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FDIC Enforcement Decisions and Orders

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   [5024]FDIC Docket No. FDIC-83-132b (6-18-84).

   Bank ordered to cease and desist from unsafe or unsound banking practices that included the maintaining of inadequate capital and loan-loss reserves. The FDIC also restricted the lending powers of the bank's president and director by withdrawing his power to extend credit to borrowers in excess of a certain amount. (This decision was affirmed by the U.S. Court of Appeals for the Sixth Circuit, 770 F.2d 81 (1985)).

   [.1]Unsafe or Unsound Banking Practice—Statutory Standard
   An "unsafe or unsound practice" is one that is contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder.

   [.2]Lending and Collection Policies and Procedures—Excessive Risk of Loss
   When a bank makes unsecured loans without first getting adequate financial information, makes loans without adequate security, fails to establish and enforce realistic programs for the repayment of loans, or makes secured loans without complete supporting documentation, it incurs an extra risk that the loan will not be repaid, and thereby presents an abnormal risk of loss to the bank and its shareholders. Each of these activities is an unsafe or unsound banking practice.

   [.3]FDIC—Rulemaking Authority
   Banking agencies have the authority to fashion relief in a form to prevent future abuses.

   [.4]Cease and Desist Orders—Additional Capital Ordered
   If a bank is operating in an unsafe or unsound condition, and the condition is attributable to an inadequate level of capital, the appropriate regulatory agency may require the bank to raise its capital to an acceptable level.

   [.5]Cease and Desist Orders—Defenses—Cessations of Violating
   The FDIC may issue a cease and desist order solely on the basis that the bank has engaged in violations of law, even when the violations have already been corrected, if the purpose of the order is to assure that the violations do not recur.

   [.6]Cease and Desist Orders—When Appropriate
   It is lawful to issue a cease and desist order as a means of rectifying the conditions currently affecting the bank.

   [.7]Cease and Desist Orders—Lending Authority Restricted
   FDIC may compel a bank to remove a director's lending powers as a corrective measure authorized by Federal Deposit Insurance Act §8(b)(1)[¶2002]. The FDIC may require a bank to take affirmative action to correct the conditions resulting from violations of law or unsafe or unsound banking practices.

   [.8]Cease and Desist Orders—Effective date
   Cease and desist orders become effective at the expiration of 30 days after service. 12 C.F.R. §308.36(b), [¶2136].

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   [.9]Capital—Adequacy—Reflection of Risk
   Ordinarily, the FDIC considers a 5% capital ratio to be adequate protection against loan loss. But that ratio is appropriate for sound banks, not for ones that have suffered losses and continue to be exposed to unusually high risks. In the latter cases, a higher level of capital is appropriate.

   [.10]Cease and Desist Orders—When Appropriate
   A cease and desist order may be issued when a bank is, has, or is about to engage in an unsafe or unsound practice or, when a bank is, has, or is about to violate a law, rule, or regulation.

In the matter of: * * * BANK OF * * *
COUNTY (FORMERLY CITY AND
COUNTY BANK OF * * * COUNTY)
* * * (INSURED STATE
NONMEMBER BANK)


DECISION AND ORDER TO CEASE
AND DESIST
FDIC-83-132b

STATEMENT OF THE CASE

   On June 8, 1983, the FDIC issued a Notice of Charges and of Hearingagainst the * * * Bank of * * * County, * * * ("the Bank"). The FDIC charged that the Bank had engaged in improper lending and collection practices, and had failed to maintain adequate capital and loan-loss reserves. The FDIC also charged that the Bank had violated state and federal laws limiting aggregate loans1to individuals.
   The FDIC proposed a cease-and-desist order. The Proposed Order called for the Bank to modify its lending policies and practices, to maintain adequate reserves for loan losses, to increase capital to 7.5 percent of adjusted total assets, and to improve the Bank's internal procedures. The Proposed Order also called for the Bank to provide management acceptable to the FDIC and to remove all lending authority from Mr. * * *, president of the Bank.
   Administrative Law Judge Donald W. Mosser held hearings from September 26 through 28, 1983. He issued his Recommended Decisionon February 28, 1984. Both sides have filed exceptions.

THE ISSUES

   Judge Mosser formulated the issues as follows:
   1. whether unsafe and unsound banking practices and violations of law, rule and regulation have occurred and, if so, whether a cease and desist order should be issued;
   2. whether the provision in the proposed cease and desist order requiring the removal of * * *'s lending authority is supported by law; and,
   3. whether the respondent should be required to maintain total equity and capital reserves at not less than 7.5 percent of adjusted total assets during the time required in the proposed cease and desist order.
   Neither the FDIC staff nor the Bank objects to this statement of the issues. The Board considers that they properly incorporate all the questions presented by the parties. Accordingly, the Board adopts Judge Mosser's formulation.

THE FACTS

I. Judge Mosser's Findings as Adopted by the Board

   Judge Mosser summarized the record in thirty-seven recommended Findings of Fact. Neither the FDIC staff nor the Bank objects to any of Judge Mosser's recommended Findings. The Board adopts all of them but one.
   The Board declines to adopt Judge Mosser's Finding #35. That Finding reads:

       35. The Bank's net equity capital (capital less adversely classified assets) was a negative $1,742,000 as of January 31, 1983. By April 30, 1983, the Bank's net equity capital was a negative $2,247,000. From the period January 31, 1983 through June 30, 1983, the Bank expensed $2,375,000 for loan losses which

1 The Bank extended credit in several different ways. The differences among the ways are not important for this case, however. For the sake of simplicity, all extensions of credit are referred to herein as "loans."
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    resulted in it reporting a loss of $1,493,000 for the first six months of 1983.
   The Board considers, however, that the statistics presented in the final sentence do not have a proper foundation in the record. Accordingly the Board replaces Judge Mosser's Finding #35 with the following:
       35. The Bank's net equity capital (capital less adversely classified assets) was a negative $1,742,000 as of January 31, 1983. By April 30, 1983, the Bank's net equity capital was a negative $2,247,000. From the period January 31, 1983, through June 30, 1983, the Bank expensed $2,527,000 for loan losses which resulted in it reporting a loss of $1,662,000 for the first six months of 1983.
   This finding provides an equally strong foundation for the conclusions of law recommended by Judge Mosser and adopted by the Board.
   The Board also adopts two additional Findings which have been proposed by the FDIC staff:
       38. Mr. * * * knew of an illegal transaction and failed to bring the transaction to the attention of his fellow directors.
       39. Mr. * * * misled the FDIC or directed a Bank officer to communicate to the FDIC in a way that was intended to mislead the FDIC.
   These findings are fully supported by the record, and required in connection with the Board's determination to require the Bank to impose restrictions on Mr. * * *'s authority to make loans on the Bank's behalf.
   The Board adopts Judge Mosser's recommended Findings of Fact, as modified herein,2and incorporates them by reference.

II. The Bank's Exceptions to Judge Mosser's Findings of Fact

   The Bank does not formally challenge any of Judge Mosser's findings. But in its Exceptions to Judge Mosser's Recommended Decision, the Bank asserts several facts that do not appear in Judge Mosser's Findings:
   —* * * and * * * acquired the Bank as trustees for a bank holding company to be formed (which was formed).
   —The Bank entered into a management contract with * * * Corporation, a company owned and controlled by * * *.
   —* * * was elected chairman of the board and chief executive officer of the Bank.
   —Mr. * * * hired Mr. * * * to serve as the Bank's president.
   —Mr. * * * told Mr. * * * that Mr. * * * was to manage the Bank's local affairs, and that Mr. * * * himself would make and approve out-of-area loans and participations.
   —Mr. * * * approved these loans in * * *.3
   —Mr. * * * told the Bank's board of directors that all out-of-area loans would be sound.
   —Mr. * * * approved the out-of-area loans criticized by the FDIC examiners during the January examination.4
   —The Bank funded the loans out of its correspondent account at * * * Bank of * * * County (* * *.).5
   —The Bank asked for information on criticized loans from the originating banks, and also from the FDIC (which is the receiver for some of those banks), but that neither the banks nor the FDIC supplied the information.


2 The Board also corrects certain nonsubstantive errors in Judge Mosser's Findings of Fact:
   Finding #4: Judge Mosser says, "* * * and * * * had a combined loan limit of $200,000.00 secured and $300,000.00 unsecured." These figures should be reversed.
   Finding #19: Judge Mosser speaks of a loan to * * * on October 15, 1983. The proper date is October 15, 1982.
   Findings #11 & 24: Judge Mosser speaks of a loan to * * * as being dated October 29, 1982 (Finding #11) and November 3, 1982 (Finding #24). The parties stipulated that the loan was made on November 3.
   Finding 26: Judge Mosser speaks of a loan to "* * * Company" dated November 16, 1982. The reference should be to a loan to the * * * Company dated November 26, 1982.

3 Judge Mosser says that Mr. * * * approved several loans, but does not speak of his location. Judge Mosser alludes to * * * only in connection with the origins of the loans.

4 Judge Mosser identifies the following loans as ones that Mr. * * * approved: (1) the loan to * * * and * * * on June 30, 1982, in the amount of $300,000; (2) the loan to * * * on August 18, 1982, in the amount of $200,000; (3) the loan to * * * on September 30, 1982, in the amount of $300,000; (4) the loan to * * * on October 19, 1982, in the amount of $100,000; and (5) the loan to * * * on October 29, 1982, in the amount of $100,000.

5 Judge Mosser suggests, but does not actually find, that the Bank used its correspondent account to fund out-of-area loans.
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   None of the Bank's proposed findings are relevant to the Board's disposition of the issues presented in this case. Accordingly the Board declines to adopt any of the Bank's proposed findings.
   The Bank also proposes one finding that implicitly contradicts Judge Mosser's Recommended Decision:
   —There is no proof in the record that the Bank's collection procedures are ineffective.
   The record does not contain any significant inquiry into the Bank's methods for collecting past-due loans. Some adversely classified loans have been paid or partially paid, and some other people owing adversely classified loans are making regular payments to the Bank.
   As Judge Mosser notes, however, the Bank failed to specify proper repayment schedules for many loans. Judge Mosser characterizes this failure as a lax loan-collection practice. Moreover, the Bank's classified loans represent an unusually high proportion of total assets, and the Board considers that improved loan-collection practices are needed. The Board therefore declines to adopt the Bank's proposed finding.

CONCLUSIONS OF LAW

I. Unsafe or unsound practices

A. Meaning of the phrase "unsafe or unsound"

   [.1] Judge Mosser reviews the meaning of the phrase "unsafe or unsound practice" as used in Section 8(b)(1). Neither side challenges his analysis. The Board adopts Judge Mosser's view that an "unsafe or unsound practice" is one that is contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder. See First National Bank of Eden v. Department of the Treasury568 F.2d 610, 611 (8th Cir. 1978); First National Bank of La Marque v. Smith610 F.2d 1258 (5th Cir. 1980); see also Financial Institutions Supervisory and Insurance Act of 1966: Hearings on S. 3158 Before the House Comm. on Banking and Currency, 89th Cong., 2d Sess., 49-50 (1966) (Memorandum of John E. Horne, Chairman of the Federal Home Loan Bank Board).

B. Lending practices

   [.2] Judge Mosser concludes that the Bank engaged in the following activities:
   —Making unsecured loans without first getting adequate financial information on all obligors;
   —Making loans that were not adequately secured;
   —Failing to establish and enforce realistic programs for the repayment of loans; and
   —Making secured loans without complete supporting documentation, such as appraisals, evidence of title, borrowing authorizations, collateral assignments or evidence of insurance.
   Judge Mosser characterizes each of these activities as an "unsafe or unsound practice". The Bank does not challenge Judge Mosser's characterization.
   When a bank engages in any of these activities, it incurs an extra risk that the loan will not be repaid, and thereby presents an abnormal risk of loss to the bank and its shareholders. See First National Bank of Eden v. Department of the Treasury, supra, 611. Judge Mosser's Findings of Fact, as accepted by the Board, show that the Bank engaged in these activities.
   The Board therefore adopts Judge Mosser's recommended conclusion that the Bank engaged in an "unsafe or unsound practice" within the meaning of Section 8(b)(1) of the FDI Act by engaging in each of these activities.

C. Classified loans

   Judge Mosser asserts, "(T)he Bank obviously has acted in an unsafe and unsound manner with respect to each of the loans that the FDIC adversely classified as of January 31, 1983." The Bank does not except to this assertion.
   Each of the loans in question is of low quality, or is secured by property worth less than the amount of the loan, or lacks an appropriate repayment schedule, or has been made without the benefit of appropriate supporting documents.
   The Bank itself has admitted that it engaged in "unsafe or unsound banking practices" in the case of several of these loans. See First State Bank of Wayne County, et al. v. City and County Bank of Knox County, et al.
{{4-1-90 p.A-226}}No. 83-141 (now pending before the United States District Court for the Eastern District of Kentucky). The Bank has not rebutted those allegations in this case. Cf. Enquip, Inc. v. Smith-McDonald Corp.655 F.2d 115 (7th Cir. 1981) (vacating summary judgment based on such pleadings, where the trial judge had rejected appellant's attempt to introduce evidence rebutting his own pleadings filed elsewhere); Fidelity & Deposit Insurance Co. of Maryland v. Hudson United Bank, 493 F.Supp. 434 (D. N.J. 1980). Accordingly, the Bank's admissions are accepted as factual. See Mitchell v. Fruehoff Corp., 568 F.2d 1139 (5th Cir. 1978), reh. denied, 570 F.2d 1391 (5th Cir. 1978); Frank R. Jelleff, Inc. v. Braden, 223 F.2d 671 (D.C. Cir. 1956).
   The Board therefore adopts Judge Mosser's recommended conclusion that the Bank engaged in an "unsafe or unsound practice" within the meaning of Section 8(b)(1) in the course of making each of the loans classified adversely on January 31, 1983.

D. Loan-loss valuation reserves

   As of January 31, 1983, the Bank had $4,724,000 in adversely classified loans. By contrast, the Bank's loan-loss reserve was a mere $152,000.
   The Bank's loan-loss reserve was far too small to accommodate the volume of loan losses that the Bank could expect to sustain. The Bank was therefore subject, on January 31, 1983, to the risk of a substantial charge against earnings.
   Judge Mosser concluded that the Bank's failure to maintain an adequate reserve for possible loan losses constitutes an unsafe or unsound practice within the meaning of Section 8(b)(1). The Bank does not except to this conclusion. The Board therefore adopts Judge Mosser's conclusion.

E. Capital adequacy

   As of January 31, 1983, the Bank's adversely classified loans represented 158.42 percent of its total equity capital and reserves.
   The Bank's capital did not provide adequate protection against losses that the Bank could reasonably expect to sustain. The Bank was therefore subject, on January 31, 1983, to a substantial risk of failure.
   Judge Mosser concluded that the Bank's failure to maintain an adequate level of capital constitutes an unsafe or unsound practice within the meaning of Section 8(b)(1). The Bank did not except to this conclusion. The Board adopts Judge Mosser's recommended conclusion.

II. Violations of law, rule or regulation

A. Regulation O—maintenance of records

   Regulation O of the Board of Governors of the Federal Reserve System provides:

       Each member bank shall maintain records necessary for compliance with the requirements of this part. These records shall (a) identify all executive officers, directors and principal shareholders of the member bank and the related interests of these persons and (b) specify the amounts and terms of each extension of credit by the member bank to these persons and to their related interests. Each member bank shall request at least annually that each executive officer, director or principal shareholder of the member bank identify the related interests of that person. 12 C.F.R. §215.7.
   The Bank, as an insured State nonmember bank, must fulfill this requirement. See12 U.S.C. §1828(j)(2). The January examination showed, however, that the Bank had not maintained the records specified by Regulation O.
   Judge Mosser concluded that the Bank stood in violation of Regulation O on January 31, 1983. The Bank did not except to this conclusion. The Board adopts Judge Mosser's recommended conclusion.

B. Regulation O—insider loans

   Judge Mosser says the Bank violated Regulation O by lending more than $25,000 to interests related to * * * , a director of the Bank, without the prior approval of the Bank's board of directors. See 12 U.S.C. §375(b)(2); 12 C.F.R. §215.4(b). Judge Mosser asserts that the Bank's loan to * * * , dated November 26, 1982, constituted the violation.
   The Bank does not challenge Judge Mosser's ruling. Nevertheless, the Board declines to adopt Judge Mosser's recommendation. The Board concludes that the record does not provide adequate support for it.
   * * * was a general partnership comprising eight corporations and a limited partnership. Mr. * * * was president of seven of the eight corporate partners and general partner of the limited partnership. Judge {{4-1-90 p.A-227}} Mosser infers that * * * was a "related interest" of Mr. * * *. The inference in improper.
   Regulation O defines a "related interest" as "a company that is controlled by a person." 12 C.F.R. §215(k). Regulation O provides that someone "controls" a company when the person can vote 25 percent of its securities, or can control the election of a majority of its directors, or can exercise a controlling influence over its management or policies. 12 C.F.R. §215.2(b)(1). In addition, Regulation O further provides that someone may be presumed (rebuttably) to control a company if the person can vote 10 percent of its securities and either (i) no one else has the power to vote a greater percentage of the company's securities, or (ii) the person is an executive officer of the company. 12 C.F.R. §215.2(b)(2).
   The record does not establish that Mr. * * * controlled * * * in any of these ways. Mr. * * * had no direct ownership interest in * * * in his own right. There is no testimony that he occupied an executive position in * * * that might have enabled him to control * * *'s management or policies.6Likewise, there is no testimony that he controlled * * * indirectly by controlling one7or more of the partners in * * * .8


C.* * * law—loans exceeding 30 percent of capital and surplus

   * * * law provides that a bank may not make aggregate loans to any person in an amount exceeding 30 percent of the bank's paid-in capital and actual surplus ("30 percent rule"). * * * Rev. Stat. Ann.§287.280(3). Loans made "for the benefit" of a person are included in the total liabilities of that person. * * * Rev. Stat. Ann.§287.280(4).
   The Bank had $1,000,000 in paid-in capital and actual surplus. Loans aggregating more than $300,000 would violate the 30 percent rule.
   The Bank allowed * * * to become indebted to the Bank in the amount of $600,000. The Bank lent $300,000 to Mr. * * * and * * * on June 30, 1982. The Bank then lent another $300,000 to Mr. * * * on September 30, 1982. Judge Mosser concludes that the Bank violated * * * law by doing so. The Board adopts Judge Mosser's recommended conclusion. The Bank allowed * * * to become indebted to the Bank in the amount of $400,000. The Bank lent $300,000 to Mr. * * * and Mr. * * * on June 30, 1982. The Bank lent another $100,000 to * * * on October 19, 1982.9Judge Mosser concludes that the Bank violated * * * law by doing so. The Board adopts Judge Mosser's recommended conclusion.
   The Bank allowed * * * to become indebted to the Bank in the amount of $550,000. The Bank acquired a loan participation of $300,000 in the name of * * * on August 17, 1982. The Bank lent $200,000 to Mr. * * * himself the next day, and also lent $50,000 to * * * on October 29, 1982.10Judge Mosser concludes that the Bank violated * * * law by doing so. The Board adopts Judge Mosser's recommended conclusion.
   On the other hand, Judge Mosser concludes that the Bank did not violate the 30 percent rule when making a series of loans January 5, 1983.11The loans aggregated $800,000; an FDIC examiner determined


6 The record does not delve into Mr. * * *'s authority in his capacity as president of any of the seven corporate partners and/or general partner of the limited partnership. The record does not reveal whether any of these entities empowered Mr. * * * to decide how to vote their interests in * * * , or whether Mr. * * * in fact had that power.

7 If the partners in * * * had equal voting rights, each partner would have 11.1 percent of the voting rights. If Mr. * * * controlled just one of the partners, he could control * * * —provided no one else controlled two or more of the others. 12 C.F.R. §215.2(b)(2)(ii). The record does not reveal whether the partners did in fact have equal voting rights, or whether anyone had the power to direct a greater number of * * * 's votes than did Mr. * * * .

8 Mr. * * * was president of seven of the eight corporate partners in * * * . But that fact alone is not enough for "control" of any of those companies under Regulation O. 12 C.F.R. §215.2(b)(3). Some other fact is needed—e.g., ownership of 10 percent of a company's stock, 12 C.F.R. §215.2(b)(2). The record does not provide the required information.
   Mr. * * * was also a general partner in the limited partnership that owned part of * * * . But the record does not discuss Mr. * * * 's authority to act on behalf of the partnership, or his influence within it.

9 Mr. * * * is a general partner of * * * . * * * law says that "in computing the indebtedness of a partnership, the liability of the individual members shall be included". * * * Rev. Stat. Ann.§287.280(4).

10 Mr. * * * was a limited partner of * * * and sole owner of * * * . The Board infers that the loans to these entities constitute funds lent "for the benefit" of Mr. * * * . See* * * Rev. Stat. Ann.§287.280(4).

11One loan was made to Mr. * * * when the Bank acquired a participation in a loan to * * * . Another was made to * * * . The third was made to * * * .
{{4-1-90 p.A-228}}that Mr. * * * received the proceeds of all three. Judge Mosser ruled, however, that the Bank did not know that the money would go to Mr. * * * . The record does not indicate that the Bank could have discovered, in the exercise of appropriate diligence, that Mr. * * * would receive the loan proceeds. Accordingly the Board adopts Judge Mosser's recommended conclusion.

D.* * * law—loans exceeding 20 percent of capital and surplus

   * * * law specifies that a bank may not make aggregate loans to any person in an amount exceeding 20 percent of the bank's paid-in capital and actual surplus unless the loans are secured by assets worth more than the loans ("20 percent rule"). * * * Rev. Stat. Ann.§287.280(1). Loans made "for the benefit" of a person are to be included in the total liabilities of that person. * * * Rev. Stat. Ann.§287.280(4).
   The bank has paid-in capital and actual surplus of $1,000,000. Loans aggregating more than $200,000 would violate the 20 percent rule.
   The Bank allowed * * * to become indebted to the Bank in the amount of $400,000 without adequate security. The Bank lent Mr. * * * and * * * $300,000 on June 30, 1982. The loan was not fully secured. The Bank then lent $100,000 to * * * on October 19, 1982. The loan was not secured. Judge Mosser concludes that the Bank violated * * * law by doing so. The Board adopts Judge Mosser's recommended conclusion.
   The Bank allowed * * * to become indebted to the Bank in the amount of $550,000 without adequate security. The Bank acquired a loan participation of $300,000 in the name of * * * on August 17, 1982. The loan to * * * was not fully secured. The Bank then lent $200,000 to Mr. * * * on August 18, 1982, and another $50,000 to * * * on October 29, 1982. The loans to Mr. * * * and * * * were not secured. Judge Mosser concludes that the Bank violated * * * law by doing so. The Board adopts Judge Mosser's recommended conclusion.
   The Bank allowed * * * to become indebted to the Bank in the amount of $300,000 without adequate security. The Bank lent $300,000 to * * * on October 29, 1982. Mr. * * * guaranteed the loan. The loan was not fully secured. Judge Mosser concludes that the Bank violated * * * law by doing so. The Board adopts Judge Mosser's recommended conclusion.
   The Bank allowed * * * to become indebted to the Bank in the amount of $300,000 without adequate security on January 5, 1983, when the Bank acquired a participation of $300,000 in a loan to * * * . The loan was not secured. Judge Mosser concludes that the Bank violated * * * law by doing so. The Board adopts Judge Mosser's recommended conclusion.

E.* * * law—loans exceeding 10 percent of capital

   * * * law specifies that a bank may not make aggregate loans to any person in an amount exceeding 10 percent of the bank's paid-in capital and actual surplus unless the excess of the loan over that 10 percent limit is secured by collateral worth at least twice as much as that excess ("10 percent rule"). * * * Rev. Stat. Ann.§287.280(2). Loans made "for the benefit" of a person are to be included in the total liabilities of that person. * * * Rev. Stat. Ann.§287.280(4).
   Judge Mosser finds that the Bank's paidin capital totalled $200,000. Loans aggregating more than $20,000 would violate the 10 percent rule.
   The Bank allowed * * * to become indebted to the Bank in the amount of $200,000. The Bank lent money to * * * Company on November 26, 1982. Mr. * * * was president of all eight corporate partners in * * * and a general partner of the limited partnership that was the ninth partner in * * * . The loan was not secured. Judge Mosser concludes that the Bank violated * * * law by doing so.
   * * * law does not speak of "related interests" of a person (as does Regulation O), but rather of "obligations entered into for the benefit" of that person. In view of Mr. * * * 's position as general partner in an entity that was itself a general partner in * * * , the Board infers that the funds lent to * * * inured to Mr. * * * benefit. The Board adopts Judge Mosser's recommended conclusion.

III. Maintenance of a capital ratio of 7.5 percent.

   Judge Mosser concludes that, in view of the evidence, the FDIC may issue an order requiring the Bank to maintain a capital {{4-1-90 p.A-229}}level of 7.5 percent. The Bank does not challenge this conclusion.
   Judge Mosser notes that a primary purpose of bank capital is to provide a reserve against losses. He finds that the Bank's net equity capital was too little to protect the Bank adequately against losses, and that as a result the Bank was engaging in an unsafe or unsound banking practice. Relying on the testimony of the FDIC's expert witness, he finds that a capital ratio of 7.5 percent would provide sufficient capital to cover the Bank's substandard assets. He finds the testimony of the expert witness to be credible, uncontradicted, and supported by the evidence.12The Board adopts these observations as its own.

   [.3—.4] Generally speaking, banking agencies have authority to fashion relief in such a form to prevent future abuses. Groos National Bank v. Comptroller of the Currency, 573 F.2d 889 (5th Cir. 1978). If a bank is operating in an unsafe or unsound condition, and the condition is attributable to an inadequate level of capital, the appropriate regulatory agency may require the bank to raise its capital to an acceptable level. 12 U.S.C. §3907; cf. First National Bank of Bellaire v. Comptroller of the Currency, supra(finding that the Comptroller of the Currency had failed to establish a rational connection between the evidence adduced in the hearing and the requirement that a bank maintain a certain level of capital, but not categorically rejecting capital requirements as allowable forms of relief).
   The Bank does not except to Judge Mosser's conclusion that the FDIC has power to issue an order specifying that the Bank must maintain a capital level of 7.5 percent. The Board adopts Judge Mosser's conclusion.

IV. Propriety of a cease-and-desist order

   Judge Mosser concludes that it is lawful to issue a cease-and-desist order under the circumstances of this case. The Bank contends that no such order should be issued, because the improper practices and violations of law have been discontinued. The Board adopts Judge Mosser's conclusion.

   [.5] The FDIC may issue a cease-and-desist order solely on the basis that the Bank has engaged in violations of law, even when the violations have already been corrected, if the purpose of the order is to assure that the violations do not recur. See First National Bank of Bellaire v. Comptroller of the Currency, supra, 681 & 683. That is the purpose of the order in this case.

   [.6] In any event, the Bank continues to suffer adverse effects resulting from the unsafe or unsound practices of the past—e.g., the continued presence of a number of the adversely classified loans on the Bank's books. The Board concludes that it is lawful to issue a cease-and-desist order as a means of rectifying the conditions currently affecting the Bank. Id.
V. Removing Mr. * * * 's lending powers and installing a new chief executive

   In the Notice, the FDIC proposed to issue an order that would compel the Bank to "remove all lending authority from its chief executive officer, * * * ." The order would also compel the Bank to "provide and continue to retain management acceptable to the Regional Director and the Commissioner," including "a qualified chief executive officer." The order specified that the chief executive officer would also be responsible for making loans.
   Judge Mosser rejects the proposal. He says that such an order "would in substance necessitate the Bank's removal of * * * as its president," and that Section 8(b) does not grant the power to issue an order of this kind.
   Judge Mosser points out that, while the FDI Act makes specific provision for enforcement actions against bank directors, officers, and employees, it does so in Section 8(e) rather than in Section 8(b). He


12 In First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674 (5th Cir. 1983), the court rejected a cease-and-desist order that was based on testimony of an expert witness. The witness offered opinions on the bank's probable future earnings and on the bank's relation to other banks in its "peer group." The Fifth Circuit found both of these opinions to be valueless—the former because the expert himself described earnings projections as "conjectural," and the latter because the expert failed to establish a correlation between the fact that a bank has lower capital ratios than other similar banks and the proposition that the bank is operating in an unsafe or unsound condition.
Here too the cease-and-desist order is based on testimony of an expert witness. But the testimony differs from that in First National Bank of Bellairein three major ways: it does not speculate about the Bank's prospects, but deals entirely with the Bank's present exposure to risk; it does not employ comparisons with other banks, but focuses only on the circumstances of the Bank itself; and it is not contradicted.
{{4-1-90 p.A-230}}concludes that the order would not be in accordance with law, and would therefore constitute an "arbitrary and capricious" act by the FDIC.
   Judge Mosser does not provide a factual basis for his conclusion. Apparently, however, he believes that making loans is an essential part of the job of the president of a small bank—and in particular of Mr. * * *'s job as president of this specific bank.
   In reaching that conclusion, Judge Mosser has evidently relied on Mr. * * * 's own testimony. Mr. * * * observed that the Bank served a comparatively small market having a population of approximately 6,000 people. Mr. * * * claimed that he would not be effective as the Bank's president unless he had full lending powers, since most borrowers in such an environment seek loan approval from the person perceived as the one in charge of the Bank's affairs. Without lending authority, Mr. * * * asserted, he would merely be a highly paid public relations man. He expressed doubts that the Bank would retain him under those circumstances.

   [.7] The FDIC staff takes exception to Judge Mosser's conclusion. The FDIC staff contends that the directive to the Bank compelling it to remove Mr. * * * 's lending powers is a corrective measure authorized by Section 8(b)(1). That section enables the FDIC to require a bank to take affirmative action to correct the conditions resulting from violations of law or unsafe or unsound banking practices.
   The FDIC staff further contends that the sanctions pertaining to Mr. * * * are needed to correct the Bank's loan portfolio problems. In the FDIC staff's view, Mr. * * * is not likely to comply with sound banking procedures and with legal lending limits. In addition, the FDIC staff believes that Mr. * * * is not likely to provide accurate information to the FDIC, and that the lack of accurate information would compromise the FDIC's efforts to monitor the Bank's condition. The FDIC staff bases its conclusions on the following observations:

       —Mr. * * * was involved in accepting many of the Bank's adversely classified extensions of credit.
       —Mr. * * * knew of an illegal transaction, yet failed to advise the other directors of the Bank or the Bank's supervisory agency.
       —Mr. * * * deliberately engaged in actions that were designed to communicate misleading information to the FDIC about one of the Bank's transactions.
   The Board concurs in the FDIC staff's views.
   In light of Mr. * * * 's past actions and the circumstances attending them, the Board considers that an order requiring the Bank to restrict or eliminate Mr. * * * 's lending powers, and to appoint a new chief executive officer, are appropriate remedies in aid of restoring the Bank to sound financial condition.

THE ORDER

I. Effective Date of the Order

   [.8] Judge Mosser's Recommended Ordersets an effective date of 10 days after service on the Bank. The FDIC's regulations provide, however, that cease-and-desist orders become effective at the expiration of 30 days after service. 12 C.F.R. §308.36(b). Accordingly, the Board's Final Order modifies the Recommended Orderby setting the effective date at 30 days after service.

II. Bank Procedures Required by the Order

   The Bank contends that as a practical matter there is no need for at least two of the order's provisions. First, the Bank says that its collection procedures—that is, its procedures for obtaining the payment of overdue loans—are perfectly adequate as they stand. The Bank objects to the provision requiring it to amend its written lending policy, and to provide in the amendment for the "development of effective collection procedures."
   The Board considers the provision to be appropriate, however. The Bank vastly increased its loan-loss reserve in the first six months of 1983, and incurred a large loss during that interval as a result. These circumstances suggest that the Bank should take extra pains to see that loans are collected properly, and that the FDIC should supervise the Bank's efforts.
   The Bank also objects to the provision requiring the Bank to "request financial information, evidence of title, borrowing authorization, proof of insurance, and collateral assignments for all extensions of credit lacking them as of January 31, 1983." The Bank says that it has already taken all available action to obtain the information specified in the order. It admits, {{4-1-90 p.A-231}}    however, that it has not been entirely successful in its efforts.
   The Board considers that this provision is appropriate as well. The Bank has a task remaining unfulfilled the completion of which is necessary to correct an unsafe or unsound condition: namely, the inadequate documentation of loans. The provisions of the order encourage the Bank to pursue the task with vigor and to complete it with dispatch.

   III. Bank Capital Required by the Order

   Judge Mosser's Recommended Ordercommands the Bank to maintain a capital level of 7.5 percent. The Bank does not challenge this requirement.

   [.9] The Bank's net equity capital was negative on January 31, 1983, and still more so on June 30, 1983. The net equity capital was not sufficient to provide an adequate cushion against loan losses not otherwise provided for (e.g., by loan-loss reserves). In Judge Mosser's view, this condition amounted to an unsafe or unsound practice on the part of the Bank. He concludes that an order requiring the Bank to increase its capital is an appropriate remedy under the circumstances of this case. The Board agrees with his evaluation.
   Judge Mosser further considers that the appropriate level of capital for the Bank would be 7.5 percent of total assets. A capital ratio of 7.5 percent sets capital at a level that is at least equal to the Bank's substandard assets for which no loan-loss valuation reserves have been established. Ordinarily the Board considers a 5 percent capital ratio to be adequate protection. But that ratio is appropriate for sound banks, not for ones that have suffered losses and that continue to be exposed to unusually high risks. In the latter cases, a higher level of capital is appropriate. Accordingly the Board adopts Judge Mosser's recommendation that the Bank be required to maintain a capital ratio of 7.5 percent.

IV. Changes in Management Required by the Order

   The Board has determined to incorporate an additional set of provisions into the Order, as follows:

       (a) Upon the effective date of this ORDER, the Bank shall restrict the lending authority of Mr. * * * by withdrawing from him the power to extend credit or a line of credit to, or for the benefit of, any borrower or group of borrowers in an amount that, when aggregated with the amount of all other extensions of credit and lines of credit by the bank to, or for the benefit of, that borrower or group of borrowers, exceeds $25,000. The Bank may authorize Mr. * * * to extend credit or a line of credit exceeding $25,000 in any individual case where the Bank's board of directors has specifically considered the particular extension of credit or line of credit in advance, and where a majority of the full membership of the Bank's board of directors has specifically approved the particular extension of credit or line of credit in advance.
       (b) Within three months from the effective date of this ORDER, the Bank shall provide and continue to retain management acceptable to the Regional Director and the Commissioner. Such management shall include a qualified chief executive officer who shall be given stated written authority by the Bank's board of directors for the administration of the Bank's affairs. Such written authority shall include responsibility for implementing and maintaining adherence to all Bank plans and policies adopted by the Bank's board of directors relative to lending, investing, funds management, and general bank administration. The chief executive officer shall also be responsible for the lending functions.
   These provisions are designated as Paragraph 11 of the Final Order; other paragraphs are redesignated as may be appropriate.
   These provisions require the Bank to revoke the authority the Bank vested in Mr. * * * after the initiation of these proceedings. When the Corporation issued the Notice of Charges against the Bank, Mr. * * * served as the Bank's president but not as its chief executive officer; his lending limits were set at $25,000 for unsecured loans and $50,000 for secured loans. Paragraph 11 of the Final Order incorporates the basic aspects of that arrangement, but curtails Mr. * * * 's powers as described above.
   The Board adopts the Recommended Order, as modified above, as its own Final Order, and incorporates it herein by reference.

{{4-1-90 p.A-232}}

   By order of the Board of Directors of the FDIC, dated June 18, 1984.

/s/ Hoyle L. Robinson
Executive Secretary

Date Issued: February 28, 1984 FDIC-83-132b

BEFORE: Donald W. Mosser

Administrative Law Judge

RECOMMENDED DECISION

   On June 8, 1983 the Federal Deposit Insurance Corporation (hereinafter FDIC) issued and served upon the respondent, * * * Bank of * * * County (Formerly * * * County Bank of * * * County, * * *) a Notice of Charges and of Hearing pursuant to Section 8(b) of the Federal Deposit Insurance Act, 12 U.S.C. Section 1818(b). The Notice charged that respondent with engaging in unsound and unsafe banking practices. It also alleged violations of law, rule, or regulation, by the respondent in violating Section 22(b)(2) of the Act, Sections 215.4(b) and 215.7 of Regulation O of the Board of Governors of the Federal Reserve System and Section 287.280(1), (2) and (3) of the * * * Revised Statutes. An answer dated August 9, 1983 was filed by the respondent in which each charge was denied and several defenses were asserted.
   A formal hearing was held in this matter at * * * , beginning on September 26, 1983 and concluding on September 28, 1983.
   By these proceedings, the FDIC has proposed and is seeking a cease and desist order to, in part, bar the respondent from continuing the alleged unsound and unsafe banking practices and violations of law, rule and regulation. Also pertinent to this controversy, the FDIC seeks in its proposed order to remove all lending authority from the respondent's current president, essentially approve the selection of new management and require the respondent to maintain a percentage of 7.5 of total equity capital and reserves to its adjusted total assets.

Issues

   The issues to be decided in this case are essentially three:

       1. whether unsafe and unsound banking practices and violations of law, rule and regulation have occurred and, if so, whether a cease and desist order should be issued:
       2. whether the provision in the proposed cease and desist order requiring the removal of * * * 's lending authority is supported by law; and,
       3. whether the respondent should be required to maintain total equity and capital reserves at not less than 7.5 percent of adjusted total assets during the time required in the proposed cease and desist order.

Findings of Fact

   I find the following facts based upon the entire record including the pleadings, stipulation, evidence and the proposed findings of fact and conclusions submitted by the parties.
   1. The * * * Bank of * * * County (hereinafter sometimes referred to as * * * Bank * * * ) a corporation existing and doing business under the laws of the * * * and having its principal place of business in * * * , is and has been, at all times pertinent to this proceeding, an insured State nonmember bank. The Bank is thereby subject to the Act, 12 U.S.C. §§1811, et seq., and the Rules and Regulations of the FDIC, 12 C.F.R. Chapter III. The FDIC has jurisdiction over the Bank and the subject matter of the proceeding.
   2. On or about May 17, 1982, control of the Bank was acquired by * * * and * * *. On or about May 19, 1982, * * * , along with * * * , * * * , * * * , * * * and * * * became directors of the Bank. (Stipulation, p. 3).
   3. * * * was president and a director of the Bank at all relevant times. He was appointed chief executive officer in January of 1983, but he executed some documents of the Bank prior to that date in which it was represented that he held that position. (Exs. 6, 7, 38, 39; Tr. 15, 18, 23, 146, 153, 420).
   4. At all times relevant to this proceeding, the loan limits of * * * and * * * , as set by the Bank's board of directors, were:


UnsecuredSecured
* * *$200,000.00$300,000.00
* * *25,000.0050,000.00

   * * * and * * * had a combined loan limit of $200,000.00 secured and $300,000.00 unsecured. (Ex. 39).
   5. An examiner of the FDIC conducted a regular examination of the Bank as of the {{4-1-90 p.A-233}}close of business on August 23, 1982. (Ex. 2-B; Stipulation, p. 3). It was brought to Mr. * * * 's attention that the Bank apparently was in violation of Section 287.230(3) of the * * * Revised Statutes as it had exceeded its legal limit for loans to a certain individual. Mr. * * * placed a phone call to * * * Bank of * * * and was told that the problem would be corrected there. * * * Bank maintained a correspondent account as well as federal funds on deposit at * * * Bank of * * * County, * * * (Stipulation, p. 3; Tr. 126–130, 428–430).
   6. There were no loans cited for technical exceptions1during the August examination, though the examiner gave special mention to those loans that were concentrated outside the Bank's normal lending area and were contrary to the Bank's established lending policies. Also, the Bank's valuation reserve of $83,400.00 was noted as inadequate to charge off the $112,900.00 classified loss at that examination. President * * * indicated that sufficient provision would be made to the reserve to allow for the charge-off of the loans classified loss and that additional provision would be made to bring the reserve to at least one percent of total loans by year end. (Stipulation, p. 3; Exhibit 2-B).
   7. Another examiner of the FDIC conducted a regular examination of the Bank as of the close of the business day of January 31, 1983. The examiner reported that loan assets subject to adverse classification2had shown a dramatic increase from the August 23, 1982 examination and were considered to be at "hazardous levels". Statistics pertinent to the adverse classifications as of January 31, 1983 and the two previous FDIC examinations of the Bank are shown below:

Examination DateSpecial MentionSubstandardLoss
1/31/83$300,000$4,676,000$48,000
8/23/822,870,000287,000113,000
6/8/81274,000198,000
(Exs. 1-A, 2-B, 3-C)

   8. Of the $4,976,000 in loans subject to special mention or substandard classification as of January 31, 1983, $4,449,000 represents credit extended to borrowers outside the Bank's trade area. Most of these loans were made to borrowers in the * * * area or close associates of individuals from that area. Of the total of the Bank's out-of-state loans, 68.68 percent were subject to adverse classification by the FDIC examiner as of January 31, 1983. (Ex. 3-C).
   9. As of January 31, 1983, 15.35 percent of total assets and 32.88 percent of total loans were adversely classified by the FDIC examiner. These represent respective increases of 1.61 percent and 3.6 percent from the August 23, 1982 examination. (Exs. 2-B, 3-C).
   10. The Bank increased its net loans by $6,495,000 during the 10 month period ending January 31, 1983. Of that amount, $6,041,000 represents loans outside the Bank's normal trade area of * * * County, and 42 percent of the Bank's total loan portfolio. The FDIC listed each of these loans for technical exceptions in the January 31, 1983 report of examination. (Ex. 3-C; Tr. 131).
   11. During the period beginning on June 25, 1982, and ending on January 5, 1983, the Bank extended the following credit remaining on its books as of January 31, 1983:


1 A "technical exception" refers to missing documentation pertinent to a loan. (Tr. 129).

2 Adverse classification includes all assets or portions thereof which are subject to a substandard, doubtful, or loss classification. A substandard classified loan has more than a normal risk of deteriorating into some loss. A doubtful classification refers to assets (loans) known to result in some loss, but the amount of loss cannot be determined at that time because of certain circumstances or unknown information. The loss classification includes non-bankable assets or loans which are essentially worthless. (Ex. 3-C; Tr. 171–172).
{{4-1-90 p.A-234}}

Balance
DateName(*)3LocationAmount on 1/31/83
6/25/82* * *$300,000$300,000
300,000293,089
300,000300,000
300,000300,000
6/30/82* * *300,000300,000
300,000297,916
270,000270,000
8/17/82* * *300,000300,000
8/18/82* * *200,000200,000
9/29/82* * *200,000200,000
224,496225,496
9/30/82* * *300,000300,000
10/15/82* * *300,000300,000
300,000300,000
* * *253,695253,695
10/19/82* * *100,000100,000
10/21/82* * *100,000100,000
10/29/82* * *50,00050,000
300,000300,000
11/3/82* * *236,383236,383
11/26/82* * *200,000200,000
12/7/82* * *200,000200,000
12/22/82* * *200,000116,000
1/5/83* * *300,000300,000
300,000300,000
200,000200,000

(Stipulation, pgs. 2, 3; Exs. 3-C, G, 46; Tr. 141–142)

   12. Most of the adversely classified credits listed in paragraph 11 above represent participations in loans originating at either * * * Bank of * * * County or * * * Bank of * * * County, both of which are located in * * * . Other of the adversely classified credits represent 100 percent interest, or more specifically, direct loans to borrowers outside the Bank's normal trade area. (Exs. 9-47). The Bank lacked information such as current credit information, appraisals, evidence of title, or evidence of insurance on all of the loans set forth above. (Ex. 3-C; Tr. 190).
   13. The Bank did not maintain records either identifying all of its executive officers, directors and principal shareholders and the related interests of the persons or specifying the amounts and terms of each extension of credit of the Bank to these persons and their related interests. (Ex. 3-C).
   14. The financial information available to the Bank regarding its extensions of credit on June 25, 1982, to * * * and * * * Corporation, as listed above, was very limited and not current. These extensions also were made by the Bank without security or were based on security having a value determined to be less than the amount of credit extended. The extension of credit to * * * was made by the Bank without a program of loan repayment other than a due date. (Exs. 3-C, 9, 10, 11, 12, 13, 14, 15, 17, 18; Tr. 25, 26, 29, 35, 37–40).
   15. The Bank had no current financial information available to it at the time it granted the extension of credit to * * * and * * * on June 30, 1982, as listed above. This extension also was made by the Bank based on security having a value determined to be less than the amount of credit extended and the extension of credit, as well as the extension of credit to * * * , was


3 Indicates line of credit subject to adverse classification or special mention in the FDIC's report of examination as of January 31, 1983.
{{4-1-90 p.A-235}}made by the Bank without a program of repayment. (Exs. 3-C, 19, 20; Tr. 41–43, 58).
   16. The extension of credit to * * * on August 17, 1982, as listed above, was made without any financial information regarding the partnership and with very limited and not current financial information regarding the general partner. The Bank's files with respect to this extension of credit did contain a statement of financial condition of the partnership's limited partner, * * * , as of June 30, 1982. This extension of credit was made by the Bank based on security having a value determined to be less than the amount of credit extended and was made by the Bank without a program of loan repayment other than a due date. (Ex. 3-C, 23; Tr. 53–56).
   17. The August 18, 1982 extension of credit by the Bank to * * * , as listed above, apparently was based on his statement of financial condition dated June 30, 1982, which was part of the Bank's file on the * * * . The statement of financial condition was the only security listed for this extension of credit. (Exs. 3-C, 24; Tr. 56–58).
   18. The extension of credit on September 30, 1982 to * * * for an additional $300,000, as listed above, also was made by the Bank without any current financial information. This extension of credit was made at a time when Mr. * * * was already obligated to the Bank in the amount of $300,000 on the extension of credit to himself and * * *. * * * approved both of the extensions of credit involving Mr. * * * . (Exs. 3-C, 19, 25; Tr. 58, 68, 149, 154).
   19. The financial information available to the Bank regarding its extension of credit on October 15, 1983 to * * * , as listed above, consisted of an unsigned balance sheet of that company dated June 30, 1982 and the extension was secured by unappraised real estate. This extension of credit was made by the Bank without a program of repayment other than a due date. (Exs. 3-C, 27; Tr. 71–72).
   20. The financial information available to the Bank regarding its extension of credit on October 19, 1982 to * * * , as listed above, was based on an unsigned balance sheet of that partnership dated December 31, 1981 and the extension was unsecured. * * * was general partner of * * * and signed the note in that capacity. At the time Mr. * * * signed this note, he was obligated to the Bank in the amount of $300,000 as a result of the Bank's extension of credit on June 30, 1982. Both of these extensions of credit were approved by * * * . (Exs. 3-C, 19, 28, 29, 30; Tr. 72–76).
   21. The financial information available to the Bank regarding its extension of credit on October 21, 1982 to * * * , Trustee, as listed above, consisted of a financial statement on * * * and a document entitled "Credit Write-up and Review" dated October 21, 1982. This extension of credit was made by the Bank without security and without a program of loan repayment other than a due date. (Exs. 3-C, 31, 32; Tr. 76–78).
   22. The financial information available to the Bank regarding its extension of credit on October 29, 1982 to * * * , as listed above, consisted of a document entitled "Credit Write-up and Review" dated October 26, 1982. The extension of credit was made by the Bank without security and without a program of loan repayment other than a due date. * * * is a proprietorship of * * * and Mr. * * * was obligated to the Bank on the extension of credit of August 18, 1982 at the time this extension was granted to his proprietorship. Both of the extensions of credit were approved by * * * . (Exs. 3-C, 33, 34; Tr. 81, 86).
   23. The extension of credit on October 29, 1982 to * * * , as listed above, was guaranteed by * * * and the Bank did not have any financial information regarding Mr. * * * at the time the extension was granted. The extension was made by the Bank based on security having a value determined to be less than the amount of credit extended. (Exs. 3-C, 35; Tr. 82).
   24. The October 29, 1982 extension of credit by the Bank to * * * , as listed above, was guaranteed by * * * and the Bank did not have any financial information regarding Mr. * * * at the time the extension was granted. The extension was secured by real estate mortgage but the Bank failed to obtain an adequate appraisal of the real estate. The Bank did not have a loan repayment program for this extension other than a due date. (Exs. 3-C; Tr. 83–85).
   25. On November 16, 1982, the Bank renewed the $200,000 extension of credit to * * * of August 18, 1982, as listed above, although the extension was unsecured. At {{4-1-90 p.A-236}}that time, Mr. * * * was obligated to the Bank on the October 29, 1982 extension of $50,000 to * * * (Exs. 3-C, 24, 33, 34, 37; Tr. 81, 86).
   26. The Bank extended credit on November 16, 1982 in the amount of $200,000 to * * * Company and the note evidencing this extension of credit was signed by * * * as "Partner". (Exs. 3-C, 40). This company was a general partnership consisting of eight corporations and a limited partnership. (Ex. G; Tr. 141–142). Mr. * * * was not a partner of * * * Company at the time he signed the note relating to the extension of credit by the Bank on November 16, 1982, but he was president of seven of the eight corporate partners and general partner of the limited partnership that had an interest in the company. (Exs. G, 46). Mr. * * * also was a director and executive officer of the Bank on November 16, 1982 and the extension of credit of that date did not receive the prior approval of the Bank's board of directors. (Stipulation, p. 5; Tr. 94–95).
   27. The January 5, 1983 extension of credit in the amount of $300,000 to * * * , as listed above, was made by the Bank through the acquisition of the participation in an unsecured loan to * * *. The extension of credit on that same date to * * * and * * * were made by the Bank based on limited financial information. The extension in the name of * * * was made by the Bank based on collateral which was determined to have a value less than the amount of credit extended. This extension of credit to * * * was made by the Bank without a program of loan repayment other than a due date. The FDIC examiner in charge of the examination of the Bank on January 31, 1983 determined that * * * ultimately received the funds advanced by the Bank on the January 5, 1983 extensions of credit to * * * and * * * . (Exs. 3-C, 44–50; Tr. 101–105).
   28. * * * , on behalf of the Bank, closed the transaction on the extension of credit of $200,000 to * * * on August 18, 1982 and he also closed the transaction regarding the renewal of this extension of credit on November 16 of that year. (Exs. 3-C, 24, 37; Tr. 56–58). Of the other adversely classified extensions of credit listed above, the certificates of participation pertaining to the following listed extensions were signed by * * * as "ACCEPTED BY:" the Bank:

DateName
6/25/82* * *
6/30/82* * *
8/17/82* * *
10/15/82* * *
10/21/82* * *
10/29/82* * *
11/3/82* * *
1/5/83* * *

(Exs. 9, 13, 14, 15, 19, 20, 23, 26, 27, 31, 35, 36, 44).

   29. The Bank made the following allegations in its complaint before the United States District Court, Eastern District of * * * in its cause of action against * * * Bank of * * * County, * * *, et al., Civil Action No. 83-141:

       a. the Bank's extensions of credit to * * * and * * * on June 25, 1982 were of low quality and the extensions of credit on that same date to * * * Corporation and * * * were undersecured;
       b. the extension of credit by the Bank on June 30, 1982 to * * * and * * * was undersecured;
       c. the Bank's extension of credit on September 30, 1982 to * * * was undersecured;
       d. the Bank's extension of credit on September 30, 1982 in the amount of $300,000 to * * * was above the Bank's loan limits when considered with its extension of credit to * * * of June 30, 1982;
       e. the extensions of credit on October 15, 1982 to * * * and * * * were undersecured; {{4-1-90 p.A-237}}
       f. the Bank's extension of credit on October 19, 1982 to * * * was undersecured and above the Bank's loan limits because * * * was a general partner and he was already obligated to the Bank for the $300,000 extension of credit on June 30, 1982;
       g. the Bank's extension of credit on October 21, 1982 to * * * , Trustee was of low quality;
       h. the extension of credit of October 29, 1982 by the Bank to * * * was above the Bank's loan limits as * * * was the sole proprietor of this entity and he was already obligated to the Bank for $200,000 on the August 18, 1982 extension of credit;
       i. the Bank's extension of credit to * * * and * * * of October 29, 1982 were undersecured; and,
       j. the extensions of credit of January 5, 1983 to * * * and * * * were undersecured and above the Bank's loan limits when considered together. (Ex. 5)
   30. The Bank had a loan loss valuation reserve of $152,000 as of January 31, 1983. (Ex. 3-C). The FDIC examiner termed this amount inadequate considering the large amount of loans subject to adverse classification. (Tr. 197–198). Although that reserve had been increased to $2,458,000 by June 30, 1983, the Bank's actual loan losses exceeded its provision for such losses over a period of time. (Exs. 21, 51; Tr. 50, 256, 2763-274). As a result of the Bank's actual loan losses exceeding its reserve for such losses, the financial statements prepared by the Bank overstated the Bank's earnings and equity capital. (Exs. 21, 22; Tr. 50-52, 196-201, 255-256).
   31. As of January 31, 1983, the total of the Bank's adversely classified assets was 158.42 percent of the Bank's total capital and reserves. (Ex. 3-C; Tr. 200).
   32. On the below-listed dates, the Bank's adjusted equity capital and reserves, its adjusted total assets, and the ratio of the Bank's adjusted equity capital and reserves to its adjusted total assets were:
(A)(B)
AdjustedAdjustedRatio
Equity CapitalTotalof
and ReservesAssets(A) to (B)
June 8, 1981$2,296,400$22,173,00010.4%
August 23, 19822,825,30024,781,10011.4%
January 31, 19832,934,00030,870,0009.5%
April 30, 19831,018,00025,430,0004.0%
June 30, 19831,684,00025,646,0006.566%
(Exs. 1-A, 2-B, 3-C, 4-D, 40, 51-N)

   33. As of January 31, 1983, the Bank's capital stock actually paid in and its actual amount of surplus were $200,000 and $800,000, respectively. (Ex. 3-C).
   34. An Assistant Director of the Division of Bank Supervision of the FDIC, * * * , who is an expert in matters related to problem bank situations and capital adequacy of banks, analyzed the FDIC's reports of examination pertaining to the Bank as of August 23, 1982, January 31, 1983 and April 30, 1983. The expert also examined the June 30, 1983 consolidated report of condition of the Bank. Mr. * * * essentially determined from his analysis of these records that a 7-1/2 percent ratio of the Bank's adjusted equity capital and reserves to its adjusted total assets would be appropriate as of January 31, 1983, considering the Bank's approximate size of $30,000,000 in total assets and Mr. * * * conclusion that the * * * Bank represents a "problem bank". (Tr. 303–326).
   35. The Bank's net equity capital (capital less adversely classified assets) was a negative $1,742,000 as of January 31, 1983. By April 30, 1983, the Bank's net equity capital was a negative $2,247,000. From the period January 31, 1983 through June 30, 1983, the Bank expensed $2,375,000 for loan losses which resulted in it reporting a loss of {{4-1-90 p.A-238}}$1,493,000 for the first six months of 1983. (Exs. 3-C, 4-D, 21, 51).

       36. Between the time of the examination on January 31, 1983 and the FDIC's next regular examination of the Bank on April 30, 1983, three of the Bank's directors had resigned, two of whom were * * * and * * * . (Exs. 3-C, 4-D, 39; Tr. 253-255, 481).
   37. As of the close of business on April 30, 1983, the Bank had not bought any loan participations or made any new out-of-area loans since the January 5, 1983 extension. Some of the out-of-area loans, which were adversely classified by the FDIC during its examination of the Bank on January 31, 1983, have been paid or partially paid. Some of the other debtors of those adversely classified extensions of credit are making regular payments to the Bank. (Ex. 4-D; Tr. 467–469).

Conclusions of Law

       1. Whether unsafe and unsound banking practices and violations of law, rule or regulation have occurred and, if so, whether a cease and desist order should be issued.
   This case arises in the regulatory scheme under the Financial Institutions Supervisor Act of 1966, Pub. L. No. 89–695, 80 Stat. 1028, as amended. Under that Act, codifying the supervision and regulation of the several systems of banks, i.e., national banks, state member banks and state nonmember banks, the FDIC retains its mandate to supervise and regulate state nonmember banks. Section 202 of the Financial Institutions Supervisory Act amended Section 8 of the Federal Deposit Insurance Act by adding, among other things, subsection (b), under which these proceedings are brought.

a. Unsafe or unsound banking practices.

   It is provided in Section 8(b)(1) of the Federal Deposit Insurance Act (Title 12 U.S.C. §1818(b)(1)), in pertinent part:

       (b)(1) If, in the opinion of the appropriate Federal banking agency, any insured bank, bank which has insured deposits, or any director, officer, employee, agent, or other person participating in the conduct of the affairs of such a bank is engaging or has engaged,. . . in an unsafe or unsound practicein conducting the business of such bank, or is violating or has violated,. . . a law, rule, or regulation, or any condition imposed in writing by the agency . . . the agency may issue and serve upon the bank or such director, officer, employee, agent, or other person a notice of charges in respect thereof. The notice shall contain a statement of the facts constituting the alleged violation or violations or the unsafe or unsound practice or practices, and shall fix a time and place at which a hearing will be held to determine whether an order to cease and desist therefrom should issue against the bank or the director, officer, employee, agent, or other person participating in the conduct of the affairs of such bank. (emphasis added).
   While the Act refers to "unsafe and unsound" banking practices, it does not define that phrase or enumerate specific acts and conduct which constitute such practices. As pointed out by the FDIC in its original brief, a memorandum introduced during the committee hearings on the Financial Institution Supervisor Act of 1966 provides some clarity as to what constitutes unsafe and unsound banking practices. That memorandum of John E. Horne, who was Chairman of the Federal Home Loan Bank Board, provided in part:
       . . . (d)espite the fact that the term `unsafe or unsound practices' has been used in the statutes governing financial institutions for many years, the Board is not aware of any statute, either Federal or State, which attempts to enumerate all the specific acts which could constitute such practices. The concept of `unsafe or unsound practices' is one of general application which touches upon the entire field of the operations of a financial institution. For this reason, it would be virtually impossible to attempt to catalog within a single all-inclusive or rigid definition the broad spectrum of activities which are embraced by the term. The formulation of such a definition would probably operate to exclude those practices not set out in the definition, even though they might be highly injurious to an institution under a given set of facts or circumstances or a scheme developed by unscrupulous operators to avoid the reach of the law. Contributing to the difficulty of framing a comprehensive definition is the fact that particular activity not necessarily unsafe or unsound in every instance may be so when considered {{4-1-90 p.A-239}}in the light of all relevant facts. Thus, what may be an acceptable practice for an institution with a strong reserve position, such as concentration in higher risk lending, may well be unsafe or unsound for a marginal operation.
       Like many other generic terms widely used in the law, such as `fraud,' `negligence,' `probable cause,' or `good faith,' the term `unsafe or unsound practices' has a central meaning which can and must be applied to constantly changing factual circumstances. Generally speaking, an `unsafe or unsound practice' embraces any action, or lack of action, which is contrary to generally accepted standards or prudent operation, the possible consequence of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.
Financial Institutions Supervisory and Insurance Act of 1966: Hearings on S. 3158 Before the House Comm. on Banking and Currency, 89th Cong., 2d Sess., 49-50 (1966).
   Also as noted by the FDIC, the courts have accepted the Comptroller of the Treasury's definition of the phrase "unsafe and unsound". First National Bank of Eden v. Department of the Treasury, 568 F.2d 610 (8th Cir. 1978) and First National Bank of La Marque v. Smith, 610 F.2d 1258 (5th Cir. 1980). As pointed out by the Eighth Circuit in considering the First National Bank of Edencase, which also involved an action under Section 8(b) of the Act, "the Comptroller suggests that these terms [unsafe and unsound] encompass what may be generally viewed as conduct deemed contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder". Supraat 611. Moreover, the courts have not attempted to substitute their judgment in cases involving alleged "unsafe and unsound" practices; rather, the agencies' findings are reviewed to determine if they are reasonable or rationally connected with the evidence as a whole. See Abilene Sheet Metal, Inc. v. National Labor Relations Board, 619 F.2d 332, 337 (5th Cir. 1980) and J.H. Rose Truck Line, Inc. v. Interstate Commerce Commission, 683 F.2d 943, 948 (5th Cir. 1982).
   As my findings of fact detail, the * * * Bank of * * * County engaged in practices of extending credit under questionable circumstances. The Bank's hazardous lending and lax collection practices, included (1) extending unsecured credit without first obtaining adequate financial information on all obligors; (2) extending credit not adequately secured; (3) failing to establish and enforce realistic programs for the repayment of loans; and (4) extending secured credit without complete supporting documentation, such as appraisals, evidence of title, borrowing authorizations, collateral assignments or evidence of insurance. In fact, the Bank has alleged in its complaint in the case of * * * , which case is pending before the United States District Court for the Eastern District of * * * that it granted credit under such circumstances and that such acts constituted "unsafe and unsound banking practices". I find the Bank's allegations in that complaint constitute admissions of fact for purposes of this case. See Mitchell v. Fruehoff Corp., 568 F.2d 1139 (5th Cir. 1978), rehearing denied, 570 F.2d 1391 (5th Cir. 1978); State Printing Co. v. Metro Envelope Co., 532 F.Supp. 431 (N.D. Ill. 1982); Fidelity & Deposit Insurance Co. of Maryland v. Hudson United Bank, 493 F.Supp. 434 (D. N.J. 1980); Frank R. Jelleff Inc., v. Braden, 223 F.2d 671 (D.C. Cir. 1956). I further conclude that the Bank obviously has acted in an unsafe and unsound manner with respect to each of the extensions of credit that the FDIC adversely classified as of January 31, 1983.
   * * * Bank also has engaged in unsafe and unsound banking practice by failing to maintain an adequate reserve for possible loan losses. As of January 31, 1983, the Bank's loan valuation reserve was only $152,000, while the total of all loans subject to adverse classification was $4,724,000. (Ex. 3C; Tr. 198).
   By operating with an inadequate level of capital for the kind and quality of assets held by the Bank, I find it also engaged in an unsafe and unsound banking practice. This is evidenced by the fact that as of January 31, 1983, the total of $4,724,000 in adversely classified loans represented 158.42 percent of the Bank's total equity capital and reserves. (Ex. 3C; Tr. 200).
{{4-1-90 p.A-240}}
b. Violations of law, rule or regulation.

   As indicated above, an agency may issue and serve upon a bank a notice of charges under Section 8(b)(1) of the Act for violations of a law, rule or regulation. 12 U.S.C. § 1818(b)(1). Moreover, the agency, upon finding such a violation, has the discretion to take relief in such a manner as to prevent further abuses. Groos National Bank v. Comptroller of the Currency, 573 F.2d 889, 897 (5th Cir. 1978). The relief may be in the form of a cease and desist Order. First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 680 (5th Cir. 1983).
   In the notice of charges, the FDIC alleged the Bank violated Section 215.4(b) and Section 215.7 of Regulation O of the Board of Governors of the Federal Reserve System. 12 C.F.R. §§ 215.4(b) and 215.7. Considering the latter section first, Section 215.7 provides:

       Each member bank shall maintain records necessary for compliance with the requirements of this part. These records shall (a) identify all executive officers, directors and principal shareholders of the member bank and the related interests of these persons and (b) specify the amounts and terms of each extension of credit by the member bank to these persons and to their related interests. Each member bank shall request at least annually that each executive officer, director or principal shareholder of the member bank identify the related interests of that person.
       12 C.F.R. § 215.7.
   There is no question that this regulation was violated as I factually found that the Bank failed to maintain the records specified in Section 215.7.
   I also conclude that the Bank violated Section 215.4(b) of the regulations and Section 22(b)(2) of the Act by extending credit to a director and executive officer, * * * , and his related interests, in amounts which exceeded $25,000 without the prior approval required by the Act and regulations. 12 U.S.C. § 375(b)(2); 12 C.F.R. § 215.4(b). In this regard, Section 215.4(b) provides:
       ...No member bank may extend credit or grant a line of credit to any of its executive officers, directors, or principal shareholders or to any related interest of that person in an amount that, when aggregated with the amount of all other extensions of credit and lines of credit by the member bank to that person and to all related interests of that person exceeds $25,000, unless (i) the extension of credit or line of credit has been approved in advance by a majority of the entire board of directors of that bank....
       12 C.F.R. § 215.4(b).
   As the above facts detail, the Bank granted an unsecured loan to * * * Company on November 16, 1982, in the amount of $200,000 and * * * signed the note evidencing this extension as "partner". The FDIC examiner stated in the January 31, 1983 report, and the Bank's president admitted while testifying, that no prior or subsequent approval by the Bank's board of directors was obtained for this extension of credit. (Ex. 3C; Tr. 95).
   * * * argues that it committed no violation of law, rule or regulation by extending credit to * * * or his related interests because though he signed as partner for the * * * Company, "he was not in fact a partner". The Bank contends, and the evidence supports, that * * * Company was a general partnership consisting of eight corporations and a limited partnership. (Ex. G; Tr. 141–142). However, the record also contains evidence which is part of the Bank's files, indicating * * * is the president of seven of the corporate partners of * * * Company and is a general partner of the limited partnership. Therefore, I conclude the extension of credit to the * * * Company was indeed an extension of credit to the related interests of * * * and clearly in violation of Section 215.4(b) of the regulations.
   Several extensions of credit by the Bank, including the loan to * * * Company, violated sections of the * * * Revised Statutes. * * * § 287.280 (1) through (3) provide:
       (1) No bank or trust company shall permit any person to become indebted to it or to become obligated as guarantor or surety to it in an amount exceeding 20 percent (%) of its capital stock actually paid in and its actual amount of surplus, unless such person pledges with it good collateral, security or executes to it a mortgage upon real or personal estate which at the time is of more than cash value of the indebtedness or obligation above all other encumbrances.
       (2) No bank or trust company shall permit any of its directors or officers to {{4-1-90 p.A-241}}become indebted or obligated as guarantor or surety to it in an amount exceeding 10 percent (%) of its capital stock actually paid in, without securing the excess by the mortgage or pledge of real personal property double in value the amount of the excess.
       (3) In no event shall the indebtedness or obligation of any person exceed 30 percent (%) of the paid-in capital and actual surplus of a bank or trust company.
   The Bank's loan to * * * Company for $200,000 exceeded by $180,000 the 10 percent limitation of the Bank's capital stock actually paid in as provided in * * * § 287.280(2). There was no security for this loan and no prior approval of the board of directors. Since this extension of credit was in substance an unsecured loan to the related interests of * * * , I find this transaction to constitute a violation of * * * § 287.280(2).
   * * * Bank also violated * * * § 287.280(1) by its extensions of credit to * * * , * * * and * * *. The Bank allowed these individuals to become indebted to it in amounts in excess of 20 percent of the Bank's capital stock actually paid in ($200,000) and its actual amount of surplus ($800,000) without securing any of these lines of credit with collateral or mortgages in excess of the respective obligations of the Bank.
   On January 5, 1983, the Bank extended credit in the amount of $300,000 to * * * , through the acquisition of the participation in an unsecured loan to * * *. This extension of credit was in excess of 20 percent of the Bank's capital stock and surplus by $100,000.
   Loans to * * * totalled $550,000. Of this amount, $200,000 was initially extended to * * * on August 18, 1982 and renewed on November 16, 1982 on an unsecured basis. On October 29, 1982, the Bank extended $50,000 on an unsecured basis to * * * which is owned by * * *. Finally, $300,000 was extended to * * * through the acquisition by the Bank of a loan participation in the name of * * * originating at * * * Bank of * * * County. While this latter extension was secured by a deed of trust on real estate, the Bank's loan records contain no income or current financial statements concerning * * *. These three extensions of credit exceeded 20 percent of its capital stock and surplus by $350,000. * * * § 287.280(1).
   * * * acquired a participation certificate of $300,000 in the names of * * * and * * * in June of 1982. The loan is secured by stock, the book value of which does not provide enough collateral to fully secure the debt. Furthermore, the Bank lacked a cash flow analysis on Mr. * * * . Nevertheless, the Bank extended another $100,000 on an unsecured basis to * * * on October 19, 1982 of which * * * is a general partner. Thus, these extensions of credit exceeded 20 percent of the Bank's capital stock and surplus by $200,000. * * * Section 287.280(1).
   On October 29, 1982, the * * * Bank extended credit in the amount of $300,000 to * * * , which was guaranteed by * * *. The Bank lacked a financial statement pertaining to Mr. * * * and the extension of credit was not fully secured. This extension of credit exceeded 20 percent of the Bank's capital stock and surplus by $100,000. * * * § 287.280(1).
   The Bank also violated * * * § 287.280(3) by its extensions of credit to * * * and * * * . These individuals became indebted to the Bank in an amount in excess of 30 percent of the Bank's paid-in capital and actual surplus ($1,000,000).
   As noted above, the extensions of credit to * * * and * * * totalled $550,000 and $400,000, respectively. Additionally, the Bank extended credit in the amount of $300,000 on September 30, 1982 to * * * at a time when he was already obligated to the Bank in an amount of $300,000 on extension of credit to himself and * * * . Thus, the extensions of credit to these individuals exceeded $300,000, or 30 percent of the Bank's paid-in capital and surplus of $1,000,000, and clearly violated * * * § 287.280(3).
   The FDIC also contends that the extensions of credit to * * * and * * * in the total amount of $800,000 constituted loans to * * *, thereby violating * * * § 287.280(1) by an additional $500,000 and * * * § 287.280(3). While the FDIC examiner determined that * * * ultimately received the proceeds from these three extensions of credit, I conclude that the loans to * * * and * * * should not be considered extensions of credit to Mr. * * * under {{4-1-90 p.A-242}}those sections of the state statute. I reach this conclusion because the evidence fails to establish that the Bank's management knew or should have known that the proceeds from the * * * and * * * loans were to be received by Mr. * * * . Thus, I find it unreasonable to conclude that the evidence as a whole establishes that there was a rational connection between these extensions on the basis of the information that was available to the Bank at the time the loans were granted.

c. Whether a cease and desist order should be issued.

   Since the evidence clearly demonstrates that * * * Bank engaged in unsafe and unsound bank practices and violated numberous laws, rules or regulations, it must next be decided whether the issuance of a cease and desist order is appropriate. Section 8(b)(1) of the Federal Deposit Insurance Act, 12 U.S.C. § 1818(b) (1978), provides in pertinent part that a cease and desist order may be issued against any bank:

       ...[i]f upon the record made at any ...hearing, the agency shall find that any violation or unsafe or unsound practice specified in the notice of charges has been established.... Such order may ...require the bank...to cease and desist from the same, and, further, to take affirmative action to correct the conditions resulting from any such violation or practice.

   [.10] The Bank argues that a cease and desist order should not be issued since the charged practices and violations have been discontinued and there is no reason to apprehend their renewal. However, the plain language of the above regulation indicates that the violations need not be ongoing and the case law is in accord. The Fifth Circuit, in a recent decision interpreting Section 8(b) of the Act, held that a cease and desist order may be issued in two situations: "when a bank is, has or is about to engage in an unsafe or unsound practice or, when a bank is, has or is about to violate a law, rule, or regulation." (emphasis added). First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 681 (5th Cir. 1983). That court also noted in that decision that cease and desist orders afford a means of moving effectively to require adherence to the law and cessation and correction of unsafe or improper practices. Id. at 680.
   There are no other cases helpful in interpreting Section 8(b) of the Act, but numerous cases have interpreted an essentially identical cease and desist order provision pertaining to the Federal Trade Commission. Those cases tend to establish that issuance of such orders is a discretionary matter which depends on the individual facts of each case, and that such an order will not be overturned unless found to be arbitrary and capricious or a clear abuse of discretion. See First National Bank of Eden v. Dept. of the Treasury, 568 F.2d 610 (8th Cir. 1978); Zale Corporation and Corrigan-Republic, Inc. v. FTC, 473 F.2d 1317 (5th Cir. 1973); Cotherman v. FTC, 417 F.2d 587 (5th Cir. 1969); Stokely-Van Camp, Inc. v. FTC, 246 F.2d 458 (7th Cir. 1957).
   The facts of this case support the issuance of a cease and desist order. Such an order is an appropriate instrument to deter and prevent future abuses, to correct conditions which have resulted from the unsafe and unsound practices and violations, and to protect the shareholders of the Bank and insure their security in the future. The flagrant and numerous abuses and violations in this case alone would justify the issuance of an order to insure their non-occurrence in the future. Moreover, several conditions caused by the abuses and violations are still plaguing the Bank, such as the continued presence of several of the adversely classified loans on the Bank's books, and an appropriate order should correct such conditions. It is also significant to recognize that this is not a case where the Bank voluntarily ceased the complained of practices; rather, the cessation of the activities was directly related to the examination undertaken by the FDIC and that agency's actions.
   The Bank argues against a cease and desist order on the grounds that it would only do further damage to the Bank's already "shaky public image" and that banks, particularly in small towns like * * * are "institutions dependent upon public confidence and sensitive to adverse publicity and rumor". I disagree. Perhaps the issuance of a cease and desist order, which directs the Bank to provide security for its past unsafe practices and prohibits it from conducting such violations in the future, will displace public rumor with fact. Shareholder and depositor confidence could be restored, as well as a good public image, with both the {{4-1-90 p.A-243}}Bank's recognition of its past indiscretions and its promotion of a more secure future.
   In conclusion, the facts of this case justify the issuance of a cease and desist order directed toward preventing future specified abuses and reversing direct, identifiable effects of the past practices on the Bank's financial soundness.
       2. Whether the provision in the proposed cease and desist order requiring the removal of * * * 's lending authority is supported by law.
   The primary goal of bank regulation is to protect the national economy and the banking system. To this end, the Comptroller of the Currency, FDIC and Board of Governors of the Federal Reserve System are granted sweeping supervisory and enforcement powers which are far reaching and flexible. In re Franklin National Bank Securities Litigation, MDL No. 196 (JBW), 478 F.Supp. 215 (E.D. N.Y. 1979); First National Bank of Bellaire v. Comptroller of Currency, 697 F.2d 674 (5th Cir. 1983). However, the power and authority of these organizations is far from unbridled.
   The legislative history of the Financial Institutions Supervisory Act of 1966, which amended the Federal Deposit Insurance Act by adding, among others, Section 8(e), noted that the power to remove or suspend an officer or director, granted in that section, must be strictly limited and carefully guarded. U.S. Code Cong. and Adm. News, 1966, p. 3538. Any attempt to use the authority of issuing a cease and desist order arbitrarily or capriciously, or in a manner considered to be an abuse of discretion or contrary to established law, will be struck down. This standard has been held applicable to the Comptroller of the Currency, First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674 (5th Cir. 1983); First National Bank of La Marque v. Smith, 610 F.2d 1258 (5th Cir. 1980), and the Board of Governors of the Federal Reserve System, Board of Governors of the Federal Reserve System v. First Lincolnwood Corp., 439 U.S. 234 (1978).
   No court has specifically addressed the "arbitrary and capricious" standard as it applies to like actions by the FDIC. (But see, In re Franklin National Bank Securities Litigation, supra). However, there appears to be no logical reason why the FDIC should not be subject to the same standard as its sister organizations. Since the same Act granting removal and prohibition powers did so to all three organizations and courts have specifically held that two of the three are subject to the arbitrary and capricious standard, the FDIC also should be held to that standard. In addition, the Comptroller of the Currency is one of three members of the Board of Directors of the FDIC. See 12 U.S.C. § 1812. I finally note in this regard that 5 U.S.C. § 706(2) provides for a reviewing court to set aside agency action, findings and conclusions, which are found to be arbitrary, capricious, an abuse of discretion or otherwise not in accordance with law.
   I find that the issuance of the FDIC's proposed cease and desist order as written would in substance necessitate the Bank's removal of * * * as its president because of the FDIC's attempt to remove his lending power. Significantly, Section 8(e) provides that the FDIC may either remove an officer or prohibit him from further participation in any manner in the conduct of the affairs of a bank. Section 8(e)(1) pertinently provides:
       (e)(1) Whenever, in the opinion of the appropriate Federal banking agency2, any ...officer of an insured bank has committed any violation of law, rule or regulation...or has engaged or participated in any unsafe or unsound practice in connection with the bank, or has committed or engaged in any act, omission, or practice which constitutes a breach of his fiduciary duty as...[an] officer, and the agency determines that the bank has suffered or will probably suffer financial loss or other damage or that the interests of its depositors could be seriously prejudiced by reason of such violation or practice or breach of fiduciary duty...and that such violation or practice or breach of fiduciary duty is one involving personal dishonesty on the part of such...officer, or one which demonstrates a willful or continuing disregard for the safety or soundness of the bank, the agency may serve upon
    2 The appropriate federal banking agency refers to the Comptroller of the Currency in the case of a national banking association; the Board of Governors of the Federal Reserve System in the case of a state member insured bank; and to the Federal Deposit Insurance Corporation in the case of a state non-member insured bank. 12 U.S.C. § 1813(q).
    {{4-1-90 p.A-244}}such...officer a written notice of its intention to remove him from office.
Section 8(e)(4) goes on to provide in part:
       (4) In respect to any...officer of an insured bank...the appropriate Federal Banking agency may, if it deems it necessary for the protection of the bank or the interests of its depositors, by written notice to such effect served upon such...officer suspend him from office or prohibit him from further participation in any manner in the conduct of the affairs of the bank. ...(emphasis added).
   By its precise language, Section 8(e)(4), in conjunction with subsection (e)(1), contemplates the removal of a bank officer or director or such individual's prohibition from further participation in any manner in the conduct of the affairs of the bank. Since lending is one of the affairs of the bank, Section 8(e)(1) provides a method for the removal of that function from an officer. Significantly, however, subsections (e)(5) and (e)(6) of Section 8 provide that any attempt to remove a bank officer or prohibit his further participation in the conduct of the affairs of the bank shall be prefaced with both written notice containing a statement of facts constituting grounds for the removal or prohibition and a hearing not later than 60 days after the date of service of such notice. 12 U.S.C. § 1818(e)(5) and (6). I find that the FDIC's power to remove a bank officer's lending authority must be instituted under Section 8(e) of the Act and not under Section 8(b).
   The evidence in this case establishes the FDIC is attempting to remove the lending authority of the Bank's president, * * *, through the issuance of a notice of charges and a hearing, together with a proposed cease and desist order, to * * * Bank of * * * County exclusively. The agency has not attempted to join Mr. * * * as a party to this proceeding. Thus, the FDIC is attempting to deprive Mr. * * * of the lending authority granted to him by the Bank's board of directors without providing him written notice of such action and the opportunity to contest the action at a hearing with the assistance of an attorney of his choosing. To permit the Federal Deposit Insurance Corporation to remove Mr. * * * 's lending authority in this Section 8(b) action against the Bank, I conclude, would not be in accordance with the law and would constitute approval of an "arbitrary and capricious" act. Thus, any cease and desist order to be issued to the Bank must not contain a provision requiring the removal of all lending authority from * * *.3
   Finally, in this regard, I note that the FDIC's proposed cease and desist order also contains a provision requiring the Bank, within three months, to provide and continue to retain management acceptable to the Regional Director of the FDIC and that such management shall include a qualified chief executive officer. Perhaps such a provision would be appropriate in a Section 8(b) order where the FDIC had successfully removed a bank's chief executive officer from his office under a Section 8(e) action. Such is not the case here. Thus, I conclude it would be unreasonable to include this proposed provision in a cease and desist order to be issued to the * * * Bank of * * * County.
       3. Whether the * * * Bank should be required to maintain total equity and capital reserves at not less than 7.5 percent of adjusted total assets during the time required in the proposed cease and desist order.
   In its proposed cease and desist order, the FDIC provides that the Bank shall take all steps necessary to maintain total equity capital and reserves at not less than 7.5 percent of adjusted total assets. The FDIC's purpose of this requirement is to correct alleged unsafe and unsound banking practices. On the other hand, the Bank has denied that it engaged in such practices and argues, therefore, that the 7-1/2 percent requirement in the proposed cease and desist order is unnecessary.
   I previously concluded that the * * * Bank failed to maintain capital at an adequate level, and, therefore, engaged in unsafe and unsound banking practices. As of January 31, 1983, the total of $4,724,000 in
3 Since the due process requirements of Section 8(e)(5) and (6) of the Act were not met by the FDIC, I need not address the question of whether the evidence supports removal of Mr. * * *'s lending authority under Section 8(e)(1) and (4). I recognize that considerable evidence was submitted by both parties as to the alleged extent of Mr. * * *'s knowledge or responsibility regarding the Bank's unsafe and unsound banking practices and its violations of law, rule or regulation. It would be unreasonable for me to comment on such evidence in view of Mr. * * *'s right to a fair hearing in the event the FDIC ultimately determines to institute a Section 8(e) action. Thus, I leave to another tribunal to judge the action of the Bank's president during the time pertinent to this proceeding.
{{4-1-90 p.A-245}}adversely classified loans was 158.42 percent of its total equity capital and reserves. Obviously, one of capital's primary functions is to provide a "cushion" to protect banks against losses. The Bank's net equity capital of a negative $1,742,000 as of January 31, 1983 unquestionably failed to provide the Bank with such a "cushion".
   The FDIC's expert, * * * , testified that the quality of a bank's assets is one of the most important determinants in capital adequacy. He noted that, in his experience, assets classified substandard in a particular examination have tended to deteriorate into loss about 30 percent of the time. Such deterioration is reflected, in this case, by the fact that between January 31 and June 30, 1983, the Bank expensed an additional $2,375,000 for loan losses which resulted in it reporting a loss of $1,493,000 for the first six months of 1983.
   The examiner for the January 31, 1983 examination by the FDIC noted that where substandard assets equal more than 50 percent of capital, correction is needed. Similarly, Mr. * * * stated that net equity capital is one indication the FDIC uses to determine capital adequacy. I reiterate the Bank's net equity capital as of January 31, 1983 was a negative $1,742,000 indicating that its adversely classified assets exceeded its capital by that amount. By April 30, 1983, the net equity capital had deteriorated to a negative $2,247,000. In this connection, the FDIC's expert testified that where adversely classified assets are greater than or equal to capital, the FDIC classifies the bank as a "problem bank" thereby indicating that the bank requires more than standard supervision and has problems which may impact its viability.
   Since numerous unsafe and unsound practices have been found, it remains to be determined if a requirement of maintaining equity capital and reserves at not less than 7.5 percent of adjusted total assets is reasonable and not arbitrary and capricious in light of the facts of this case. I note that it has been held that once the Comptroller of Currency finds a violation, he may, within his allowable discretion, fashion relief in such a form to prevent future abuses. Groos National Bank v. Comptroller of Currency, 573 F.2d 889 (5th Cir. 1978). Furthermore, as noted by the FDIC, Congress and the President reaffirmed and fortified the authority of financial institutions' regulatory agencies to mandate the enhancement of a bank's capital structure with the passage of the International Lending Supervision Act of 1983, Pub. L. No. 98–181, 97 Stat. 1280, which became effective on November 30, 1983. Section 908(a)(1) and (2) of that Act essentially provide that each appropriate federal banking agency shall establish minimal levels of capital for banking institutions and that the agency shall cause such institutions to achieve and maintain such capital levels. Subsections (b)(1) and (2)(A) go on to provide that the failure of a banking institution to maintain minimum capital levels may be deemed by an agency to constitute an unsafe and unsound practice and such agency may issue an enforceable directive to the institution requiring it to achieve its required capital level.
   The ratio of a bank's adjusted capital and reserves to its adjusted gross assets provides an indication of the amount of protection which a bank's capital accounts provide for its depositors. This ratio also reflects the extent to which asset loss or depreciation can be absorbed by the bank's capital accounts before its depositors' funds are impaired. In this regard, Mr. * * * testified that maintaining such a ratio at 7-1/2 percent in the case of * * * is reasonable because that would provide sufficient capital to cover the Bank's substandard assets. He noted that the FDIC's Statement of Policy on Capital Adequacy establishes a minimum acceptable level of adjusted equity capital at 5 percent of adjusted total assets and a threshold level for adjusted equity capital at 6 percent of adjusted total assets. 46 Fed. Reg. 62694 (1981). However, he correctly emphasized that the policy statement notes that such percentages apply only to financially sound, well-managed, diversified institutions with established records of adequate capital formation relative to asset growth. Obviously, the * * * Bank of * * * County was not financially sound and apparently not a well-managed institution as of January 31, 1983.
   * * *'s ratio of adjusted equity capital to adjusted total assets was found by the FDIC's examiner to be 9.5 percent as of January 31, 1983. The examiner noted that while such ratio was presently adequate, the ultimate impact in the event the excessive loan losses became a reality would be on the {{4-1-90 p.A-246}}Bank's equity capital position. Such an event did become a reality and the pertinent ratio dropped to 4 percent as of the April 30, 1983 examination. This ratio had risen to 6.566 percent as of June 30, 1983.4
   I finally note that the Bank relied in its original brief on the recent decision in the case of First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674 (5th Cir. 1983). The court found in deciding that case that the requirement in a cease and desist order directing a bank to maintain a 7 percent equity capital/assets ratio was unreasonable. However, I find that case is readily distinguishable from the instant fact situation. The expert witness, who testified in that case, was found not to be credible by the court because the record did not support the Bank's capital level as unsafe or unsound. Moreover, other expert testimony was submitted in that case establishing that the bank's present ratio was adequate and that the quality of the bank's assets, its earnings, liquidity and deposit structure were basically sound. In this case, I find the testimony of the only expert witness to be credible, uncontradicted and supported by the evidence. Additionally, as noted by the FDIC, the above-cited Section 908 of the International Lending Supervision Act of 1983, Pub. L. No. 98–181, 97 Stat. 1280, was enacted to clarify and enhance the banking agencies' authority to require banks to raise capital in light of the First National Bank of Bellaire decision. 129 Cong.Rec. S 7910 (Daily Ed. June 8, 1983).
   In view of the foregoing evidence, I find the FDIC's requirement that * * * Bank maintain a ratio of total equity capital and reserves to adjusted total assets of not less than 7.5 percent is not unreasonable and should be included in a proposed cease and desist order.

PROPOSED ORDER

   In view of the above findings of fact and conclusions of law, it is proposed that the Federal Deposit Insurance Corporation issue a Cease and Desist Order to the * * * Bank of * * * County (formerly * * * Bank of * * * County, * * *) providing:
   IT IS ORDERED, that * * * Bank of * * * County (formerly * * * Bank of * * * County), * * * , its directors, officers, employees, agents, or other persons participating in the conduct of the affairs of the Bank, CEASE AND DESIST, directly or indirectly, from the following unsafe and unsound practices and violations:
   1. extending unsecured credit without first obtaining adequate financial information on all obligors;
   2. extending credit that is not adequately secured;
   3. failing to establish and enforce realistic programs for the repayment of loans;
   4. extending credit without complete supporting documentation such as appraisals, evidence of title, or evidence of insurance;
   5. failing to make provisions for an adequate reserve for possible loan losses ("loan valuation reserve");
   6. operating with inadequate capital;
   7. violating Sections 215.4(b) and 215.7 of Regulation O of the Board of Governors of the Federal Reserve System (12 C.F.R. §§ 215.4(b) and 215.7), Section 22(h)(2) of the Federal Reserve Act (12 U.S.C. § 375(b)(2)), and Section 287.280 of the * * * Revised Statutes ( * * * § 287.280).
   IT IS FURTHER ORDERED:
   1. Upon the effective date of this ORDER, the Bank shall cease and desist from extending credit, as defined in Section 215.3 of Regulation O (12 C.F.R. § 215.3), without obtaining and analyzing the following:

       (a) where any credit in excess of $20,000 is or will be secured, a promissory note or lease and any documents necessary to perfect the Bank's lien and evaluate its priority and value, and, if the property is insurable, evidence of insurance covering the security in at least the amount of the loan with a loss payable clause in favor of the Bank;
       (b) where any credit in excess of $20,000 is or will be unsecured, or is or will be secured by corporate securities not readily marketable, or where the value of the security does not adequately support the credit, a promissory note and
    4 There was considerable discussion at the hearing as to the proper method of computing the ratio. (Tr. 340–351, 365). Mr. * * * testified that the amount of reserve for loan losses should be added in to arrive at adjusted total assets while the Bank counsel took a contrary position. Based on the fact that all the ratios computed during the various bank examinations included the amount of reserve for loan losses in adjusted total assets and based on Mr. * * * 's uncontradicted expert testimony, I find that adding that amount to adjusted total assets is the correct procedure. (See Exs. 1A, 2B, 3C, 4D, K, 51).
    {{4-1-90 p.A-247}}current and complete credit and financial information as to all persons who will be obligated on the credit and all obligors whose not readily marketable securities will be pledged as security (as used herein, "financial information" includes statements of the condition, and in the case of business entities, earnings statements); and,
       (c) in addition to any promissory note required by paragraph (1) above, an agreement establishing a repayment program consistent with the credit's purpose, security and source of payment.
   2. Upon the effective date of this ORDER, the Bank shall, to the extent it has not previously done so, eliminate from its books, by charge-off or otherwise, all assets classified "Loss" by the FDIC as a result of its examination of the Bank as of January 31, 1983.
   3. Upon the effective date of this ORDER, the Bank shall cease and desist from extending credit to any borrower the proceeds of which are used to pay off, in whole or in part, any adversely classified credit, unless the board of directors makes a prior determination, in writing, that the original credit would be significantly strengthened by the extension.
   4. Upon the effective date of this ORDER, the Bank shall review the loan valuation reserve and make such entries as are necessary to provide a loan valuation reserve that is adequate in light of the condition of its loan portfolio at that time. In reviewing the adequacy of the loan valuation reserve, the Bank shall consider the volume and severity of adverse loan classifications as of January 31, 1983. The basis upon which adjustments to the loan valuation reserve are made shall be reduced to writing and submitted to the Regional Director of the FDIC's * * * Region ("Regional Director") for review. Subsequent to such submission, the Bank shall review at least quarterly the adequacy of its loan valuation reserve and make such entries as are necessary to provide a loan valuation reserve that is adequate in light of the then current condition of the Bank's loan and lease portfolio and shall maintain a record indicating the basis for any such entries.
   5. Within three months from the effective date of this ORDER, the Bank shall amend its written lending policy and submit the amended policy to the Regional Director for review. The amended policy will include at a minimum the following provisions.
       (a) A defined primary trade area for lending, which shall include only the area within which the Bank can reasonably expect to establish a primary deposit relationship. Criteria for extensions of credit made outside the primary trade area shall include guidelines for the direct extension of or purchase of out-of-territory extensions of credit. Such guidelines shall include without limitation criteria for documentation, establishment of a limitation on the maximum volume of out-of-territory extensions of credit as a percentage of the portfolio of total assets, and procedures for loan committee or board of directors approval.
       (b) A requirement that applications be obtained for all loans and leases. The application shall describe the purpose of the credit, the means of repayment, and identify the officer closing the credit as well as any officer or director who participates in the transaction.
       (c) A requirement that before disbursement is made on any loan in excess of $50,000, the lending officer shall summarize in writing the pertinent facts of the loan such as purpose, source and terms of repayment, distribution of proceeds, collateral, the financial position of the borrower, compliance with the lending policy, and compliance with laws and regulations.
       (d) Lending authorities within the demonstrated expertise and capabilities of the Bank's lending officers. Such authorities shall provide for prior approval by the loan committee or the board of directors of larger lines of credit.
       (e) A requirement that specific repayment terms commensurate with the nature and purpose of the extension of credit be established upon the origination of the credit.
       (f) Formation of a loan committee, a majority of which shall be composed of local directors not employed by the Bank on a full time basis.
       (g) Establishment of specific criteria for unsecured extensions of credit.
       (h) Establishment of guidelines and procedures with respect to secured credit.
    {{4-1-90 p.A-248}}
       (i) A requirement for board review of all lines of credit in excess of $100,000 on an annual basis.
       (j) A requirement that current financial information be obtained for all obligors prior to disbursement of funds and that financial information be maintained on a current basis for unsecured and marginally-secured credits.
       (k) Establishment of a maximum amount that may be loaned to one obligor and related interests.
       (l) Establishment of a list of the types of credits that are considered to be desirable based upon the expertise of management and local economic characteristics.
       (m) Development of effective collection procedures.
       (n) Adoption of loan interest nonaccrual procedures which conform with the Instructions for Preparation of Reports of Condition and Income published by the Federal Financial Institutions Examination Council.
   6. Within one month from the effective date of this ORDER, the Bank shall request financial information, evidence of title, borrowing authorization, proof of insurance, and collateral assignments for all extensions of credit lacking them as of January 31, 1983.
   7. Within one month from the effective date of this ORDER, and monthly, thereafter, the board of directors of the Bank shall require a progress report from the Bank's lending officers on all adversely classified loans in excess of $50,000.
   8. Within twelve months from the effective date of this ORDER, the Bank shall reduce the volume of the assets adversely classified by the FDIC as a result of its January 31, 1983 examination and remaining on the Bank's books after compliance with paragraph 2 of this ORDER to not more than $2,000,000. As used in this paragraph 8, "reduce" means: (1) to collect, (2) to charge off, or (3) to improve the quality of adversely classified assets sufficiently to warrant removing any adverse classification.
   9. Upon the effective date of this ORDER, the Bank shall take all necessary steps to correct all violations of the law, rules or regulations existing as of the January 31, 1983 examination. In addition, the board of directors of the Bank shall adopt procedures to assure future compliance with all applicable law, rules and regulations.
   10. (a) Effective with the date of this ORDER, the Bank shall take all steps necessary to maintain total equity capital and reserves at not less than 7.5 percent of adjusted total assets during the time this ORDER is in effect. The maintenance of capital and reserves required by this ORDER may be accomplished by any of the following:
       (i) the sale of equity capital for cash;
       (ii) the sale or collection of assets previously charged off;
       (iii) retention of earnings;
       (iv) any other means acceptable to the FDIC; or
       (v) any combination of the above means.
   (b) If any or part of the capital requirements of paragraph 10(a) of this ORDER is accomplished by the sale of securities, 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 securities, including soliciting proxies and voting any shares of proxies owned or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Bank's securities (including a distribution limited 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 15 days prior to the dissemination of such materials, the Bank shall submit the plan and any materials to be used in the sale of the securities to the FDIC at Washington, D.C. for its review. The Bank shall make any changes requested to be made in the plan or materials by the FDIC prior to their dissemination.
   11. On the fifteenth day of the second month following the effective date of this ORDER, and on the fifteenth day of every second month thereafter, the Bank shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results {{4-1-90 p.A-249}}thereof. Such reports may be discontinued when the Regional Director has in writing released the Bank from making future reports.
   12. Upon full compliance with this ORDER, but in no event later than thirteen months from the effective date of this ORDER, the Bank shall deliver to the Regional Director a written report setting forth in detail the extent to which the Bank has complied with this ORDER. The Bank shall preserve evidence of its compliance with this ORDER until this ORDER is terminated.
   The provisions of this ORDER shall be binding upon the Bank and its directors, officers, employees, agents, or other persons participating in the conduct of the affairs of the Bank.
   The provisions of this ORDER shall become effective ten days after its issuance and shall remain effective and enforceable except to the extent that, and until such time as, any provision of this ORDER shall have been modified, terminated, suspended, or set aside by the FDIC.
   Executed at * * * this 28th day of February 1984.
/s/ Donald W. Mosser
Administrative Law Judge

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