Federal Deposit
Insurance Corporation

   [.1] Practice and Procedure—Evidence—Expert Opinion
   The opinions of a highly competent expert in the field of banking, bank operations, and bank examinations are to be given great weight.

   [.2] Concentration of Credit—Defined
   A "concentration of credit" refers to all extensions of credit to the same or related interests that are large in relation to a bank's capital structure.

   [.3] Loans—Classifications
   The classifications of a bank's loans speak as of the date of the bank examination and the documentation, or lack of documentation, in the bank's records that would tend to secure said loans. Although adversely classified loans were later repaid and the classifications appear to have been in error, it was proper to evaluate the loans without waiting many months to determine if the loans were actually repaid or not.

   [.4] Cease and Desist Orders—When Appropriate
   A cease and desist order is appropriate and necessary when unsafe or unsound banking practices jeopardize the safety of a bank's deposits.

   [.5] Capital—Adequacy—Unsafe or Unsound Practices
   Operating with adjusted capital and reserves that are inadequate in relation to the kind and quality of assets by adversely classifying assets that grossly exceed the adjusted capital and reserves is an unsafe or unsound banking practice.

   [.6] Lending and Collection Policies and Practices—Adversely Classified Loans
   Engaging in hazardous lending and collection policies and practices by having too large a percentage of total loan dollar volume in adversely classified loans is unsafe or unsound banking practice.

   [.7] Liquidity—Unsafe or Unsound Practices
   Operating with inadequate liquidity is unsafe or unsound banking practice.

In the Matter of * * * (INSURED
STATE NONMEMBER BANK)

DECISION OF BOARD OF
DIRECTORS:
FINDINGS OF FACT, CONCLUSIONS
OF LAW, CEASE AND DESIST
ORDER

   Pursuant to its authority under Section 8(b) of the Federal Deposit Insurance Act (12 U.S.C. 1818(b)), the Federal Deposit Insurance Corporation, on July 24, 1974, issued a notice of charges against the * * *, specifying that it had engaged in a number of alleged unsafe and unsound banking practices and had violated two State of * * * statutes. The Respondent Bank, represented by counsel, filed an answer denying the Corporation's charges.
   Following the disposal of several preliminary motions, an administrative hearing was held in * * * before Administrative Law Judge Erwin L. Stuller on September 16 through September 19, 1974. The * * * Company filed exception to Judge Stuller's Recommended Decision, dated December 27, 1974, and requested oral argument before the Board of Directors. The motion for oral argument was denied on March 26, 1975 this matter was submitted to the Board of Directors for final decision.
   The Board of Directors of the Federal Deposit Insurance Corporation, having now reviewed and considered this matter, concludes that the Respondent Bank and its Board of Directors have engaged in unsafe and unsound practices in conducting the business of the bank and that the Bank has {{4-1-90 p.A-2}}violated certain statutes of the State of * * *, makes the following Findings Of Fact and Conclusions Of Law, and orders that the following Cease and Desist Order be entered forthwith.

FINDINGS OF FACT AND
CONCLUSIONS OF LAW

   With the exception of those additions, deletions and modifications specifically noted below, the Board of Directors adopts the Findings Of Fact, Conclusions of Law, and the basis therefore, contained in the Recommended Decision of Administrative Law Judge Erwin L. Stuller, dated December 27, 1974, which is hereby incorporated by reference and made a part of this decision.
   Likewise, the Board of Directors expressly adopts Judge Stuller's determinations that "Those requested findings of fact that have not been reflected herein are rejected as being immaterial, irrelevant or as not being predicated on credible evidence" and that "The credible evidence sustains each of the allegations made in the Notice of Charges and of Hearing herein." Exceptions:

   1. The finding that with an adjusted capital ratio of 4.2%, an additional 5% loan loss would make the Respondent Bank insolvent, is modified to a finding that with an adjusted ratio of 4.2%, an additional 5% loss in assets would make Respondent Bank insolvent.
   2. The group of loans described as being secured by various restaurants and restaurant equipment is deleted from the list of three concentrations of credit found to represent an unsafe and unsound lending practice; there being insufficient evidence to establish that a 6.8 percentage of a bank's loans to an industry not shown to be in serious economic condition is unsafe and unsound.
   3. The Board of Directors adopts the finding that certain classified loans were paid by shifting them to other borrowers or paid with the proceeds of new loans, but rejects the finding that such was an "obvious subterfuge" that "raises further doubt as to the integrity of the Respondent's senior managing officers" as a conclusion not established by the evidence.

   NOW, THEREFORE, IT IS ORDERED,
That * * * ("Bank"), its directors, officers, and agents, cease and desist from operating with adjusted capital and reserves which are inadequate in relation to the kind and quality of its assets, engaging in hazardous lending and collection policies and practices, operating without adequate provisions for liquidity, and operating with weak management officials, and take affirmative action, as follows:

   1. Within 90 days from the effective date of this Order the Bank shall retain a qualified executive officer who shall have the necessary competence and experience to assume responsibility for implementing and maintaining sound lending, investment and operating policies, under the stated authority in writing by the Bank's board of directors.
   2. Within 30 days from the effective date of this Order, the Bank shall eliminate from its book assets, by charge-off or likewise:
   (a) All assets or portions of assets classified "Loss" in the Report of Examination of the Federal Deposit Insurance Corporation ("Corporation") as of February 4, 1974; and
   (b) Not less than 50% of the aggregate of assets classified "Doubtful" in the Report of Examination of the Corporation as of February 4, 1974.
   3. The Bank shall reduce the total remaining assets classified "Doubtful" and "Substandard" in the Report of Examination of the Corporation as of February 4, 1974, in accordance with the following:
   (a) Within 120 days from the date of this Order to not more than $3,800,000.
   (b) Within 240 days from the date of this Order to not more than $3,000,000.

4. The Bank shall not extend, directly or indirectly, any additional credit to any borrower whose extension of credit has been classified, in whole or in part, "Loss" or "Doubtful" in either the latest Report of Examination of the Corporation or the Commissioner of Finance of the State of * * * ("Commissioner"), unless and until the Corporation's recommended measures for correction of the existing classified loans and the further provisions of this Order have been fully implemented. This requirement shall not preclude the Bank from renewing credit already extended to any such borrower.
5. The bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower obligated in any manner on any extension of credit, or portion thereof, which has been charged off the books of the Bank and remains uncollected, unless and until the Corporation's recommended measures for collection of the existing charged off loan and the further provisions of this Order have been fully implemented.
6. (a) In not more than 60 days from the effective date of this Order, the board of directors of the Bank shall take all the steps necessary to increase total capital and reserves by not less than $2,440,000. Such increase in capital and reserves shall be accomplished by:

   (i) the sale of new capital in the form of capital stock and/or capital debentures; or
   (ii) the direct contribution of cash by the directors of the Bank; or
   (iii) the elimination of all of the "Loss" and 50% of the "Doubtful" assets, as specified in paragraph 2 of this Order, without loss or liability to the Bank; or
   (iv) any combination of the above means.

   6. (b) If all or part of the increase in total capital and reserves required by paragraph 6(a) above of this Order is accomplished by the sale of new capital stock, the board of directors of the Bank shall forthwith take all steps necessary to adopt and implement a plan for the sale of such additional capital stock, including voting any shares owned by them in favor of said plan. Prior to the implementation of the plan, the plan and any materials used in the sale of the stock of the Bank to new or existing stockholders shall be reviewed by the Corporation and the Commissioner.
   7. The Bank shall not sell or purchase any additional asset or portion of an asset to or from the * * * that is delinquent in the payment of either interest or principal, or has been classified, in whole or part, "Loss" or "Doubtful" in either the latest Report of Examination by the FDIC or the * * * Commissioner of Finance;
   Nor shall the Bank participate in any manner whatsoever in any additional extension of credit with the * * * Company without prudent credit analysis and sufficient documentation.
   8. The Bank shall pay no cash dividends without the prior written consent of the Director and the Commissioner.
   9. Within 60 days from the effective date of this Order, the Bank shall adopt and thereafter strictly follow written loan policies which shall be in accord with sound banking principles and which are consistent with written loan policies maintained and followed by commercial banks of comparable size similarly located in the * * * metropolitan area. Such written loan policies shall include, but not be limited to the following:

   (a) The general fields of lending in which the Bank will engage and the kinds of types of loans within each general field;
   (b) The lending authority of each loan officer;
   (c) The lending authority of a loan or executive committee, if any;
   (d) The responsibility of the board of directors in reviewing, ratifying, or approving loans;
   (e) The guidelines under which unsecured loans will be granted;
   (f) The guidelines for rates of interest and the terms of repayment for (i) unsecured loans and
(ii) secured loans;
{{4-1-90 p.A-4}}
   (g) With regard to secured loans: (i) limitations on the amount advanced in relation to the value of the collateral and (ii) the documentation required by the Bank for each type of secured loan;
   (h) The maintenance and review of complete and current credit files on each borrower;
   (i) Appropriate and adequate collection procedures, including, but not limited to, the actions to be taken against borrowers who fail to make timely payments;
   (j) Guidelines establishing limitations on the maximum volume of loans in relation to total assets;
   (k) Appropriate limitations on the extension of credit through overdrafts and cash items; and
   (l) A description of the Bank's normal trade area and the circumstances under which the Bank may extend credit outside of such area.

   10. The Bank shall immediately correct all violations of law by the Bank as more fully set forth in paragraph 7 of the Notice of Charges and of Hearing, dated June 28, 1974.
   11. On the tenth day of the second month following the date of issuance of this Order, and on the tenth day of every second month thereafter, unless and until each and every correction required by this Order is accomplished, the Bank shall furnish written progress reports to the Regional Director of the Corporation's * * * Regional Office detailing the form and manner of any actions taken to secure compliance with this Order and the results thereof. Such reports may be discontinued when the corrections required by this Order have been accomplished and the Regional Director has in writing released the Bank from making further reports.

/s/ Alan R. Miller
Executive Secretary

ORDER TERMINATING THE ORDER
TO CEASE AND DESIST

   IT IS HEREBY ORDERED, that the Order to Cease and Desist issued against * * *, pursuant to Section 8(b) of the Federal Deposit Insurance Act (12 U.S.C. § 1818(b)) on June 11, 1975, be and hereby is, terminated.
   Dated at Washington, D. C., this 22nd day of November, 1977.
   By direction of the Board.

/s/ Alan R. Miller
Executive Secretary

Docket No. 74-1

RECOMMENDED DECISION

DECISION

   The Federal Deposit Insurance Corporation, the Proponent herein, is a Federal banking agency which is authorized by Section 8(b) of the Federal Deposit Insurance Act (12 U.S.C. 1818(b)) to issue and serve upon a bank which has insured deposits a notice of charges, if, in the opinion of the agency, the bank is engaging or has engaged in an unsafe or unsound practice in conducting the business of such bank. The * * *, the Respondent herein, is an insured state non-member bank with deposits insured by the Proponent.
   On July 24, 1974 the Proponent issued and served upon the Respondent a Notice of Charges and of Hearing in which the Proponent detailed unsound and unsafe practices in which the Respondent allegedly had engaged in the conduct of its banking business. Thereafter, the Respondent timely filed its Answer denying most of the charges and, upon assignment of the case, the undersigned Administrative Law Judge acquired jurisdiction over the subject matter. A private hearing was held in this matter in * * * which is in the Federal judicial district in which the home office of the Respondent is located. The hearing began on September 16, 1974 and ended on September 19, 1974.
   By these proceedings the Proponent has proposed and is seeking a cease and desist order to bar the Respondent from continu- {{4-1-90 p.A-5}}ing banking practices that have been characterized as unsafe and unsound. These alleged and denied practices are as follows:
   1. The Respondent's adjusted capital and reserves are inadequate in relation to the kind and quality of its assets in that as of February 4, 1974, the cutoff date for the examination of the Respondent bank, it had adversely classified assets that grossly exceeded the adjusted capital and reserves.
   2. The Respondent had followed hazardous lending and collection policies and practices as of the cutoff date in that it had too large a percentage of its total loan dollar volume in adversely classified loans. The adverse classifications specified were "Substandard," "Doubtful," and "Loss".
   3. As of the cutoff date, the Respondent had overdue loans that constituted an excessive percentage of its total loans.
   4. As of the cutoff date, the Respondent's ratio of loans total assets was excessive and unwarranted.
   5. The Respondent failed to diversify risk in that it gave excessive concentrations of credit.
   6. Respondent gave extensions of additional credit to borrowers whose loans had previously proven to be deserving of adverse classification.
   7. Respondent extended credit without sufficient documentation.
   8. Respondent allowed the extension of credit in the form of overdrafts to borrowers whose loans were adversely classified.
   9. The Respondent conducted banking business without adequate provisions for liquidity.
   10. The Respondent violated the banking laws of the State of * * * by extending lines of credit which exceeded the State-imposed lending limit, and by extending credit to salaried officers of the bank without prior approval of the majority of the board of directors or of the executive or discount committee.
   11. The Respondent sanctioned and permitted the misuse of the bank's credit facilities in that it purchased from a sister bank, * * *, loans made by the sister bank which were weak, speculative, and inadequately documented.
   12. The Respondent failed to heed the admonitions and follow the recommendations of the Proponent and of the proper authorities of the State of * * * in regard to the practices stated above.
   The Proponent has alleged that the specified practices and policies jeopardize the safety of the Respondent's deposits. To determine whether the Proponent herein has carried its burden of proof, the evidence presented must first be evaluated. In addition to the admissions of allegations made in the pleadings and the stipulations of the parties, testimony of witnesses and documentary evidence was received. The Proponent offered the Report of Examination of the Respondent bank which examination was directed by * * * as Examiner-In-Charge for the Proponent and by * * * as State Examiner-In-Charge. The examination speaks as of February 4, 1974. A second Report of Examination conducted by Mr. * * * was offered in evidence. This examination of the Respondent's bank reflected the bank's status as of February 20, 1973. In addition the Proponent offered the testimony of Mr. * * * and Mr. * * * The principle testimonial evidence introduced by the Respondent was the testimony of the Respondent's Chairman of the Board and President, Mr. * * * , and the Respondent's Executive Vice-President Mr. * * *. In addition, the Respondent offered the testimony of its accountant and 26 documentary exhibits which consisted primarily of excerpts from the bank's records, forms and financial statements.
   The Proponent relies heavily on the Reports of Examination, Proponent's Exhibits 1 and 2, and argues that all assertions of fact, conclusions of fact, and conclusions of law contained therein must be accorded great weight. The Respondent stipulated to the authenticity of the exhibits and there is no question as to the relevancy and materiality of the 1974 Report of Examination. These exhibits are clearly admissible under Rule 44 of the Federal Rules of Civil Procedure and under the Federal Records Act (28 U.S.C. 1733). The issue then arises as to what weight should be given to the many assertions made by the exhibits. The Proponent argues that all assertions made in the exhibits including the expert opinions of Mr. * * * must "be given considerable weight." Richardson v. Perales, 402 U.S. 389(1971) is given as authority for this conclusion. A simple reading of Perales, indi- {{4-1-90 p.A-6}}cates otherwise. The Perales case arose from a Social Security disability insurance claim. It concerns the admission of medical reports of physicians who did not appear at the hearings in that case. The Court held that the reports were "substantial evidence" that could support a denial of the claim. Perales did not establish that the rules regulating non-adversary adjudicatory hearings under the Social Security Act governed adversary hearings under the Administrative Procedure Act such as the present case. The rules under each of these Acts are similar in many ways. In fact many of the rules concerning proceedings under the Administrative Procedure Act were taken from the older Social Security Act. But at that point the similarity ended. Perales concerned a non-adversary hearing wherein the hearing officer is required to offer evidence both for and against the claim and then decide the case of the basis of the evidence presented. The Social Security Administration is not represented by counsel in such cases, and the claimant rarely has counsel. In the present case, each of the parties was well represented by counsel. The Court in Perales noted that it would be virtually impossible for the Social Security Administration to conduct disability insurance benefits hearings if it were required to subpoena and present the testimony of physicians in each of the thousands of Social Security disability benefits cases that were conducted each year. Therefore, the rule in Perales appears to be a rule of need and expediency. No such need is evident in the present case. Therefore, the Proponent's argument that the conclusions and opinions contained in the Reports of Examination must be given considerable weight without further corroboration by reason of the decision in Perales is rejected.

   [.1] The author Reports of Examination testified at the hearing and was subject to cross examination as to the assertions made in the Reports of Examination. A great deal of the material in the Reports of Examination is a summary of the Respondent's records. Throughout the trial, the Respondent relied on the summaries in Exhibit 1 and often made reference to those summaries as the basis for questions asked of his witnesses. These summaries of factual information taken from the Respondent's records was supported by those records which were received in evidence. Based on these conclusions it is determined that the factual materials and the summaries of factual materials contained in Exhibit 1 are reliable and have great probative value. As to the weight to be given the conclusions and expert opinions of Mr. * * * it is determined that each of the conclusions was based on reliable fact and is given great weight. Mr. * * * holds the degree of bachelor of science in commerce from St. Louis University and majored in accounting. He completed and received credit for numerous American Institute of Banking courses including Principles of Bank Operation, Commercial Law, Negotiable Instruments, Economics, Accounting, Business Administration, and numerous others. He attended inter-agencies schools in Washington, D.C. for bank examiners. He attended the Stoiner Graduate School of Banking conducted by the American Bankers Association at Rutgers University and graduated from that school in 1969. He participated in in the conduct of a survey for the Federal Deposit Insurance Corporation, a nationwide survey dealing with computer processing and how to effect an examination of banks. He helped establish a training course for the Proponent's bank examiners in Washington, D.C. and taught at the training courses. He also served as an instructor for the Pacific Coast Graduate Banking School in Seattle for the last two years. He has served the Proponent as a bank examiner for a period of 15 years and based on merit, was promoted from time to time and has served as examiner in charge of other examiners in the examination of many banks. For the last seven years, he has acted in that capacity in the * * * Metropolitan area. His experience includes new bank examinations and examinations for bank branches in the State of * * *. He has participated in approximately five hundred examinations. Based on his training and experience as shown in the record and his demeanor while testifying, both under direct and cross examination, it is determined that Mr. * * * has great expertise in the field of banking, bank operations, and bank examinations. Based on the foregoing, his testimony is determined to be highly credible and his opinions are given great weight. As the opinions expressed in Exhibit 1 are those of Mr. * * * and as each of those opinions were based on a factual predicate and were uttered by a highly competent expert and credible witness, those opinions are given great weight.
{{4-1-90 p.A-7}}
   The Report of Examination for the period ending February 20, 1973 was not corroborated. Therefore, it is given weight and considered only to the extent that it indicates that there was such a examination made, that the document reflects the results of the Proponent's examination, and that this information, together with the recommendations of the Proponent contained in that exhibit, was made available to the Respondent long before the February 4, 1974 examination concerned herein.
   The evidence establishes that * * * is Chairman of the Board and President of * * * Company. He had been President of * * * since January 2, 1969 and Chairman of the Board since September or October 1969. He attended St. Louis University for three years, but did not obtain a degree. After World War II at age 32, * * * went into the small loan business working for * * * Loan Company. Initially he worked at collections. He later became a Branch Manager. In that capacity, he supervised the making and collection of loans. He was then employed by the Bank of * * *. He worked as a Loan Officer in the Installment Loan Department and later became Manager of the Installment Loan Department. He described the Department activity as having a large volume consumer credit installment loans. That bank engaged in commercial lending "to some degree". In 1956, Mr. * * * was employed by * * * , Bank in a suburb of * * *. He described the bank as being small. He managed the bank's small loan operation and also engaged in commercial loan bank lending and collecting. In January, 1959, he was employed by the * * * Company of * * *. This bank had approximately $85 million in assets and later the assets rose to approximately $120 million. He became a loan officer in the commercial lending operation of the bank and in 1961, became Vice President. He then became a member of the bank's loan committee. In 1965, that bank merged with the * * * Trust Company which at the time was the largest bank in the metropolitan * * * area. He retained his position as the Vice President and continued to perform functions of lending and collecting commercial loans. In January of 1969, he was employed by the Respondent which was then known as the * * *. At the time of the hearing, Mr. * * * was 61 years of age.
   Based on the evidence concerning Mr. * * *'s education, training and experience, it is determined that Mr. * * * is an expert in banking but has less expertise than that of Mr. * * *. Based on the observation of Mr. * * *'s demeanor while testifying, his attempts to be evasive and those portions of his testimony that appear to be nothing more than approval of his own acts which are at issue herein, his testimony is determined to be less than credible. Much of his testimony was self serving in that in reality as chief operating officer of the Respondent bank, the practices sought to be condemned by the Proponent herein are practices initiated and carried out by this witness. Many of the opinions of this bank officer concerning the propriety of making questionable loans to proven questionable risks and the refinancing of these loans after the examination in attempt to show the Proponent's adverse designation as being improper, are inherently unbelievable and raised great doubt as to the veracity and credibility of this witness.
   * * *, the Respondent's Executive Vice President, obtained an Associate Degree from Washington University in credit management. An Associate Degree is equivalent to about two years of college study without academic requirements. He attended a Senior Bank Manager Seminar at the Harvard Business Graduate School, and has been a discussion leader at the Robert Morse Lending Officer Development Program. In addition, when he first started in the banking business in 1958, he attended the American Institute of Banking. In January of 1958, he obtained a job as a teller with the * * *. He worked for that institution for 4½ years in various operational departments and finally worked in the installment lending department as an assistant manager. He worked in this latter capacity from 9 months to one year. He then went to work for Standard Oil Company of Indiana in the American Oil Division as a credit representative approving and administering and collecting credit for all wholesale accounts for the states of Arkansas, Louisiana and Missouri. The loans concerned were made to wholesalers to finance inventory and receivables. He worked at this job approximately five years and then went to work for the * * * County Bank as a business development officer with a title of Assistant Vice {{4-1-90 p.A-8}}President. He held this job for one year and then was moved into the position of Vice President working as a commercial lending officer. This bank is in * * * County. In July 1971 he joined the Respondent herein as Executive Vice President and has held that position continuously since that time. He is now 37 years of age. As Executive Vice President, Mr. * * * has the responsibility of supervising the various departments and vice presidents of the bank as well as the commercial lending department. He acts in behalf of the President in his absence. For the last two years, he has been a director of the bank.
   Mr. * * *'s education, training and experience establishes that he does have expertise in the field of banking. However the level of expertise shown for this witness is far less than that proven for Mr. * * * or Mr. * * *. Based on this witness' demeanor while testifying, his evasiveness and his apparent self serving statements, little credibility is accorded this witness' testimony.
   The admissions, stipulations and credible evidence establishes that the Respondent is a corporation existing and doing business under the laws of the State of * * * having its principle place of business at * * * which is in * * * County, * * *, and has at all times concerned herein been an injured State non-member bank. The Respondent, therefore, has been and, all times mentioned herein, is subject to the Act (12 U.S.C. § 1818, et seq.) and the Rules and Regulations of the Proponent (12 C.F.R. Part 301, et seq.).
   The Proponent is a Federal Banking Agency which is authorized, among other things, to conduct examinations of banks with deposits that are insured by the Proponent. At all times material to this case, the Respondent has had deposits insured by the Proponent. From time to time, the Proponent has examined the Respondent's records. On February 20, 1973 the Proponent examined the Respondent. Mr. * * * acted as Examiner-In-Charge. The result of that examination was received in evidence as Proponent's Exhibit 2.
   On February 4, 1974 the Proponent again examined the Respondent bank. Some 15 of the Proponent's bank examiners examined the Respondent's records over a period extending between one and two months. Mr. * * * again acted as Examiner-In-Charge.
   The officers of the Division of Finance of the State of * * * joined with the Proponent's examiners in a concurrent examination. Mr. * * * acted as Examiner-In-Charge for the examiners of the state agency. Each group arrived at their own conclusions and submitted their reports to their respective offices. Before and during a meeting of the Respondent's Board of Directors on March 18, 1974, Mr. * * * presented results of the examination to the senior managing officers, principally Mr. * * * and Mr. * * * and members of the Respondent's Board. The loans in question, the classifications of these loans and the Proponent's reasons for making these classifications were discussed. Respondent was given a copy of the Report of Examination (Proponent's Exhibit 1) in May of 1974.
   In the course of examining the Respondent bank, Proponent's examiners analyzed the bank's assets and classified them according to their degree of risk. The three categories of adverse classifications which were assigned to assets. A Substandard classification was applied to assets which involved more than a normal risk due to the financial condition or unfavorable record of the obligor, the insufficiency or total lack of security, or other factors noted by the examiner. A Doubtful loan classification was given to loans which the examiner, based on facts available to him at the time of the examination, concluded would not be fully collectible, but no determination could be made as to the amount of probable loss that would be sustained. A loan classified Loss was considered by the examiner to be without any asset value at the time of the examination, either because the loan appeared at that time to be uncollectible or appeared not capable of being collected in the near future.
   As of February 20, 1973, Respondent's loans subject to adverse classifications totaled $2,940,000, including $2,913,000 classified Substandard, $17,900 classified Doubtful and $8,800 classified Loss. These classified loans constituted 9 percent of Respondent's total loan portfolio as of February 20, 1973. As of February 4, 1974, Respondent's loans subject to adverse classifications increased to $6,629,000, including $4,145,700 Substandard, $884,200 Doubtful, and $1,599,100 Loss. Respondent's loans subject to adverse classifications as of February 4, 1974, amounted to 16.5 percent of Respondent's entire loan portfolio. These {{4-1-90 p.A-9}}loan classification totals indicate a dramatic increase since the 1973 examination in the dollar amount and in the percentage of Respondent's total assets that involve more than normal risk.
   Respondent's total book capital and reserves is the amount of funds available to protect Respondent's depositors and other creditors against asset losses. It consists of Respondent's capital stock, surplus, paid in surplus, accumulated retained earnings, and loan loss reserves. Respondent's book capital and reserves as of February 4, 1974, totaled $4,355,400. Thus, Respondent's loans subject to adverse classifications as of February 4, 1974 ($6,629,000), exceeded Respondent's total book capital and reserves by more than $2,000,000, amounting to 152.2 percent of Respondent's total capital accounts. Respondent's adjusted capital and reserves are determined by subtracting all assets classified Loss and 50 percent of the assets classified Doubtful from Respondent's total capital and reserves. The ratio of Respondent's adjusted capital and reserves to its adjusted gross assets provides an indication of the amount of protection which Respondent's capital accounts provide for its depositors and reflects the extent to which asset loss or depreciation can be absorbed by the capital accounts of Respondent before its depositors' funds are impaired. Additional classifications of assets as Doubtful or Loss would further reduce the adjusted capital and reserves of Respondent and further diminish the amount of protection of Respondent's depositors' funds. Respondent's adjusted capital and reserves as of February 4, 1974 were $2,313,200, constituting 4.2 percent of Respondent's adjusted assets as of February 4, 1974, a substantial decrease from the 8.3 percent ratio reflected in the Report of Examination of Respondent as of February 20, 1973. Since respondent's adjusted capital and reserves as of February 4, 1974 amounted to only 4.2 percent of Respondent's adjusted gross assets, Respondent would be insolvent if it sustained an additional 5 percent loss in its loan portfolio. Respondent's ratio of adjusted capital and reserves to adjusted assets (4.2%) was far less than the average of banks of comparable size in the * * * trade area (approximately 8%).
   As of February 4, 1974, the dollar amount of Respondent's adversely classified assets which were not considered in computing Respondent's adjusted capital and reserves (that is, all the Substandard loans and 50% of the Doubtful loans) totaled approximately $4,700,000. This amount exceeded Respondent's adjusted capital and reserves by $2,387,000. Eleven of Respondent's loans totaling $509,400 had interest overdue for six months or more. In addition, 100 loans totaling $5,568,200 had past maturities or had installments overdue for at least one month as of February 4, 1974. Thus, Respondent's total dollar amount of overdue loans as of that date was $6,077,600, constituting 15.1 percent of Respondent's total loan portfolio. While it is normal for a bank to have some overdue loans, experience has shown that when the volume of overdue loans exceeds 5 percent of the bank's total loans serious collection problems may develop.
   As of February 4, 1974, over 35 percent of Respondent's overdue loans were subject to adverse classifications. Respondent's total loan volume on that date was $40,121,200, constituting 70 percent of Respondent's gross assets. This percentage of total loans to gross assets far exceeded the 51 percent ratio for banks of comparable size in the State of * * * and the 53 percent ratio for all banks in the * * * trade area.
   A bank's liquidity is ascertained by an analysis of its cash, balances due from banks, its bond account, securities portfolio, and commercial paper. The primary source of a bank's liquidity is its cash and balances due from banks, which for Respondent totaled $2,985,900 as of February 4, 1974. This amount constituted 5.2 percent of Respondent's total assets, a percentage significantly lower than the 9.4 percent average for all banks located in the * * * trade area, and a decline from 6.7 percent as of February 20, 1973. Of this amount all but $104,600 must be maintained by Respondent as its cash reserve for deposits required by state law. Thus, only $104,600 is readily available to Respondent from its primary liquidity source.
   Respondent's secondary sources for liquidity are similarly limited. As of February 4, 1974, of Respondent's total securities account of $12,834,000, only securities totaling $1,349,000 were not pledged to se- {{4-1-90 p.A-10}}cure deposits and were therefore available for liquidity purposes. The securities in excess of secured liabilities constituted only 2.4 percent of Respondent's total assets, a decline from 6.6 percent as of February 20, 1973, and 12.2 percent in 1972. Respondent had no commercial paper so the normal secondary source of liquidity in the loan portfolio was not available. Because of the rapid decline in Respondent's liquid assets, Respondent has borrowed funds at an ever increasing rate since 1972. In 1972 it was necessary for Respondent to borrow funds on only 76 of the 434 days that had passed since the previous examination, and it was not borrowing on the date of the examination. In 1973 Respondent borrowed on 289 of the 330 days that elapsed between examinations, and was borrowing $233,000 on the date of the examination. As of the February 4, 1974 examination, Respondent had been indebted 100 percent of the time since the 1973 examination and was indebted on the date of the examination in the amount of $2,273,000.
   As of February 4, 1974, 15 percent of Respondent's total deposits consisted of the accounts of only four depositors. These large deposits, each of which constitutes at least 2 percent of Respondent's total deposits, pose a potential liquidity problem to Respondent since such deposits tend to be highly volatile. Because of Respondent's lack of sufficient liquid assets, the withdrawal of these large deposits or a substantial portion of them without warning would leave Respondent without sufficient funds to pay these deposits. As of February 4, 1974, the dollar amount of Respondent's total loans had increased by 23.2 percent over its February 20, 1973 loan total. During the same period, Respondent's total deposits increased by 16.6 percent. Thus, Respondent's loan volume has increased at a rate faster than its deposit growth. This condition, together with the fact that Respondent's ratio of loans to total assets (70 percent) substantially exceeds that maintained by comparable banks, that its cash position is declining in relation to total assets (only $104,600 in excess of legal reserves is held), that its secondary liquidity reserves, namely securities, are being pledged in increasing amounts to secure deposits and therefore not readily available for liquidity, and that a small number of depositors own a relatively large share of its total deposits creating a potential danger in the event of withdrawal of these large deposits indicates that Respondent's business is being operated without adequate provisions for liquidity.

   [.2] A "concentration of credit" refers to all extensions of credit to the same or related interests which are large in relation to a bank's capital structure. A concentration can exist in a single line to an obligor or in extensions to two or more unrelated obligors, the repayment of which is based upon the same type of production or business, or for which the same type of collateral is held. A "concentration of credit" may arise from extensions of credit to closely allied interests, the repayment of whose obligations is inter-dependent by reason of affiliated ownership or control. As of February 4, 1974, Respondent's loan portfolio included three large concentrations of credit totaling $8,662,000 or almost twice the amount of Respondent's total capital and reserves of $4,355,400. These loans represented 21.6 percent of Respondent's total loans. The three concentrations consisted of extensions of credit to borrowers involved in the * * * community development, to borrowers whose interests were related to the * * * family and the * * * corporate enterprises, and to borrowers whose loans were secured by restaurants or restaurant equipment.
   The * * * concentration totaled $3,050,880, representing 70 percent of Respondent's total capital and reserves and 7.6 percent of Respondent's total loans. Included in this concentration were loans to corporations controlled by or related to the interests of Mr. * * *, including loans to * * *. The repayment of these loans depends in whole or in part upon the successful completion of the * * * residential community, and the subsequent resale, in a tight money market, of the completed homes. As of 1974, $1,573,300 of this concentration was classified Substandard, due to, among other things, the absence of tangible collateral, the weak financial position of several of the borrowers concerned, and because much of the line was overdue at the time of the examination. Subsequent to the examination, Mr. and Mrs. * * * and several of the * * * related corporations for reorganization under Chapter II of the Bankruptcy Act.
   The * * * concentration totaled $3,335,273, representing 76.6 percent of Respondent's total capital and reserves and 8.3 percent of Respondent's entire loan {{4-1-90 p.A-11}}portfolio. Included in this concentration were loans to members of the * * * family, business associates of the family members, executives of their various operating companies, and to their operating companies, affiliates, and subsidiaries, including loans to * * *. As of February 4, 1974, the financial statements of many of these borrowers were not available in Respondent's credit files. The financial statement of the principal company, * * * dated April 30, 1973, was prepared by a certified public accountant but contained a qualified opinion because the accountant could not determine whether the company's accounts receivable, which constituted the largest portion of its assets, would be collectible. The collateral for many of the loans included in this concentration was stock having little or no market value. As of February 4, 1974, $316,600 of this concentration was classified Substandard, $811,400 Doubtful, and $1,582,500 Loss.
   The third concentration of credit included in Respondent's loan portfolio as of February 4, 1974 was a group of loans all of which were secured by various restaurants and restaurant equipment. This concentration of credit totaled $2,744,913, representing 63 percent of Respondent's total capital and reserves and 6.8 percent of Respondent's total loan portfolio. Loans included in this concentration of credit were those to * * *.
   The repayment of these loans depends in whole or in part upon the successful operation of restaurant businesses.
   The concentrations of credit involving the * * * development and the * * * -related interests were criticized by Proponent during the February 20, 1973 examination. Nonetheless, as of February 4, 1974, the total dollar amount involved in these two concentrations of credit had actually increased since the February 20, 1973 examination despite the warnings given to Respondent's management concerning the dangers of failing to diversify risk in its loan portfolio. Respondent's management was criticized in the February 20, 1973 examination report regarding the heavy and excessive volume of loans subject to adverse classification as of that date. Despite this admonishment, Respondent's management has evidenced its hazardous lending policies by disregarding Proponent's previous classifications and extending new credit and renewing existing lines of credit which had been criticized. Included in this group were additional extensions of credit to * * *, and * * * totaling $497,500.
   In order to properly evaluate a loan application to ascertain the soundness of the financial condition and the paying ability of the borrower, a bank's lending officers must obtain complete financial records of the borrower and sufficient documentation to determine the value of any collateral to be pledged as security. Documentation to be maintained in a borrower's credit file includes a financial statement and property statement, and, in the case of a corporate or business borrower, a financial statement certified by an accountant, a profit and loss statement, and an income statement. If financial statements indicate a weakness, additional data should be obtained to justify the extension of credit. As of February 4, 1974, Respondent's credit files for a large number of its borrowers lacked documentation sufficient to ascertain the creditworthiness of those borrowers. The extensions of credit made by Respondent's loan officers without proper documentation constitute a sizeable portion of Respondent's entire loan portfolio.
   The extension of credit which is secured by liens on accounts receivable or inventory, requires certain precautions which must be taken to protect the interest in such collateral. Where the accounts receivable and inventory constitute the primary collateral for the advance, it is a customary banking practice to ascertain the validity of the accounts by, for example, spot checking or direct verification of the existence of the account. In addition, an audit may be required of the borrower's books to verify the amount of past due accounts and outstanding balances. As of February 4, 1974, Respondent's loans to two borrowers, * * *, were primarily secured by liens on accounts receivable and inventory, but Respondent's lending officers failed to take any of the precautions necessary to adequately protect Respondent's interest.    As of February 4, 1974, Respondent had granted credit in the form of overdrafts to several of its borrowers whose loans were subject to adverse classification. These borrowers whose credit was criticized included * * * is an affiliate of Respondent by virtue {{4-1-90 p.A-12}}of common ownership interests. As of February 4, 1974, Respondent had acquired a loan participation from * * *, which had been classified as a Substandard risk at that bank. In addition, Respondent's credit files lacked sufficient information and documentation upon which Respondent's lending officers could have analyzed the creditworthiness of the borrower.
   As of February 4, 1974, Respondent had violated Section 362.170-1(1) of the * * * Revised Statutes ( * * * Revised Statute § 362.170-1(1) (1967)). This section states in applicable part that:

   "No bank or trust company subject to the provisions of this chapter shall (1) Directly or indirectly lend to any individual, partnership, corporation, or body politic, . . . an amount or amounts in the aggregate which will exceed . . . . twenty percent of the capital stock actually paid in and surplus fund of the bank or trust company. . . ."

   "Where loans are made to active salaried officers they must first be approved by a majority of the board of directors or of the executive or discount committees, the approval to be in writing and the officer to whom the loans are made, not voting."

[.3] The Respondent argues that the Proponent failed to sustain its burden of proving the adverse classifications of the Respondent's loans. The Respondent has requested many findings of fact that would appear to support this theory. The argument implies that as many as the adversely classified loans were later repaid the classifications were in error. The Report of Examination primarily concerned is that reporting the status of the respondent bank as of the close of business of February 4, 1974. The classifications of the Respondent's loans speak as of that date and are based on the payment records as of that date and the documentation, or lack of documentation, in the bank's records that would tend to secure said loans. Therefore, it was entirely proper to evaluate the loans without waiting many months to determine if, in fact, the loans were repaid or not. Some classifications estimate that part of the loans would be repaid. These are expert opinions properly arrived at. The evidence presented by the Respondent to indicate that the later experience of that bank in regard to the adversely classified loans established that the loans were improperly classified due to alleged repayment, is not persuasive. Although these requested findings were taken from the bank records, a more thorough scrutiny of these records and the cross-examination of the Respondent's principal witnesses indicated a great deal of manipulation of the loans took place, impliedly on the part of the bank's senior managing officers, in an apparent attempt to create evidence that would weaken the Proponent's criticism of their conduct of the bank's business. Several of the loans that were claimed to have been paid, in form appear to have been paid, but in substance were merely extended or shifted. Payment of several of the loans were financed with the proceeds of new loans made to a related borrower with equally as poor or less collateral. Some loans were merely shifted from one party in a loan classification group to another party in the same loan classification group without any additional security with the result that an equally poor or worse classification was justified. In several cases the loans were paid with the proceeds of a new loan from another bank with the Respondent purchasing an equal or greater participation in that new loan from the principal lender. As a result, the Respondent was in a poorer position in regard to collateral and the probability of receiving repayment. These activities are detailed in the Proponent's reply brief. This obvious subterfuge not only refutes the argument that the loans were improperly classified but raises further doubt as to the integrity of the Respondent's senior managing officers and the Respondent's banking practices and is evidence indicating the continued unsafe and unsound practices of the Respondent.
   The Respondent has offered into evidence its financial statements for the years 1969 through June 30, 1974. It is noted that this last financial statement was not the result of an audit but merely a reflection of the records of the bank. The Respondent appears to argue that the continuing growth and profitability of the Respondent bank as indicated in these financial statements are indicative of the fact that the Respondent's banking practices are both safe and sound. This, of course, is not true. The evidence here indicates that in order to report growing assets and profit, the Respondent here has reported many of its assets at book value rather than the lesser values as indicated by the recommended adverse classifications. As the adverse classifications would reduce the Respondent's assets, capital and profit and as those adverse classifications have been sustained herein, the Respondent's argument is rejected as being immaterial, irrelevant and not credible.
   The Respondent argues that the unsafe and unsound practices complained of by the Proponent are mere isolated conduct which is not likely to recur. This is clearly refuted by the credible evidence. The unsafe and unsound practices and substantial, extremely serious and continuing. The Respondent's activities after the February 4, 1974 examination indicate that the Respon- {{4-1-90 p.A-14}}dent has continued and clearly intends to continue into the future the conduct complained of herein.
   Respondent alleges that the Proponent is seeking to require compliance with selected ratios with respect to percentages of classified loans, percentages of overdue loans, ratios of loans to assets, ratios of cash and securities to assets, et cetera. The undersigned in considering the record, viewed the percentages and ratios merely as convenient and proven tools used by experts in banking in determining the financial status of the Respondent's bank and to evaluate its banking activity. There is no evidence that the Proponent is seeking to impose these ratios or any set ratios or percentages upon the Respondent herein in its proposed cease and desist order. Therefore, the Respondent's arguments in this respect are rejected.
   Those requested findings of fact that have not been reflected herein are rejected as being immaterial, irrelevant or as not being predicated on credible evidence.

   [.4--.7] The credible evidence sustains each of the allegations made in the Notice of Charges and of Hearing herein. Respondent has engaged in, and is continuing to engage in, unsafe and unsound banking practices within the meaning of Section 8(b) of the Federal Deposit Insurance Act by engaging in hazardous lending and collection policies, operating without sufficient capital and reserves in relation to the kind and quality of its assets, operating without adequate provisions for liquidity, failing to comply with applicable statutes and regulations, and by operating under the direction of weak management officials who have refused to recognize Respondent's problems. These practices have jeopardized the safety of the Respondent's deposits. Therefore, the issuance by Proponent of an order to cease and desist from such practices is both appropriate and necessary. Based on these findings of fact and conclusions of law, it is RECOMMENDED that the Proponent's proposed cease and desist order, a copy of which is attached hereto, be issued to the Respondent upon the conclusion of these proceedings.

/s/ Erwin L. Stuller
Administrative Law Judge
Dated: December 27, 1974