as to equal or exceed eight (8.0) percent of the Bank's total assets; and within 180 days from the effective date of this ORDER, the Bank shall have Tier 1 capital in such an amount as to equal or exceed eight and one-half (8.5) percent of the Bank's total assets. Thereafter, during the life of this ORDER, the Bank shall maintain Tier 1 capital in such an amount as to equal or exceed eight and one-half (8.5) percent of the Bank's total assets.

   (b) The level of Tier 1 capital to be maintained during the life of this ORDER pursuant to subparagraph 3(a) shall be in addition to a fully funded allowance for loan and lease losses, the adequacy of which shall be satisfactory to the Regional Director as determined at subsequent examinations and/or visitations.

   (c) Any increase in Tier 1 capital necessary to meet the requirements of Paragraph 3 of this ORDER may be accomplished by the following:

       (i) the sale of common stock; or

       (ii) the sale of noncumulative perpetual preferred stock; or

       (iii) the direct contribution of cash by the board of directors and/or shareholders of the Bank; or

       (iv) any other means acceptable to the Regional Director; or

       (v) any combination of the above means.

   Any increase in Tier 1 capital necessary to meet the requirements of Paragraph 3 of this ORDER may not be accomplished through a deduction from the Bank's allowance for loan and lease losses.

   (d) If all or part of the increase in Tier 1 capital required by Paragraph 3 of this ORDER is accomplished by the sale of new securities, the board of directors shall forthwith take all necessary steps to adopt and implement a plan for the sale of such additional securities, including the voting of any shares owned or proxies held or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Bank's securities (including a distribution limited only to the Bank's
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   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 fifteen (15) days prior to the dissemination of such materials, the plan and any materials used in the sale of the securities shall be submitted to the FDIC, Registration and Disclosure Section, Washington, D.C. 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 increase in Tier 1 capital is provided by the sale of noncumulative perpetual preferred stock, then all terms and conditions relative to interest rate and convertibility factor, shall be presented to the Regional Director for prior approval.

   (e) In complying with the provisions of Paragraph 3 of this ORDER, the Bank shall provide to any subscriber and/or purchaser of the Bank's securities, a written notice of any planned or existing development or other changes which are materially different from the information reflected in any offering materials used in connection with the sale of Bank securities. The written notice required by this paragraph shall be furnished within thirty (30) 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.

   (f) For the purposes of this ORDER, the terms "Tier 1 capital" and "total assets" shall have, the meanings ascribed to them in Part 325 of the FDIC Rules and Regulations, 12 C.F.R. §§ 325.2(t) and 325.2(v).

   [.4]4. Within 90 days from the effective date of this ORDER, the Bank shall establish and thereafter maintain an adequate allowance for loan and lease losses.

   Additionally, within 30 days from the effective date of this ORDER, the board of directors shall develop or revise, adopt and implement a comprehensive policy for determining the adequacy of the allowance for loan and lease losses. For the purpose of this determination, the adequacy of the reserve shall be determined after the charge-off of all loans or other items classified "Loss." The policy shall provide for a review of the allowance at least once each calendar quarter. Said review should be completed at least fifteen (15) days prior to the end of each quarter, in order that the findings of the board of directors with respect to the loan and lease loss allowance may be properly reported in the quarterly Reports of Condition and Income. The review should focus on the results of the Bank's internal loan review, loan loss experience, trends of delinquent and non-accrual loans, an estimate of potential loss exposure of significant credits, concentrations of credit, and present and prospective economic conditions. A deficiency in the allowance shall be remedied in the calendar quarter it is discovered, prior to submitting the Report of Condition, by a charge to current operating earnings. The minutes of the board of directors meeting at which such review is undertaken shall indicate the results of the review. Upon completion of the review, the Bank shall increase and maintain its allowance for loan and lease losses consistent with the allowance for loan and lease loss policy established. Such policy and its implementation shall be satisfactory to the Regional Director as determined at subsequent examinations and/or visitations.

   [.5]5. (a) Within 30 days from the effective date of this ORDER, the Bank shall eliminate from its books, by charge-off or collection, all assets classified "Loss" and one-half of the assets classified "Doubtful" as of January 22, 2002, that have not been previously collected or charged off. Elimination of these assets through proceeds of other loans made by the Bank is not considered collection for the purpose of this paragraph.

   (b) On or before December 31, 2002, the Bank shall have reduced the assets classified "Substandard" and those assets classified "Doubtful" as of January 22, 2002 that have not previously been charged off to not more than $8,000,000.

   (c) On or before June 30, 2003, the Bank shall have reduced the assets classified "Substandard" and those assets classified "Doubtful" as of January 22, 2002 that have not previously been charged off to not more than $7,000,000.

   (d) On or before December 31, 2003, the Bank shall have reduced the assets classified "Substandard" and those assets classified "Doubtful" as of January 22, 2002 that have
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   not previously been charged off to not more than $6,000,000.

   (e) The requirements of subparagraphs 5(a), 5(b), 5(c) and 5(d) of this ORDER are not to be construed as standards for future operations and, in addition to the foregoing, the Bank shall eventually reduce the total of all adversely classified assets. Reduction of these assets through proceeds of other loans made by the Bank is not considered collection for the purpose of this paragraph. As used in subparagraphs 5(b), 5(c), and 5(d) the word "reduce" means:

       (i) to collect;

       (ii) to charge-off; or

       (iii) to sufficiently improve the quality of assets adversely classified to warrant removing any adverse classification, as determined by the FDIC.

   [.6]6. (a) Beginning with the effective date of this ORDER, the Bank shall not extend, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, "Loss" and is uncollected. Subparagraph 6(a) of this ORDER shall not prohibit the Bank from renewing or extending the maturity of any credit in accordance with the Financial Accounting Standards Board Statement Number 15 ("FASB 15").

   (b) Beginning with the effective date of this ORDER, the Bank shall not extend, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been classified, in whole or part, "Substandard" or "Doubtful" without the prior approval of a majority of the board of directors or the loan committee of the Bank.

   [.7]7. (a) Within 90 days from the effective date of this ORDER, the Bank shall revise, adopt, and implement written lending and collection policies to provide effective guidance and control over the Bank's lending function, which policies shall include specific guidelines for placing loans on a non-accrual basis. In addition, the Bank shall obtain adequate and current documentation for all loans in the Bank's loan portfolio. Such policies and their implementation shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.

   (b) The initial revisions to the Bank's loan policy and practices, required by this paragraph, at a minimum, shall include the following:

   (i) provisions, consistent with FDIC instructions for the preparation of Reports of Condition and Income, under which the accrual of interest income is discontinued and previously accrued interest is reversed on delinquent loans;

   (ii) provisions which prohibit the capitalization of interest or loans related expense unless the board of directors supports in writing and records in the minutes of the corresponding board of directors meeting why an exception thereto is in the best interests of the Bank;

   (iii) provisions which require complete loans documentation, realistic repayment terms and current credit information adequate to support the outstanding indebtedness of the borrower. Such documentation shall include current financial information, profit and loss statements or copies of tax returns and cash flow projections;

   (iv) provisions which incorporate limitations on the amount that can be loaned in relation to established collateral values.

   (v) provisions which specify the circumstances and conditions under which real estate appraisals must be conducted by an independent third party;

   (vi) provisions which establish standards for unsecured credit;

   (vii) provisions which establish officer lending limits;

   (viii) provisions that require extensions of credit to any of the Bank's executive officers, directors, or principal shareholders, or to any related interest of such persons, to be approved in advance by a majority of the entire board of directors in accordance with section 215.4(b) of Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. §215.4(b);

   (ix) provisions which prohibit the issuance of standby letters of credit unless the letters of credit are fully secured by readily marketable collateral and/or are supported by current and complete financial information;
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   (x) provisions that directors first determine that the lending staff has the expertise necessary to properly supervise construction loans and that adequate procedures are in place to monitor any construction involved before funds are disbursed;

   (xi) provisions which prohibit concentrations of credit in excess of 25 percent of the Bank's total equity capital and reserves to any borrower and that borrower's related interests;

   (xii) provisions which require the preparation of a loan "watch list" which shall include relevant information on all loans in excess of $1,000,000 which are classified "Substandard" and "Doubtful" as of January 22, 2002 or by the FDIC or California Department of Financial Institutions in subsequent Reports of Examination and all other loans in excess of $2,000,000 which warrant individual review and consideration by the board of directors as determined by the loan committee or active management. The loan "watch list" shall be presented to the board of directors for review at least monthly with such review noted in the minutes; and

   (xiii) the board of directors shall adopt procedures whereby officer compliance with the revised loan policy is monitored and responsibility for exceptions thereto assigned. The procedures adopted shall be reflected in minutes of a board of directors meeting at which all members are present and the vote of each is noted.

   [.8]8. Within 90 days from the effective date of this ORDER, the Bank shall develop an internal audit program that establishes procedures to protect the integrity of the Bank's operational and accounting systems. The program shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations or visitations.

   [.9]9. Within 90 days of the effective date of this ORDER, the Bank shall develop and submit to the Regional Director a written three-year strategic plan. Such plan shall include specific goals for the dollar volume of total loans, total investment securities, and total deposits as of December 31, 2002, December 31, 2003, and December 31, 2004. For each time frame, the plan will also specify the anticipated average maturity and average yield on loans and securities; the average maturity and average cost of deposits; the level of earning assets as a percentage of total assets; and the ratio of net interest income to average earning assets. The plan shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.

   [.10]10. (a) Within 90 days from the effective date of this ORDER, the Bank shall formulate and fully implement a written plan and a comprehensive budget for all categories of income and expense. The plan and budget required by this paragraph shall include formal goals and strategies, consistent with sound banking practices, to improve the Bank's net interest margin, increase interest income, reduce discretionary expenses, and improve and sustain earnings of the Bank. The plan shall include a description of the operating assumptions that form the basis for and adequately support, major projected income and expense components. Thereafter, the Bank shall formulate such a plan and budget by November 30 of each subsequent year.

   (b) The plan and budget required by subparagraph 10(a) of this ORDER, upon completion, shall be submitted to the Regional Director for review and opportunity for comment.

   (c) Following the end of each calendar quarter, the board of directors shall evaluate the Bank's actual performance in relation to the plan and budget required by subparagraph 10(a) of this ORDER and shall record the results of the evaluation, and any actions taken by the Bank, in the minutes of the board of directors meeting at which such evaluation is undertaken.

   [.11]11. Within 90 days from the effective date of this ORDER, the Bank shall eliminate and/or correct all violations of law which are more fully set out on pages 20-33 of the Report of Examination of the Bank as of January 22, 2002. In addition, the Bank shall take all necessary steps to ensure future compliance with all applicable laws and regulations.

   [.12]12. Within 30 days after eliminating from its books any asset in compliance with Paragraph 5 of this ORDER, the Bank shall file with the FDIC amended Consolidated Reports of Condition and Income which shall accurately reflect the financial condition of the Bank as of December 31, 2001. Thereafter, during the life of this ORDER, the Bank shall file with the FDIC Consolidated
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   Reports of Condition and Income which accurately reflect the financial condition of the Bank as of the end of the period for which the Reports are filed, including any adjustment in the Bank's books made necessary or appropriate as a consequence of any California Department of Financial Institutions or FDIC examination of the Bank during that reporting period.

   [.13]13. The Bank shall not pay cash dividends without the prior written consent of the Regional Director.

   [.14]14. Within 30 days from the effective date of this ORDER, the board shall formally establish a steering committee to give direction to Information Systems ("IS") activities and to monitor performance. The committee shall establish a mission statement, meet regularly, but not less than quarterly, maintain minutes and establish periodic reporting to the board on IS activities.

   [.15]15. Within 60 days from the effective date of this ORDER, the board shall establish a formal management reporting system to ensure adequate evaluation and monitoring of data processing activities. Such reporting system shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations or visitations.

   [.16]16. Within 60 days from the effective date of this ORDER, the board shall establish and implement a comprehensive IS audit program that includes the following:

       (a) An audit policy defining the scope, frequency of audits, techniques used in performing the audits and qualifications of auditors.

       (b) Periodic review of the overall condition of IS controls and corrective measures identified in audit reports by the board, or designated steering committee.

   The audit program and its implementation shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations or visitations.

   [.17]17. Within 90 days from the effective date of this ORDER, the board shall provide supervision over IS functions by:

       (a) Establishment of specific policies and procedures to secure the IS from potential risks.

       (b) Providing for training of appropriate personnel in IS policies and procedures and in IS security issues.

       (c) Establishment of procedures to properly safeguard non-public customer information from misuse by employees and from intrusion of the bank's computer networks.

       (d) Assigning IS administrator and IS security officer duties to different individuals.

       (e) Ensuring that the maximum access rights assigned to bank employees with critical control functions are "inquiry-only" for the areas of their responsibility.

       (f) Providing for an annual review of user access rights in relation to internal control structure.

       (g) Ensuring that Fedline settings and related practices are consistent with Fedline recommended guidelines.

       (h) Developing electronic banking policies and procedures to ensure that the bank's Website is properly monitored.

       (i) Developing a process to ensure that the Bank's contingency plan is complete and current, which includes a procedure for annual testing of the contingency plan.

       (j) Developing procedures and monitoring tools to ensure compliance with software licensing agreements.

   [.18]18. Within 90 days from the effective date of this ORDER, the board shall improve security controls including:

       (a) Monitoring vendors' activities;

       (b) Updating the operating systems with the latest service packs and patches in a timely manner;

       (c) Developing baseline security configurations to ensure that only authorized changes are being made to the system; and

       (d) Reviewing server logs on a daily basis.

   [.19]19. Following the effective date of this ORDER, the Bank shall send to its shareholders or otherwise furnish a description of this ORDER in conjunction with the Bank's next shareholder communication and also 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, Washington, D.C. 20429, at least fifteen (15) days prior to dissemination to shareholders.
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   Any changes requested to be made by the FDIC shall be made prior to dissemination of the description, communication, notice, or statement.

   20. Within 30 days of the end of the first calendar quarter following the effective date of this ORDER, and within thirty (30) days of the end of each quarter thereafter, the Bank shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. Such reports shall include a copy of the Bank's Report of Condition and the Bank's Report of Income. Such reports may be discontinued when the corrections required by this ORDER have been accomplished and the Regional Director has released the Bank in writing from making further reports.

   This ORDER shall become effective ten (10) days from the date of its issuance.

   The provisions of this ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provisions of this ORDER shall have been modified, terminated, suspended, or set aside by the FDIC.

   Pursuant to delegated authority.

   Dated at San Francisco, California, this 18th day of July, 2002.

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