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   [5028] FDIC Docket No. FDIC-83-223b (8-20-84)

   Bank that engaged in unsafe or unsound banking practices ordered to increase its capital within 180 days from the effective date of the final order despite the bank's insistence that the 180-day time period was too short. The FDIC reasoned that the bank's deteriorating condition mandated the imposition of the shorter period.

   [.1] Cease and Desist Order—Increase Capital—Time
   A bank that sought an extended period in which to comply with an order to increase its capital does not have the luxury of the extended time frame because the small bank's capital cushion would soon be eroded by continued losses.

   [.2] Cease and Desist Order—Increase Capital—Additional Time Denied
   A bank's recent deteriorating condition makes it imperative that remedial action be taken within a very short time if the bank is to continue to serve as a viable institution. A 180-day time period in which to increase the bank's capital is necessary to prevent the total erosion of the bank's capital.

   [.3] Cease and Desist Order—FDIC Authority to Issue
   There is no authority for the proposition that the FDIC must prove the feasibility of its proposed orders. The FDIC has broad discretion to cure the effect of a violation, and the remedy selected should be appropriate to correct the condition resulting from the violation.

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In the Matter of * * * (Insured State Nonmember Bank)




DECISION AND ORDER TO CEASE AND DESIST
EFDIC 83-223b

BACKGROUND

   On October 5, 1983, the Federal Deposit Insurance Corporation ("FDIC") issued a Notice of Charges and of Hearing ("Notice") to the Bank of * * * ("Bank") pursuant to Section 8(b)(1)) of the Federal Deposit Insurance Act ("Act") 12 U.S.C. § 1818(b)(1) and Part 308 of the FDIC Rules of Practice and Procedures (12 C.F.R. Part 308). The Notice charged the Bank with engaging in unsafe or unsound banking practices and violating certain laws and regulations. The general thrust of the allegations was that the Bank was deficient with respect to capital adequacy, quality of assets, management performance, loan loss reserves and liquidity.
   At a hearing on January 17, 1984, the Bank made no attempt to refute FDIC's allegations, nor did it oppose the remedies proposed by FDIC, which included a directive to increase the Bank's capital by $7,000,000. The Bank did object, however, to the time frame proposed by FDIC for effecting the capital increase (i.e., within 180 days from the effective date of the final order in this action). The Bank's new Chief Executive Officer testified that it would be impossible to achieve such an increase before April 30, 1985, which is approximately one month longer than the FDIC's proposed time frame which would expire near the end of March 1985.
   Based on the record, the only real issue in dispute between the parties in this proceeding concerns not the purpose of the proposed cease and desist order or its general terms, but rather the time frame during which remedial measure must be implemented. In this regard, the FDIC has insisted that within 180 days from the effective date of the order, the Bank's Board of Directors take all measures necessary to raise $7,000,000 in additional capital. The FDIC contends that the 180-day time frame is necessary because the Bank has a dangerously low capital ratio, as is reflected by the record, and is in need of an immediate infusion of capital. It further points out that the Bank could face a possible withdrawal of FDIC insurance if the capital rates drop below 3.0 percent. In essence, FDIC maintains that the Bank does not "have the luxury of an extended time frame" for obtaining capital.
   The Bank, primarily through its interim Chief Executive Officer, Mr. * * *, presented evidence related to the feasibility of raising the $7 million within a given time frame. In examining potential sources of capital and outlining a plan aimed at attracting investors through a demonstrated turnaround in profitability, Mr. * * * estimated that a more realistic and appropriate time frame would be in the vicinity of one year. These projections were based on Mr. * * * expertise acquired from substantial prior experience in managing banks, including financially troubled ones.
   On May 4, 1984, the Administrative Law Judge issued his Recommended Decision in the case. In the Recommended Decision, he makes specific Findings of Fact and concludes that the Bank has committed the violations and engaged in the unsafe or unsound banking practices cited in the Notice. Further, he adopts all of FDIC's PROPOSED ORDER TO CEASE AND DESIST except the provision requiring the Bank to take all necessary steps to increase its capital by $7 million within 180 days from the effective date of the Order. The Administrative Law Judge adopted the Banks limit of April 30, 1985, on the premise that FDIC had not established the feasibility of raising the capital in the shorter (180-day) time period.
   The Bank has not filed any exceptions to the Recommended Decision. The FDIC, however, has filed exceptions on the grounds: (1) that certain of its Proposed Findings of Facts were not adopted; and (2) that the 180-day time period for increasing capital is appropriate under the circumstances. These issues are discussed below in conjunction with the discussion and decisions regarding the Findings of Fact, Conclusions of Law and Order.

FINDINGS OF FACT

   In the Recommended Decision, the Administrative Law Judge made 24 Findings of Fact. The FDIC excepted because the Administrative Law Judge failed to adopt FDIC's Proposed Findings of Fact ("PFF") Nos. 7, 9, 11, 17, 19, and 21 through 24.
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   PFF No. 7 details the deterioration of each of the Bank's financial components over the period covered by the last three FDIC examinations of September 12, 1980, April 23, 1982, and May 31, 1983. PFF No. 9, derived from the testimony of the Bank's only witness, illustrates the continued deterioration of the Bank. The witness, on cross-examination, admitted that the Bank's total losses for 1983 were approxi mately $2,600,000 (Tr. 149–150). The Administrative Law Judge failed to make that finding, despite the fact that the evidence was unrefuted and was very significant in assessing the trend of the Bank's condition. PFF No. 11, which was not explicitly adopted by the Administrative Law Judge, was unrefuted and indicates that all of the Bank's losses must be charged against the Bank's capital account.
   PFF No. 17, also derived from the Bank's witness on cross-examination, indicates that as a result of the losses experienced in 1983 the Bank's adjusted capital ratio as of January 17, 1984 was possibly at or below 3.0 percent. PFF No. 19 contains the unrefuted testimony of FDIC Examiner * * *, supplemented by the testimony of the Bank's witness, that the Board of Directors of the Bank knew officially as early as June or July of 1983 of the need for additional capital. Finally, PFF Nos. 21 through 24 are derived from the testimony of Assistant Regional Director * * *, who testified unequivocally, on direct examination and on cross-examination that augmentation of the Bank's capital account must be accomplished quickly to prevent insolvency and to preserve the viability of the Bank.

   [.1] The significance of these Proposed Findings of Fact is that they bring into sharp focus the distressed condition of the Bank and the need for very rapid action to restore the Bank's capital account. The Bank's adjusted capital ratio was 3.78 percent on May 31, 1983. The FDIC examiner found losses of $402,000 for the period January 1, 1983 to May 31, 1983. In fact, the Bank's total losses for 1983 were admitted to be $2,600,000 (PFF 9). This amount would have to be deducted from the Bank's capital account (PFF 11). There was no evidence that the capital account had been increased in any amount between May 31, 1983 and December 31, 1983. The obvious result was that the Bank's adjusted capital ratio, as of January 17, 1984, was probably less than 3.0 percent (PFF 9), and might have been at 2.5 percent or lower. (Tr. 171) These facts underscore the deterioration of the Bank illustrated by PFF 7 and indicate that the deterioration continued up to the date of the hearing. The net result of this, translated into a time frame for the augmentation of the Bank's capital account, was emphasized and re-emphazised at the hearing by Mr. * * *. His testimony, based on many years' experience in bank supervision, was that the Bank was in a very distressed condition, that it does not have the luxury of the extended time frame the Bank's witness suggested and that unless the momentum of the past is halted shortly, even the small capital cushion the Bank now has will soon be eroded by continued losses.
   The significance of PFF 19 is that the Bank's board of directors, even if they were totally unaware of the trends of the past and the Bank's need for capital up until the FDIC examination of May 31, 1983, were on notice as early as June or early July of 1983 that a significant capital infusion would be required.
   Based upon the record of this case and for the reasons cited above, the Board of Directors of FDIC (the "Board") concludes that it should, and hereby does, adopt the Findings of Fact in the Recommended Decision as well as those referred to in the FDIC exceptions. Accordingly, the Findings of Fact in the Recommended Decision are amended to include the following additional findings:

   [.2] 1. The condition of the Bank has deteriorated over the period covered by the last three examinations conducted by the FDIC, as follows:
   (a) The volume of classified loans was $5,989,000 as of September 12, 1980; $9,675,000 as of April 23, 1982; and $16,543,000 as of May 31, 1983. (Exhibit G-4, Tr. 33, 41).
   (b) The ratio of classified loans to total loans was 8.08 percent as of September 12, 1980; 10.35 percent as of April 23, 1982; and 13.75 as of May 31, 1983. (Exhibit G-6, Tr. 43, 44).
   (c) The volume of classified assets was $7,344,000 as of September 12, 1980; $10,944,000 as of April 23, 1982; and $22,339,000 as of May 31, 1983. (Exhibit G-3; Tr. 37, 39).
   (d) The volume of assets classified "Loss" was $142,000 as of September 12, 1980; {{4-1-90 p.A-299}}$451,000 as of April 23, 1982; and $627,000 as of May 31, 1983. (Exhibit G-5; Tr. 42).
   (e) The percentage of classified assets of total equity capital and reserves was 104.68 percent as of September 12, 1980; 125.44 percent as of April 23, 1982; and 313.05 percent as of May 31, 1983. (Exhibit G-7; Tr. 46).
   (f) The ratio of the Bank's adjusted equity capital and reserves to adjusted total assets was 5.86 percent as of September 12, 1980; 5.96 percent as of April 23, 1982, and 3.78 percent as of May 31, 1983. (Exhibit G-8; Tr. 54, 55).
   (g) The net income of the Bank for calendar year 1980 was $1,044,000; for calendar year 1981 it was $1,041,000. For calendar year 1982 the Bank experienced a net loss of $880,000 and for the period January 1, 1983 thru May 31, 1983, the Bank experienced a net loss of $402,000. (Exhibit G-9; Tr. 62, 63).
   (h) The after-tax net operating income of the Bank, as a percentage of total assets, was 0.94 percent in 1980; 0.79 percent in 1981; and a negative 0.46 percent in 1982. (Exhibit G-10, Tr. 65, 66).
   2. The actual operating losses of the Bank for 1983 totaled approximately $800,000; in addition, there were other losses, which the Bank hopes will be non-recurring, of approximately $1,800,000 for 1983; the Bank's total losses for calendar year 1983 were approximately $2,600,000. (Tr. 149-150).
   3. All losses of the Bank, whether operating losses of other forms of losses, must be charged against the Bank's capital account, and the Bank's capital account has been and will continue to be reduced by all losses experienced by the Bank. (Tr. 45, 60).
   4. As of January 17, 1984, if the Bank continues to deteriorate in the future at the rate it has in the recent past, the Bank will or possibly has already reached a point where its ratio of adjusted equity capital and reserves to adjusted total assets is at or below 3.0 percent. (Tr. 157).
   5. The Bank's officers and directors have been aware of the need for additional equity capital since approximately June or July, 1983, at the conclusion of the FDIC examination which commenced May 31, 1983. (Tr. 23, 123, 124).
   6. It is imperative that remedial action be taken within a very short time if the Bank is to continue to survive as a viable institution (Tr. 118).
   7. If remedial action is not taken quickly, the Bank will probably become totally insolvent within 18 months to two years. (Tr. 118).
   8. The severely distressed condition of the Bank is such that the augmentation of the Bank's capital account must be accomplished quickly to prevent the total erosion of the Bank's capital. (Tr. 168).
   9. In the event the proposed Order were adopted, requiring the infusion of $7,000,000 of additional capital within 180 days after the effective date of the Order, the additional capital would probably be required by March 1985.

CONCLUSIONS OF LAW

   As noted earlier, the Administrative Law Judge concluded that the Bank has committed the violations and engaged in the unsafe or unsound banking practices cited in the Notice. Based upon a review of the record, the Board concurs with and adopts this conclusion.
   In addition, the Administrative Law Judge concluded that the FDIC's 180-day time period for infusion of capital into the Bank was not appropriate because the FDIC had not demonstrated the feasibility of the requirement. In its exceptions to the Recommended Decision, the FDIC made the following statements regarding the proposed 180-day requirement:

III. ARGUMENT

       ...The suggested time frame of 180 days from the effective date of the Order will require that capital infusion by November or December 1984 (perhaps later, depending on the date of issuance of the Order). This means that the Bank's directors will have had approximately one and one-half years to take action, based on the FDIC's proposed time frame.
       There is no evidence of the Bank's Board of Directors taking any significant action regarding capital after the examination of May 31, 1983, and the ALJ made no finding that any action had been taken. However, ten days before the hearing, they hired an interim CEO who
    {{4-1-90 p.A-300}}came into the Bank, did what was necessarily a very quick analysis, and developed a capital plan, the adoption of which would have the effect of giving the Bank almost two years from the date of the May 31, 1983 examination to raise the required amount of capital. The adoption of the Bank's suggested time frame by the ALJ appears to place the official imprimatur of the court on the board's months of inaction, followed by its 11th-hour hiring of a new CEO....
       Admittedly, it is not easy for a bank in a distressed condition to sell capital. However, such banks have been able to sell capital, by means of a public offering, and there are other methods provided for in the Proposed Order by which capital might be raised. (Tr. 170) In any event, the FDIC has an affirmative duty to a bank's depositors to take action to require banks under its supervision to be adequately capitalized, despite the fact that it may be difficult for the bank to do so.

IV. FEASIBILITY

       The RD [Recommended Decision], at 10 states, "Here, the FDIC has offered no evidence on the feasibility of raising $7 million in so short a time period." FDIC takes exception to this statement, and the implications thereof. The logical extension of such a theory would indicate that in a case where the FDIC requires a bank to raise additional capital, the FDIC has an affirmative duty of proving the feasibility of raising the required amount of capital within the time frame suggested....

   [.3] The law does not so provide. We have found no authority for the proposition that the FDIC must prove the feasibility of its proposed Orders, and no authority is cited in the RD. The law provides that the FDIC does have a duty, in fashioning remedies under its cease-and-desist powers, of not acting arbitrarily or capriciously, nor in abuse of its discretion. (First National Bank of Eden v. Department of the Treasury, 568 F.2d 610 (8th Cir. 1978). Once a condition of unsafe or unsound banking practices is found, the FDIC may fashion relief in such a form as to prevent future abuses, so long as it does not abuse its discretion in so doing (Groos National Bank v. Comptroller of the Currency, 573 F.2d 889 (5th Cir. 1978)). The FDIC has broad discretion to cure the effect of a violation, and the remedy selected should be appropriate to correct the condition resulting from the violation ( del Junco v. Conover, 682 F. 2d 1338, (9th Cir. 1982)). The RD points out that the agency must be able to articulate some correlation between the action taken and the reason given for the action. (RD at 10) (Citing First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, (5th Cir. 1983)). We do not disagree. In this case, the only contested "action taken" by the FDIC is the proposed 180-day time frame for raising additional capital. The "reason given for the action" is the distressed condition of the bank, particularly its capital account. This condition is undenied and unrefuted. The FDIC contends that the evidence adduced at the hearing articulates unequivocally the nexus or correlation between the provision establishing a time frame of 180 days from the effective date of the Order and the condition of the Bank. Briefly stated, the correlation, which was articulated in various ways at the hearing as the basis for the "action taken" (the 180-day time frame), is that the Bank's financial condition is so tenuous that a rapid infusion of capital is mandated in order for the Bank to remain a viable institution. (In fact, if the Bank's past deterioration is a valid indication of its current condition, considering the continued passage of time, it may well be that 180 days from the effective date of the Order is too long, and that the Bank will approach or reach insolvency before that time runs its course.)

V. CONCLUSION

       It is the contention of the FDIC that in proposing a time frame of "180 days from the effective date of the Order" for meeting the acknowledged need for a capital infusion of $7 million, it has exercised its board discretion in fashioning a remedy appropriate to the Bank's condition, that such remedy has a rational basis, is supported by substantial evidence and that there is a clearly articulated correlation between the time frame so selected and the distressed condition of the Bank. Moreover, there is no indication whatsoever in the record that the FDIC has been or would be acting arbitrarily or capriciously in providing such a time frame. Finally, with reference to the most recent legislative action pertaining {{4-1-90 p.A-301}}to bank capital, the FDIC contends that the 180-day time frame is a "reasonable time period," particularly in light of the fact that by the time that period runs (assuming issuance of an Order in June or July 1984) the Bank will have actually had almost one and one-half years to take action since first being advised by the FDIC of the need for additional capital.
   The Board concurs with the position stated above. Accordingly, it rejects and does not adopt the Administrative Law Judge's conclusion that there is an inadequate legal basis for imposing the 180-day time period.

ORDER

   Having found that the Bank has committed the offense in the Notice of Charges, the Administrative Law Judge adopted all of the FDIC's Proposed Cease and Desist Order, except for the provision requiring infusion of capital into the Bank within the 180-day period after the effective date of the Order. For reasons stated above, the Board concludes that the 180-day time period is appropriate and should be included in the Order rather than the Bank's April 30, 1985 deadline. Accordingly, the Board adopts the Order in the Recommended Decision except that the introductory part of Paragraph 2(a) of the affirmative action requirements is amended to read:

       (a) Within 180 days from the effective date of the ORDER, the Bank's board of directors shall take all necessary steps to increase the Bank's total equity capital and reserves by not less than $7,000,000. Such increase in equity capital and reserves may be accomplished by:
   By Order of the Board of Directors.
   Dated at Washington, D.C. this 20th day of August, 1984.
/s/ Hoyle L. Robinson
   Executive Secretary

FDIC-83-223b
Before: ALLAN W. HEIFETZ
Administrative Law Judge

Recommended Decision

Statement of the Case

   This administrative action was instituted by the Federal Deposit Insurance Corporation ("FDIC") on October 5, 1983, when it issued against the Bank of * * * ("Bank") a Notice of Charges and of Hearing pursuant to Section 8(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. § 1818(b)(1); the "Act") and Part 308 of the FDIC Rules of Practice and Procedures (12 C.F.R. Part 308). The Notice charged the Bank with engaging in unsafe or unsound banking practices and violating certain laws and regulations. A proposed cease and desist order accompanied the Notice, requesting that the Bank take various affirmative actions concerning its banking practices. In its answer, the Bank declined to stipulate to issuance of the cease and desist order and instead made a request for a private hearing in accordance with the Federal Deposit Insurance Act. The Bank admitted jurisdiction and denied all other allegations.
   By letter dated November 9, 1983, the matter was referred to me for hearing and the issuance of a Recommended Decision. A formal hearing was held January 17, 1984, in * * *. Upon consideration of a joint request for an extension of time for the filing of post-hearing briefs, an order dated March 1, 1984, granted an extension to March 9, 1984. On that same date, briefs were filed by both the FDIC and Bank counsel.
   Upon consideration of the entire record, I make the following findings, conclusions and recommendations:

Findings of Fact

   1. The Bank of * * * is a corporation doing business under the laws of the State of * * * and has its principal place of business at * * *. As an insured, State nonmember bank, the Bank is subject to the Act (12 U.S.C. §§ 1811-1831d), the FDIC's Rules and Regulations (12 C.F.R. Chapter III) and the laws of the State of * * *.
   2. The Federal Deposit Insurance Corporation is a federal regulatory agency organized in 1933, responsible primarily for insuring bank deposits. A subsidiary role of the agency is the supervision of state chartered banks which are not members of the Federal Reserve System (State nonmember banks). In its role as supervisor of these banks, the FDIC regularly conducts examinations intended to reflect the financial condition of the bank as of the date of the particular examination.
   3. The FDIC has an array of supervisory options at its disposal should it find the bank it examines to be in an unsafe or {{4-1-90 p.A-302}}unsound condition. The most severe sanction the FDIC can impose, under Section 8(a) of the Act (12 U.S.C. § 1818a), is the termination of a bank's insurance if the bank has become an uninsurable risk. A less severe sanction is found at Section 8(b) of the Act (12 U.S.C. § 1818b), the cease and desist proceeding. The FDIC has relied on this sanction in the instant proceeding, calling on the Bank to cease and desist certain practices and to take certain affirmative action to bring the Bank into compliance with sound banking practices.
   4. * * * served as the Examiner-in-charge of the Bank of * * * examination conducted as of the close of business May 31, 1983. A written report was prepared at the conclusion of the four-week investigation. (Ex. G-2).
   5. The FDIC report of examination consists of consolidated financial statements of the Bank and its wholly-owned subsidiary, * * * Corporation. Major emphasis is placed on the Bank's loan portfolio, investment account, other real estate and contracts, earnings and capital. The primary purpose of the examination was to determine the condition of the Bank as reflected in its adequacy of capital, quality of assets, liquidity, capabilities or management and potential regulatory violations. The findings of the report reveal the following information about the Bank's condition as of May 31, 1983:
   (a) The Bank's adjusted total assets equaled $169,835,000;
   (b) The Bank's total loans, the largest component of the Bank's assets, equaled $120,277,000;
   (c) The Bank's total deposits equaled $130,848,000;
   (d) The Bank's total equity capital and reserves, or the differences between total liabilities and total assets, equaled $7,136,000; and
   (e) The Bank's adjusted equity capital and reserves equaled $6,421,000.1
   (6) In examining the quality of the Bank's assets, the report found an excessive volume of "classified" or substandard assets. The deterioration had especially occurred in the loan account, with the Bank having extended credit to borrowers without adequate credit scrutiny or a proper check into sources of repayment. (Ex. G-2, p.1). The total volume of classified assets stood at $22,339,000, equaling 313.05 percent of total equity capital and reserves. The figure represented a dramatic increase from percentage rates of 126.44 as of the April 23, 1982, examination and 104.68 from the prior examination of September 12, 1980. Mr. * * * characterized the most recent ratio as extremely high when compared to the usual percentage in a bank of 50–75 percent (Tr. 47).
   7. The classification process places suspect loans into one of three categories: substandard, doubtful or loss. Substandard loans have a definite weakness reflected in collectibility either through the lack of a borrower's financial capability or the lack of adequate collateral as security on the loan. A doubtful loan differs in degree from a substandard loan, possessing the above mentioned characteristics along with a great loss potential and, accordingly, is a more serious risk to the bank. A loss loan, by contrast, is essentially an uncollectible item or of so little value as to warrant deletion entirely from the bank's books. (Tr. 29–30).
   8. As of May 31, 1983, the total number of overdue loans was 284, totaling $16,543,000. ($16,221,000 was classified substandard and the remaining $322,000 as loss.) This amount represented 13.75 percent of the total amount of the Bank's loans. (Ex. G-2, p. 2; Tr. 48, 49). The percentage is considerably higher than the 3–5 percent range typically encountered in commercial banks (Tr. 43).
   9. Other non-loan assets were similarly classified, including real estate acquired through foreclosure. These assets totaled $5,796,000, $5,316,000 of which were classified substandard, $175,000 as doubtful, and $305,000 as loss. (Ex. G-2, p.2).
   10. In view of the excessive volume of adversely classified assets, the FDIC concluded in its report that "there continues to be a need to further strengthen the lending function and to provide the supervision and collection efforts needed to improve the quality of the loan portfolio." (Ex. G-2, p.1). The overdue loans reflected a growing number of borrowers not performing according to their original loan terms, indicating the likelihood of future deterioration.


1 This figure reflects the amount of equity capital and reserves, reduced by assets classified as either "doubtful" or "loss", as described below.
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   11. The FDIC examination also considered the Bank's adequacy of capital in determining potential exposure to the depositors' funds or the FDIC insurance funds. It first looked at the adjusted equity capital and reserves, totaling $6,421,000. This amount was 3.78 percent of adjusted total assets of $169,835,000. (Ex. G-2, p.3; Tr. 52–54). The more typical ratio for comparably sized banks would run between 6.5 and 7.5 percent (Tr. 54). The adjusted capital was also considered, which is the Bank's equity capital and reserves, less any loss classifications and 50 percent of the doubtful classifications. Adversely classified assets which were not considered in computing the adjusted equity capital and reserves totaled $21,624,000. Those assets equaled 336.77 percent of the adjusted equity capital and reserves of the Bank. (Tr. 56). Mr. * * * found to be significant such a large amount of classified assets not reflected in the adjusted capital computation since a substantial portion of these could ultimately deteriorate and become losses (Tr. 37).
   12. The examination also found undesirable the Bank's failure to maintain an adequate reserve for loan losses. As of May 31, 1983, the loan valuation reserve was $857,000, or .71 percent of total loans outstanding. (Ex. G-2, p.1-a). This amount was sufficient to absorb loan losses resulting from loans classified loss and half of those classified doubtful as of the date of the examination. However, the report concludes:
       It is rather obvious that the current provision is insufficient to cover even current losses and the large volume of substandard credits would indicate that additional losses will yet be sustained. The present reserve is inadequate and additional provision will be necessary if an adequate reserve is to be maintained. (Ex. G-2, p.1-a, 1-a-1).
   Mr. * * * opined that a well run bank should have a loan valuation account of at least 1.0 percent of its total loans. He advised that the Bank of * * * have a reserve in excess of 1.0 percent because of the potential losses on its loan portfolio (Tr. 59).
   13. The FDIC examination found that the Bank's earnings dropped significantly in 1982, with the Bank experiencing an after tax operating loss of $880,000, compared with a $1,000,000 profit in 1981. (Ex. G-2, p.4; Ex. G-9). The trend continued for the first five months of 1983, during which time the Bank suffered an additional net loss of $402,000. (Ex. G-2, p.4; Tr. 62). Several reasons were identified for the Bank's unprofitability, including its large volume of nonearning assets, overly-rapid expansion, high overhead expenses and excessive loan losses. (Tr. 65).
   The ratio of after tax net operating income to average assets for 1982 was negative .46 percent. This figure contrasts with a peer group ratio2 of .93 for 1982 (See Ex. G-10). The Bank management is cognizant of its poor earnings performance and its adverse effect on the capital account. At the time of the examination, management had initiated actions intended to restore profitability to the Bank's operation, including the closure of four branch offices, the consolidation of services at the remaining offices, suspension of cash dividends, and salary cuts. The FDIC, however, recommended more stringent measures, including the reduction in volume of nonearning assets and the improvement in the Bank's net interest margin. (Ex. G-2, p.1-a). These measures were viewed as imperative in preventing the further erosion of capital.
   14. Liquidity is a measure of a bank's ability to meet its cash needs, such as deposit withdrawals. A bank's cash, short-term investments, and deposits with other banks constitute a bank's liquidity account. (Tr. 68).
   15. The examination concluded that the Bank's liquidity condition was marginal, in that while immediate cash needs were met, the balance sheet structure was problematic. The FDIC found the large volume of volatile deposits (funds likely to leave the bank on short notice) to be particularly troubling. The FDIC believed that the Bank was relying too heavily upon short-term borrowings to fund its long-term earning assets, thus producing a high dependency ratio (28 percent on December 31, 1982 compared to a peer group ratio of 3 percent). (Ex. G-2, p.5, 5-a; Tr. 72). Also of concern to the FDIC was the absence of many temporary, readily available cash investments to cover these volatile liabilities
2 The peer group consists of comparably sized banks, operating in a banking environment similar to that in which the Bank of * * * operates (Tr. 66).
{{4-1-90 p.A-304}}and the significant amount of depreciation in the Bank's security portfolio. (Tr. 69, 70). Additionally, the Bank's wholly-owned subsidiary * * * had sold many of its agricultural loans to the * * * Bank ("* * *") on a recourse basis, such that * * * could ask the Bank to repurchase the loans at any time.3 $26,000,000 of such loans are still held by the * * * on a recourse basis (Ex. G-2, p.1-a-1).
   16. In the course of its investigation, the FDIC found that the Bank was in violation of certain laws and regulations. The Bank had violated Section 708.305 of the * * * Revised Statutes (* * * § 708.305) in granting extensions of credit to a person, on an unsecured basis, in excess of five percent of the Bank's capital stock, unimpaired surplus, and qualifying debentures. The Bank had also violated Section 23A of the Federal Reserve Act (12 U.S.C. § 371c) made applicable to State nonmember banks by Section 18(j)(1) of the Federal Deposit Insurance Act (12 U.S.C. § 1828(j)(1)) by funding $1,318,420 in unsecured notes from * * *, a subsidiary of the Bank's holding company (Ex. G-2, p.6-a). These violations, along with others (i.e., apparent violations of * * * State Statutes with regard to inadequate documentation on real estate acquisitions), led the FDIC to conclude that corrective action must be taken to see that such behavior does not recur in the future. (Ex. G-2, p.1-a-1).
   17. On the basis of its examination findings, the FDIC is required to assign a Uniform Financial Institution Performance Rating to the Bank. The system is developed from what is known as "CAMEL" rating, CAMEL being an acronym for Capital, Assets, Management, Earnings, and Liquidity. The rating is done numerically on a one to five scale, with a one being the most desirable rating. The ratings are then quantified into a composite figure. (Tr. 73–74). The composite figure assigned to the Bank was a four. Institutions in this group "have an immoderate volume of serious financial weaknesses or a combination of other conditions that are unsatisfactory." (Ex. G-2, p.1-a-2). The assessments, on a category by category basis, were as follows:
   (a) CAPITAL—"4."—Low capital ratio, a low volume of adjusted equity capital as a percentage of assets and deteriorating capital were the basis for this rating.
   (b) ASSETS—"5."—The lowest possible rating was assigned because of a substantial volume of classified assets.
   (c) MANAGEMENT—"4."—Management was said to have done a poor job of overseeing the Bank's financial condition. Those who formulated bank policy were especially found to be doing a less than adequate job.
   (d) EARNINGS—"4."—Recently sustained large losses and ominous projections for the future accounted for this rating.
   (e) LIQUIDITY—"3."—The Bank was relying too heavily on volatile liabilities to fund their liquidity. (Tr. 75–78).
   18. On the basis of the findings of the examination and conclusions concerning the Bank's financial difficulty, * * *, Assistant Regional Director in the FDIC * * * Office, made recommendations to appropriate personnel concerning corrective measures to be taken. * * *, along with Regional Director * * * and State Superintendent of Banks, * * *, concurred in proposing a cease and desist order under Section 8(b) of the FDIC Act. (Tr. 101) The proposed order would require that the Bank charge off assets classified as loss, replenish capital reserves, and change the loans policy to improve lending and collection procedures. With respect to earnings, the FDIC officials recommended that a budget be established to control expenses. Finally, with regard to capital, the order proposed raising $6,000,000 in order to bring the Bank's capital to assets ratio up to above seven percent.4 This capital infusion would have to be accomplished within a period of 180 days from the effective date of the order. (Tr. 104) The initial recommendation of $6,000,000 in additional equity capital was later revised to $7,000,000 after it was determined that a generous employment contract between the Bank and its Chief Executive Officer ("CEO") * * * reflected compensation far in excess of that paid to other CEOs in other banks in the region. (Tr. 106).5

3 In December 1982, * * * was requested to repurchase $5,000,000 in loans because it did not meet * * * standards. The FDIC concludes that a repurchase of these farm loans is a very real possibility and that the Bank's liquidity position should take this into account. (Ex. G-2, p. 1-a-1).

4 The FDIC's capital policy for well run banks establishes a minimum acceptable capital ratio of five percent. Peer group banks could probably have a ratio of around seven and one-half percent. (Tr. 94).

5 The additional one million dollars was intended to approximate the present value of the $200,000 annual payments remaining under the * * * contract, assuming such contract to be enforceable. (Tr. 106).
{{4-1-90 p.A-305}}
   19. As a policy matter, when the FDIC finds the ratio of adjusted equity capital and reserves to adjusted total assets to be at or below 3.0 percent, it will initiate an action for the termination of deposit insurance under Section 8(a) of the FDIC Act. (Tr. 118). In the estimation of Mr. * * *, if the Bank continues on its present course, it will continue to lose capital to the point where it would no longer be an insurable risk to the FDIC. The FDIC, therefore, anticipates reexamining the Bank before May 31, 1984 (Tr. 118, 119).
   20. The FDIC Report of Examination of the Bank as of May 31, 1983, was sent to the Bank's Board of Directors on August 15, 1983. (Ex. G-H) The Board of Directors were made aware of the Regional Director's recommendation that the Bank be designated a problem bank. Similarly, the Regional Director concluded that the management of the Bank was inferior in directing it "along a path that resulted in a large volume of poor quality assets and operating losses." (Tr. 96). Specifically, the Regional Director considered Mr. * * * to be an inferior and unacceptable CEO and anticipated a change in that office. (Ex. G-14). A September 15, 1983, letter from Regional Director * * * to the Bank's Board of Directors stated that neither * * * nor * * * were suitable replacements in the context of the proposed 8(b) cease and desist order. Instead, Mr. * * * recommended that the Bank retain a new CEO from outside the Bank "to truly reverse the course of the institution." (Ex. G-14).
   21. On or about January 7, 1984, Mr. * * * was employed as CEO of the Bank. The Regional Director of the * * * Regional Office of the FDIC found Mr. * * * selection acceptable and Mr. * * * speculated that his selection as permanent CEO might also meet with FDIC approval. (Tr. 121, 122) Prior to his present position, Mr. * * * had served as a CEO for eight different * * * banks in a consulting capacity. MR. * * * helped devise plans to alleviate capital shortages experienced by these banks, many of which had been considered "troubled institutions." (Tr. 125–126).
   22. Mr. * * * has been involved with a thorough review of the Bank's financial condition as well as the proposed cease and desist order drafted by the FDIC. On the basis of his review, Mr. * * * concluded he "[had] no quarrel with the examiner's findings of fact, nor with the criticisms." (Tr. 127–128). His only reservation was with the order's contemplated time frame in which additional capital is to be raised. Based on his prior experience with troubled banks, Mr. * * * finds it extremely unlikely that $7,000,000 in capital can be raised until the course of the bank is reversed. (Tr. 127, 137) Instead, he believes that a seven-month time frame is more appropriate in order to achieve major positive results. Within these seven months, Mr. * * * stresses the need for demonstrating to potential investors the Bank's financial turnaround. This must be done, he posits, before developing either a public stock offering, private placements or potential mergers or acquisitions to outside groups. Efforts to make such a presentation to potential investors have so far failed because of the Bank's poor financial condition. (Tr. 134, 135–137).
   23. Mr. * * * believes the financial problems experienced by Bank of * * * to be less severe than those experienced by other banks with which he has been associated in recent years. While he was involved with three other bank failures which resulted from credit losses incurred prior to his arrival, he distinguishes the Bank of * * * from the others in that those three banks had loss classifications far in excess of this Bank's. (Tr. 159). Similarly, he believes the Bank to be an operation with a good core deposit base, excellent contingency, over $40,000,000 in extremely stable senior citizen accounts and an absence of abusive inside transactions evident at other banks experiencing financial problems. (Tr. 145).
   24. It is the opinion of Mr. * * * that the implementation of a viable plan to raise $7,000,000 in capital cannot be accomplished until April 30, 1985. It is his opinion that to impose a more abbreviated time frame would result in "commit[ting] [his] energies to something that doesn't have any possibility of success..." (Tr. 175).

Discussion

   The Bank, in responding to the Notice of Charges and proposed order, takes no exception to the FDIC findings concerning its banking practices, nor does it generally oppose the proposed remedial measures. It does, however, oppose the required 180-day {{4-1-90 p.A-306}}time frame during which the Bank would have to raise additional capital in the amount of $7 million.
   The term "unsafe or unsound" as used in Section 8(a) of the Federal Deposit Insurance Act is a term of art widely used in banking regulatory statutes and frequently referred to in case law. In adopting the phrase "unsafe or unsound," Congress has purposefully left its definitional coverage to the discretion of banking regulatory agencies which can determine with great latitude which acts will be proscribed. Groos National Bank v. Comptroller of Currency, 573 F.2d 889, 897 (5th Cir. 1978). Congress authorized the regulatory agencies to employ the cease and desist power in order to "mov[e] quickly and effectively to require adherence to the law and cessation and correction of unsafe or improper practices," First National Bank of Bellaire v. Comptroller of Currency, 697 F.2d 674, 680 (5th Cir. 1983).
   The FDIC proposes measures well within its discretion in proscribing the Bank's past practices. The record makes abundantly evident the need to curb the Bank's past abuses. As indicated in the Report of Examination itself and the testimony of Mr. * * * and Mr. * * *, the Bank's performance was deficient with respect to sufficiency of capital, quality of assets, management performance, available loan loss reserves and liquidity accounts. Similarly, the Bank had failed to comply with various banking laws and regulations (See Ex. G-2). In nearly all of those categories, the Bank compared unfavorably with its peer group. On the basis of these exhaustive findings, the FDIC recommended corrective action to curb the effect of these practices which, if unchecked, could possibly lead to the Bank's insolvency.
   The Bank has neither attempted to refute the validity of the FDIC's findings nor take exceptions to the proposed remedies. At the hearing, the Bank presented no evidence to contradict the FDIC findings and thus acquiesces to the FDIC's proposed findings. I find that the FDIC has met its burden of demonstrating unsafe or unsound practices based on substantial evidence on the record.
   The only issue in dispute in this proceeding concerns not the purpose of the proposed cease and desist order or its general terms, but rather the time frame during which remedial measures must be implemented. In this regard, the FDIC has insisted that within 180 days from the effective date of the order, the Bank's Board of Directors take all measures necessary to raise $7,000,000 in additional capital. It then proceeds to suggest various methods by which such funds can be raised. (See Section 2(a) of the Proposed Order to Cease and Desist). The FDIC suggests that the 180-day time frame is necessary because as Mr. * * * indicated in testimony, the Bank does not "have the luxury of an extended time frame" (Tr. 168). The FDIC maintains that in view of the dangerously low capital ratio reflected in the examination, an immediate infusion of capital is needed; otherwise the Bank could face a possible withdrawal of FDIC insurance under a Section 8(b) proceeding (should the capital ratio drop below 3.0 percent). Therefore, because of the urgency of its capital requirements, the FDIC argues that the 180-day time limit be imposed.
   The Bank, primarily through its interim Chief Executive Officer, Mr. * * *, presented evidence related to the feasibility of raising the $7 million within a given time frame. In carefully examining potential sources of capital and outlining a plan aimed at attracting investors through a demonstrated turnaround in profitability, Mr. * * * estimated that a more realistic and appropriate time frame would be in the vicinity of one year. These projections were based on Mr. * * * expertise acquired from substantial prior experience in managing banks, including financially troubled ones. The FDIC's approval of Mr. * * * as an interim CEO lends further credence to the accuracy and validity of these projects.
   I find impressive the Bank's argument in support of its time frame for the raising of additional capital. While the agency is to be accorded great discretion in devising a remedial scheme when it has found certain unsafe or unsound practices, such discretion is not unbridled. The agency must be able to articulate some correlation between the action taken and the reason given for the action. First National Bank of Bellaire v. Comptroller of Currency, 697 F.2d 674, 680 (5th Cir. 1983). Here, the FDIC has offered no evidence on the feasibility of raising $7 million in so short a time period. It merely points to the acknowledged need for a capital infusion. Conversely, the Bank has offered evidence through Mr. * * * testimo- {{4-1-90 p.A-307}}
ny, on the impossibility of compliance with the time frame suggested. Mr. * * * articulated a detailed step-by-step plan through which the Bank seeks to meet its capital needs. The FDIC has simply not advanced any arguments or evidence to refute these conclusions. To issue an order for affirmative actions which are not achievable within the strictures set by the FDIC would defeat the purpose of the order, which is to return the financial condition of the Bank to a sound footing. Therefore, having found that the Bank has been engaging in unsafe and unsound banking practices and has been violating laws and regulations as specified herein, I recommend that the Federal Deposit Insurance Corporation issue the following:

ORDER

   ORDERED, that the Bank of * * *, its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank cease and desist from the following unsafe or unsound banking practices and violations:
   (a) following hazardous lending and lax collection practices;
   (b) operating with a large volume of poor quality loans;
   (c) operating with inadequate equity capital and reserves;
   (d) operating with an inadequate loan valuation reserve;
   (e) operating in violation of laws and regulations;
   (f) operating with high overhead expenses and a declining net interest margin; and
   (g) operating with inadequate provisions for liquidity.
   FURTHER ORDERED that the Bank take affirmative action as follows:
   (1) Within 60 days from the effective date of this ORDER, the Bank shall provide and thereafter continue to retain management acceptable to the Regional Director of the * * * Regional Office of the FDIC ("Regional Director") and the Superintendent of Banks for the State of * * * ("State Superintendent"). Such management shall include a qualified chief executive officer who shall be given stated written authority by the Bank's Board of Directors. Such written authority shall include the responsibility of implementing and maintaining lending policies and other Bank policies in accordance with sound banking practices.
   2. (a) On or before April 30, 1985, the Bank's Board of Directors shall take all necessary steps to increase the Bank's total equity capital and reserves by not less than $7,000,000. Such increase in equity capital and reserves may be accomplished by:
   (i) the sale of common stock; or
   (ii) the sale of perpetual preferred stock; or
   (iii) the direct contribution of cash by the shareholders and/or directors of the Bank; or
   (iv) the collection of assets previously charged-off; or
   (v) the reduction of the "Loss" assets specified in Paragraph 3 of this ORDER without loss or liability to the Bank; or
   (vi) any other method acceptable to the Regional Director.
   (b) If all or part of the increase in total equity capital and reserves required by Paragraph 2 of this Order is accomplished by the sale of new securities, the Board of Directors of the Bank shall forthwith take all necessary steps to adopt and implement a plan for the sale of such additional securities, including voting any shares owned or proxies held or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Bank's securities (including a distribution limited only to the Bank's 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 thirty (30) days prior to the dissemination of such material, the plan and any materials used in the sale of the securities shall be submitted to the FDIC at Washington, D.C. Any changes requested to be made in the plan or materials by the FDIC shall be made prior to their dissemination. If the increase in equity capital is provided by the sale of preferred stock, then all terms and conditions of the issue, including but not limited to those terms and conditions rela- {{4-1-90 p.A-308}}tive to interest rate and any convertibility factor, shall be presented to the Regional Director for prior approval.
   (c) In complying with the provisions of Paragraph 2 of this ORDER, the Bank shall provide to any subscriber and/or purchaser of the Bank's securities written notice of any planned or existing development or other change which is materially different from the information reflected in any offering materials used in connection with the sale of Bank securities. The written notice required by this paragraph shall be furnished within ten (10) calendar days from the date such material development or change was planned or occurred, whichever is earlier, and shall be furnished to every subscriber and/or purchaser of the Bank's securities who received or was tendered the information.
   (d) As of the effective date of this ORDER, neither the Bank nor any of its subsidiaries shall make any payment in cash or kind as dividends on common stock or otherwise to the Bank's parent holding company or any of the parent's subsidiaries without the prior approval of the Regional Director.
   3: (a) Within 10 days from the effective date of this ORDER, the Bank shall eliminate from its books, by charge-off or collection, all assets classified "Loss" as of May 31, 1983, that have not been previously collected or charged-off. Reduction of these assets through proceeds of other loans made by the Bank is not considered collection for the purpose of this paragraph.
   (b) Within 180 days from the effective date of this ORDER, the Bank shall have reduced the assets classified "substandard" as of May 31, 1983, to not more than $13,000,000.
   (c) Within 270 days from the effective date of this ORDER, the Bank shall have reduced the assets classified "Substandard" as of May 31, 1983, to not more than $10,000,000.
   (d) The requirements of 3(a), 3(b), and 3(c) above are not to be construed as standards for future operations and, in addition to the foregoing, the Bank shall eventually reduce the total of all adversely classified assets. As used in subparagraphs 3(b), 3(c), and 3(d), the word "reduce" means (1) to collect, (2) to charge-off, or (3) to sufficiently improve the quality of assets adversely classified to warrant removing any adverse classification, as determined by the FDIC.
   4. As of the effective date of this ORDER, the Bank shall not extend, directly, or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit with the Bank that has been charged-off or classified, in whole or in part, "Loss" and is uncollected. The requirements of this paragraph shall not prohibit the Bank from renewing (after collection in cash of interest due from the borrower) any credit already extended to any borrower.
   5. Within 60 days from the effective date of this ORDER, the Bank shall revise, adopt, and implement written lending and collection policies to provide effective guidance and control over the Bank's lending function. Such policies and their implementation shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.
   6. Within 60 days from the effective date of this ORDER, the Bank shall eliminate and/or correct all violations of laws and regulations existing in the Bank as of May 31, 1983. In addition, the Bank shall take all necessary steps to ensure future compliance with all applicable laws and regulations.
   7. Within 60 days from the effective date of this ORDER, the Bank shall establish and thereafter maintain an adequate reserve for loan losses which shall equal at least one percent of the Bank's total loans. Such reserve shall be established by charges to current operating income, together with collection of assets previously charged-off. In complying with the provisions of this paragraph, the Board of Directors of the Bank shall review the adequacy of the Bank's reserve for loan losses prior to the end of each calendar quarter. The minutes of the board meeting at which such review is undertaken shall indicate the results of the review, the amount of any increase in the reserve, and the basis for determination of the amount of the reserve provided.
   8. Within 60 days from the effective date of this ORDER, the Bank shall initiate a program and establish a budget to control overhead and other expenses. The program and its implementation shall be in a form and manner acceptable to the Regional Di- {{4-1-90 p.A-309}}rector as determined at subsequent examinations and/or visitations.
   9. Within 60 days from the effective date of this ORDER, the Bank shall develop or revise, adopt, and implement a written liquidity and funds management policy that adequately addresses the Bank's liquidity needs. Such policy and its implementation shall be in a form and manner acceptable to the Regional Director as determined at subsequent examinations and/or visitations.
   10. On the tenth day of the second month following the effective date of this ORDER, and on the tenth day of every second month thereafter, the Bank shall furnish written progress reports to the Regional Director and the State Superintendent detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. Such reports may be discontinued when the corrections required by this ORDER have been accomplished and the Regional Director has released the Bank in writing from making further reports.
   The provisions of this ORDER shall be binding upon the Bank, its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank.
   This ORDER shall become effective ten (10) days from the date of its issuance.
   The provisions of this ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provisions of this ORDER shall have been modified, terminated, suspended, or set aside by the FDIC.
/s/ Alan W. Heifetz
Chief Administrative Law Judge
U.S. Department of Housing and Urban
Development
451 7th Street, S.W., Room 2156
Washington, D.C. 20410
(202) 755-0132
May 4, 1984

CERTIFICATE OF SERVICE

   I hereby certify that copies of this Recommended Decision issued by ALAN W. HEIFETZ, Chief Administrative Law Judge, Docket No. FDIC 83-223b, were mailed to the parties listed below on this 4th day of May, 1984, in the manner indicated.
/s/ Helen L. Shepard

REGULAR MAIL:

Arthur L. Beamon, Esquire
Counsel
Federal Deposit Insurance Corporation
550—17th Street, N.W.
Washington, D.C. 20429
* * *

Alan J. Kaplan
Deputy Executive Secretary
Federal Deposit Insurance Corporation
550—17th Street, N.W.
Washington, D.C. 20429
* * *
Regional Counsel
* * *

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