Each depositor insured to at least $250,000 per insured bank



Home > Regulation & Examinations > Bank Examinations > FDIC Enforcement Decisions and Orders




FDIC Enforcement Decisions and Orders

ED&O Home | Search Form | Text Search | ED&O Help


{{4-1-90 p.A-208}}
   [5023]FDIC Docket No. FDIC 83-79b (4-9-84).

   FDIC issued a cease and desist order to a bank and its directors for maintaining an excessive and disproportionately large volume of inferior quality assets in relation to the total capital and reserves of the bank, failing to make provisions for an adequate reserve for loan losses, misrepresenting and misstating the actual earnings and income of the bank, and operating with inadequate capital and reserves in relation to the large volume of inferior quality assets held by the bank. FDIC also ordered the bank to take affirmative action to correct these practices.

   [.1]Cease and Desist Orders—Additional Capital Ordered
   Injection of additional capital into a bank is designed to achieve a long-term result—a significant improvement in the bank's financial stability.

{{4-1-90 p.A-209}}
   [.2]Directors—Duties and Responsibility—Correction of Known Problems
   It should be the responsibility of a bank's directors and management to make every attempt to correct the bank's problems, and the FDIC has the right to expect that such efforts will be undertaken.

   [.3]Management—Conduct of Prior Management
   The fact that the vast majority of bad loans were originated by prior management, the difficulty in upgrading adversely classified assets due to the depressed regional economy, and evidence of efforts made by management to correct the situation, must be considered in determining the culpability for the bank's condition, and tends to rebut the FDIC's assertion of mismanagement by current bank directors.

   [.4]Capital—Adequacy—Unsafe or Unsound Practices
   Unsafe or unsound banking practices include the following: maintaining an excessive and disproportionately large volume of inferior quality assets in relation to the total capital and reserves of a bank; failing to provide for an adequate reserve for loan losses; misrepresenting and misstating the actual earnings and income of the bank; and operating with inadequate capital and reserves in relation to the volume of inferior quality assets held by the bank.

   [.5]Directors—Duties and Responsibility—Correction of Known Problems
   Bank directors have a legal duty and responsibility to take effective action to correct any problems or deficiencies in the operation of the bank that have had a negative effect on the bank.

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


DECISION AND ORDER
FDIC-83-79b

STATEMENT OF THE CASE

   The proceeding arises under Section 8(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1818(b) (1)). On April 7, 1983, the Federal Deposit Insurance Corporation ("FDIC") and ("Proponent") issued a Notice of Charges and of Hearing ("Notice") against * * * ("Bank") and its board of directors (the Bank and its board of directors are collectively referred to as "Respondent") pursuant to the provisions of Section 8(b)(1) of the Federal Deposit Insurance Act ("Act") (12 U.S.C. §1818(b)(1)) and Part 308 of the FDIC Rules of Practice and Procedures (12 C.F.R. Part 308). The Notice charged that the Bank and its board of directors engaged in certain unsafe or unsound practices in conducting the business of the Bank within the meaning of Section 8(b)(1) of the Act and called for a hearing to take evidence and determine whether a Cease and Desist Order should be issued requiring the Respondent to terminate such practices and to take affirmative action to correct the conditions resulting from such practices. On April 27, 1983, counsel for the bank filed an Answer to the Notice ("Answer") admitting certain allegations and denying others.
   A formal hearing was conducted on June 28 and 29, 1983 in * * * before Administrative Law Judge John H. Fenton (the "ALJ"). The FDIC submitted a brief containing proposed Findings of Fact, Conclusions of Law and an Order on August 26, 1983. The Respondent submitted its proposed findings of fact, conclusions of law and brief on September 9, 1983. The FDIC submitted a reply brief on September 26, 1983. On December 9, 1983, the ALJ issued a Recommended Decision in the matter. The FDIC filed exceptions to the ALJ's recommended decision on January 4, 1984 and the Respondent filed exceptions on January 18, 1984.

BACKGROUND

   Based on a series of examinations, the FDIC alleged that the Respondent engaged in the following unsafe or unsound practices:

       (1) Maintaining an excessive and disproportionate volume of inferior quality assets in relation to its total capital and reserves.

{{4-1-90 p.A-210}}

       (2) Failing to provide an adequate reserve for loan losses (thus misstating actual earnings).
       (3) Operating with inadequate capital and reserves in relation to its large volume of inferior quality assets.
       (4) Failing adequately to supervise officers so as to avoid such detriment to the Bank and such jeopardy to the safety of its deposits.
   With respect to the first three unsafe or unsound practices, the Respondent did not contest the facts upon which the charges were based but denied the legal conclusions drawn, asserting that the existence of these facts was the result of unsafe or unsound practices by the prior management and board of directors. Respondent maintained that the present management was operating the bank as well as could be expected under the circumstances. In light of these assertions, the Respondent denied the existence of the fourth unsafe or unsound practice alleged by the FDIC.
   The FDIC maintained that the Respondent possessed a responsibility to correct the problems and deficiencies in the Bank regardless of the date on which such problems originated and the management under which the deficiencies occurred. Consistent with this position, the FDIC requested the following affirmative action:
       (1) Appointment of a new chief lending officer acceptable to it, who shall not be a present employee of the bank.
       (2) Elimination by charge-off or collection, of all assets classified `Loss" as of December 17, 1982, except for the * * * property.
       (3) Substantial reduction of assets classified "Substandard" over the course of the year following the Order.
       (4) Limitations on the extension of further credit to borrowers whose loans are charged off or are classified loss and are uncollected.
       (5) Establishment of an adequate reserve for loan losses by charges to current operating income.
       (6) Injection of at least $450,000.00 in capital and reserves by any combination of common or perpetual preferred stock issues, direct contributions of shareholders or Directors, cash collection of assets previously charged off, or of assets classified "Loss" as of December 17, 1983.
       (7) Periodic submission to FDIC of a budget designed to reduce expenses and increase retained earnings, as well as progress reports detailing actions taken to secure compliance with such an Order.
ANALYSIS OF THE ALJ'S RECOMMENDED DECISION

   As has been previously discussed, the facts in this proceeding are largely undisputed. The basic issue is whether the remedy sought by the FDIC, a Cease and Desist Order, is appropriate given the facts and other relevant circumstances.
   There exists a disagreement between the FDIC and the Respondent as to the conclusions to be drawn from the facts and the remedy, if any, to be imposed. The Respondent's initial assertion was that the problems and deficiencies of the Bank were created by prior management and that, as a consequence, current management should not be held responsible. In the Respondent's view, the Bank was being operated as well as could be expected given the legacy with which the current management had been burdened. The Respondent also pointed to external circumstances to not only justify the current operation of the Bank but to support the contention that the affirmative action requested by the FDIC was not feasible. These external circumstances related primarily to the depressed state of the economy and high unemployment in the * * * area where the Bank is located. Due to these outside economic factors, the Respondent argued that it was not possible to upgrade its loan portfolio due to the precarious financial status of many bank customers. The Respondent also argued that the injection of $450,000 of additional capital by stock sale or other methods would be infeasible in such an economically depressed area.
   The FDIC argued that the origin of the problems and deficiencies of the Bank was irrelevant as far as determining the responsibility to correct the situation. In FDIC's view, despite the fact that the vast majority of bad loans originated with bank management, it was the Respondent's responsibility to take affirmative action to ameliorate the situation. While acknowledging the depressed state of the economy in the area, the FDIC maintained that current management had sufficient time to correct many of the problems caused by previous management but had not done so, as evidenced by the {{4-1-90 p.A-211}}continued deterioration of the Bank's financial stability. The FDIC was not satisfied that the Respondent had taken all available actions to improve the financial condition of the Bank, the ultimate success of those actions notwithstanding.
   The ALJ's recommended decision viewed the issues in this proceeding from essentially the same perspective. In reaching his conclusions based upon a review of the record, the ALJ supported the FDIC's position with respect to the Bank's poor financial condition and the need to purge loans classified as "Loss", reduce assets classified as "Substantial", improve the level of reserve for loan losses, inject $450,000 in additional capital and submit a budget and progress reports to the FDIC. The ALJ departed from the FDIC's position in declining to find that the condition of the Bank was due to mismanagement and consequently declined to order a replacement of the Bank's loan officer with an outsider.
   With respect to the findings concerning the level of adversely classified loans and adequacy of the reserve for loan losses, the ALJ offered little rationale for his decision that affirmative actions should be taken. This could be due to the fact that there was no real dispute that these conditions existed, there was a universally acknowledged need to correct them and the Respondent was generally willing to take such actions (although not pursuant to an Order to Cease and Desist).
   The ALJ was less comfortable with his order to inject $450,000 in additional capital into the Bank. Although the ALJ was not convinced by the evidence on the record that such an undertaking would be feasible, he recommended that the action be taken as it was clear that additional capital was necessary.
   The ALJ had difficulty in understanding FDIC's position that the financial condition of the Bank was due to mismanagement by the Respondent. As the ALJ viewed the FDIC's argument, the undisputed evidence that the Bank has serious problems based upon the amount of adversely classified assets, the low level of reserves for loan losses and three years of deficit earnings and an inadequate and eroding capital base raised a presumption that these conditions were caused by the mismanagement of the Respondent.
   Based upon his reservations about this logic, the ALJ could not conclude that the failure of the Respondent to resolve the Bank's problems established the existence of mismanagement and warranted the retention of a new lending officer.

DECISION

   After a careful review and consideration of the entire record in this proceeding, the FDIC's Board of Directors adopts the ALJ's recommended decision in its entirety with minor modifications, both substantive and procedural in nature.
   The FDIC has established by substantial evidence that the Bank was in poor financial condition and that affirmative action to purge loans classified as "Loss", reduce assets classified as "Substandard", improve the level of reserves for loan losses and submit a budget and progress reports to the FDIC was necessary and appropriate in such a situation. It is clear from the record that these actions are consistent with a prudent effort to correct the problems and deficiencies of the Bank.

   [.1—.2] The need to inject $450,000 in additional capital into the Bank was also supported by substantive evidence in the record. While the other affirmative actions are more short term responses to the Bank's problems, this action is designed to achieve a more long-term result—a significant improvement in the Bank's financial stability. The ultimate feasibility of such an undertaking is not as significant in comparison with the obvious need to attempt such an action. Further, there is no evidence that the FDIC has the responsibility to prove such an action is feasible, although testimony indicated that it could be accomplished in this case. The FDIC has the right to be satisfied that a problem bank has exhausted all methods of correcting its deficiencies. In this instance, the Respondent's reluctance to inject additional capital into the Bank indicates a desire to place the risk of the ultimate success or failure of the Bank on the FDIC insurance fund, rather than on the shareholders, directors and management of the institution. It should be the responsibility of these parties to make every attempt to correct the Bank's problems and the FDIC has the right to expect that such efforts will be undertaken. For these reasons, the FDIC's Board of Directors adopts {{4-1-90 p.A-212}}the ALJ's findings pertaining to the injection of $450,000 of additional capital.
   While it has been established that the Respondent is responsible for correcting the Bank's deficiencies, it has not been established by substantial evidence that the Respondent is responsible for failing to prevent the Bank's problems. The Respondent has argued that the Bank's problems were originated by previous management and that intervening external factors have hampered efforts to correct them. The evidence introduced by the FDIC concerning current management's culpability involved the renewal of some problem loans originated by prior management. In rebuttal, the Respondent provided evidence of past and current efforts to remedy the problems and deficiencies of the Bank. An assessment of both these arguments is inconclusive in determining a causal connection between the Bank's problems and mismanagement by the Respondent. Thus, the FDIC's primary contention that the Respondent is responsible for the Bank's condition is that the condition exists.

   [.3] While it is likely that the actions (or lack thereof) of the Respondent had an impact on the Bank's condition, the FDIC has not established a causal connection by substantial evidence. The fact that the vast majority of bad loans were originated by prior management, the difficulty in upgrading adversely classified assets due to the depressed regional economy and evidence of efforts made by management to correct the situation, must be considered in determining the culpability for the Bank's condition and tends to rebut FDIC's assertion of mismanagement. In light of this analysis, the focus of this proceeding is more appropriately placed upon correcting the situation rather than determining culpability for its existence.

Findings of Fact

   Consistent with the above discussion, the FDIC's Board of Directors adopts the Findings of Fact of the ALJ in their entirety with several modifications. The FDIC's Proposed Finding of Fact paragraph number 7, pertaining to FDIC examinations, shall be incorporated into the Board's findings. It is clear from the record that the results of the FDIC's examinations and the conclusions drawn from them were in accordance with the appropriate standards. The FDIC provided substantial evidence as to the existence and validity of these guidelines which are critical to the conclusions drawn from the results of the examinations. Modifications to the figures in the ALJ's paragraphs number 28 and 29 should be made in accordance with the Respondent's exceptions and Proponent's Exhibit # 1A as discussed below.

Conclusions of Law

   The ALJ did not provide any specific conclusions of law in his opinion. Inasmuch as the ALJ supported the FDIC's position, the FDIC's Board of Directors adopts the conclusions of law proposed by the FDIC, omitting paragraph 6 which pertains to mismanagement and is not supported by the Findings of Fact. An analysis of the ALJ's Findings of Fact and subsequent recommendations for affirmative action establishes a nexus for the adoption of the FDIC's Proposed Conclusions of Law as modified.

Order

   The ALJ recommended that certain affirmative action be ordered but failed to issue a formal, numbered Order to Cease and Desist. The FDIC's Board of Directors adopts FDIC's Proposed Order to Cease and Desist to the extent that it reflects the recommendations of the ALJ. This results in the deletion of paragraph 1 which pertains to the retention of a new chief lending officer from outside the Bank. Not only is this proposed order unsupported by the Findings of Fact and the Conclusions of Law, as previously discussed, but the issue has been rendered moot as the record indicates that the Respondent has hired a new chief lending officer. Paragraphs 2(c) and 2(d) of FDIC's Proposed Order, which are not specifically included in the ALJ's recommendations, shall be included in the Order as an extension of the ALJ's general recommendation to improve the bank's loan portfolio.1

EXCEPTIONS

   Subsequent to the ALJ's recommended decision, both parties submitted exceptions to the findings and conclusions. These


1 The ALJ's paragraph on page 8 of the recommended decision pertaining to paragraph 2(b) of FDIC's Proposed Order contains an obvious error with reference to the need to reduce "Substandard" assets. The correct figure is $1,000,000 rather than $1,000.
{{4-1-90 p.A-213}}exceptions have been reviewed and considered as follows.

Proponent's Exceptions

   The FDIC excepted to the ALJ's failure to find facts requested in paragraph 7 and paragraphs 46-51 of the FDIC's Proposed Findings of Fact.
   As previously discussed, it was found that the facts contained in paragraphs 47-51 pertaining to mismanagement were not supported by substantial evidence and were properly omitted from the ALJ's findings. The FDIC has offered no basis for their exception to the omission of paragraph 46. For reasons stated above, FDIC's paragraph 7 has been incorporated in the Findings of Fact adopted by the Board.
   The FDIC also excepted to the ALJ's failure to adopt its Proposed Conclusions of Law as contained in its initial brief. As discussed above, the FDIC's Conclusions of Law have been adopted except for one provision.
   With respect to the ALJ's order, the FDIC has conceded that paragraph 1 of its Proposed Order is now moot and has urged the adoption of paragraph 2 in its entirety. These assertions are consistent with the order issued by the Board herein.

Respondent's Exceptions

   The Respondent filed lengthy exceptions to the ALJ's recommended decision. Without responding to each exception individually, the Respondent's exceptions to the ALJ's Findings of Fact can be categorized as articulating several basic arguments.
   The general theme of many of the Respondent's exceptions is that the ALJ's Findings of Fact are not supported by substantial evidence in the record. Absent specific examples of evidence contrary to the ALJ's findings, however, these exceptions are little more than self-serving characterizations and are dismissed as being without merit.
   One exception took issue with the ALJ's characterization of the Bank's "maintaining" the adversely qualified assets as indicating management's acquiescence with the Bank's condition. This exception is without merit for it seems to overlook the fact that the ALJ made no findings of mismanagement by Respondent.
   The Respondent also excepts to generalized conclusions pertaining to the quality of the Bank's assets as a whole rather than an asset by asset analysis. This exception overlooks the fact that the FDIC's examination reports, which contain such an analysis, are part of the record as Proponent's Exhibits 1, 2, and 3.
   The Respondent further excepts to the ALJ's Findings of Fact alleging an error in the calculation of the adjusted total assets of the Bank. The Respondent claims that the ALJ erroneously included $25,000 in classified losses in connection with the * * * property. The Respondent also excepts to the ALJ's finding that the adjusted capital and reserves on December 17, 1982 equalled 6.1% of the adjusted total assets of the Bank. Pursuant to Proponent's Exhibit # 1A, these figures should be adjusted as indicated. The correction of the inadvertent errors contained in the ALJ's Findings of Fact numbered 28 and 29 is in no way inconsistent with the finding that unsafe or unsound banking practices exist.
   In a number of other exceptions to the ALJ's Findings of Fact, the Respondent challenges the relevance of adequate loan loss reserves to the financial soundness of the Bank, the inclusion of data pertaining to net loss during part of 1983, and the failure of the ALJ to include specific findings regarding the economic conditions at the time in question. The Board finds these exceptions to be without merit.
   The bulk of the Respondent's remaining exceptions focus on allegations that the ALJ's findings and conclusions drawn from the factual evidence, such as adverse loans being "excessive" or "disproportionate" to assets and capital reserves, cannot be sustained absent evidence establishing standards upon which the conclusions are based. The Respondent takes issue with the validity of FDIC policy statements as a proper measure of potential loan losses, adequacy of reserves for loan losses and other factors indicative of unsafe or unsound practices. Based upon the record, the Board finds these exceptions to be without merit. The FDIC introduced a number of policy statements and guidelines utilized in determining whether the existence of certain conditions evidence unsafe or unsound practices. An abundance of oral testimony was based upon these exhibits. The Respondent {{4-1-90 p.A-214}} had ample opportunity to raise objections to the introduction of these exhibits at the hearing and to test their reliability and credibility through cross-examination of FDIC witnesses. The Respondent did not do so. In fact, the Respondent's expert witness relied on information derived from these exhibits in his testimony. Having been unwilling or unable to raise these issues at the hearing, there is no legitimate basis for the Respondent to contest the validity of these standards and the conclusions derived therefrom without having developed evidence upon which to base such exceptions.
   The Respondent also excepts to the ALJ's conclusions of law, although no formal conclusions were rendered. The Respondent interprets the ALJ's findings of no mismanagement as a basis for arguing that no cease and desist order has been recommended. This assertion is without merit. While the ALJ did not find the Respondent responsible for failing to prevent the unsafe or unsound practices, his decision clearly holds the Respondent responsible for taking all reasonable steps to correct them. The ALJ's determination is wholly consistent with the record.
   The Respondent also excepts to the recommended orders of the ALJ but provides no rationale other than the assertion that no evidence exists to support the ALJ's decision. A review of the record indicates otherwise.

FINDINGS OF FACT

   1. The Bank is an insured, state-chartered bank which is subject to the Federal Deposit Insurance Act and the Rules and Regulations of the FDIC.
   2. The Board of Directors of the Bank is composed of eight members, six of whom have served since March, 1979 and the others since July, 1980.
   3. The Bank was examined by the FDIC on September 29, 1980; on August 7, 1981; and on December 17, 1982.
   4. The FDIC examinations were conducted in accordance with published examination instructions, guidelines, standards, and criteria.
   5. As of September 29, 1980, the Bank maintained past due loans totalling $1,686,700 which equalled 15.2 percent of the total loans of the Bank.
   6. The volume of past due loans of the Bank as of September 29, 1980, was excessive in relation to the total loans of the Bank.
   7. As of August 7, 1981, the Bank maintained past due loans totalling $1,383,300, which equalled 13.22 percent of the total loans of the Bank.
   8. The volume of past due loans of the Bank as of August 7, 1981, was excessive in relation to the total loans of the Bank.
   9. As of December 17, 1982, the Bank maintained past due loans totalling $1,848,300, which equalled 17.45 percent of the total loans of the Bank.
   10. The volume of past due loans of the Bank as of December 17, 1982, was excessive in relation to the total loans of the Bank.
   11. In the FDIC examinations of the Bank conducted in 1980, 1981, and 1982, assets of the Bank were examined and analyzed for asset quality and assigned a designated classification of "Substandard," "Doubtful," or "Loss."
   12. It has been the general experience of the FDIC that the amount of loss that will be sustained by a bank for loans that are adversely classified "Substandard" is approximately 18 percent of the gross amount of such loans; however, the amount of such loss is higher for banks examined by the FDIC in the State of * * * and is approximately 25 percent of the gross amount of such loans.
   13. It has been the general experience of the FDIC that the inherent amount of loss that will be sustained by a bank for loans that are adversely classified "Doubtful" is approximately 50 percent of the gross amount of such loans.
   14. Assets of a bank classified "Loss" in an FDIC examination are considered uncollectable and are of such little value that their continuance as bankable assets is unwarranted; such assets, therefore, should not be carried on the books of the bank.
   15. As of September 29, 1980, the Bank maintained loans adversely classified by the FDIC totalling $1,039,500, which equalled 9.03 percent of the total loans of the Bank, including loans totalling $1,007,900, classified "Substandard," and loans totalling $31,600 classified "Loss."
   16. As of August 7, 1981, the Bank maintained loans adversely classified by the {{4-1-90 p.A-215}} FDIC totalling $1,165,000, which equalled 10.5 percent of the total loans of the Bank including loans totalling $1,111,500 classified "Substandard" and loans totalling $54,100 classified "Loss."
   17. As of December 17, 1982 the Bank maintained loans adversely classified by the FDIC totalling $1,163,000, which equalled 10.98 percent of the Bank's total loans including loans totalling $1,062,000 classified "Substandard" and loans totalling $101,000 classified "Loss."
   18. As of September 29, 1980, the Bank maintained assets totalling $1,224,300 that were adversely classified by the FDIC, which equalled 7.6 percent of the total assets of the Bank, and 90.67 percent of the total capital and reserves of the Bank.
   19. The volume of the total assets of the Bank that were adversely classified by the FDIC as of September 29, 1980, was excessive in relation to the total assets of the Bank, and was disproportionate in relation to the total capital and reserves of the Bank as of the same date.
   20. As of August 7, 1981, the Bank maintained assets totalling $1,623,000 that were adversely classified by the FDIC, which equalled 9.78 percent of the total assets of the Bank, and 125.13 percent of its total capital and reserves.
   21. The volume of the total assets of the Bank that were adversely classified by the FDIC as of August 7, 1981, was excessive in relation to the total assets of the Bank, and was disproportionate in relation to its total capital and reserves.
   22. As of December 17, 1982, the Bank maintained assets totalling $1,599,000 that were adversely classified by the FDIC, which equalled 9.65 percent of the total assets of the Bank, and 142.01 percent of its total capital and reserves.
   23. The volume of the total assets of the Bank that were adversely classified by the FDIC as of December 17, 1982, was excessive in relation to the total assets of the Bank, and was disproportionate in relation to its total capital and reserves.
   24. As of December 17, 1982, the Bank was operating with a reserve for loan losses totalling $118,000; as of the same date, the Bank had loans totalling $101,000 that were adversely classified "Loss" by the FDIC.
   25. After the elimination of all loans of the Bank adversely classified "Loss" as of December 17, 1982 by a charge to the loan loss reserve of the Bank, the remaining balance in the loan loss reserve of the Bank was reduced to $17,000.
   26. A loan loss reserve of the Bank totalling $17,000 as of December 17, 1982, was inadequate to absorb future loan losses inherent in the loans of the Bank classified by the FDIC as "Substandard."
   27. The failure of the Bank to make provisions for an adequate loan loss reserve to absorb future loan losses of the Bank resulted in the misstatement of the actual earnings and income of the Bank.
   28. As of December 17, 1982, the Bank was operating with total capital and reserves of $1,126,000; after adjusting such capital and reserves to eliminate all assets of the Bank adversely classified "Loss" and 50 percent of all assets adversely classified "Doubtful" as of the same date, the total adjusted capital and reserves of the Bank equalled $1,017,000.
   29. As of December 17, 1982, the Bank was operating with total assets of $16,564,000; after adjusting such total assets by adding the loan loss reserve of the Bank and eliminating all assets of the Bank adversely classified "Loss" and 50 percent of all assets adversely classified "Doubtful," the adjusted total assets of the Bank equalled $16,573,500.
   30. As of December 17, 1982, the Bank was operating with adjusted capital and reserves that equalled 6.14 percent of the adjusted total assets of the Bank; as of the same date, the Bank was operating with total assets that were adversely classified "Substandard" in the amount of $1,489,000 that equalled 146 percent of the adjusted capital and reserves of the Bank.
   31. As of December 17, 1982, the Bank was operating with capital and reserves that were inadequate in relation to the volume of inferior quality assets held by the Bank on such date.
   32. The Bank sustained net income losses of $15,000.00 in 1980, $27,000.00 in 1981, $206,000.00 in 1982, and $104,700.00 in the first five months of 1983.
{{4-1-90 p.A-216}}
CONCLUSIONS OF LAW

   1. The FDIC has legal jurisdiction and authority to issue an Order to Cease and Desist against the Bank under Section 8(b)(1) of the Act.

   [.4] 2. The Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by maintaining an excessive and disproportionately large volume of inferior quality assets in relation to the total capital and reserves of the Bank.
   3. The Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by failing to make provisions for an adequate reserve for loan losses of the Bank.
   4. The Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by misrepresenting and misstating the actual earnings and income of the Bank.
   5. The Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by operating with inadequate capital and reserves in relation to the large volume of inferior quality assets held by the Bank.

   [.5] 6. The Board of Directors of the Bank had the legal duty and responsibility to take effective action to correct any problems or deficiencies in the operation of the Bank that have had a negative impact on the Bank's earnings and the quality of the Bank's assets, and which have caused a continued erosion of the Bank's capital and reserves, regardless of the time or date on which such problems or deficiencies may have originated.

ORDER TO CEASE AND DESIST

   IT IS HEREBY ORDERED, that * * * its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank, CEASE AND DESIST from the following unsafe or unsound banking practices.
   1. Operating the Bank with an excessive level of adversely classified assets.
   2. Operating the Bank with an inadequate reserve for loan losses.
   3. Operating the Bank with inadequate capital.
   IT IS FURTHER ORDERED, that * * * take affirmative action as follows:
   1. (a) Upon the effective date of this ORDER, the Bank shall eliminate from its books, by charge-off or collection, all assets or portions of assets classified "Loss" as of December 17, 1982, except for the * * * property carried in other real estate. Reduction of these assets through proceeds of other loans made by the Bank are not considered collection for the purpose of this paragraph.
   (b) Within 180 days from the effective date of this ORDER, the Bank shall reduce the total of the remaining assets classified "Substandard" as of December 17, 1982, to not more than $1,000,000 and within 360 days from the effective date of this ORDER, such assets shall be reduced to not more than $700,000.
   (c) Following 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 with the Bank that has been charged off or classified, in whole or in part, "Loss" and is uncollected. The requirements of this paragraph shall not prohibit the Bank from renewing (after collection of interest due in cash from the borrower) any credit already extended to any borrower.
   (d) The requirements of (a) and (b) above are not to be construed as standards for future operations and, in addition to the foregoing, the Bank shall eventually reduce all other adversely classified assets. As used in this ORDER, the "reduce" means (1) to collect, (2) to charge off, or (3) to sufficiently improve the quality of assets adversely classified to warrant removing any adverse classification, as determined by the FDIC.
   2. Within 60 days of the effective date of this ORDER, the Bank shall establish and continue to maintain an adequate reserve for loan losses and such reserve shall be established by charges to current operating income. In complying with the provisions of this paragraph, the board of directors of the Bank shall review the adequacy of the Bank's reserve for loan losses prior to the end of each calendar quarter. The minutes of the board meeting at which such review is undertaken shall indicate the results of the review, the amount of any increases in the reserves recommended, and the basis for determination of the amount of reserve provided.
{{4-1-90 p.A-217}}
   3. (a) Within 120 days of the effective date of this ORDER, the Bank's board of directors shall increase the Bank's total capital and reserves by not less than $450,000. Such increases in capital and reserves may be accomplished by:
   (i) Sale of common stock; or
   (ii) Sale of perpetual preferred stock; or
   (iii) Direct contribution of cash by the shareholders and/or directors of the Bank; or
   (iv) Cash collection of assets previously charged off; or
   (v) Cash collection of assets classified "Loss" as of December 17, 1982, without loss of liability to the Bank.
   (vi) Any combination of the above means
   (b) If all or part of the increase in total capital and reserves required by paragraph 3(a) of this ORDER is accomplished by the sale of new 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 stock, including voting any shares owned by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Bank's securities (including a distribution limited only to the Bank's existing shareholders) the Bank shall prepare offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Bank and the circumstances giving rise to the offering, and any other material disclosures necessary to comply with the Federal securities laws. Prior to the implementation of the plan and, in any event, not less than 30 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 at Washington, D.C. Any changes requested to be made in the plan or materials by the FDIC, shall be made prior to their dissemination.
   4. Within 60 days of the effective date of this ORDER, the Bank shall formulate, adopt and submit to the Regional Director of the FDIC's * * * Regional Office, a budget for a minimum of two years, designed to reduce expenses and increase retained earnings. The budget and adherence thereto shall be acceptable to the Regional Director.
   5. Every successive 60 days from the effective date of this ORDER, unless and until each and every correction required by this ORDER is accomplished, 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 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.
   The provisions of this ORDER shall be binding upon the Bank and its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank.
   The provisions of this ORDER shall become effective 30 days after it is served on the Bank or its officials and 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.
   By order of the Board of Directors.
   Dated at Washington, D.C., this 9th day of April, 1984.

/s/ Hoyle L. Robinson
Executive Secretary

Case FDIC-83-79b)

Before: JOHN H. FENTON,
Administrative Law Judge

RECOMMENDED DECISION

   This proceeding arises under Section 8(b)(1) of the Federal Deposit Insurance Corporation Act (12 U.S.C. 1818(b)(1). FDIC issued a Notice of Charges and of Hearing on April 7, 1983, pursuant to the provisions of Section 8(b)(1) and its Rules of Practice and Procedures (12 C.F.R. 308), alleging that the Bank and its Board of Directors (herein collectively called the Bank) had engaged in certain unsafe or unsound practices, and calling for a hearing to take evidence and determine whether a Cease and Desist Order should issue requiring the Respondent to end such practices and to take affirmative action to correct the conditions resulting from such practices.
   On April 27, Respondent filed its Answer to the Charges, admitting some allegations and denying others. A hearing was held on {{4-1-90 p.A-218}}June 28 and 29 in * * * before the undersigned.

Preliminary Statement

Background

   FDIC, in essence, alleges that the Branch has engaged in the following unsafe or unsound practices:

       (1) Maintaining an excessive and disproportionate volume of inferior quality assets in relation to its total capital and reserves.
       (2) Failing to provide an adequate reserve for loan losses (thus misstating actual earnings).
       (3) Operating with inadequate capital and reserves in relation to its large volume of inferior quality assets.
       (4) Failing adequately to supervise officers so as to avoid such detriment to the Bank and such jeopardy to the safety of its deposits.
   The Bank, while not quarreling with the facts alleged to constitute unsafe or unsound practices (1), (2) and (3), above, denies the legal conclusions drawn, and vigorously asserts that such facts are the result of unsafe or unsound practices by the prior Board of Directors, and that present management is doing as well as can prudently be done given such legacy.
   FDIC requests that the Bank be ordered to cease and desist from operating with an excessive level of adversely classified assets, with an inadequate reserve for loan losses, and with inadequate capital. It further requests the following affirmative action:
       (1) Appointment of a new chief lending officer acceptable to it, who shall not be a present employee of the bank.
       (2) Elimination by charge-off or collection, of all assets classified "Loss" as of December 17, 1982, except for the * * * property.
       (3) Substantial reduction of assets classified "Substandard" over the course of the year following the Order.
       (4) Limitations on the extension of further credit to borrowers whose loans are charged off or are classified loss and are uncollected.
       (5) Establishment of an adequate reserve for loan losses by charges to current operating income.
       (6) Injection of at least $450,000.00 in capital and reserves by any combination of common or perpetual preferred stock issues, direct contributions of shareholders or Directors, cash collection of assets previously charged off, or of assets classified "Loss" as of December 17, 1982.
       (7) Periodic submission to FDIC of a budget designed to reduce expenses and increase retained earnings, as well as progress reports detailing actions taken to secure compliance with such an Order.
   Respondent generally contends that the requested order is unwarranted, unnecessary and premature. Specifically, it asserts its willingness to appoint a new chief lending officer from outside the Bank (due to the incumbent's resignation), and its willingness to "initiate" action to establish an adequate reserve for loan losses. It indicates qualified and conditional acquiescence in the demand that assets classified as "Loss" be eliminated, and "Substandard" assets be substantially reduced and that further extensions of credit to borrowers whose loans have been charged off or classified "Loss" be stopped. It is also willing to submit a budget (within 180 rather than the requested 60 days) and to furnish progress reports every 90 days, as opposed to the proposed 60 days. However, it strongly opposes any effort to inject further capital (except by cash collection of assets charged off or classified "Loss") on the ground that it is unnecessary that there is, in any event, no substantial evidence that an increase is feasible, and that imposition of the requirement would therefore result only in a substantial and unwarranted expense to the Bank.
   * * * Bank is located in * * *, a small town in the northwest part of the Lower Peninsula. During material times that town and its environs have suffered through a recession of rather severe dimensions, with unemployment ranging upwards of three times the national norm. Prior to 1979, when the new Board of Directors assumed control of the Bank's affairs, the Bank had made many long-term, low-interest loans. It was soon caught up in the combination of rapidly rising interest rates, unemployment and the effects of banking deregulation. Whatever the quality of evidence on these points, we well as the relevancy of such circumstances to this inquiry, I think its fair to conclude that there was no real dispute over the fact that present management was {{4-1-90 p.A-219}} thus saddled with many long-term, low-yielding notes, with increasing costs for its money, and with an economy (and hence collateral) which was collapsing. It was clearly established that the great majority of the problem notes in the loan portfolio were issued by prior management, and that the Bank Examiner who first noted the deteriorating trends at the bank in 1980 expressed some confidence in the capacity of * * * Chairman of the Board of Directors, to manage such problems because of his reputation as a good and "conservative" banker.
   I dwell on these matters at the outset because I am frankly confused by the FDIC approach to much of this case. In its pretrial memorandum, FDIC, after acknowledging that many of the Bank's adversely classified and low quality assets originated with prior management, asserted that:
       current bank management has had sufficient time to correct many of the errors of prior management, but failed to retain an adequate staff to fully address the problems in the loan portfolio. Management failed to take obvious and necessary steps to improve earnings, inject capital, collect loans, improve lending techniques, and create an adequate reserve for loan losses.
   Naively, I anticipated an inquiry into specific courses of conduct alleged to constitute unsafe or unsound approaches to the business of managing a bank.1Except for the matter of the admitted failure to create an adequate reserve for loan losses, I was instead confronted with largely undisputed evidence that the Bank was in serious shape based on its level of adversely classified assets, its high loan losses, its three consecutive years of deficit earnings and an inadequate and eroding capital base. From this present (and developing) posture, FDIC simply posits mismanagement as the cause. In something akin to the doctrine of res ipsa loquitur, or perhaps the converse of post hoc ergo propter hoc, FDIC appears to reason that an institution in bad shape must be the result of bad management. Thus reasoning from effect back to cause, it eliminates as irrelevant the question whether these alleged unsafe and unsound practices are not, in fact, the consequences of external forces with which a management stipulated to be absolutely first-rate could not have coped any more successfully than have the incumbents.
   At the hearing, I repeatedly tried to make clear my need for help in grasping the notion that one can reliably so reason from effect back to cause, thus pinning culpability for unsafe and unsound practices without any significant evidence of imprudent actions taken. One could, similarly, look at the sad condition of a house's paint, and conclude that the occupant has for years seriously neglected his maintenance responsibilities. One might also learn, upon inquiry, that a rasping sand storm struck it the day before. As I understand FDIC, such an intervening event is inconsequential, the plain fact being that the paint job no longer constitutes adequate protection for the structure and the sole and self-evident cause being unsafe and unsound maintenance practices. While FDIC, understandably, would not wish to assume the burden of monitoring and second-guessing the Bank's every move, traditional norms would suggest that it, as proponent, would be required to establish some measure of poor lending, investment, collection, payroll or other practice inimical to the financial health of the institution and its depositors.2

Findings of Fact

   1. The Bank is an insured, state-chartered bank which is subject to the Federal Deposit Insurance Act and the Rules and Regulations of the FDIC.
   2. The Board of Directors of the Bank is composed of eight members, six of whom have served since March, 1979 and the others since July, 1980.


1 One court defined "unsafe and unsound practice" as follows: "Generally speaking (it) embraces any actionor lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk of loss or damage to an institution, its shareholders or the agencies administering the insurance funds." (Emphasis mine). As examples, the Court gave such "management defalcations as paying excessive dividends, disregarding a borrower's ability to repay, careless control of expenses and inadequate liquidity." Except perhaps for the last, these are examples of actions within management's clear control. See Gulf of Federal Savings and Loan v. Federal Home Loan Bank Board, 651 F.2d 259 (CA5, 1981).

2 I find solace for my inability fully to fathom the nature of this proceeding in the following observation about banking regulations in K.C. Davis' Administrative Law Treatise(1958, Section 4.04, page 250). "The hearing, when one is held, is said to be `merely a concession to convention, rather than a serious aid to the formation of an informed judgement."'
{{4-1-90 p.A-220}}
   3. The Bank was examined by the FDIC on September 29, 1980; on August 7, 1981; and on December 17, 1982.
   4. As of September 29, 1980, the Bank maintained past due loans totalling $1,686,700, which equalled 15.2 percent of the total loans of the Bank.
   5. The volume of past due loans of the Bank of September 29, 1980, was excessive in relation to the total loans of the Bank.
   6. As of August 7, 1981, the Bank maintained past due loans totalling $1,383,300, which equalled 13.22 percent of the total loans of the Bank.
   7. The volume of past due loans of the Bank as of August 7, 1981, was excessive in relation to the total loans of the Bank.
   8. As of December 17, 1982, the Bank maintained past due loans totalling $1,848,300, which equalled 17.45 percent of the total loans of the Bank.
   9. The volume of past due loans of the Bank as of December 17, 1982, was excessive in relation to the total loans of the Bank.
   10. In the FDIC examinations of the Bank conducted in 1980, 1981, and 1982, assets of the Bank were examined and analyzed for asset quality and assigned a designated classification of "Substandard," "Doubtful," or "Loss."
   11. It has been the general experience of the FDIC that the amount of loss that will be sustained by a bank for loans that are adversely classified "Substandard" is approximately 18 percent of the gross amount of such loans; however, the amount of such loss is higher for banks examined by the FDIC in the State of * * * and is approximately 25 percent of the gross amount of such loans.
   12. It has been the general experience of the FDIC that the inherent amount of loss that will be sustained by a bank for loans that are adversely classified "Doubtful" is approximately 50 percent of the gross amount of such loans.
   13. Assets of a bank classified "Loss" in a FDIC examination are considered uncollectable and are of such little value that their continuance as bankable assets is unwarranted; such assets, therefore, should not be carried on the books of the bank.
   14. As of September 29, 1980, the Bank maintained loans adversely classified by the FDIC totalling $1,039,500, which equalled 9.03 percent of the total loans of the Bank, including loans totalling $1,007,900, classified "Substandard," and loans totalling $31,600 classified "Loss."
   15. As of August 7, 1981, the Bank maintained loans adversely classified by the FDIC totalling $1,165,600, which equalled 10.5 percent of the total loans of the Bank, including loans totalling $1,111,500 classified "Substandard" and loans totalling $54,100 classified "Loss."
   16. As of December 17, 1982, the Bank maintained loans adversely classified by the FDIC totalling $1,163,000, which equalled 10.98 percent of the Bank's total loans including loans totalling $1,062,000 classified "Substandard" and loans totalling $101,000 classified "Loss."
   17. As of September 29, 1980, the Bank maintained assets totalling $1,224,300 that were adversely classified by the FDIC, which equalled 7.6 percent of the total assets of the Bank, and 90.67 percent of the total capital and reserves of the Bank.
   18. The volume of the total assets of the Bank that were adversely classified by the FDIC as of September 29, 1980, was excessive in relation to the total assets of the Bank, and was disproportionate in relation to the total capital and reserves of the Bank as of the same date.
   19. As of August 7, 1981, the Bank maintained assets totalling $1,623,000 that were adversely classified by the FDIC, which equalled 9.78 percent of the total assets of the Bank, and 125.13 percent of its total capital and reserves.
   20. The volume of the total assets of the Bank that were adversely classified by the FDIC as of August 7, 1981, was excessive in relation to the total assets of the Bank, and was disproportionate in relation to its total capital and reserves.
   21. As of December 17, 1982, the Bank maintained assets totalling $1,599,000 that were adversely classified by the FDIC, which equalled 9.65 percent of the total assets of the Bank, and 142.01 percent of its total capital and reserves.
   22. The volume of the total assets of the Bank that were adversely classified by the FDIC as of December 17, 1982, was excessive in relation to the total assets of the Bank, and was disproportionate in relation to its total capital and reserves.
{{4-1-90 p.A-221}}
   23. As of December 17, 1982, the Bank was operating with a reserve for loan losses totalling $118,000; as of the same date, the Bank had loans totalling $101,000 that were adversely classified "Loss" by the FDIC.
   24. After the elimination of all loans of the Bank adversely classified "Loss" as of December 17, 1982 by a charge to the loan loss reserve of the Bank, the remaining balance in the loan loss reserve of the Bank was reduced to $17,000.
   25. A loan loss reserve of the Bank totalling $17,000 as of December 17, 1982, was inadequate to absorb future loan losses inherent in the loans of the Bank classified by the FDIC as "Substandard."
   26. The failure of the Bank to make provision for an adequate loan loss reserve to absorb future loan losses of the Bank resulted in the misstatement of the actual earnings and income of the Bank.
   27. As of December 17, 1982, the Bank was operating with total capital and reserves of $1,126,000; after adjusting such capital and reserves to eliminate all assets of the Bank adversely classified "Loss" and 50 percent of all assets adversely classified "Doubtful" as of the same date, the total adjusted capital and reserves of the Bank equalled $1,017,000.
   28. As of December 17, 1982, the Bank was operating with total assets of $16,564,000; after adjusting such total assets by adding the loan loss reserve of the Bank and eliminating all assets of the Bank adversely classified "Loss" and 50 percent of all assets adversely classified "Doubtful," the adjusted total assets of the Bank equalled $16,548,000.
   29. As of December 17, 1982, the Bank was operating with adjusted capital and reserves that equalled 6.1 percent of the adjusted total assets of the Bank; as of the same date, the Bank was operating with total assets that were adversely classified "Substandard" in the amount of $1,489,000 that equalled 146 percent of the adjusted capital and reserves of the Bank.
   30. As of December 17, 1982, the Bank was operating with capital and reserves that were inadequate in relation to the volume of inferior quality assets held by the Bank on such date.
   31. The Bank sustained net income losses of $15,000.00 in 1980, $27,000.00 in 1981, $206,000.00 in 1982, and $104,700.00 in the first five months of 1983.

Conclusions

   For the reasons given in the preliminary statement, I have great difficulty in concluding, merely from the failure of the Board of Directors to abate or reverse these obviously adverse trends, that mismanagement and the need for a new chief lending officer are thereby established.3However, the request for a new lending officer is probably mooted, given attorney * * * representation that * * * has resigned, and that a new officer will be recruited. In any event, I decline on this record to recommend a finding that the loan officer has failed to discharge his responsibilities prudently, or an order that he be replaced by an outsider.
   I find record support for the need to purge the Bank's assets of the inordinately large volume of loans classified as "Loss," on December 17, 1982, and recommend that an order be entered requiring it to make every effort to eliminate such loans by charge-off or collection (or improvement in the quality of the assets).
   I find record support for an order that the Bank within 180 days of this decision shall assiduously attempt to reduce those assets classified "Substandard" on December 17, 1982 to not more than $1,000.00, and within 360 days to not more than $700,000, by the same means.
   Likewise, the clear need has been demonstrated for substantial improvement in the level of the reserve for loan losses. I therefore recommend that such transfers shall be made, from current operating income, in the manner set forth in paragraph 3 page 34, of the Proposed Order submitted by FDIC.
   I find most troubling the proposal that at least $450,000 in additional capital be injected into this enterprise, whether by stock sale or by direct contributions of shareholders and/or Directors. There is no convincing evidence on this record that such a sale


3 I do not find, from * * * admission that he could have used assistance in the collection effort, that such function was undermanned. Most incumbents seem to be of that view and, as one would expect, * * * defended the Bank's stewardship in this area.
{{4-1-90 p.A-222}}is feasible. The local bank examiner expressed his doubts respecting such a sale, and the testimony that a local broker expressed interest is hardly persuasive. While I am persuaded that the capital base must, if possible, be strengthened, I find it far from clear that such a move is feasible. Nevertheless, given my understanding of my role in this controversy, and my conclusion that the infusion of further capital would be highly desirable, ie., would be mandated if clearly available, I see no alternative to the FDIC's proposal set forth in paragraph 4 of its Proposed Order. I therefore adopt it, notwithstanding my misgivings.
   I further adopt paragraphs 5 and 6 of that Proposed Order, and specifically provide that all the provisions of this recommended order shall be binding on the Bank, its Directors, officers, employees, agents, successors and assigns. The requirements for affirmative action shall become effective ten days after issuance of this decision, except to the extent that they be modified or terminated by FDIC.

/s/ John H. Fenton
Administrative Law Judge
Dated: December 9, 1983
Washington, D.C.

ED&O Home | Search Form | Text Search | ED&O Help

Last Updated 6/6/2003 legal@fdic.gov