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FDIC Enforcement Decisions and Orders

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   [5030]FDIC Docket No. FDIC-83-172b (11-19-84)

   Cease and desist order issued to a bank that had committed unsafe or unsound banking practices. The bank's condition had not improved since the bank was examined, but even if the bank's condition had improved, the FDIC could still issue a cease and desist order. (This decision was affirmed by the U.S. Court of Appeals for the Fifth Circuit, 766 F.2d 175 (1985)).

   [.1] Unsafe or Unsound Banking Practice—Statutory Standard
   The term "unsafe and unsound practices" is a generic term, like "negligence" or "probable cause," having a central meaning that must be applied to constantly changing factual circumstances. An unsafe or unsound practice is any action, or lack of action, that is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.

   [.2] Lending and Collection Policies and Practices—Hazardous Lending
   Hazardous lending and lax collection practices constitute unsafe or unsound banking practices.

   [.3] Loan Loss Reserve—Adequacy
   Operating with inadequate loan-loss reserves constitutes unsafe or unsound banking practices.

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   [.4] Capital—Adequacy—Unsafe or Unsound Practices
   Operating with inadequate capital constitutes an unsafe or unsound banking practice.

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

   [.6] Directors—Duties and Responsibilities—Standard of Care
   Directors of banks are held to a standard of ordinary care and prudence in the administration of bank affairs.

   [.7] Directors—Duties and Responsibilities—Delegation to Officers
   Directors are entitled to delegate banking business to their duly authorized officers, but may be held liable for negligence if they fail to exercise reasonable supervision over the management.

   [.8] Directors—Duties and Responsibilities—Generally
   Directors of a bank have a duty to investigate when necessary to protect shareholders' interests, to supervise the bank's affairs, to have a general knowledge of its business, and to know to whom and upon what security its large lines of credit are given.

   [.9] Cease and Desist Orders—Defenses—Correction of Violation
   Cessation of unsafe or unsound practices is not a defense to an action under the Federal Deposit Insurance Act.

   [.10] Cease and Desist Orders—When Appropriate
   Unsafe or unsound banking practices need not be ongoing at the time a cease and desist order is issued. A cease and desist order may be issued against any bank if any violation or unsafe or unsound practice specified in the notice has been established. A cease and desist order can be issued for unsafe or unsound practices for corrective purposes and to prevent future abuses.

   [.11] Ex-parte Communication—Defined
   An ex parte communication is an oral or written communication not on the public record with respect to which no reasonable prior notice to all parties is given.

   [.12] Practice and Procedure—Submission of Proposed Oder to ALJ
   Submission by the FDIC of a proposed order to an ALJ is no more influential than transmittal of a notice of charges or proposed findings of fact or conclusions of law. The ALJ must have each of these documents in order to recommend a decision.

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


DECISION AND ORDER DENYING
MOTION FOR STAY OF ORDER TO
CEASE AND DESIST

FDIC-83-172b

   Reference is made to the Order to Cease and Desist (the "Order") issued on October 19, 1984, by the Board of Directors of the Federal Deposit Insurance Corporation (the "Board" and the "FDIC", respectively) against the Bank of * * * (the "Bank").
   The Bank has forwarded a Notice of Appeal of the Order to the United States Court of Appeals for the Fifth Circuit (the "Fifth Circuit"). On November 1, 1984, the Bank filed a Motion For Stay pending appeal (the "Motion') with the FDIC's Office of the Executive Secretary. On November 7, 1984, counsel for the FDIC filed a response in opposition to the Motion.
   In weighing these competing arguments, the Board is guided by the criteria used by the Fifth Circuit in ruling upon a motion for stay. An applicant for a stay in the Fifth Circuit must demonstrate:
   1) a likelihood of success on the merits of the appeal;
   2) irreparable injury if the stay is not granted;
   3) that no substantial harm will come to other parties if a stay is granted; and
   4) that a stay will serve the public interest.
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Ruiz v. Estelle, 650 F.2d 555, 565 (5th Cir. 1981), cert. denied, 103 S.Ct. 1438 (1983).
   With regard to the above factors, the Bank bases its hopes for success on the merits of its appeal in the improvements it claims to have made in its operations and conditions since the January 14, 1983 examination. Second, it claims that it will be irreparably injured if the changes in its operations and management mandated in the Order are instituted before the appeal is heard. Third, it alleges that no harm will come to the FDIC if the Order does not go into effect on the date provided. Finally, it asserts that the public interest will be served best by a stay pending appeal.
   Counsel for the FDIC argues that the Bank has cited no basis for its hopes for success on appeal. The opposition to the Motion also denies that the Bank will be harmed if the Order goes into effect on schedule, and alleges that the FDIC's insurance fund will be threatened if the Order is stayed. Counsel for the FDIC maintains that a stay would not be in the public interest, citing the condition of the Bank at the time of its examination that led to the issuance of the Order.
   After considering the Motion and the opposition thereto, the Board finds that the arguments of the Bank fall short of the requirements of Ruiz v. Estelle, 650 F.2d at 565, and that they do not include any other compelling reason for granting a stay. In alleging likelihood of success on merits, the Bank is arguing, as it did in the administrative hearing, that cessation of unsafe or unsound practices, with resultant improvement in a bank's condition, is a defense to a Section 8(b) proceeding. The Board has already addressed and rejected this contention in its Order of October 19, 1984, based upon statutory and case law. There the Board noted, moreover, that the record demonstrates that unsafe or unsound practices and conditions continued at the Bank after the date of the FDIC examination upon which the charges against the Bank were brought. The Board therefore finds that the Bank has not made a strong showing of likely success on the merits. Furthermore, the Board concluded in its Order of October 19 that the changes mandated therein will not harm the Bank, but will help to restore it to a sound financial condition. The Board also found in its Order that the Bank's unsafe or unsound practices entail an abnormal risk of loss to the Bank's shareholders and depositors, as well at to the FDIC's insurance fund. The Bank thus has failed to meet its burdens of demonstrating that a stay is in the interest of the public and will not harm other parties.
   Accordingly, the Motion is hereby denied.
   By direction of the Board of Directors, this 19th day of November, 1984.
/s/ Hoyle L. Robinson
Executive Secretary

DECISION AND ORDER FDIC-83-172b

I. STATEMENT OF THE CASE

   On July 28, 1983, the Federal Deposit Insurance Corporation ("FDIC" or "Proponent") issued a Notice of Charges and of Hearing ("Notice") against Bank of * * * ("Bank" or "Respondent") under Section 8(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. § 1818(b)(1) and Part 308 of the FDIC's Rules of Practice and Procedures (12 C.F.R. Part 308). The Notice charged that the Bank engaged in certain unsafe or unsound practices in conducting the business of the Bank within the meaning of Section 8(b)(1), and called for a hearing to take evidence and determine whether a cease-and-desist order should be issued. The order would require the Bank to terminate such practices and to take affirmative action to correct the conditions resulting from such practices.
   On February 14 through 18, 1984, a formal hearing was held in * * * before Administrative Law Judge Earl S. Dowell (the "ALJ"). The FDIC and the Bank filed initial briefs containing proposed findings of fact, conclusions of law and orders on May 30, 1984, followed by reply briefs in June 1984. The ALJ issued his Recommended Decision on June 28, 1984.
   On July 26, 1984, the FDIC filed exceptions to the ALJ's Recommended Decision. The Respondent did not file exceptions to the Recommended Decision, but did file, under a cover letter dated July 16, 1984, a Motion for Oral Argument before the FDIC Board of Directors ("Board"). The motion was denied by the Board on August 20, 1984.

II. ALJ's RECOMMENDED DECISION

   In the Recommended Decision, the ALJ concludes that FDIC's action against the {{4-1-90 p.A-325}} Bank should be dismissed. Consequently, the decision contains no Recommended Cease-and-Desist Order. Also, the ALJ's decision, which summarizes portions of the record for 22 pages but contains only one-and-one-half pages of discussion and conclusions, does not specifically enumerate any findings of fact or conclusions of law. However, several such findings and conclusions are discernible from the decision.
   The ALJ found that the condition of the Bank had "improved a great deal" after the January 14, 1983 examination that gave rise to the charges, and concluded that a cease-and-desist order should not be issued because, in his opinion, the record does not sustain a finding that unsafe or unsound banking practices were being committed by the Bank at the time of the decision. In reaching this decision, the ALJ accepted the Bank's argument that cessation of unsafe or unsound banking practices after the date of an examination on which a Notice of Charges is based is a defense to a Section 8(b) action. The ALJ concluded, therefore, that it was unnecessary to make any findings of fact as of the January 14, 1983 examination date.
   The ALJ also found that the Bank's capital ratio (i.e., total equity capital and reserves to total assets) of 8.5 percent as of December 31, 1983 was adequate with the addition of $1,200,000 in capital at that time. The ALJ noted that larger banks were running with significantly lower capital ratios. Further, the ALJ concluded that on the date of the January 14, 1983 examination, the Bank would have been in full compliance with the liquidity provisions of a May 5, 1982 Memorandum of Understanding between the FDIC and the Bank if the FDIC had included certificates of deposit of $100,000 or more in the core deposit ratio in determining liquidity. The ALJ believed that these certificates of deposit were stable in nature and should have been included by the FDIC. Also, while the ALJ agreed that the Bank had numerous loan problems, he noted that the Bank has proposed a new loan policy incorporating FDIC's suggestions, is more carefully evaluating collateral for new loans and will have its own inhouse, asset-liability management programs in 1984. The ALJ remarked on the depressed agricultural economy in the Bank's area, but did not actually state that these adverse economic conditions caused the Bank's loan problems. The ALJ also took note of the Bank's testimony that indicates that a cease-and-desist order is "unnecessary" and would be "detrimental" to the Bank.
   For the reasons discussed below in this Decision, the Board rejects the ALJ's conclusion of law that cessation of unsafe or unsound practices is a defense to a Section 8(b) action. The Board also declines to adopt the ALJ's findings that the Bank's condition improved a "great deal" after the January 14, 1983 examination date. Moreover, even if cessation of unsafe or unsound practices were a defense, the Board finds that the evidence in the record does not support a finding of such subsequent improvement.
   The Board further finds that there is substantial evidence in the record supporting FDIC's charge that the Bank had committed unsafe or unsound banking practices as of the January 14, 1983 examination date. Accordingly, the Board adopts as its own the FDIC's proposed Findings of Fact without substantive modifications, except for deletion of the loans listed in 3(b) as being inadequately secured after the January 14, 1983 examination date. The Board declines to adopt the FDIC's Additional Proposed Findings of Fact 1 through 8 as being irrelevant to the charges made since they pertain to events after January 14, 1983. The Board also adopts two new Findings of Fact 4 and 5 as well as the FDIC's Proposed Order to Cease and Desist. Further, the Board arrives at various conclusions of law which are similar to those proposed by the FDIC. These are discussed in greater detail below.

III. DISCUSSIONS OF CHARGES AND PROPOSED FINDINGS OF FACT

   1. Allegations of Jurisdiction.
   In paragraph 1 of the Notice, FDIC alleges the basis for FDIC jurisdiction over the Bank and the subject matter in this proceeding. This allegation is undisputed; however, the ALJ made no finding regarding the matter. The Board finds the allegation to be accurate and accordingly adopts the FDIC's Proposed Findings of Fact 1 pertaining to the allegations of jurisdiction as set forth in full in the Findings of Fact section presented later.
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   2. Allegations Regarding Capital, Adjusted Capital, Adjusted Total Assets, Total Deposits and Net Loans.
   Paragraph 2 of the Notice alleges certain statistical information about the capital, adjusted capital, adjusted total assets, total deposits and net loans of the Bank as of the January 14, 1983 examination date. The information is relevant to the basic charges in the Notice and is undisputed. Again, the ALJ's decision contains no formal finding regarding the allegations. Since the information is substantiated by the record, the Board adopts the FDIC's Proposed Finding of Fact 2 containing the information.
   3. Allegations that Bank Engaged in Hazardous Lending and Lax Collection Practices.
   The FDIC Notice charges that as of January 14, 1983 the Bank had engaged in four practices that evidenced hazardous lending and lax collection practices. They are discussed below.

       (a) Loans have been renewed or extended without collection in cash of interest due. To support this charge FDIC presented evidence regarding three Bank loans: the * * *, loan, the * * * and * * * loans, and the * * * Company, Inc. loan. Each of these loans had been renewed without the collection in cash of interest due. Further, in no case does the record establish that the Bank made an effort to ascertain whether the borrower was capable of paying interest or examined options (including that of alternative repayment programs or foreclosure) to determine the best approach to protect the Bank's interest before renewal. FDIC testimony does establish, however, that the renewal or extension of a loan without the collection of interest generally indicates that the borrower is in financial difficulty, that it is considered more hazardous to extend interest payments than principal, and that interest should be collected if at all possible.
       Based upon the hazardous lending and lax collection practices evidenced with respect to the loans cited here, the Board concludes that the Bank engaged in activities that presented abnormal risks of loss to the Bank. In view of this, the Board adopts the FDIC's Proposed Finding of Fact 3(a) without modification.
       (b). Loans have been made that are inadequately secured. The FDIC cited one loan (the * * * loan) during the hearing as an example of the alleged practice in its Proposed Findings of Fact 3(b) referred to numerous other loans described in the FDIC and Bank exhibits as additional evidence in support of the charge. The Bank presented evidence at the hearing in an attempt to prove that the * * * loan was adequately secured, and further argued that the other loans listed in FDIC's Proposed Finding of Fact 3(b) should be disregarded because the FDIC did not offer any testimony on these loans at the hearing.
       The Bank's argument for disregarding all loans not specifically discussed at the hearing has no merit. At the hearing, the FDIC introduced into evidence FDIC's January 14, 1983 Examination Report (FDIC Ex. 1) which contains the examiner writeups on a number of the loans. The Bank's attorney indicated that he had no objection to its admission into evidence. In fact, writeups on some of the loans were actually offered into evidence by the Bank itself through introduction of the Bank's September 1983 Loan Portfolio Review and the FDIC's February 1982 Examination Report. The Board is not only entitled, but required, to consider all relevant evidence in the record before making a decision, and information relevant to the determination of whether the loans were inadequately secured is contained in these exhibits which are in the record. The Bank could have presented its own testimony refuting the writeups through its own witnesses. Moreover, the Bank was not precluded from doing this simply because the FDIC chose not to elicit testimony on direct examination from FDIC witnesses about these loans.
       The basic question here is whether the FDIC has met its burden of establishing by substantial evidence in the record that the Bank has made loans that are not adequately secured. At least seven of the loans cited by the FDIC as evidence of loans that were inadequately secured are after the January 14, 1983 examination date. These loans are viewed by the Board as irrelevant to the charges regarding the Bank's condition as of January 14, 1983. However, the loans are discussed briefly later in this Decision as they relate to claims by the Bank that the Bank's condition had improved after {{4-1-90 p.A-327}}    January 14, 1983. A review of the numerous loans cited by the FDIC as evidence of inadequately secured loans on January 14, 1983 indicates the FDIC has proved by substantial evidence that the Bank has made a number of loans that are not adequately secured.
       The Bank contends that the deterioration in the Bank's loan portfolio and any inadequately secured loans at the Bank were caused primarily by adverse economic conditions in the surrounding agricultural community that are beyond the Bank's control. Declining land values may have reduced the value of the Bank's collateral, but as the FDIC pointed out, the Bank should have planned for such downturns in the economy when the loans were made and as economic conditions worsened, especially since agricultural fortunes have historically been unstable. The record indicates that it is not unusual for a predominately agricultural area periodically to face adverse economic conditions, and that effective management is expected to plan for such situations by carefully monitoring loans, maintaining a suitable liquidity margin, and establishing and enforcing an ongoing loan review policy. Here, the Bank's poor lending practices led to the problem of inadequately secured loans, which became exacerbated when land values declined. Stated in a nutshell, "[a]lthough the local farming economy has contributed to the increase in problem credits, it appears that in too many cases loans have been made to borrowers in weak financial condition without providing for adequate collateral or collection procedures." FDIC Ex. 1 at 4.
       Since the FDIC has established the allegation by substantial evidence in the record, the Board adopts the FDIC's Proposed Finding of Fact 3(b) with respect to the loans cited as being inadequately secured as of January 14, 1983.
       (c). Loans have been made without establishing definite repayment programs or sources of repayment. The record contains substantial, undisputed evidence supporting this contention. FDIC Examiner * * * testified that although he was sure there were some oral understandings with regard to repayment schedules, few written amortization or repayment plans were found prepared and placed in the Bank's files. Further, Bank witness * * * admitted that "[o]ver the past years the Bank has not required as careful a plan for repayment as we understand their policy is today" (i.e., at the time of the hearing in February 1984).
       The record indicates that the establishment of definite repayment programs or sources of repayment is a basic, sound lending principle. Testimony at the hearing indicates that the failure to record written repayment agreements allows borrowers to dispute terms previously agreed upon, thereby enabling them to sidestep their repayment obligations and the bank's loan collection efforts. The failure to record repayment arrangements can result in confusion later since the lending officer or customer can forget the details of an oral agreement made some time earlier, especially when the lending officer works a large number of other loans at the same time. Further, the same loan officer will not know the details of the borrower's oral agreement with the original loan officer.
       The failure of the Bank to establish definite, enforceable programs impairs, among other things, management's ability to collect funds when due and to determine when loans are in default so that the Bank can best protect its interest. Consequently, the practice creates an abnormal risk of loss to the Bank.
       In view of the above, the Board adopts the FDIC's Proposed Finding of Fact 3(c) without modification.
       (d). Loans have been renewed without reduction of principal and/or established repayment programs have not been enforced. In support of the charge, the FDIC cited one loan during the hearing: the loan to * * *. In addition, it listed in its Proposed Finding of Fact 3(d) a number of other loans which are relevant here. In each case, the record indicates that the financial condition of the borrower was weak at the time of the renewal and provides no evidence that the Bank made any effort to reduce the principal or to enforce an established repayment plan before renewal of the loans.
       In cases where a borrower's financial condition is deteriorating, it is sound banking practice to try to collect some of {{4-1-90 p.A-328}} the funds owed or explore alternative repayment programs before renewal of a loan in order to minimize potential losses. The failure of the Bank to attempt these steps with respect to the loans cited above increased the risk of loss to the Bank and represents hazardous lending and lax collection practices.
       Accordingly, the Board concludes that the FDIC allegation pertinent here has been substantiated. It adopts, therefore, the FDIC's Proposed Finding of Fact 3(d) without modification.
   4. Allegation that the Bank extended credit to * * * brother of President * * * and his related interest in amounts which when aggregated constitute an excessive concentration of credit equaling 47 percent of the Bank's total equity capital and that a substantial portion of this concentration of credit is adversely classified.
   The Bank argues that FDIC offered no testimony at the hearing concerning this allegation and that even if proof had been submitted, the FDIC October 1983 Visitation Report shows that the concentration of credit was eliminated. Although the FDIC did not produce testimony of FDIC witnesses on this subject at the hearing, the record contains evidence in the form of testimony elicited by the ALJ from Bank witness * * *, and documentary evidence supporting the allegation.
   The January 1983 Examination Report reveals that the Bank extended credit to * * * and to * * * Company, a corporation whose stock was 100 percent owned by * * *. This is confirmed by * * * own testimony. Consequently, an extension of credit to the Company was in essence a loan to * * *. The Examination Report indicates that the amount of the two debts equaled 47 percent of the Bank's total equity capital. This concentration of credit violated the sound banking principle of diversification of risk. The risk is particularly acute here because a portion of the credit is now subject to adverse classification. According to the Report $1,102,000 of the $1,913,000 loaned to * * * Company and * * * was classified "Substandard" as of January 14, 1983 due to the marginal security and * * * apparent inability to service both his heavy personal debt and the corporate debt.
   With respect to this allegation, the Board concludes that the FDIC has supported it with substantial evidence and that the Bank's actions in this case constituted hazardous lending practices which created an abnormal risk of loss to the Bank as a result of the excessive concentration of credit. Accordingly, the Board adopts the FDIC's Proposed Finding of Fact 3(e) without modification.
   5. Allegation that the Bank extended credit secured by collateral subject to substantial prior liens and that the magnitude of the senior liens severely limits management's ability to deal with the loans and realize the value of the Bank's collateral.
   FDIC testimony indicated that a bank's ability to recover on defaulted loans is impaired if a bank accepts collateral subject to substantial prior liens because the bank must pay off those prior liens before the collateral can be foreclosed. The taking of collateral subject to substantial prior liens creates an abnormal risk to a bank especially when the bank fails to monitor the status of the loans and allows the bank's collateral position to disappear without taking timely actions to protect the bank's interests as occurred at the Bank of * * *.
   FDIC witness * * * testified that the bulk of the loans secured by real estate were subject to senior liens, and the Bank's collateral position had declined not only because of declining real estate values, but because management was too optimistic, actually expecting real estate values to increase sufficiently to provide improved collateral support. For example, the February 1982 Examination Report indicates that the * * * loan was secured by mortgages subject to at least five prior liens. The writeup status that "the borrower is rapidly reaching the point at which the bank may be forced to take up the large [prior liens] on the properties pledged as collateral in order to liquidate the debt." In addition, FDIC Examiner * * * testified that because of the Bank's highly leveraged position, it did not have sufficient liquid assets to pay off the large amount of prior liens. Accordingly, its ability to realize its value in the collateral was impaired.
   In addition to the * * * loan, the FDIC's Proposed Finding of Fact 3(f) lists a number of loans on the books of the Bank as of January 14, 1983 that were secured by collateral which was subject to substantial prior liens. These loans experienced significant charge-offs for losses later during 1983 and {{4-1-90 p.A-329}} 1984 as is noted in the Bank's Loan Portfolio Review dated September 28, 1983 and its Report of Condition dated January 13, 1984. This fact clearly suggests that the presence of the prior liens impaired the Bank's ability to realize on its collateral. As previously discussed, the depreciation in farmland values was not the only factor contributing to the deterioration in the Bank's loan portfolio. In too many cases, the Bank made loans to borrowers in weak financial condition without providing for appropriate collateral as in the cases cited above or planning for downswings in the economy. This has resulted in an increased risk of loss to the Bank.
   The Board concludes that the FDIC has established its charge by substantial evidence and adopts the FDIC's Proposed Finding of Fact 3(f), with one minor, technical modification.1
   6. Allegation that the Bank's hazardous lending and lax collection practices set forth above resulted in an excessive volume of poor quality assets in relation to total equity capital and reserves and an excessive volume of overdue loans in relation to gross loans.
   Both the ALJ and the Bank acknowledge that the Bank has had numerous loan problems which have resulted in an excessive volume of adversely classified assets. The Bank's own witness, * * * Commissioner of Financial Institutions * * *, testified that "[t]he classifications are entirely too high," and that his office shared the FDIC's concern about the Bank. Tr. 775.
   As of January 14, 1983, the total amount of the FDIC-classified assets in the Bank was $9,651,000 (including $376,000 classified as losses). The amount is derived, primarily, if not entirely, from classified loans and equals 205.6 percent of (or more than two times) the total equity capital and reserves of the Bank at that time. This data supports the statement quoted above by the Bank's own witness that the volume of classified assets is "entirely too high". Moreover, if half the classified assets ultimately proved to be losses, the Bank's capital and reserves would be exhausted and the Bank's uninsured creditors and the FDIC insurance fund would be at risk. It is noted that the Bank's counsel suggests that the Bank is not likely to experience such a significant amount of loss. The Board disagrees. In particular, it notes: (1) that the January 14, 1983 Examination Report indicates that the vast majority of the classified assets were "Substandard" loans which have well-defined weaknesses that could result in losses if not corrected; (2) that FDIC Examiner * * * testified that there was the potential for 100 percent of the "Substandard" loans in the Bank's portfolio to end up losses if its management did not act to collect on the loans or improve the quality of the loans; and (3) that the Bank's problems in this area were increasing because the records shows that the Bank's classified assets as of January 14, 1983, represented a significantly higher proportion of the Bank's total equity capital and reserves than they did at the February 1, 1982, examination.
   The record contains substantial evidence that the hazardous lending and lax collection practices described above resulted not only in an excessive volume of adversely classified assets, but also an excessive volume of overdue loans in relation to gross loans. The January 1983 Examination Report reveals that the Bank had total overdue loans (loans with principal or interest payments past due for 30 days or more) of $4,859,000 as of January 14, 1983, representing 11.7 percent of gross loans. FDIC testimony establishes that the past due ratio was higher than FDIC would like to have seen it and far higher than similar ratios in other banks examined by Examiner * * *. FDIC testimony also indicates that a high overdue ratio is indicative of poor lending standards and/or lax collection procedures.
   Based upon the above, the Board adopts the FDIC's Proposed Finding of Fact 3(g), with the deletion of the last sentence regarding renegotiated troubled debt which has no definition in the record.
   7. Allegations that the Bank has failed to maintain an adequate reserve for loan losses based on the volume and quality of its loan portfolio.
   Testimony in the record indicates that the purpose of a loan loss reserve is to absorb current as well as potential, future losses in a bank's loan portfolio. Further, that testimony establishes that an inadequate loan loss reserve generally results in

1 The phrase "as part of the refinancing of the debt" has been substituted for the words "before foreclosure."
{{4-1-90 p.A-330}}an overstatement of bank earnings and an inaccurate reflection of the true condition of a bank in its published financial statements.
   The January 1983 Examination Report indicates that the Bank's loan loss reserve remained constant at $598,000 from December 31, 1981 to January 14, 1983. FDIC Examiner * * * testified that this loan loss reserve figure should not have remained stable because the condition of the Bank's loan portfolio changed constantly. This indicates that the Bank's management was not carefully analyzing the Bank's condition to determine what size reserve was required. The Examination Report states that the loan loss reserve was last reviewed by the Bank's board of directors on November 3, 1982, and that while the Bank's management had a history of recognizing losses promptly, the January 14, 1983 loan loss reserve was inadequate to support the large volume of classified loans at the Bank. As of January 14, 1983, $376,000 in loan amounts were classified "Loss" and $8,615,000 were classified "Substandard." The Board concurs that the $598,000 loan loss reserve was not adequate for this volume of loans classified as "Loss" and "Substandard," especially since FDIC Examiner* * * testified that based on his experience in examining banks, 15 to 20 percent of the loans classified as "Substandard" generally result in losses. The Bank, consequently was not in compliance with paragraph D of the May 5, 1982 Memorandum of Understanding which directed the Bank to establish and maintain an adequate loan loss reserve after quarterly reviews of the condition of the Bank's loan portfolio.
   As the record indicates, it was not sufficient for the Bank to simply charge off its bad debts against current income. The Bank should have set up a reserve large enough to take into account both current and potential, future losses in the loan portfolio.
   The Board concludes that the FDIC has presented substantial evidence in the record supporting its charge and adopts the FDIC's Proposed Finding of Fact 3(1).
   8. Allegation that the Bank has operated with an inadequate level of capital protection in view of the volume and quality of assets held.
   According to the FDIC Statement of Policy on Capital Adequacy ("Policy Statement"), the capital composite to be used in assessing the adequacy of bank capital is the adjusted equity capital (equity capital minus assets classified Loss and one-half of assets classified Doubtful) expressed as a percentage of adjusted total assets (total assets minus assets classified Loss and one-half of assets classified Doubtful). Equity capital is defined to include, among other things, reserves for loan losses.
   The January 1983 Examination Report indicates that as of that date, the Bank's adjusted equity capital of $4,315,000 was 7.6 percent of the adjusted total assets of $57,002,000. Excluded from the computation of this adjusted capital ratio is the large volume of assets classified "Substandard" ($9,271,000) which equaled 214.9 percent of adjusted equity capital and reserves. According to FDIC testimony, the significance of the 214.9 percent is that as of January 14, 1983, the capital accounts could only absorb less than half of the problem loans before the uninsured depositors' funds would be at risk.
   FDIC testimony establishes that a thorough analysis of the overall condition of the bank is required to determine the minimum acceptable capital level of a bank. The factors that should be considered are the bank's so-called "CAMEL" factors: capital, assets, management, earnings and liquidity. Each of these is discussed below.
       (a). Assets. The January 1983 Examination Report states that as of that date, the Bank's classified assets totaled 205.6 percent of the Bank's total equity capital and reserves. This means that for every dollar in capital, the Bank had more than two dollars in classified assets. Also, the Examination Report indicates that the Bank's adjusted capital ratio had declined at each examination since 1980. Given the high level of classified assets on January 14, 1983, the Bank's capital was inadequate as of that date. FDIC testimony also noted that as the volume of classifications increases, so does the risk to the FDIC insurance fund.
       (b). Earnings. With respect to the effect of earnings on the capital level, FDIC testimony and the January 1983 Examination Report indicated that heavy charge-off's of loan losses had effectively eliminated earnings as a major source for improving the Bank's capital position.
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       (c). Liquidity. FDIC testimony also indicated that the Bank's lack of liquidity (discussed later in this Decision) has had an adverse effect on the Bank's capital position.
       (d). Management. The record reflect that the Bank's poor management practices (discussed later in this Decision) have had an adverse impact on the Bank's capital position.
       (e). Capital Ratio. FDIC's Policy Statement prescribes a presumptive threshold capital ratio requirement of 6 percent, and a minimum acceptable level of 5 percent for well-run, financially sound, and diversified financial institutions. An analysis of the other CAMEL factors establishes that on January 14, 1983, the Bank was experiencing inadequate liquidity, poor earnings, unsatisfactory management, and an excessive volume of classified assets. In essence, the Bank was in poor condition and under the Policy Statement was required to have more than the minimum 5 percent capital ratio. After considering the overall condition of the Bank, the FDIC concluded that the Bank's 7.6 percent of capital ratio on January 14, 1983 was inadequate and that the Bank, therefore, was not sufficiently capitalized.
   In view of the Bank's poor condition, the Board finds that the FDIC's conclusions are consistent with the Policy Statement. Accordingly, the Board concurs with the conclusions and adopts the FDIC's Proposed Finding of Fact 3(j) pertaining thereto.
   9. Allegation that the Bank has been operated with inadequate provisions for liquidity.
   The FDIC charges that the Bank has operated with inadequate provisions for liquidity and is extremely vulnerable to a large volume of sudden deposit withdrawals. Testimony indicated that liquidity is the bank's ability to convert assets to cash in order to consistently meet normal deposit demands, as well as any unexpected and highly volatile deposit outflow with a minimum of loss. As noted by one FDIC witness, virtually anything can trigger a deposit runoff, including such things as bad publicity, depositors' fears, interest rate charges, and increased competition.
   There are various ratios that can be used together in assessing the liquidity of a bank. Some of these are discussed below.
       (a). Liquidity Ratio. The January 14, 1983 Examination Report shows that the Bank had a Liquidity Ratio (net cash, short-term and marketable assets divided by net deposits and short-term liabilities) of 22.3 percent. This represented an improvement over the 14.17 percent reported for the 1982 examination since the higher the ratio the smaller the proportion of less liquid (long-term) assets being funded by short-term volatile liabilities. The denominator of this ratio includes time deposits of $100,000 or more, which the FDIC considers to be "potentially volatile liabilities" because depositors of such Jumbo Certificates of Deposit ("Jumbo CD's") tend to be more sophisticated about protecting the uninsured portions of their CD's by withdrawing their deposits upon rumors that a bank may be experiencing problems. Such depositors are also more likely to move their deposits to competing banks offering higher interest rates. According to FDIC's testimony, "volatile liabilities" are liabilities that cannot be counted on to remain in the bank for any length of time. The 22.3 percent Liquidity Ratio in the present case indicates that short-term liabilities are being used to fund significant amounts of long-term assets, reducing the Bank's ability to meet its short-term liability obligations.
       (b). Dependency Ratio. The January 14, 1983 Examination Report indicates that the Dependency Ratio measures the extent to which potentially volatile liabilities (including Jumbo CD's) are relied upon to fund total long-term earning assets. This ratio for the Bank was 36.3 percent as of January 14, 1983 and reflects no improvement from the 1982 examination. According to the Report, this ratio far exceeded the December 31, 1982 peer group ratio of -06.16 percent.
       (c). Loan-to-Deposit Ration. The Examination Report reveals that as of January 14, 1983, the Bank's net loans were 68.7 percent of total assets, 75.6 percent of total deposits, and 133.2 percent of core deposits (total deposits minus time deposits of $100,000 and over). The examiner commented that the 75.6 percent {{4-1-90 p.A-332}}figure was a significant improvement over the 85.39 percent ratio reported at the last examination, but that when Jumbo CD's were factored out of the denominator, the resulting 133.2 percent ratio is considered excessive in that it further reflects a substantial reliance on volatile liabilities to fund the Bank's lending activity.
       (d). Temporary Investments-to-Volatile Liabilities Ratio. The Examination Report indicates that this ratio was 28.16 percent on January 14, 1983 as compared with the Bank's peer group ratio of 177.4 percent on December 31, 1982. The 28.16 percent establishes that the Bank is using volatile liabilities to fund a significant portion of its investments other than its temporary investments (i.e., it's long-term investments) which impairs its liquidity position.
   With respect to the use of the Jumbo CD data in a ratio, an FDIC study confirms the Bank's contention that a large percentage of the Bank's Jumbo CD's could generally be regarded as permanent in nature. However, FDIC Examiner * * * testified that in times of crisis or problem bank situations, these Jumbo CD's would not be stable, and the purpose for requiring adequate liquidity is to ensure that the bank can meet not only normal deposit demands but unexpected, highly volatile deposit outflows as well.
   It is evident from the above analysis that the Bank's liquidity was inadequate as of January 14, 1983. Further, the situation was exacerbated by the Bank's other problems which increased the potential volatility of the Bank's large deposits (i.e., the Jumbo CD's). Accordingly, the Board adopts the FDIC's Proposed Finding of Fact 3(k).2
   10. Allegation that by reason of the practices set forth in the charges cited above, the Bank has been and is being operated with a management whose policies and practices are detrimental to the Bank and jeopardize the safety of its deposits.
   The Board finds substantial evidence in the record to support the charge. The earlier discussions of the imprudent practices of the Bank and their attendant risks to the Bank demonstrate that the management of the Bank has caused or permitted the Bank to operate in a manner that is detrimental to the Bank's interests. As a result of this poor management, the Bank has had liquidity problems, poor earnings, and high loan losses. In essence, its financial condition was not good as of January 14, 1983 and the January 1983 Examination Report shows that its loan portfolio had significantly deteriorated between 1979 and 1983. The Board concludes, therefore, that it is appropriate to adopt a finding of fact with respect to this charge and has included such a finding in its Finding of Fact 4 below.
   11. Allegation that the Bank's board of directors has failed to provide adequate supervision over the officers and employees of the Bank to prevent practices that were detrimental to the Bank.
   The record shows that the Bank's board of directors has not been actively involved in dealing with the Bank's hazardous lending and lax collection problems even though these problems were brought to the Bank's attention as early as 1980. As discussed previously, the severe problems at the Bank are an indication that the Bank has not been properly managed by its officers and employees. It also indicates that the board has not been adequately supervising the management. The record demonstrates, for instance, that the Bank's board adopted a Liquidity Policy approved by the FDIC in February 1981, but failed to revise and update the Policy in response to the deteriorating condition of the Bank and the surrounding agricultural community until September 1983, well after the Bank's condition had significantly deteriorated. Despite FDIC warnings as early as 1980, the Bank's board permitted the Bank's loan and liquidity problems to deteriorate substantially.
   The record contains substantial evidence supporting this finding. The Board adopts a finding regarding the matter which is listed as Finding of Fact 5 below.

IV. FINDING OF FACT

   Based on the record and the analysis of charges discussed previously, the Board adopts the following Findings of Fact:
   1. The Bank, a corporation existing and doing business under the laws of the State of * * * 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 Federal Deposit Insurance Act (12 U.S.C. §§ 1811-1831d) and


2 The date in the last sentence is changed to the correct date, December 31, 1982.
{{4-1-90 p.A-333}}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. As of January 14, 1983:
   (a) The Bank's total equity capital and reserves equaled $4,695,000;
   (b) The Bank's adjusted equity capital and reserves equaled $4,315,000;
   (c) The Bank's adjusted total assets equaled $57,002,000;
   (d) The Bank's total deposits equaled $51,638,000; and
   (e) The Bank's net loans equaled $39,054,000.
   3. The Bank engaged in unsafe or unsound banking practices in that the Bank engaged in hazardous lending and lax collection practices, including the following activities.
   (a) Loans have been renewed or had their due dates extended without collection in cash of interest due. Tr. at 49–50, 135–138, 894–900 and 914–915. Renewal or extension of loans without the collection of interest in cash raises questions about the borrower's ability to repay interest and principal and is an indicator of financial difficulties. Tr. at 50. It is more hazardous to renew interest than principal; if at all possible, interest should be collected. Tr. at 994–995 and 1,011.
   (b) Loans have been made that are not adequately secured. Tr. at 50. Ex. 1-FDIC at 10–11 (The * * * loan and the * * * loan), at 11 (The * * * loan), at 12–13 (The * * * loan), at 13 (The * * * loan) and at 15 (The * * * loan). Ex. 8-Joint at 14 (* * * and * * * and loans), at 15 (* * * loan), at 15–16 (* * * loan), at 17–18 (* * * et al. loan) and at 25 (* * * loan).
   (c) Loans have been made without establishing definite repayment programs or sources of repayment. Tr. at 51–53, 132–135, 911, 916 and 986–987. Ex. 1-FDIC at 4.
   (d) Loans have been renewed without reduction of principal and/or established repayment programs have not been enforced. Tr. at 54–55, 129, 986, 1010–1011, Ex. 1-FDIC at 50, Ex. 8-Joint at 20 (* * * loan).
   (e) The Bank extended credit to * * * and his related interest in amounts which when aggregated together constitute a concentration of credit equaling 47 percent of the Bank's total equity capital. Tr. at 740–742. Ex. 1-FDIC at 4.
   (f) The Bank extended credit secured by collateral subject to substantial prior liens. The magnitude of the senior liens inhibits the Bank's ability to realize the value of its collateral position by requiring the Bank to pay off prior liens before collateral can be foreclosed. Tr. at 55–57, 138–142, 214, 719–720, 738, 883 and 904. Ex. 1-FDIC at 12 (* * * and * * * loans), at 13 (* * * Company and * * * loans), at 14 (* * * loan), at 15 (* * * and * * * loans), at 16 (* * * loan) at 18 (* * * loan), at 19 (* * * and * * * and * * * loans), and at 20 (* * * and * * * Company, Inc. loans). Ex. 8-Joint at 15 (* * * * * * loan), at 16 (* * * and * * * loans), at 17 (* * * loan), at 18 (* * * and * * * loans), at 19 (* * * * * * loan), at 20–21 (* * * loan), at 21–22 (* * * loan), at 22 (* * * loan), at 24 (* * * loan), at 25 (* * * loan), at 27 (* * * and * * * loans), and at 28 (* * * loan). Ex. 10-Bank at 1. The * * * loan referred to above had the interest rate reduced to 5 percent. Ex. 26-Bank at 26. The * * * loan which required that a prior lien be paid off as part of the refinancing of the debt. Ex. 26-Bank at 26.
   The following credits involved collateral subject to both prior liens and charge-offs as shown at Ex. 25-Bank:

NAME AMOUNT CHARGED OFF PAGE
* * * $        7,500 23
* * * $      30,000 26
* * * $      30,000 28
* * * $      70,000 32
* * * $    100,000 39
* * *
* * * $    200,000 42
* * * $      70,000 47

{{4-1-90 p.A-334}}

* * * $      30,000 52
* * * $      30,000 54
* * * $      14,000 54

   The following credits involved collateral subject to both prior liens and charge-offs as shown at Ex. 26-Bank:

NAME AMOUNT CHARGED OFF PAGE
* * * $    1,101,777 32
* * *               6,897 45
* * * $          33,365 46

   (g) A result of the Bank's hazardous lending and lax collection practices set forth in paragraphs 3(a)-3(f) is an excessive volume of poor quality assets in relation to total equity capital and reserves and an excessive volume of overdue loans in relation to gross loans. Tr. at 59–64, 234, 249, 253–254, 387–388, 597–598 and 775. Ex. 1-FDIC at 4, 8, 29 and 30. Ex. 8-Joint at 2 and 5. Ex. 10-Bank at 1. See also Ex. 14-Bank at 3. Total classified assets as of January 14, 1983 were $9,651,000 including $376,000 classified Loss. Ex. 1-FDIC at 4 and 7. Total classified assets as of January 14, 1983 were equal to 205.6 percent of the Bank's total equity capital and reserves. Ex. 1-FDIC at 4 and 29. Consequently, if half of the classified assets ultimately prove to be losses, the depositors are in peril. Tr. at 62. The Bank's total overdue loans of $4,859,000 as of January 14, 1983 represented 11.7 percent of loans. Ex. 1-FDIC at 5, 7, 8 and 27. When a past due ratio gets much above 5 percent there is some concern generated. Tr. at 263. A high overdue ratio is indicative of poor lending standards or lax collection procedures or both. Tr. at 365–366.
   (h) As a result of the Bank's hazardous lending and lax collection practices described in paragraphs 3(a)-3(f), the Bank had charge-offs amounting to $2,448,000 in 1981 and $674,000 in 1982. Ex. 1-FDIC at 29.
   (i) The Bank has failed to maintain an adequate reserve for loan losses based on the volume and quality of its loan portfolio. Tr. at 73–76, 182–185. Ex. 1-FDIC at 3, 33 and 34. Ex. 8-Joint at 2. As of January 14, 1983, the Bank's valuation reserve for loans was $598,000. Ex. 1-FDIC at 29, 30. As of January 14, 1983, loans classified "Loss" totaled $376,000; loans classified "Substandard" totaled $8,615,000 and unclassified loans totaled $30,661,000 (net of unearned income). Ex. 1-FDIC at 7, 8, 20, 24 and 27. The failure to maintain an adequate loan loss reserve would tend to overstate earnings. Tr. at 76.
   (j) The Bank has operated with an inadequate level of capital protection in view of the volume and quality of assets held. Tr. at 91–93, 248–252 and 364–365. Ex. 1-FDIC at 5. Ex. 8-Joint at 3. See also Ex. 14-Bank at 3. Capital is the stockholders' equity. It is viewed as the protection against losses, serving as a cushion to protect the bank against losses. Tr. at 91. As of January 14, 1983, the Bank's adjusted equity capital and reserves of $4,315,000 was 7.6 percent of its adjusted total assets of $57,002,000. Ex. 1-FDIC at 29. Adversely classified assets not considered in computing adjusted equity capital and reserves totaled $9,271,000. This amount represents assets classified "Substandard". Ex. 1-FDIC at 7. Adversely classified assets not considered in computing adjusted equity capital and reserves equaled 214.9 percent of adjusted equity capital and reserves. Ex. 1-FDIC at 8 and 29.
   (k) The Bank has been operated with inadequate provisions for liquidity. Tr. at 67–73, 242, 244–247, and 364. Ex. 1-FDIC at 5, 39, 40 and 41. Ex. 8-Joint at 3 and 4. The Bank cannot withstand any substantial deposit runoff. Tr. at 150. There is very little control over deposits, especially in an agricultural economy. Tr. at 983. See also Ex. 14-Bank at 3. As of January 14, 1983, the Bank's net cash, short-term and marketable assets of $10,913,000 was 22.3 percent of net deposits and short-term liabilities of {{4-1-90 p.A-335}}$48,847,000. Ex. 1-FDIC at 40. As of January 14, 1983, the Bank had net potentially volatile liabilities of $16,110,000 and longterm earning assets of $44,428,000. As a result, 36.3 percent of the Bank's long-term earning assets were funded by net potentially volatile liabilities. Ex. 1-FDIC at 40. As of January 14, 1983, net loans were 75.6 percent of total deposits and 133.2 percent of core deposits (total deposits less time deposits of $100,000 and over). On December 31, 1982, the Bank's ratio of temporary investments to volatile liabilities was 29.8 percent while peer group banks had a ratio of 177.4 percent. Ex. 1-FDIC at 39.
   4. By reason of the practices set forth in Findings of Fact 3(a)-3(k), the Bank has been operated with a management whose policies and practices are detrimental to the Bank and jeopardize the safety of its deposits.
   5. The Bank's board of directors has failed to provide adequate supervision over the officers and employees of the Bank to prevent these practices.

V. CONCLUSIONS OF LAW

   1. Bank has engaged in unsafe or unsound practices

   [.1] Section 8(b) of the Federal Deposit Insurance Act, 12 U.S.C. § 1818(b), refers to the term unsafe or unsound banking practices; however, it does not define the phrase or specify what particular acts and conduct constitute such practices. As the FDIC notes in its initial brief, the legislative history of the Financial Institutions Supervisory and Insurance Act of 1966 (which amended Section 8 by adding, among other things, subsection (b)) provides some clarity as to what constitute unsafe or unsound banking practices. The Senate and the House both quoted with approval from a memorandum introduced during committee hearings by then Chairman of the Federal Home Loan Bank Board John E. Horne. 112 Cong. Rec. 24022 (daily ed. Oct. 4, 1966) (House); 112 Cong. Rec. 25416 (daily ed. Oct. 13, 1966) (Senate). The memorandum stated that the term "unsafe or unsound practices" is a generic term, like "negligence" or "probable cause," having a central meaning which must be applied to constantly changing factual circumstances. Further, it notes that an "unsafe or unsound practice" is "any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences 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).
   The courts have adopted essentially the same definition of the term "unsafe or unsound" practices for Section 8(b) cases. See First Nat'l Bank of Eden v. Department of the Treasury, 568 F.2d 610, 611 n.2 (8th Cir. 1978) (per curiam); First Nat'l Bank of La Marque v. Smith, 610 F.2d 1258, 1265 (5th Cir. 1980).
   The Bank argues that the court in Eden did not adopt the above standard, but simply noted it. However, almost immediately after citing the definition, the court proceeded to hold that the ALJ's findings of unsafe or unsound banking practices were supported by substantial evidence in the record. Eden, 568 F.2d at 611. Clearly, the court was relying on the definition as the standard for its decision.
   The Bank also attempts to distinguish La Marque on the basis that it involved insider abuses not implicated in the instant proceeding. However, La Marque supports the conclusion that any conduct which might result in abnormal risk or loss to a bank constitutes an unsafe or unsound practice. Insider abuses are just one example of such conduct. Notwithstanding the Bank's arguments, that case did not limit unsafe or unsound practices to insider abuses alone.
   The courts have tended to defer to the expertise of the bank regulatory agencies in defining what constitutes an unsafe or unsound practice, limiting their review to a determination of whether the agency's action was arbitrary, capricious, or otherwise unsupported by substantial evidence in the record. E.g., Eden, 568 F.2d at 611; Groos Nat'l Bank v. Comptroller of the Currency, 573 F.2d 889, 897 (5th Cir. 1978); La Marque, 610 F.2d at 1264; see also In re Franklin Nat'l Bank Securities Litigation, 478 F. Supp. 210, 221 (E.D.N.Y. 1979).

   [.2-.5] The record and Findings of Fact adopted herein support the conclusion that as of January 14, 1983, the Bank's hazardous lending and lax collection practices, {{4-1-90 p.A-336}}inadequate loan loss reserves, inadequate capital and inadequate liquidity involved abnormal risk of loss or damage to the Bank, its shareholders and depositors, and the FDIC insurance fund and thereby constituted unsafe or unsound banking practices. Accordingly, the Board concludes as a matter of law that the Bank has engaged in unsafe or unsound banking practices.
   2. The Bank's board of directors has failed to properly supervise Bank officers and staff to prevent unsafe or unsound practices

   [.6,.7] Directors of banks are held to a standard of ordinary care and prudence in the administration of bank affairs. Briggs v. Spaulding, 141 U.S. 132, 165-66 (1891). They are entitled to delegate banking business to their duly authorized officers, but may be held liable for negligence if they fail to exercise reasonable supervision over the management. As Finding of Fact 5 demonstrates, the Bank's directors exercised less than ordinary care by permitting loan and liquidity problems to steadily deteriorate after those problems were brought to their attention in the FDIC August 18, 1980 Examination Report.
   In Lippitt v. Ashley, 94 A. 995 (Conn. 1915), the court held the directors of a bank liable for negligence in the failure of the bank due to the defalcations of its treasurer. The court stated that the directors had failed to exercise ordinary reasonable care in supervising the bank's officers, even though they had discharged their duty to select an operating officer, had diligently attended directors meetings, had met often informally to discuss the bank's business, had selected competent auditors and reviewed their work, and had made inquiry of the dishonest officer as to the condition of the bank. Id.

   [.8] The board of directors of a bank has a duty to investigate where necessary to protect shareholders' interests, to supervise the bank's affairs, to have a general knowledge of its business, and to know to whom and upon what security its large lines of credit are given. DePinto v. Provident Security Life Insurance Co., 374 F.2d 37, 46 (9th Cir.), cert. denied, 389 U.S. 822 (1967); Gibbons v. Anderson, 80 F. 345, 349 (C.C. W.D. Mich 1897). As Finding of Fact 5 states, the Bank's board ignored this responsibility despite FDIC warnings and admonitions as early as 1980, The huge loan losses suffered by the Bank indicate that this duty has not been satisfied.
   On the basis of the record, the FDIC Board concludes that the Bank's board has failed to properly supervise its officers and staff to prevent the unsafe or unsound practices and conditions cited in the Findings of Fact.

   [.9] 3. Cessation of Unsafe or Unsound Practices is not a Defense to a Section 8(b) Action
   The ALJ recommended that no cease-and-desist order be issued in this case because the Bank's condition had purportedly shown a "great deal of improvement" since January 14, 1983, the date of the examination that gave rise to the charges herein. Apparently, implicit in the ALJ's opinion is the conclusion that cessation of unsafe or unsound practices with resulting improvement in a bank's condition is a defense to a Section 8(b) proceeding. The Recommended Decision fails to cite any case or statutory law supporting this conclusion of law. The Bank also argues that a cease-and-desist order should not be issued because its problems have been corrected and it is "making every reasonable effort" to return the Bank to profitability.

   [.10] The plain language of Section 8(b) indicates that unsafe or unsound practices need not be ongoing at the time a cease-and-desist order is issued. Section 8(b)(1) of the Act 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...." 12 U.S.C. § 1818(b) (emphasis added). Further, judicial interpretations of the ceaseand-desist powers of the FDIC and other agencies support the view that a cease-and-desist order can be issued for unsafe or unsound practices a bank has committed for corrective purposes and in order to prevent future abuses. See First Nat'l Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 680-81 (5th Cir. 1983); Zale Corp. and Corrigan-Republic, Inc. v. F.T.C., 437 F.2d 1317, 1320 (5th Cir. 1973). Such an approach is, of course, entirely consistent with the remedial and enforcement policies underlying Section 8(b). If cessation of prior unlawful activity were considered a sufficient defense to an action under Sec- {{4-1-90 p.A-337}}tion 8(b), a bank could engage in unsafe or unsound practices with virtual impunity, knowing that it could bring those practices to a halt when challenged by a bank regulatory agency.
   The Board concludes, therefore, that the cessation of unsafe or unsound banking practices is not a defense to this proceeding. Moreover, even if it were, the record here demonstrates that unsafe or unsound practices and conditions continued at the Bank after the January 14, 1983 examination. For example, FDIC's October 1983 Visitation Report states that of $8,584,000 in assets classified in the January 1983 Examination Report, the remaining balances in October totaled $8,413,000, with chargeoffs equaling $1,695,000. In essence, the Bank still had an excessive volume of classified assets. In addition, the Bank's own September 1983 Loan Portfolio Review cites a number of loans, which FDIC lists in its Proposed Finding of Fact 3(b) as evidencing inadequately secured credits subsequent to the January 14, 1983 examination date.
   4. Transmittal of FDIC's Proposed Order was in compliance with FDIC regulations
   The Bank contends that the FDIC violated 12 C.F.R. §§ 308.01(f) and 308.07(c) (which prohibit ex parte communications and require a fair and impartial hearing), when the Executive Secretary forwarded a copy of FDIC's Proposed Order to the ALJ assigned to hear the case. The Board disagrees.

   [.11,.12] An "ex parte communication" is defined as an oral or written communication not on the public record with respect to which no reasonable prior notice to all parties is given. 12 C.F.R. § 308.01(f). FDIC's Proposed Order is on the record, and was provided to the Bank prior to the appointment of the ALJ, giving the Bank reasonable advance notice of the document. Section 557(c)(3) of the Administrative Procedure Act (5 U.S.C. § 557(c)(3)) ("APA") provides that the ALJ's recommended decision is a part of the record and shall include a statement of the basis for the decision and the appropriate order or denial thereof. The record is intended to include the FDIC's Proposed Order and the ALJ's disposition with respect to it. The APA contains no restriction as to when a proposed order is to be sent to the ALJ. Certainly, submission of a proposed order is no more influential than transmittal of a notice of charges or proposed findings of fact or conclusions of law. The ALJ must have each of these documents in order to recommend a decision.
   The Board concludes that sending a copy of FDIC's Proposed Order to the ALJ was not proper in this case. In that regard, it is noted that the ALJ also ruled on the record that he was not influenced by the document.
   5. Initiation of the Section 8(b) proceeding was not arbitrary or capricious
   The Bank contends that the initiation of this Section 8(b) proceeding by the FDIC without consulting Examiner * * *, the principal examiner for the Bank, and despite his recommendation of a Memorandum of Understanding, constituted an arbitrary and capricious violation of FDIC's standard operating policies and procedures. In addition, the Bank complains that other changes were made to the examiner's report including one which changed the rating for the Bank from a "3" to a "4".
   The Board concludes that the Bank's complaints are without merit. As the FDIC notes in its reply brief, there was no disagreement among the FDIC staff (including Examiner * * *) about the fact that the Bank has had serious problems. With respect to the changes regarding recommendations for the issuance of a cease-and-desist order and the rating of the Bank, the Regional Director had the authority and responsibility to change the recommendations of the examiner after reviewing the facts and determining that this was appropriate. The fact that the Regional staff disagreed with and overruled the recommendation of the person examining the Bank without consulting him does not make the initiation of the Section 8(b) proceeding an arbitrary and capricious act. As the FDIC points out in its reply brief, the Examiner and the Regional Office only make recommendations. In a contested proceeding, it is the FDIC Board which ultimately determines whether a cease-and-desist order is to be issued pursuant to its authority under Sections 2 and 8 of the Federal Deposit Insurance Act (12 U.S.C. §§ 1812, 1818). The FDIC reply brief indicates that the difference of opinion between Examiner * * * and the Regional Office staff over the {{4-1-90 p.A-338}}recommendations was reflected in an addendum to the Report of Examination when it was sent to the Washington Office, where the matter was reviewed again and the FDIC Board of Review, acting pursuant to authority delegated by the FDIC Board, ultimately made the decision to initiate proceedings for the issuance of a cease-and-desist order. Further, the record indicates that the decision at the Regional Office to change the Examiner's recommendations was not the result of one individual's deliberation as the Bank argues. On the contrary, the decision was considered by various senior examiners in the Regional Office who were qualified to evaluate the facts in the case and assess the Bank's condition.
   Other changes were made to the Examination Report at the Regional Office. There were minor changes which involved the updating of data, technical editing (e.g., rounding off figures and correcting spelling), and the addition of an addendum that was clearly labelled in the final report as a Regional Office addition. Although the general policy in the * * * Office is that an examiner be contacted regarding any changes made to a Report of Examination prepared by him or her, the apparent failure to contact Examiner * * * in this case regarding the minor changes cited above did not affect the Bank's rights and does not constitute arbitrary and capricious conduct.

VI. EXCEPTIONS

   Only the FDIC submitted exceptions to the ALJ's Recommended Decision. The FDIC excepted to the ALJ's failure to review and resolve the issues presented in the Notice of Charges issued on July 28, 1983. The FDIC took exception to the ALJ's purported failure to adopt any findings of fact or conclusions of law, and specifically, FDIC's Proposed Findings of Fact 1 through 3, Additional Proposed Findings of Fact 1 through 8, Proposed Conclusions of Law 1 through 3, and Proposed Order to Cease and Desist. These matters are dealt with throughout the Board's Decision and Order.
   The FDIC also excepted to the ALJ's decision to exclude evidence concerning the response of other similar banks to economic conditions affecting the Bank, and comparisons of the Bank's performance data with that of other banks of similar size in nonmetropolitan areas ("peer" group statistics contained in the Bank's December 1982 Uniform Bank Performance Report). The Board concludes that the ALJ erred in excluding this evidence. Unlike civil and criminal judges, who must apply strict rules excluding hearsay and other unreliable evidence, administrative law judges are generally expected to admit all relevant and probative evidence, thereafter judging the weight to be given it accordingly. See K. Davis, Administrative Law Text § 14.01 (3d ed. 1972).
   The comparative data offered by the FDIC is, at a minimum, relevant to the determination of the issues in this proceeding, and should have been admitted and given the appropriate weight.
   The Bank cited First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674 (5th Cir. 1983), as authority for exclusion of peer group statistics. This case is distinguishable. In Bellaire, the court held that peer group statistics alone could not establish a Bank's capital level as unsafe or unsound. 697 F.2d at 686. Here, peer group data is not the sole evidence relied upon to support the FDIC's charge of unsafe or unsound practices, and consequently, should have been admitted.
   Even excluding such information, however, the FDIC has presented other substantial evidence in the record, discussed previously in the analysis of the record and charges, that substantiates the Notice of Charges. In addition, several FDIC Examination Reports, which were admitted into evidence without Bank objection, contain peer group data drawn directly from the Uniform Bank Performance Report excluded by the ALJ.

VII. ORDER TO CEASE AND DESIST

   Both the Bank and the ALJ have taken the position that a cease-and-desist order should not be issued because the unsafe or unsound practices have ceased and the condition of the Bank has improved. Further, the Bank contends that the FDIC's Proposed Cease-and-Desist Order is unduly restrictive in nature and that the issuance of any form of a cease-and-desist order will harm the Bank's reputation.
   As noted earlier, the Board finds that the record does not establish that the Bank has ended its unsafe or unsound practices. Further, the Board concludes that the issuance of a Cease-and-Desist Order is necessary to insure that the Bank corrects its existing {{4-1-90 p.A-339}}problems as soon as possible as well as to make sure that the Bank does not engage in the unsafe or unsound practices cited above in the future. In the Board's opinion, the FDIC's Proposed Cease-and-Desist Order is not unduly restrictive given the condition of the Bank, and its implementation would more likely improve the reputation of the Bank in the long run by helping to restore the Bank to a sound financial condition. Accordingly, the Board adopts the FDIC's Proposed Cease-and-Desist Order in full.
   In view of the above, IT IS ORDERED, that Bank of * * * , its directors, officers, employees, agents, successors, and 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:
   (a) Renewing and extending loans without collecting in cash interest due.
   (b) Making loans without establishing and/or enforcing programs for their repayment.
   (c) Failing to provide and maintain adequate risk diversification in its assets.
   (d) Operating with an inadequate valuation reserve for loan losses.
   (e) Operating with inadequate capital.
   (f) Operating with inadequate liquidity provisions.
   IT IS FURTHER 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, take affirmative action as follows:
   1. As of the effective date of this Order, the Bank shall cease and desist from extending credit as defined in section 215.3 of Regulation O of the Board of Governors of the Federal Reserve System (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) In addition to any promissory note required by paragraph 1(a) above, an agreement establishing a repayment program consistent with the credit's purpose, security and source of payment.
   2. (a) As of the effective date of this ORDER, the Bank shall not make any further extensions of credit to any borrower whose loans are charged off, in whole or in part, or were adversely classified "Loss" as of January 14, 1983, and remain uncollected.
   (b) As of the effective date of this ORDER, the Bank shall not make in the aggregate any further extensions of credit to any borrower in excess of $50,000 whose loans are adversely classified "Substandard" as of January 14, 1983, unless approved by the Bank's board of directors in advance and unless the Bank's board of directors affirmatively determines, as reflected in the minutes of the meeting, that the extension of credit is in full compliance with the Bank's loan policy, is necessary to protect the Bank's interest or that the extension of credit is adequately secured, that credit analysis has determined the customer to be trustworthy, and that all necessary loan documentation is on file, including satisfactory appraisal, title, and lien documents.
   (c) As of the effective date of this ORDER, the Bank shall not renew loans without the full collection, in cash, of interest due. Issuance of separate notes to the borrowing customer or a third party, the proceeds of which are used to pay interest due, shall not satisfy the requirements of this paragraph.
   3. (a) As of the effective date of this ORDER, the Bank shall eliminate from its books, by charge-off or collection, all assets or portions of assets classified "Loss" as of January 14, 1983, that have not been previously collected or charged off. Reductions of these assets through proceeds of loans made by the Bank are not considered collection for the purpose of this paragraph.
   (b) Within 180 days from the effective date of this ORDER, the Bank shall reduce the remaining assets classified "Substandard" as of January 14, 1983, to not more than $7,000,000.
   (c) Within 360 days from the effective date of this ORDER, the Bank shall reduce the remaining assets classified "Substandard" as of January 14, 1983, to not more than $3,500,000.
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   These requirements are not to be construed as standards for future operations and, in addition to the foregoing, the Bank shall eventually reduce all other adversely classified assets. As used in this ORDER, the word "reduce" means (1) to collect, (2) to charge off, or (3) to sufficiently improve the quality of assets adversely classified so as to warrant removing any adverse classification.
   4. The Bank shall obtain and thereafter shall retain management acceptable to the Regional Director of the FDIC's * * * Regional Office ("Regional Director") and the Commissioner of Financial Institutions for the State of * * * ("Commissioner"). Unless an alternative management plan and time frames are submitted to the Regional Director and the Commissioner for approval within 30 days of the effective date of this ORDER, such management shall include and be selected within time frames commencing with the effective date of this ORDER as follows:
   (a) Within 30 days, the board of directors of the Bank shall appoint an executive committee of the board which shall include at least two non-officer directors. Such committee shall meet at least bi-weekly and shall have duties as assigned by the board of directors to include interim reviews of measures taken by the Bank to effect compliance with the provisions of this ORDER. The results of these reviews shall be presented at each board of directors meeting and recorded in the minutes of the meeting.
   (b) Within 90 days, the Bank shall establish a credit review department to provide satisfactory prior analysis of credit information and documentation for all loans, lines of credit, and renewals that are not fully secured by readily-marketable collateral and which are in excess of $50,000. The results of each analysis shall be properly documented in the loan file.
   (c) Within 90 days, the board of directors of the Bank shall designate a qualified, experienced lending officer who shall be the senior lending official responsible for supervising the Bank's overall lending function.
   5. (a) The Bank's board of directors shall take all steps necessary to maintain adjusted equity capital and reserves at not less than 8.0% of adjusted total assets during the time this ORDER is in effect. Such maintenance in adjusted equity capital and reserves may be accomplished by:
   (i) the sale of common stock; and/or
   (ii) the direct contribution of cash by the shareholders and/or
   (iii) the collection of assets previously charged off; and/or
   (iv) any other means approved by the Regional Director and the Commissioner.
   (b) If all or part of any increase in total equity capital and reserves under paragraph 5(a) of this ORDER is accomplished by the sale of new common stock, the board of directors of the Bank shall forthwith take all steps necessary to adopt and implement a plan for the sale of such additional common stock, including voting any shares owned or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Bank's stock (including a distribution limited only to the Bank's existing shareholders), the Bank shall prepare offering materials fully describing the stock 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 20 days prior to the dissemination of such materials the plan and any materials used in the sale of the common stock shall be submitted to the FDIC at Washington, D.C. for review.
   (c) In complying with the provisions of paragraph 5(b) of this ORDER, the Bank shall provide to any subscriber and/or purchaser of the Bank stock 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 stock. 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 purchaser and/or subscriber of Bank stock who received or was tendered the information contained in the Bank's original offering circular.
   6. Within 60 days from the effective date of this ORDER, the Bank shall establish and thereafter continue to maintain an adequate reserve for loan losses by charges to current operating income. In complying with the provisions of this paragraph, at a {{4-1-90 p.A-341}}minimum, 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 recommended, and the basis for determination of the amount of reserve provided. Adequacy of the reserve for loan losses shall be determined by the Regional Director and the Commissioner based on subsequent Federal or State examinations or visitations.
   7. Within 180 days from the effective date of this ORDER, unless an alternative timetable or proposal is submitted by the Bank for the written approval of the Regional Director and the Commissioner within 60 days, the Bank shall limit extensions of credit to any individual or his related interests to an amount which shall be less than 25 percent of the Bank's equity capital. In addition, the Bank shall be prohibited from making any secured extension of credit to any borrower where the amount of the Bank's lien aggregated with any senior lien on the same collateral totals more than 25 percent of the Bank's total equity capital.
   8. Within 60 days from the effective date of this ORDER, the Bank shall review its written loan policy and make whatever changes may be necessary to provide for the safe and sound administration of all aspects of the lending function. The policy will, as a minimum, require repayment programs on all loans prior to disbursement and the designation of a primary trade area. The loan policy shall be forwarded to the Regional Director and the Commissioner for comment and acceptance and thereafter shall be fully implemented.
   9. As of the effective date of this ORDER, the Bank shall review and strengthen its collection policies and procedures and adopt and implement a loan interest nonaccrual policy which conforms with requirements contained in Instructions for Preparation of Reports of Condition and Income published by the Federal Financial Institutions Examination Council.
   10. (a) Within 60 days of the effective date of this ORDER, the Bank shall adopt and implement a written liquidity policy. Such policy shall include the establishment of acceptable ranges of ratios in the following areas: liquidity, volatile liability dependence, total loans to total deposits and temporary investments to volatile liabilities. In addition, the liquidity policy shall incorporate a funds management program which designates acceptable levels for: volatile liabilities, including borrowing; asset mix, including temporary funds and investments, long-term investment securities and classes of obligors, and loans to assets; and ratesensitive assets as a percent of rate-sensitive liabilities. The written liquidity policy shall be submitted to the Regional Director and the Commissioner for comment and acceptance.
   (b) Within 180 days from the effective date of this ORDER, the Bank shall reduce net loans (exclusive of unearned income) to not more than 65% of total assets. Further, the Bank shall increase its "Net Cash, Short Term and Marketable Assets" to not less than 25% of its "Net Deposits and Short Term Liabilities" calculated in accordance with the FDIC's Report of Examination.
   (c) Within 360 days of the effective date of this ORDER, the Bank shall reduce net loans (exclusive of unearned income) to not more than 60% of its total assets. Further, the Bank shall increase its "Net Cash, Short-Term and Marketable Assets" to not less than 30% of its "Net Deposits and Short-Term Liabilities" calculated in accordance with the FDIC's Report of Examination.
   11. 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 Commissioner 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 and the Commissioner have released in writing the Bank from making future reports.
   12. The effective date of this ORDER shall be thirty (30) days from the date of service upon the Bank.
   The provisions of this ORDER shall be binding upon Bank of * * *, its directors, officers, employees, agents, successors, as- {{4-1-90 p.A-342}}signs, and other persons participating in the affairs of such Bank.
   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.
   By Order of the Board of Directors on October 19, 1984.
/s/ Hoyle L. Robinson
Executive Secretary

RECOMMENDED DECISION

No. 83-172b
Decided: June 28, 1984

   Issuance of a Cease and Desist Order not supported by the record, Bank improvements since January 14, 1983, have been and are being made. The action in this proceeding ordered dismissed and the proceeding discontinued.

By Earl S. Dowell, Administrative Law Judge:

   On July 28, 1983, the Board of Review of the Federal Deposit Insurance Corporation (FDIC) pursuant to authority delegated by the FDIC's Board of Directors and pursuant to section 8(b)(1) of the Federal Deposit Insurance Act [12 U.S.C. 1818(b)(1)], issued a Notice of Charges and of Hearing to Bank of * * *, which charged the bank with having engaged in unsafe or unsound banking practices. The issue is whether the "unsafe and unsound" practices require the issuance of a cease-and-desist order that forbids their continuation and requires affirmative action to remedy any resulting conditions.
   The Bank of * * * is a state banking corporation, which was incorporated under the laws of the State of * * * in 1899. It operates at one banking location in * * *.
   The proceeding was assigned for hearing at * * * : and was heard by the Judge on February 14, 15, 16, 17, and 18, 1984. FDIC and the bank were represented by counsel. Initial briefs were filed by both parties on May 30, 1984, followed by reply briefs in June 1984.
   The FDIC in its Trial Memorandum spells out that the term "unsafe and unsound practices" has been found in legislation applicable to the FDIC for more than 40 years. Banking Act of 1935, Ch. 614, section 101.49, Stat. 684, 690. In 1966 Congress enacted the Financial Institutions Supervisory Act of 1966, Pub. L. No. 89695; 80 Stat. 1028, which added section 8(b) to the Federal Deposit Insurance Act.
   The legislative history of the Financial Institutions Supervisory Act of 1966 shows that Congress carefully considered the phrase "unsafe and unsound" and, by retaining that phrase in the final legislation, concluded that the phrase was sufficiently clear and definite as to be understood by those subject to its proscription. Both the Senate and House quoted with approval from a memorandum introduced by the then Chairman of the Federal Home Loan Bank Board, John E. Horne, in essence, attempted to clarify what constitutes "unsafe or unsound practices." 112 Cong. Reg. 25008 (Oct. 4, 1966) (House); 112 Cong. Reg. (Oct. 13, 1966) (Senate). The amplification by the then Chairman Horne read, in part, as follows:

       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 accepted standards of prudent operation, the possible consequences of which if continued, would be an abnormal risk or loss or damage to an institution, its shareholders, or the agencies administrating the insurance funds.
   FDIC emphasizes that thus, a particular activity not necessarily unsafe or unsound in every instance may be so when considered in light of all relevant facts.
   The Bank was last examined by the FDIC on January 14, 1983. As of that date, the Bank's total equity capital and reserves equalled $4,695,000, its adjusted total assets equalled $57,002,000, its deposits equalled $51,638,000 and its net loans equalled $39,054,000.
   The Bank was criticized by the FDIC for excessive classified loans, for having an unduly high portion of the bank's loans in an overdue status, a high loan to deposit ratio and the potential for a strained liquidity position in the FDIC Report of Examination as of April 2, 1979, and in the subsequent examination reports as of August 18, 1980, February 1, 1982 and January 14, {{4-1-90 p.A-343}}1983. The continuing deterioration of the Bank's condition was recognized in a Memorandum of Understanding between the Bank's Board of Directors and the Regional Director of the * * * Region of the FDIC. "The Bank failed to correct the problems addressed in the memorandum. The Bank has also failed to fulfill subsequent promises to correct these problems described in the examination reports.
   In its trial memorandum, and as reflected by the record, FDIC submits that the Bank has engaged in the unsafe and unsound practices specified in the Notice of Charges and of Hearing dated July 28, 1983. In particular, fundamental banking principles were ignored in that loans were reviewed or extended without the collection of interest in cash; loans were made without adequate security; loans were made without establishing definite repayment programs or source of repayment; loans were renewed without reduction of principal and/or compliance with established repayment programs; the bank permitted a concentration of credit and loans were made with collateral subject to senior liens.
   FDIC contends that the results of the described "unsafe and unsound practices" were excessive loans classified loss, excessive classified loans in general, and inordinate volume of overdue loans and substantial renegotiated troubled debt. Also it points out that the bank failed to maintain an adequate reserve for loan losses, operated with an inadequate level of capital protection for its depositors and operated with inadequate liquidity which jeopardizes its ability to satisfy unexpected deposit withdrawals among other dangers. "The described unsafe and unsound practices reflect a management whose policies and practices are detrimental to the Bank and jeopardize the safety of its deposits."
   In its trial memorandum the Bank of * * * emphasizes that it is the burden of the FDIC to support the Notice of Charges by substantial evidence and not a mere preponderance of the evidence.
       Even though the FDIC may give reasons for its action, these actions should be considered arbitrary and capricious since the FDIC's reasons are not supportable. The FDIC must be able to articulate a correlation between the action to be taken and the reason given for the actions. It is the Bank's position that the allegations are merely rhetoric and insufficient to substantiate this proceeding. Therefore, the FDIC can not meet its burden of proof to establish its allegations.
   The Bank notes that the FDIC has failed to follow its own policies and regulation which makes this proceeding arbitrary and capricious. It insists that the FDIC is Subordinate to the law from which it received its authority and is subject to the limitations imposed by that law. Thus, the FDIC is acting in excess of its statutory grant of powers, acting arbitrarily or capricously and abusing its discretion. Webster Groves Trust Company v. Saxon, 370 F. 2d 381 (8th Cir. 1966).
   FDIC's first witness was * * * , who was in charge of the FDIC examination of the Bank as of January 14, 1983 and also described the results of a visitation to the Bank on October 12, 1983. The January examination included consolidated financial statements of the Bank and its whollyowned subsidiary, * * *, prepared in accordance with the general principles of consolidation.
   The Bank is operating under a Memorandum of Understanding, dated May 5, 1982. Following is a listing of the Memorandum (in part) with facts concerning the Bank's compliance, or lack thereof:
       Within 60 days from this Memorandum, the bank shall review its current written lean policy, with emphasis on collections, overdrafts, concentrations, credit information, collateral documentation, lending limits, and internal loan review. Any changes it may adopt, a written policy and amendments shall be sent to the Regional Director and the Commissioner for their review.
       Thirty days from the date of this memorandum the bank shall eliminate from its books, by charge-off or collection, all assets or portions of assets classified "loss" and 50 percent of those classified "doubtful" as of February 1, 1982, not previously collected or charged off.
       Within 180 days from this memorandum, the bank shall reduce the total of the remaining assets classified "doubtful" and the assets classified "substandard" as of February 1, 1982, to not {{4-1-90 p.A-344}}more than $6 million. Within 270 days the latter figure should be $5 million. Within 360 days the figure should be $4 million. The bank president stated that this last figure would be impossible to achieve.
       The bank should strengthen its credit files and correct technical exceptions as of February 1, 1982 to the satisfaction of the Regional Director and the Commissioner.
   Most of the bank problems has been with loans. The above memorandum of understanding was the result of management following policies which resulted in excessive classifications, a high volume of overdue loans, an inadequate loan valuation reserve, numerous technical exceptions, a concentration of credit, a potential liquidity problem and violations of law and regulations. "Management needs to take additional action to alleviate the bank's unsatisfactory condition."
   Following FDIC lists asset classifications at the last four Federal Deposit Insurance Corporation examinations:

Date     Substandard Doubtful     Loss         Total    
January 14, 1983 9,271,000 380,000 9,651,000
February 1, 1982 7,010,000 893,000 339,000 8,242,000
August 18, 1980 1,932,000   3,000 170,000 2,105,000
April 2, 1979 1,297,000   5,000   73,000 1,375,000

   FDIC stresses that the bulk of the classified assets is loans and the above summary reflects significant deterioration in the loan portfolio. It admits the local farming economy may have contributed to the increase in problem credits, but loans were made to borrowers in weak financial condition without providing for adequate collateral or collection procedures. A significant portion of the classified loans is based on real estate mortgages in which there are large outstanding prior liens, and the past two calendar years the loan portfolio has resulted in net loan losses totaling $3,162,000.
   The bank president anticipates collection of $1,456,000 in adversely classified loans within six months. FDIC insists that even if full collection materializes—the volume of classified assets would remain excessive. Classified assets equal 205.56 percent of total equity capital and reserves and the asset deterioration places the bank in a precarious position.
   While the Bank developed a written loan policy generally regarded as being comprehensive, it is not always adhered to. Some of the more important deficiency areas include: (1) failure to establish repayment programs; (2) failure to meet security margin requirements; and (3) failure to eliminate concentrations of credit. One loan concentration was to the son of the Bank board chairman, which equals 46.69 percent of the Bank's total equity capital. A portion of the credit is subject to adverse classification. Concentrations of credit violate the sound banking principle of diversity of risk and are particularly objectionable when sound credit quality is missing.
   An analysis of the Bank's liquidity position reveals that net liquid assets equal only 22.34 percent of net current liabilities. While this ratio has improved from the 14.17 percent at the last examination, the Bank's liquidity position remains low.
   In 1981, net operating income after taxes was a deficit $403,000, and in 1982, net operating income was a marginal $449,000. The unsatisfactory earnings for the combined two years are attributable to a heavy provision for loan losses which aggregated $3,384,000.
   Overdue loans equal 11.65 of gross loans. The heavy volume thereof is a further indication of problems in the loan portfolio. FDIC spells out in its January examination that the Bank does not maintain sufficient records to fully ascertain the outstanding balances on loan participations sold. Records consist of file cards with payments not always posted and maintenance of copies of the participation certificates which are frequently not purged when the applicable loans are paid.
   FDIC submits that implementation of the following would add strength to the existing loan policy:

       (1) Designate the Bank's trade area.
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       (2) Establish the proportion of the various types of loans with consideration given both liquidity needs and earnings.
       (3) Provide for a review of existing loans.
       (4) Require written acknowledgment by the borrower as to repayments arrangements.
       (5) Prepare a cash flow analysis where appropriate.
       (6) Provide for a detailed record of Board of Director approval of loans. The current procedure is generally limited to a statement that all loans made since the last meeting are approved.
       (7) Provide for a review of the financial strength of third parties when substantial amounts of warehouse receipts on commodities used for collateral are stored with them.
       (8) Provide procedures for the selling of loan participations.
   The lending limit for the president, chairman of the board, and executive vice president is $350,000. The lending limit for senior lending officers is $150,000 and $25,000 for junior lending officers. FDIC points out that the policy does not identify senior or junior officers and does not distinguish between secured or unsecured credit. The lending limits are high on an individual basis and officers are allowed to combine their limits. The liberal lending limits have the potential for allowing excessive loans to one borrower without prior approval by Board of Directors or its designated committee.
   The January report indicated that the major problem facing the Bank is loans. The Bank is located in an area that is almost entirely dependent upon farming. Despite receiving almost 90 inches of rainfall in 1982, farmers in the area harvested fair crops. It appears that the bank will continue to have asset problems unless commodity prices increase and/or government aid programs to farmers are restored. There is considerable hope by management that the new "Payment in Kind" program will be an aid to the community. Another factor which has contributed to deterioration in the loan portfolio is farmland value depreciation. A number of loans in the portfolio that previously were well secured now have equity deficiencies and are classified. The advances on loans previously classified can be attributed to management having to fund loans for farming or foreclose on the collateral.
   The Bank has a history of a fully loaned position. At the last examination, the gross loan-deposit ratio was 91.8 percent. The ratio has declined to 80.75 percent at this examination and the dollar volume has declined slightly despite over $5 million in deposit growth. The Bank took liberal loan charge-offs in 1981 and 1982, and substantial recoveries are expected this year. The Bank's liquidity position has improved somewhat since the last examination. Historically, the Bank has depended upon large time deposits to finance loans.
   The ratio of net loans to net deposits was 133.15 percent on the date of the examination. FDIC in its comments therein notes that with the exception (regarding loans) the Bank has complied with, or has made progress towards, compliance with the "memorandum of understanding". It further submits that the Bank's directors appear to recognize that the "bank" has serious problems and seems sincere in improving the condition of the Bank. While it is believed that the restoration of the Bank is within management's capacity, it appears that a new memorandum of understanding will provide important guidance. Some recommended areas to be included are: (1) reduce classified assets; (2) reduce the loan/deposit ratio; and (3) provide for and adhere to an acceptable loan policy.
       The comment section includes a "Regional Office Addendum" that states:
       Due to the heavy volume of classified assets and the declining capital trend, a performance rating of 4 has been assigned to capital. The rapid deterioration in asset quality and heavy loan losses experienced in the last two years have not brought about a significant change in bank's liberal lending philosophy. While the desire to work with bank customers in troubled economic times is commendable, efforts to date have been unilateral to the borrowers' benefit without apparent benefit to the bank. Management rating is lowered to a 4. Also, the magnitude of the asset problems facing the bank indicate that a composite 4 designation is appropriate.
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   On January 4, 1983, the regional director at * * *, in a letter to the field office supervisor referred to a request of the Bank that the memorandum of understanding be modified or deleted based on the fact that many of the Bank's large deposits of $100,000 or more are stable, having been maintained in the Bank for many years. The regional director suggested that FDIC may offer some relief, depending of course, on the conclusions provided by the examiner.
   Section 9 herein includes, among other factors, comments for the FDIC examiner pertaining to a bank visit on October 12, 1983. In part, it states:
       In an effort to avert a Section 8(b) Cease and Desist, management prepared a 128 page progress report which appears to be dated October 6, 1983. In lieu of the Section 8(b), management is proposing a Memorandum of Understanding. The primary areas of concern at the January 14, 1983 examination were adversely classified assets, inadequate written loan policy, concentrations, liquidity, earnings, and capital.
       * * * the loan committee and loan officers have reviewed all of the outstanding loans, leases, and other real estate. The bank has identified problem assets totaling $13,174,355 of which $2,603,649 is scheduled for charge off. The bank's classifications equal approximately 243 percent of existing total equity capital and reserves before charge off and 376 percent after the charge offs before tax refunds and new capital injection. While it is believed that management's identification of the problem assets have been liberal to take advantage of the bank's income tax situation, based on the lack of progress made since the last examination the list appears to be reasonably accurate.
   Also, the examiner notes that of the $2,603,649 slated for charge off, it is expected that substantial recovery will eventually be made. With the projected charge offs, the bank will have net charge offs totaling $5,792,000 for 1981, 1982, and thus far this year. At the last examination, the Bank president indicated that he expected to collect $1,456,000 in classified loans within 60 days to six months. Of that amount the Bank has collected only $256,000. The president also furnished a listing, at the last examination, of previously charged-off loans which he anticipated recovering within six months. Of that amount, only $175,000 has been recovered.
   The progress report contained a new written loan policy. While the policy covers some important areas, it does not fully address the deficiencies noted at the last examination and is considered inadequate. Some of the areas not provided for or in which the written loan policy could be improved are as follows:
   1. Designate the Bank's trade area.
   2. Provide for the maximum loan limits for the various loan officers and committees.
   3. Provide for the responsibility for the monitoring of compliance with laws and regulations.
   4. Provide for participations.
   5. Define and address nonaccrual loans.
   6. Provide a definition of an extension of credit.
   7. Establish the proportion of the various types of loans with consideration given to both liquidity and earnings.
   Improvement needing to be effected include:
       States that a real estate loan may be made in an amount not to exceed 80 percent of the appraised value of the real estate. Since the bank frequently makes second mortgages, equity should be substituted for the word appraised.
       Provide for more formal collection procedures. Provide a time frame when collection letters are to be sent and when accounts are to be turned over to the bank's attorneys. Provide for exceptions to the collection procedures.
       The statement that the bank will have a general policy of having aggregate loans not exceeding 75 percent of the total deposits is ambiguous and a maximum loan/deposit ratio should be set.
   The loan concentration to the son of the chairman of the board listed at the last examination has been eliminated by the payment of his personal debt. Although the decline in the Bank's liquidity position since the last examination can be partially attributed to seasonal timing, the fact remains that the Bank has liquidity problems throughout the year. The Bank's loan/deposit ratio for each of the call dates in 1982 are as follows: 3-31-82, 82.50 percent; {{4-1-90 p.A-347}} 6-30-82, 82.13 percent; 9-30-82, 86.41 percent; and 12-31-82, 75.20 percent. The loan/deposit ratio on 10-10-83 was 81.97 percent.
   While a liquidity policy is included in the progress report, the examiner notes that the policy does not adequately address the Bank's needs. The liquidity ratio, as calculated in the Corporation's report of examination, will be maintained at a level of at least 10 percent. However, the policy does not adequately address temporary investments, volatile liabilities, seasonal requirements, or unexpected needs. The Bank's president stated that a 10 percent liquidity ratio was decided upon because the Bank happened to have that ratio when the policy was prepared.
   The president indicates that the Bank was going to sell approximately $6 million in longer-term securities and invest the proceeds in bonds with maturities of 12 months or less to improve the Bank's liquidity ratio. The transaction will reportedly result in a $200,000 loss net of the tax benefit. According to the Bank's CPA, the net loss will be recouped within 12 months by the increased yields on the securities. It was pointed out to the Bank's president that while the securities transactions may enhance the Bank's liquidity position, the liquidity ratio would not materially change. The policy states that two of the primary sources for providing for unexpected needs is the purchase of Federal funds and the selling of loan participations. FDIC explains that the bank has not obtained written commitments from correspondent banks for either and both are difficult to accomplish in a time of true need. "While it is recognized that the bank has considerable differences in loan demand because of the farming economy, meaningful improvement in liquidity can only be obtained by reducing the loan/deposit ratio to a more realistic figure."
   Current year-to-date earnings total $549,038. A total of $240,000 has been transferred to reserve for bad debts. When consideration is given the anticipated loan charge offs, the Bank will operate at a substantial deficit for 1983. The Bank's current capital/asset ratio is approximately 8.4 percent. Basically the Bank projects that earnings for the year, plus sale of $1 million in new stock, loan recoveries, and tax refunds, minus loan charge offs will enable the Bank to increase capital to at least 9.0 percent. While the Bank's capital projections are optimistic, no material exception is taken. FDIC believes capital should be between 7 and 8 percent. Some larger banks have capital ranging between 4 and 5 percent.
   The FDIC examiner notes that the overdue loan ratio has increased to 13.14 percent and is an indication of additional deterioration in the loan portfolio. While the depressed economy has undoubtedly contributed to the Bank's problems, management's past liberal lending policies have been the major factor. It is noted that the former president, no longer active in management, was a liberal lender and is responsible for a large portion of the problem loans. It appears that the current management now recognizes that the Bank has a problem, has identified the problem assets, and has at least formulated some semblance of a plan to work out of most of the loans.
   The October 12, 1983 "visitation" concludes that if the new loan committee functions as envisioned and a satisfactory loan policy is adopted and followed, the Bank could be headed in the right direction. While the present president of the Bank seems sincere in his desire to clean up the Bank, he is not supported by a particularly strong staff and management's ability to effect the desired improvements is unknown.
   The FDIC examiner observes that the portions of the 8(b) which management objects to would also be objected to in a memorandum of understanding.
       Regardless of which device is used, correction is going to be difficult. As a minimum, there needs to be a substantial decrease in the loan/deposit ratio and an accelerated program to be implemented. Based on management's stated desire for correction and willingness to supply capital, it is believed that a Memorandum of Understanding will achieve the necessary corrections.
   A letter of May 13, 1983, written by * * *, regional director of the FDIC, addressed to the Bank, notes significant areas of noncompliance with the memorandum of understanding dated May 5, 1982. The concluding paragraph, in part, states that due to the deteriorating trends evident at this examination and the apparent continuation {{4-1-90 p.A-348}} of liberal lending practices responsible for much of the deterioration, this office is recommending that formal action be initiated pursuant to section 8(b) of the Federal Deposit Insurance Act.
   One exhibit identified and received and submitted by FDIC refers to its statements of policy. The rating system, stated therein provides a general framework for evaluating and assimilating all significant financial, operational and compliance factors in order to assign a summary or composite supervisory rating to each Federally regulated commercial bank, saving and loan association, mutual savings bank and credit union.
       Each financial institution is assigned a uniform composite rating that is predicated upon an evaluation of pertinent financial and operational standards, criteria and principles. The rating is based upon a scale of one through five in ascending order of supervisory concern. Thus, "1" represents the highest rating and, consequently, the lowest level of supervisory concern; while "5" represents the lowest, most critically deficient level of performance and, therefore, the highest degree of supervisory concern. Each of the five composite ratings is described in greater detail below.
   Composite 1 includes institutions that are basically sound; composite 2 are fundamentally sound; composite 3 includes institutions that include a combination of financial, operational or compliance weaknesses ranging from moderately severe to unsatisfactory; and composite 5 is reserved for institutions with an extremely high immediate or near probability of failure.
       Composite 4, as previously noted, has been assigned to this Bank. It reads:
       Institutions in this group have an immoderate volume of serious financial weaknesses or a combination of other conditions that are unsatisfactory. Major and serious problems or unsafe and unsound conditions may exist which are not being satisfactorily addressed or resolved. Unless effective action is taken to correct these conditions, they could reasonably develop into a situation that could impair future viability, constitute a threat to the interests of depositors and/or pose a potential for disbursement of funds by the insuring agency. A higher potential for failure is present but is not yet imminent or pronounced. Institutions in this category require close supervisory attention and financial surveillance and a definitive plan for corrective action.
   Also, in its statement of policy—FDIC explains "capital adequacy". In part, it states:
       To foster objectivity in the analytical process a benchmark for evaluating capital adequacy, the Corporation has established a threshold level for adjusted equity capital for all insured nonmember commercial banks at 6 percent of adjusted total assets. When the adjusted equity capital ratio falls below this level, the Corporation's staff, in cooperation with the State banking department, will contact bank management and/or directors and require submission of a comprehensive capital plan acceptable to the Corporation and the State banking department.
   Exhibit 14, identified and received in evidence, was taken, in part, from "Formal Administrative Actions" and states:
       To assure greater uniformity of action and help assure that supervisory efforts are directed to banks most in need of them, the Division of Bank Supervision has adopted a policy that presumes either a formal or informal administrative action will be taken on banks with Composite Uniform Bank Ratings of "3", "4" or "5" unless specific circumstances argue strongly to the contrary.
       Banks with composite ratings of "4" or "5" will, be definition, have problems of sufficient severity to warrant formal action. Therefore, the policy of the Division of Bank Supervision is that it shall recommend to its Board of Directors that formal action pursuant to Section 8 of the FDI Act be taken against all insured State nonmember banks rated "4" or "5", where evidence of unsafe or unsound practices is present.
   The formal action may consist of either a corrective order under Section 8(a) or a Cease and Desist Order under either section 8(b) or 8(c).
   In another memorandum of understanding, dated May 5, 1982, FDIC notes that the Bank is in substantial compliance with most of the provisions of the memorandum. Liquidity has greatly improved but the major problem continues to be the loan portfolio. This situation is not considered the {{4-1-90 p.A-349}} result of any lack of initiative or sincerity on the part of management, but is a result of continuing poor economic conditions. "It does not appear that any material improvement in asset quality is likely until local economic and agricultural conditions improve."
   Exhibit No. 14 explains that "unsafe or unsound practices" can result from either action or lack of action by management. The FDI Act does not define the term "unsafe or unsound practices" but the Corporation's Board of Directors, in previous section 8 proceedings, has established examples of such practices. This exhibit spells out that—
       * * * it is impossible to define precisely what constitutes an unsafe or unsound condition because the condition of the bank is dependent upon an analysis of virtually every aspect of the bank's operation and position within a given time frame. As minimums, the bank's capital position, asset condition, management, earnings posture and liquidity position, must be carefully evaluated. While precise definition of unsafe or unsound condition is not possible, it is certain that a bank's condition need not deteriorate to a point where it is on the brink of insolvency before its condition may be found to be unsafe or unsound.
       The following having been found to evidence unsafe or unsound conditions by the FDIC's Board of Directors: (1) Maintenance of unduly low net interest margins. (2) Excessive overhead expenses. (3) Excessive volume of loans subject to adverse classification. (4) Excessive net loan losses. (5) Excessive volume of overdue loans. (6) Excessive volume of nonearnings assets. (7) Excessive large liability dependence.
    * * *

       * * * Great care should be exercised in listing violations. The erroneous designation of conduct as a violation tends to discredit the report of examination and detract from its value as evidence. * * *

   The Bank of * * *, in a letter dated October 6, 1983, responded to the Regional Director at * * * of the Federal Deposit Insurance Corporation regarding Notice of Charges and of Hearing. It details many of the procedures that it has taken since the last examination of its Bank in January 1983, and tells of the extensive effort that it has made to rectify many of the inadequacies in the examination report. The Bank has thoroughly analyzed the potential of any recovery on loans and leases previously charged off. It has restructured many of the internal policies of the Bank including lending policies and collection procedures. Also, with the letter, it submitted a new loan policy and liquidity policy which had been adopted by the Bank's board of directors and which it felt, in large part, address the items mentioned in the Notice of Charges.
   In the letter the Bank stated it had reviewed and analyzed the customers of the Bank with deposits of $100,000 or more. It submitted a projection for the next three years with proforma balance sheets indicating where it expects to be on an annual basis. Its independent auditor details the improvements made by Bank management during calendar year 1983 and it also discusses the tax effect of charged-off loans. Finally, a suggested Memorandum of Understanding was submitted which it felt satisfies FDIC concerns and also allows the Bank the flexibility to continue its operation without the constraints of a Cease and Desist Order.
   The Bank considers its problems primarily are of a local nature. It has not purchased participations in loans from banks located in other parts of the country. Its loan problems revolve around its depressed local economy. It stresses that it deals with people located in northeast * * * and southeast * * * who find themselves in the midst of the worst agricultural depression since 1930.
   Reference is made to the September issue of The * * * Banker wherein it explains that apparently in response to a spring meeting with the American Bankers Association Agricultural Credit Task Force, federal regulators have instructed examiners to change traditional attitudes by allowing farm lenders to practice a certain amount of forbearance.
   An official at the Federal Reserve System stated that as economic conditions close in on borrowers, lenders "may find that the most prudent policy is to stretch out payments and exercise forbearance rather than to take more precipitous action, such as foreclosures and/or forcing a borrower into {{4-1-90 p.A-350}} bankruptcy." The FDIC director of bank supervision, * * *, urged his examiners to "call the loans as you see them and be constructure and realistic in your management and board discussion. He wrote "the current problems in farming ... come down to a matter of capital. My perception of our job as regulators is to preserve the private banking system—and that means keeping the industry supported by private capital. If economic conditions don't improve—banks have no real choice but to absorb much of the problem because of their already heavy involvement in serving their borrowers." An examiner of the Office of the Comptroller of the Currency said that examiners should not be insensitive to farm customers or to the problems facing agricultural lenders; and that they remain sensitive to the difficult situations facing bankers and borrowers.

   The August 1983 issue of the Farm Journal tells of a Kentucky farmer who once felt a religious loyalty to his cooperative Production Credit Association and the Federal Land Bank but now is bitter. After investing 25 years and nearly $100,000 in both organizations that earned no interest, he has been forced to file Chapter 11 bankruptcy to prevent an FLB foreclosure. The farmer stressed that it hurts to lose a life's work. "But it also hurts to think about having stock in a farmer-owned financial cooperative and having them turn their backs on you, especially when 90 percent of your problems are beyond your control."
   The Bank recognizes that it has not been able to accomplish all of the items contained in the FDIC previous memorandum of understanding. It admits this was due in large part to the turnover it has experienced with its personnel. Also much of its time was dedicated to working out large bankruptcies which involved large loans and it is still plagued with the problems of bankruptcy today.
   The Notice of Charges and of Hearing outlines certain practices which allegedly evidence hazardous lending and lax collection practices on the part of the Bank. It is not a regular practice to renew loans without the collection of interest. Any loans initially made at the Bank were, in the opinion of the loan officer, adequately secured and did have definite repayment programs or sources of repayment. The Bank's area has been in a depression for approximately two years and in many cases the value of the collateral securing the loans at the Bank has diminished greatly. The board of directors and management have revised the loan policy for the Bank, and intends to strictly abide by the terms and conditions of the loan policy in the future.
   Reference is made to the "extended of credit" to a brother of the Bank's president and the amounts when aggregated amounted to a concentration of credit equal to 47 percent of the Bank's total equity capital. This loan has been paid in full. The loan actually was made to property and even though the brother is the sole stockholder, officer and director of the corporation—he was not liable to the Bank for this indebtedness. However, as stated, the loan has been paid and the (farm) property continues to produce income. The brother has been actively engaged in the liquidation of this property and has, in fact, sold several of the tracts of land which has benefited the Bank. The FDIC comments regarding a possible conflict of interest with the brother attorney are considered reasonable. However, at the time of the "closing" Bank management felt it imperative that it use the law firm which was intimately familiar with the title to this property.
   Regarding alleged charges that the Bank engaged in unsafe and unsound banking practices by extending credit secured by collateral subject to substantial senior liens, the Bank explains that in a farming community such as * * * it has been the practice of many lending institutions to accept second mortgage collateral to secure lines of credit for their borrowers. In the past, farm land has always been excellent collateral and it is only due to the severe depression that the value of farm land had diminished. The Bank did not engage in unsafe and unsound banking practices at the time these loans were made because the value of the collateral at the time of the initial advance was, in most cases, adequate to secure the loan. However, the new loan policy addresses these items.
   The Bank also notes the allegation regarding time deposits of $100,000 and feels that it is unfair to categorize these as volatile liabilities of the Bank. In excess of 90 percent of these deposits are held by either long-term customers of the bank or by board members of the Bank or are held as public funds which are secured by liquid, pledged securities offsetting any volatility. The Bank has asked the regional director {{4-1-90 p.A-351}} that it be allowed to use that "portion" of its time deposits of $100,000 or more as core deposits for its Bank to the extent that they are held by loyal customers of the Bank, bank directors or public funds secured by liquid securities. The Bank still feels that this is a legitimate request.
   The Bank is proud of the fact that its management and the board of directors are not involved in any fraudulent or illegal activities. Again, due to the tremendous amount of work done by the management since January 1983, it feels that the deposits of the Bank are not in any jeopardy. It proposes as an alternative that the Bank enter into a new Memorandum of Understanding with FDIC and it submits a draft of the memorandum for review. It further feels that the time schedules shown are achievable and "would prefer this method of operation as opposed to an order to cease and desist."
   The Bank highlights some of the things which it has accomplished since the date of the January examination which it feels represents safe and sound banking practices. It instituted an asset-liability management program with * * * Bank * * *. It has created a Compliance Department which is staffed with three employees. It explains that the department has done an extremely good job in identifying deficiencies in its loan portfolio and this department is expected to aid and assist the loan officers in the future so that they might adequately monitor their loans, and make certain it has the correct, current information in the loan files.
   A full-time appraiser, highly qualified, has been retained and will assist management in evaluating collateral for new loans. Also, all of the loans previously charged to undivided profits have been reviewed and management made a conservative determination of any recoveries which will result from these loans in the near future.
   In a letter dated January 30, 1984, not mailed, but addressed to the FDIC Regional Director at * * *, the Bank stated, among other things, that a Cease and Desist order is not necessary. The Bank reminded FDIC that (in this letter also filed as exhibit No. 26 herein) it had injected a total of $1.2 million into the capital accounts since its last correspondence of October 6, 1983. Under that letter it had only projected an infusion of $1 million, thus it exceeded its proposal by $200,000. It also booked an income tax recovery of $1,067,737. In its previous proposal it had projected a recovery of $1 million.
   Also, in its earlier report it had anticipated a need to charge off $2,487,150 of problem loans. In fact it did charge off $2,423,207. It also charged off $115,000 against other real estate. Since its earlier report to the Regional Director, the bank management decided to sell $6,171,000 of its investment portfolio at a loss of approximately $318,000. Actually the Bank recognized a total investment portfolio of $338,000 for 1983.
   The Bank refers to a recent written comment of one of FDIC's examiners wherein it was stated in the Report of Visitation that: "Based on management's stated desire for correction and willingness to supply capital, it is believed that a Memorandum of Understanding will achieve the necessary corrections." In other words the Bank explains that the examiner concluded that it did not desire an Order to Cease and Desist.
   In fact, the Bank requests that the FDIC change the composite rating from 4 to 3. Not only does it feel that it has addressed the major and serious problems identified in FDIC's January 1983 examination, but it has developed a definitive plan for corrective action that is being implemented and presently is working. The Bank not only feels that the future is viable, but it should be profitable in 1984 and the years to come. The bank management is aware of numerous saving and loan associations who have capital to asset ratios of less than 3 percent, but are not operating under cease and desist orders.
   The Bank points out that under the updated analysis of the recovery of loans previously charged-off, it is important to note that it has recovered approximately $530,000 during calendar year 1983. The Bank has recovered $245,000 against the total anticipated recoveries of $565,000 shown in the September 20, 1983 report. During this "same abbreviated period", management recovered an additional $40,000 of loans previously charged off, but which were not listed as anticipated recoveries in the September 1983 report.
   The Bank is particularly proud of the progress made in the personnel reorganization.

{{4-1-90 p.A-352}}
   The collateral department was fully implemented during 1983 and has become an integral part of the Bank. Tremendous strides were made correcting deficiencies which previously existed in its loan files. Its computer department continues to provide needed information to management and in 1984 the Bank will have its own in-house asset-liability management program. The Bank stresses that management is now in a better position than ever to monitor its liquidity, loan to deposit ratio; and other ratios against those levels deemed desirable by the FDIC and as compared to other banks in its peer group. It is proposing a new loan policy which incorporates all of the suggestions mentioned in the Report of Visitation filed by the FDIC examiner.
   A new liquidity policy includes many of the changes recommended by FDIC. It reports that its liquidity ratio was at a low of 10.56 percent in September, and increased to 14.87 percent in October to 15.78 percent in November and finally reached 20 percent in December 1983. The new liquidity policy is being amended to specifically provide actions which can be taken automatically by management in case the ratio declines to a serious level.
   As previously noted, the Bank also disposed of the majority of its tax exempt bond portfolio recognizing a loss in the process. This action improved and helped increase the bank's liquidity ratio. The Bank insists that it has experienced a very healthy improvement in the rate sensitive assets to rate sensitive liabilities ratio. This ratio was at 79.92 in September and increased to 83.04 percent in October and increased again in November to 95.86 percent. In December there was

       "A calculation of this ratio on January 23, 1984, indicating that this ratio was approximately 97 percent which indicates that the bank is well in line with the projections previously mentioned and with its peer group. With respect to the dependency ratio, there has been some concern in the past that this ratio was falling in the thirty (30 percent) to forty (40 percent) range."
   The Bank completed an analysis of the certificates of deposit of $100,000 or over which indicates that a large amount (over 70 percent) are old established customers of the Bank or are members of the Board of Directors and, in the case of the Bank of * * * , should not be considered potentially volatile liabilities. If these deposits are discounted, the dependency ratio will fall to a negative ratio of approximately 6.5 percent and will be in line with its peer group. The Bank submits that a calculation of ratios based on cold data tends to bias the report unless specific underlying numbers used in the calculations are reviewed considering the specific bank or organization for which they are reported. The Bank stresses that it has reviewed these deposits in greater detail and will continue to review them. It insists that these deposits are core deposits and are not volatile.
   The Bank considers the 1984 proposed budget as a "very realistic one." Its income is based upon the actual asset/liability gap model which is currently being used in the projections made by * * * Bank * * *. Expenses include approximately $150,000 per year for the interest payment on the $1.2 million capital note. The * * * brothers (president of the bank and the attorney) indicate that they might be willing to convert some portion or all of the capital note to common stock which would totally eliminate this interest expense to the Bank. The Bank believes that the net income of $762,000 is achievable without the necessity of the conversion of the capital note.
   Management has attempted to draft a new loan policy which incorporates many of the suggestions offered by an examiner of the FDIC. This policy has not been adopted by the Bank since management feels that it would be better to allow FDIC to comment on the new loan policy prior to its actual adoption. Management welcomes any new suggestions or comments.
   Listed below are selected ratio analysis that shows an improvement in the ratios and percentages which are used in the calculation of the liquidity policy. Considering the selected improvement in the ratios and a review of the liquidity policy the Bank concludes with reservation that it has improved liquidity and providing a system to properly monitor on a daily and monthly basis the ratios and percentages concerning liquidity.
   The Bank considers "liquidity" as its ability to convert assets into cash with little or no loss to meet the needs of its customers at any time. Thus, it must be able to meet the funding requirements of its depositors, the funding requirements of all lines of {{4-1-90 p.A-353}} credit, and the short term credit needs of its established customers. Its specific goal is to work towards pairing assets and liabilities off so that it will:
       1. Maintain a 4.0 percent net interest spread with a goal of 5.0 percent.
       2. Have its rate-sensitive assets and liabilities maturing in about the same amounts at the same times to protect the Bank from swings in interest rates. It will use its forecasting model to monitor its "gap" (its rate-sensitive assets less its rate-sensitive liabilities) and invest its securities in such a manner as to create a 180-day rate-sensitive asset/rate-sensitive liability ratio not to exceed plus of minus 1.1 percent (rate-sensitive assets) as a percent of rate-sensitive liabilities of 90-110 percent.
       3. Maintain a liquidity ratio of 15-25 percent.
   It has developed procedures that will measure the liquidity ratio on a daily basis. The liquidity ratio shall be measured by net cash, short term and marketable assets to net deposits and short term liabilities. Its goal is to maintain the liquidity ratio at 20 percent. As defined in the loan policy, the Bank experiences large fluctuations in reduced deposits and increased demand for loans during the winter and summer months. During those seasons, this ratio shall be at least 15 percent.
   4. Maintain a dependency ratio of 6.5 percent plus or minus.
   For purposes of calculating the dependency ratio it shall reclassify volatile liabilities to exclude time deposits of $100,000 or more due within one year as outlined in paragraph seven below.
   The following specific procedures will be followed in maintaining sufficient liquidity:
       1. It always will have 10 percent of its investment portfolio maturing in the next quarter. As these securities mature, the funds will be used to meet the Bank's cash needs, or they will be reinvested in securities to maintain a desired liquidity position. Until the liquidity ratio is increased to a satisfactory level the maturity of investments in the next six months will be maintained at 25 percent.
       2. It will establish and maintain Federal Fund lines of credit totaling $3 million with its upstream correspondent banks, but it will not rely on these lines except during short term seasonal peaks in loan demand. Should it become necessary, it will secure its Federal Fund borrowings by pledging investment securities.
       3. The Bank will normally balance its liquidity position by buying and selling loans through its primary correspondent bank. When it is too liquid, it will consider buying the government-guaranteed portion of SBA floating-rate loans; when it experiences temporary high demands for loans, it will attempt to meet this demand by selling loans upstream. In the event the liquidity position falls below 15 percent then it will obtain written commitments for participations before funding additional loans.
       4. Should the Bank become illiquid in spite of these steps, it will curtail its lending activities. The first step in this process will be to cease making term commercial loans; the second step will be to tighten its consumer loan decision criteria to slow its consumer loans; and the third step will be to refuse all loans to new customers. Only as a last resort will it refuse short-term working capital loans to existing commercial customers.
       5. It will maintain average Fed Funds Sold balances equal to 3 percent to 5 percent of its total assets. Its Fed Funds and portfolio securities maturing in the next 90 days will always be equal to or slightly greater than 5 percent of its total assets.
       6. The Bank will only on a short-term basis in a crisis situation rely on purchased or borrowed money as a source of funds.
       7. It will monitor volatile liabilities on a monthly basis. The time deposits of $100,000 or more due in one year will be reviewed against its permanent customer list to determine if the percent of these deposits is still due to its old established customers and directors. Its analysis has indicated that over 70 percent of these deposits are in this category.
       8. Develop a comprehensive plan that will (over the next three years) allow it to cover at least 40 percent of its operating expenses. The budget plan is compared to actual expense on a monthly basis. Corrective action will be taken for items
{{4-1-90 p.A-354}}
    indicating a significant variance. The Bank believes that this will also aid management in controlling liquidity.
   As noted above, the Bank feels that the jumbo certificates of deposit represent core of deposits for the Bank of * * *. The six different categories as of September 20, 1983 may be compared with the same accounts as of January 13, 1984.
PercentPercent
9-20-83Of Total1-13-84Of Total
Established Accounts$13,341,42063$14,244,19066
Board of Directors2,093,821102,034,7129
Other Banks714,0003214,0001
Public Funds4,057,862194,075,01819
Brokerage Funds700,0003600,0003
Other332,0112438,1002
Totals$21,239,114100$21,606,020100

   The first two categories equal 75 percent of the total jumbo certificates of deposit as of January 13, 1984. Also it is explained that the public funds deposits which are secured by a pledge of high quality collateral offsets the volatility of this category.
   In its 1984 proposed budget, the bank, among other things, pointed out that the budgeted expenses were based on 1983 actual with some reductions, which should be attainable based on 1984 projections. The income tax was reduced because it is anticipated that the expense on the income tax return for charged off loans will be greater than the book amount due to using the six year moving average on the tax return. Due to the large amount of loans charged off in the prior three years, the Bank anticipates the charged off loans will be netted by the recoveries on charged off loans.
   The Bank of * * * in updating a four-year projection at the beginning used $762,000 as the projected net income. Total assets and related items were increased by 5 percent per year. Even though summary data for banks in * * * reported an average of 11.13 percent through 1982 for banks in the $25-$100,000,000 size, the 5 percent rate is more applicable to this Bank, due to the size of the community, the nature of the agricultural economy; and because the actual ending balances, December 31, 1983, were higher than projected due to specific larger deposits that may be withdrawn in early 1984. Thus, the Bank concluded that using 1983 as a base year, a projected 5 percent increase should be more reasonable.
   A return on assets after taxes of 1.2 was projected with a cash dividend of 15 percent of income to shareholders and a retention of 85 percent of earnings by the Bank. In normal years the Bank has reported in excess of this estimate and with efforts in reduction of expenses this projection should be attainable even with the added expense of interest on capital notes. The Bank's history of substantial recovery of chargedoff loans combined with the amount of charged-off loans in the last few years would equal any additional charge-offs in future years.
   Since the date of the infusion of capital (the $1.2 million previously noted), the holders of the Capital Note have written all the stockholders of the Bank and are offering to allow each one of them to purchase up to their pro rata share of common stock which would have otherwise been issued under the terms of the Capital Note when the holders of the note exercised their right to convert the note to common stock. This will allow each stock holder the opportunity to maintain his or her current percentage of ownership in the Bank of * * *. The holders of the note are considering a conversion of their note to common stock so as to relieve the Bank of the interest expense it would otherwise incur in the event the holders decide not to convert the Capital Note.
   A certified public accountant, with a firm of independent auditors, has audited the Bank of * * * for about 10 years. This firm, located at * * * has audited a large number of national and state banks ranging in size from small banks of 6 million to close to a hundred million, including one bank holding company, that has two banks—multibank holding company. Such banks are located {{4-1-90 p.A-355}} in north * * *, south * * * and * * *.
   In auditing the Bank of * * *, as well as other banks, the witness explained that external independent auditors are retained by the stockholders of the Bank to review the financial statements to determine if they are prepared in accordance with generally accepted accounting practices and to express an opinion as a licensed expert that properly prepared reports reflect the financial condition of the Bank. The witness suggested that the FDIC's policies are changing—somewhat. However, they look at the regulatory end, if the bank is in violation of the law or the technical standards issued by the FDIC and review loans and other documents in the bank. FDIC's examination may last a week or two or there may not be an examination. The audit would last on the average 400 to 500 manhours for a $40 to $50 million bank. The accountant stated that the audit process that it conducts is somewhat comprehensive in different areas. It verifies with third parties, mails out confirmations, and tests transaction. Basically it reviews the system of internal accounting controls and applies its audit program to test the transactions and express its opinion on the fairness of presentation of the financial statements.
   The accountant contends that making a loan is a judgmental decision and as time passes the loan can deteriorate or can be questioned. Loans are divided into three classifications, substandard, doubtful and loss. Banks have three sets of records, one for the Internal Revenue Service, one under RAP for the FDIC and one under GAP for all of the accountants. —GAP being generally accepted accounting principles, RAP is regulatory accounting principles for the FDIC. It was explained that the bank has realized income tax savings from loan charge-offs. For example, the Bank in charging off $2.6 million worth of loans in 1981 received $600,000 from the Internal Revenue.
   The witness' firm has provided some assistance with bank management in developing a liquidity policy. The goal was to incorporate the recommendations of the FDIC examiner regarding certain comments that he had made about the previous liquidity policy.
   Its review of the various files of the Bank of * * * indicates there are no instances wherein the Bank has made loans that were secured by inadequate collateral at the time the loans were made. He notes that all lenders are very aware that—especially in the agricultural area—cash flows and payment plans are a very important part of a loan package.
   The auditor is aware of the practice in farming communities of making loans subject to senior liens, a common practice, and the equities of the individuals or borrowers have substantial equity in the land. On large tracts of land, millions of dollars must have senior liens on it or the cash flow would be acute. A lot of these mortgages are fixed rate mortgages for a long period of time which enables the farmer to withstand the interest price. Although there has been an allegation that the Bank of * * * operated with inadequate capital—the auditor disagrees. He stresses that the standard that has been used is about 8 percent and notes that the Bank has sufficient capital with the addition of $1.2 million in December 1983.
   The witness would, as an independent auditor, worry if the capital ratio slipped below 7 but notes there are larger banks running with a lot lower capital ratio, 4 to 5 percent. Reference is made to criticism by the FDIC as to the bank's liquidity posture. In fact the witness refers to the FDIC report of January 1983 wherein the bank was criticized because the ratio had increased from 14 percent during the last examination to nearly 23 percent. He emphasizes that if the Bank went from 14 to 23 it should be congratulated—not criticized.
   Based on historical facts and the way that this bank is uniquely operated, with the large loan volume that it has, serving the community, it is invariably going to have some periods of a low liquidity ratio according to this auditor. He points out that the liquidity ratio monitored during 1983 was back—just barely over 20 percent by the end of the year, the loans to deposits were down, and all the percentages were falling into line.
   Although the FDIC charges the bank engages in policies that are detrimental to the bank and/or endanger the deposits of the bank—this witness does not agree. For example, in 1981 the bank wrote off and charged substantially more loans than were {{4-1-90 p.A-356}} required by the final FDIC report, and it charged them directly off and did not set up a reserve. He insists that the agricultural economy is somewhat responsible for some of the "errors." He recommends highly the Bank's directors' guidance and supervision. He does admit that it will take the Bank two or three years to work slowly out of its "problems" without sustaining substantial losses, especially, the "loan problem."
   This witness, * * *, labels the "cease and desist" order of the FDIC as ridiculous. The fact that such an order would have to go in "its audit report" as an item to inform any investor or anybody looking at the report—that's going to put it in the hands of bonding companies, correspondent banks, "and it would be very detrimental in my opinion to the Bank."
   On cross-examination, the auditor submitted that generally he does not render an opinion as to what are "safe and sound banking practices." Primarily he notes that he is concerned with the fairness of presentation on the financial statement. During the last two years the auditor has been required to comment on any impairment of the going concern that the bank or entity will continue to operate.
Briefs—Herein FDIC addresses the position that the cessation of unsafe and unsound banking practices is not a defense. Thus—the existence of unsafe and unsound practices in existence as of January 14, 1983, as well as "the Bank's amplification of those facts" govern as to the decision of this proceeding.
   FDIC submits that although section 8(b) of FDIC's act, 12 U.S.C. section 1818(b) does not specify what practices are unsafe or unsound, the term "unsafe or unsound" has been in Section 8(a) of the Act [presently codified to 12 U.S.C. section 1818(a) (1972)], since it was first enacted as part of the Banking Act of 1935, Ch. 614, section 101(I), 49 Stat. 684, 690. It is pointed out that the phrase "unsafe or unsound practices" is somewhat similar to the language in section 5 of the Federal Trade Commission Act, 15 U.S.C. section 45 (1982), which proscribes unfair methods of competition and unfair or deceptive acts or practices. In enacting the Federal Trade Commission Act, Congress intentionally refrained from defining that phrase or enumerating the practices which were within its scope, S. Rep. No. 597, 63d Cong., 2d Sess. (1914); H.R. Rep. No. 1142, 63d Cong., 2d Sess., pp. 18-19 (1914). Congress advisedly adopted a phrase the meaning and application of which must be arrived at by the gradual process of inclusion and exclusion. Fed. Tr. Comm'n v. Keppel & Bro., 291 U.S. 304, 312 (1934). Congress undoubtedly adopted a similar regulatory scheme in the Federal Deposit Insurance Act.
   The Financial Institutions Supervisory Act of 1966, Pub. L. No. 89–695; 80 Stat. 1028, was enacted into law in large measure at the request of the Secretary of the Treasury, the Board of Governors of the Federal Reserve System, the Federal Home Loan Bank Board and the Federal Deposit Insurance Corporation. Financial Institutions Supervisory and Insurance Act of 1966; Hearings on S. 3158 Before the House Comm. on Banking and Currency, 89th Cong., 2d Sess. 50 (1966). Section 202 of the Financial Institutions Supervisory Act of 1966 amended section 8 of the Federal Deposit Insurance Act by adding, among other things, subsection (b), under which this proceeding was brought.
   The legislative history of the Financial Institutions Supervisory Act of 1966 shows that Congress carefully considered the phrase "unsafe or unsound" and, by retaining that phrase in the final legislation, concluded that the phrase was sufficiently clear and definite as to be understood by those subject to its proscription.
   At the top of page 2 of this decision Chairman Horne is quoted regarding unsafe or unsound banking practices. Also he explains that:

       * * * 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.
   FDIC refers to First Nat. Bank of Eden v. Department (Eden), 568 F.2d 610, 611 (8th Cir. 1978), a case applying section 8(b) of the Act, wherein the Eighth Circuit approved a definition given to the phrase "unsafe or unsound" by the Comptroller of the Currency, stating: {{4-1-90 p.A-357}}
       Congress did not define unsafe and unsound banking practices in section 1818(b). However, the Comptroller suggests that these terms 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.
   The Court also deferred to the expertise of the Comptroller of the Currency in defining what constitutes an unsafe or unsound practice, stating that the courts could only overturn an agency's determination based on a showing of arbitrary and capricious judgment. If substantial evidence supported the agency, its determination would stand. 568 F.2d at 611. Also see Franklin Nat. Bank Sec. Litigation, 478 F.Supp. 210 (E.D.N.Y. 1979).
       FDIC points out that the trend of judicial review of bank regulatory action under section 8(b) of the Act has been general deferring to the expertise of the bank regulatory agencies in defining what constitutes an unsafe or unsound practice and limiting review to a determination of whether the action taken by the regulatory agency was arbitrary, capricious, or otherwise unsupported by substantial evidence. The Fifth Circuit in Groos Nat. Bank v. Comptroller of Currency, 573 F.2d 889, 897 (5th Cir. 1978), noted:
       * * * [T]he phrase "unsafe and unsound banking practice" is widely used in the regulatory statutes and in case law, and one of the purposes of the banking acts is clearly to commit the progressive definition and eradication of such practices to the expertise of the appropriate regulatory agencies.* * *
   The District of Columbia Circuit in Independent Bankers Ass'n v. Heimann, 613 F.2d 1164 (D.C. Cir. 1979) considered whether the Comptroller could statutorily define a particular "unsound or unsafe" practice. The Comptroller's challenged regulation prevented national bank insiders from receiving commissions for credit life insurance sold to the bank's borrowers. In upholding the regulation, the court observed that the agency's discretionary authority to define and eliminate unsafe or unsound practice is to be "liberally construed."
   In First Nat. Bank of LaMarque v. Smith, 610 F.2d 1258 (5th Cir. 1980), the court affirmed the Comptroller's definition of "unsafe or unsound" practices reported in Eden. Therein it was held that payment of credit life insurance commissions to bank insiders constituted an unsafe or unsound banking practice.
   Herein, FDIC insists that the record clearly supports the conclusion that the hazardous lending the lax collection practices, inadequate loan reserves, inadequate capital and inadequate liquidity of the Bank involve abnormal risk or loss or damage to the institution, its shareholders, or the agencies administering the insurance fund.
   FDIC notes that the standard of care for directors of banks was forcefully stated in Briggs v. Spaulding, 141 U.S. 132, 165-66 (1891):
       * * * [W]e hold that directors must exercise ordinary care and prudence in the administration of the affairs of a bank, and that this includes something more than officiating as figure-heads. They are entitled under the law to commit the banking business, as defined, to their duly authorized officers, but this does not absolve them from the duty of reasonable supervision, nor ought they to be permitted to be shielded from liability because of want of knowledge of wrongdoing, if that ignorance is the result of gross inattention;* * *
   It is negligence for directors to leave the management of a corporation entirely up to others. Meit v. Bixby, 276 F.Supp. 217, 231 (E.D. Mo. 1967). Accordingly, directors may be held liable for the breaches of trust of officers and directors to whom management is entrusted, and reliance upon their apparent trustworthiness does not afford an escape from such liability. "The directors of the Bank exercised less than ordinary care when loan and liquidity problems were brought to their attention in the August 18, 1980, FDIC Report of Examination and permitted those problems to steadily worsen."
   Applying the test of Briggs v. Spaulding, supra, the court held that directors may not confide the management of a corporation to an officer, however trustworthy, and then totally rely on his trustworthiness. "It is a well-known fact that a large proportion of the disasters which befall banking institutions {{4-1-90 p.A-358}} come from the malfeasance of just such men" and the board of directors of a bank has a duty to supervise, a duty to have a general knowledge of the bank's business, a duty to know to whom and upon what security its large lines of credit are given, and to know and give direction with regard to the important and general affairs of the Bank. FDIC stresses that the huge loan losses that the Bank of * * * suffered demonstrate that this duty has not been fulfilled.
   This duty is not met by reposing confidence in an officer, no matter how worthy of confidence the officer seems to be, because "confidence without supervision has often proved to be a temptation and an opportunity." Atherton v. Anderson, 99 F.2d 883, 888 (6th Cir. 1938). Where directorial ignorance results from a failure to supervise the banks, the courts have not excused the negligence; instead the fact of ignorance has operated to establish a presumption of knowledge. F.S.L.I.C. v. Geisen, 392 F.2d 900, 904 (7th Cir. 1968). It is the directors' duty to examine, the violation is "in effect an intentional violation." del Junco v. Conover, 682 F.2d 1338 (9th Cir. 1982), cert. denied, 103 S. Ct. 786 (1983). In the instant proceeding, FDIC insists that the Bank's board of directors has failed to properly supervise its officers and staff to prevent the unsafe and unsound practices.
   A memorandum of understanding between the Bank's Board of Directors and the * * * Regional Office of the FDIC became effective on May 5, 1982. Among other issues, the memorandum addressed loan policies, reduction of assets classified in the February 1, 1982, Report of Examination, evaluation of the loan loss reserve for adequacy and reduction of the loan to deposit ratio. FDIC explains that a memorandum of understanding is a gentlemen's agreement by which the FDIC outlines its concerns and proposes a corrective program. It is not enforceable in a court of law.
   FDIC notes that this memorandum (as of January 14, 1983) revealed increasing classified loans (up $1.4 million from the 1982 examination) with an 11.65 percent overdue ratio, a low liquidity ratio, an inadequate loan loss reserve and inadequate capital. It points out that the * * * Commissioner of Financial Institutions generally shared the FDIC concern about the Bank's overloaned position and its loan classifications. The Bank was again given a 4 rating by the FDIC. Ratings were previously discussed early in this decision.
   As of January 14, 1984—FDIC emphasizes that the Bank engaged in unsafe or unsound banking practices included (sic) (among others) the following activities: Loans were renewed or had their due dates extended without collection in cash of interest due; loans not adequately secured; loans were made without establishing definite repayment programs or sources of repayment; loans renewed without reduction of principal and/or established repayment programs have not been enforced; Bank extended credit to brother of the present president of the Bank and his related interest in amounts when aggregated together constitute a concentration of credit equalling 47 percent of the Bank's total equity capital; the Bank extended credit secured by collateral subject to substantial prior liens; the Bank had charge offs amounting to $2,448,000 in 1981 and $674,000 in 1982; the Bank has failed to maintain an adequate reserve for loan losses based on the volume and quality of its loan portfolio; the Bank has operated with an inadequate level of capital protection in view of the volume and quality of assets held; and the Bank has been operated with inadequate provisions for liquidity.
   FDIC is highly critical of the Bank's position that its problems have been corrected. Section 8(b) of the Federal Deposit Insurance Act, 12 U.S.C. 1818(b), provides in applicable part that a cease-and-desist order may be issued against any bank "if upon the record made any * * * hearing, the agency shall find that any violation or unsafe or unsound practice specified in the notice of charges has been established." Thus, FDIC contends that Section 8(b) distinguishes between violations of law and unsafe or unsound practices which are ongoing at the time of the issuance of the order and those which have already occurred, clearly indicating that there need not be violations of law or unsafe or unsound practices occurring at the moment of issuance of a cease-and-desist order. "Administrative and judicial interpretation of the cease-and-desist powers of other agencies is in accord."
   The Eden proceeding was the first judicial application of section 8(b) of the Federal Deposit Insurance Act. While the case does not specifically deal with the defense of discontinuance, FDIC holds that the decision of the Comptroller of Currency in {{4-1-90 p.A-359}} issuing a cease-and-desist order can only be disturbed if it is shown to be arbitrary and capricious. Also—it notes that ample precedent exists for the issuance of a cease-and-desist order in a case where the respondent relies on a defense of discontinuance of violations.
   In Zale Corporation and Corrigan-Republic, Inc. v. F.T.C., 473 F.2d 1317 (5th Cir. 1973), the court reviewed an FTC cease-and-desist order issued against a retail jewelry concern to prohibit the store from selling to consumers on credit without properly disclosing finance charges as required by the Truth in Lending Act. Respondent Zale contended that after completion of the FTC examination that uncovered the violations, the company has remedied all such violations, thereby extinguishing the need for the cease-and-desist order. The court applied an "abuse of discretion" test and denied Zale's petition for review of the order, stating:
       * * * Whether or not such practices have actually been abandoned can only be determined through subsequent enforcement procedures. Hence, while respecting the good corporate name of the Zale Enterprise, there is no valid assurance that if Zale were free of the Commission's restraint it would not continue its former course. * * *
   FDIC submits that the Zale court recognized that a cease-and-desist order is not only a tool to stop abuse which has occurred, but an instrument to deter and prevent future abuses, even if the original violations have in fact been remedied. "In view of the FDIC's broad power to require affirmative action to correct condition resulting from unsafe or unsound practices and violations, it is even clearer that cessation is not a defense in FDIC proceedings."
   A deceptive advertising case, Beneficial Corp. v. F.T.C., 542 F.2d 611 (3d Cir. 1976), cert. denied, 430 U.S. 983 (1977), affirms the power of the Federal Trade Commission to impose a cease-and-desist order notwithstanding discontinuance even prior to FTC action:
       * * * It [petitioner] contends, however, that because the early text was soon abandoned with no prompting from the Commission the finding cannot support a cease and desist order. But this and other courts have held that at least where a discontinued deceptive trade practice could be resumed, the prior practice may be the subject of a cease and desist order. * * *
   FDIC argues that based on the foregoing case law and the express statutory language of section 8(b) of the Act, it is clear that it can issue a cease-and-desist order based on facts as of a given date even if those facts have changed subsequently. Thus, "in the present case, even if respondents could establish that subsequent to the January 14, 1983, examination they had ceased unsafe or unsound practices cited in the Notice of Charges, the FDIC would still be justified in issuing a cease and desist order based on unsafe or unsound practices that existed at the time of the examination." As noted by the court in Zale, "whether or not * * * practices have actually been abandoned can only be determined through subsequent enforcement procedures." FDIC points out that in addition to the FTC precedent, the fact that its powers under section 8(b) include the power to require correction of the conditions resulting from unsafe or unsound practices would by itself justify an order herein.
   On brief the Bank feels comfortable with its efforts to correct any problems it may have and does not believe a cease and desist order is necessary.
   As of January 14, 1983, FDIC determined that the Bank's total equity capital and reserves equalled $4,965,000, its adjusted capital and reserves equalled $4,315,000, its adjusted total assets equalled $57,002,000, and its net loans equalled $39,054,000. As of January 14, 1983, the Bank's adjusted capital and reserves to adjusted total assets equalled 7.57 percent. FDIC's brief agrees with these figures.
   As of December 31, 1983, the Bank testified that its total equity capital and reserves equalled $5,141,104, its total assets equalled $60,467,844, and its net loans equalled $42,015,277. As of December 31, 1983, the Bank's total equity capital and reserves to total assets equalled 8.5 percent. The Bank thus takes the position that its equity capital and reserves to assets ratios at January 14, 1983; and December 31, 1983, were at an adequate level that was not unsound or unsafe.
   As noted on sheet 1 of this initial decision —the Bank is located in * * * the * * * {{4-1-90 p.A-360}} seat of * * *. The * * * is almost exclusively dependent on farming. The area of * * * in which the Bank is located has been suffering from one of the worst recessions since the Great Depression in the thirties.
   The Bank submits that it is now exercising proper business judgment and follows safe and sound banking practices. It exercises prudent lending practices and policies in securing its loans. It has sought adequate collateral and definite repayment programs for its loans. It admits that on limited occasions it has renewed loans without collecting interest due, but in all such cases it testified that the extensions were safe and sound banking practices.
   For example, the * * * , and * * * loans were renewed without the collection of interest in order to restructure the two notes into a single monthly payment note and to provide working capital for the borrowers' business. The * * * Company loan was extended without collecting interest because the company was late being paid by FHA for work it was doing. The Bank received total payment 45 days later. A renewal to * * * and the Company, by this same name, without a reduction of principal, involved a long-term customer and borrower capable of generating large sums of cash. Substantial repayments are expected this year, and also additional collateral was secured. Also—loans secured by junior "liens" are prevalent in an agricultural community, and the Bank insists that it always has determined that sufficient equity exists before making such loans.
   On brief—respondents explain that the process of classifying loans and other assets during an examination is an extremely subjective determination. FDIC uses substandard, doubtful and loss classifications as noted previously. The Bank lists numerous improvements it has made recently last year such as increasing to four full-time employees in the loan department, and the Bank's directors monitor the adequacy of the loan loss reserve on a frequent basis, and at no time has found it to be inadequate.
   Its independent auditor, whose firm audits 12 banks annually, recommended to the board that the adequacy of the provision for loan losses be kept at approximately one percent of capital due to Internal Revenue Service regulations. FDIC has provided no recommendation as to what the loan loss provision should be, but has taken the position that this decision is entirely up to the discretion of the Board of Directors of the Bank.
   As of February 1, 1982, the Bank's overdue loans were 16.1 percent of total loans as compared with 11.65 percent as of January 14, 1983. Also, as observed previously, the Bank would have been in full compliance with the Memorandum of Understanding had the FDIC included certificates of deposit of $100,000 or more in the core deposit ratio referred to in the memorandum. The FDIC examiner testified that the "certificates" were stable and not "volatile" and if these deposits are excluded from the "volatile" category, the Bank's volatile liability dependence is reduced.
   The Bank's liquidity ratio on January 14, 1983, was 22.34 percent as compared with 20 percent on December 31, 1983. The Bank insists that these percentages reflect a substantial increase in liquidity from the 1982 examination, when the liquidity ratio was 14.1 percent. Thus, the Bank considers its liquidity as adequate. In fact—the FDIC approved the liquidity policy submitted on February 9, 1981, "and all modifications to it have been an effort to meet FDIC suggestions."
   In its brief the Bank stresses that it is FDIC's burden to support its "Notice of Charges" by substantial evidence and not a mere preponderance of the evidence. Like the FDIC the Bank refers to the Eden proceeding. Also, the Bank submits that the FDIC must establish a rational connection between the facts which it seeks to prove and the action which it proposes as appropriate; otherwise, any order which could be issued would be arbitrary and capricious. Citizens State Bank of Marshfield v. F.D.I.C., 718 F.2d 1400 (8th Circ. 1983). Herein, "FDIC failed to establish that the Bank has engaged in unsafe or unsound practices or that the problems in the Bank's loan portfolio are the result of such practices."
   As noted above, FDIC especially was critical of the Bank's loans. For example, reference was made to a loan to an * * * . However, later it was demonstrated that the FDIC erred in calculating prior liens on * * * collateral by including a prior crop lien which had been paid in full. Moreover, the loan has now been restructured, the Bank has taken a new $700,000 collateral mortgage on equipment, and substantial {{4-1-90 p.A-361}} repayments of principal and current interest payments are made.
   In its brief the Bank refers to FDIC's charges that it operated with an inadequate level of capital protection. The Bank observes that while the record is clear that its equity to assets ratio was 7.5 percent on January 14, 1983, there was no testimony that this was an unsafe or unsound level. The ratio is far above the 5 percent ratio which is the FDIC's minimum capital requirement. Even the Bank's auditor testified that he would not be concerned unless the Bank's capital ratio fell below 7 percent. Moreover, the Bank's capital ratio as of the end of 1983 was 8.5 percent. This increase in ratio resulted from an injection of capital by the present Bank's president and his attorney brother—which was four times that suggested by the FDIC. The Bank's president testified that its liquidity was "floating" because the majority of the borrowers and depositors were farmers or dependent on agriculture.
   As indicated above, the condition of the Bank as of January 14, 1983, was primarily the result of the stagnant agricultural economy of * * *. In fact, the principal FDIC examiner noted in one of his reports that a significant factor in the problems in the loan portfolio was depreciation of farm land. As a result of this depreciation, "a number of loans in the portfolio that were previously well secured now have equity deficiencies and are classified." Counsel to the Bank and an attorney in * * * testified that the economy in * * * has been on a downswing for the past two years.
   * * * , an expert testifying on behalf of the Bank, agreed that the condition of the Bank was a result of the depressed economy and not impropriety of management. The Bank's independent auditor further substantiated the fact that the economy and not management caused the existing conditions of the Bank. Also, he stated that the economy of the * * * was like that of the * * * area in * * * , which is an economically depressed agricultural area. The * * * bank commissioner, as well as the auditor, emphasized that the Bank had recognized the problems that resulted from the economy and had been dealing with them appropriately for some time.
   The Bank renews its motion (as made during the oral hearing) that the transmittal of the FDIC's proposed cease and desist order by the Executive Secretary to the Law Judge violated FDIC regulations and due process. While the Judge stated that he had not relied on the proposed order, the Bank insisted that prejudice to the Board must be presumed from this effort to influence the hearing officer. Webster Groves Trust Company v. Saxon, 370 F.2d 381 (8th Cir. 1966). The Bank stresses that the FDIC's regulations state, in pertinent part, that the Judge shall conduct the hearing in a fair and impartial manner, 12 C.F.R. Section 308.07(b), and the regulations prohibit ex parte communications with the hearing officer.
   The Bank continues that the error was compounded when, later in the proceeding and during the Bank's case in chief, the FDIC was allowed to reopen its case to present a witness, * * * of * * * , an employee of FDIC. The witness was present throughout most of the FDIC's case in chief but was never called to testify. He testified regarding how he had arrived at the affirmative action provisions which he included in the FDIC's order. The Bank emphasizes that the witness should not have been permitted to testify. Both motions (if they are renewed) are again denied. As to the latter motion regarding witness * * * the record does not reflect that his testimony has been prejudicial as to the Bank. Moreover, * * * was not even from the * * * Regional Office. In fact, he acknowledged that he had never been to the Bank of * * * or to north-east * * * and that he had never met anyone from the Bank. The recommendation of the FDIC by its examiner were against the Section 8(b) proceeding, while witness * * * was for the issuance thereof.
   The Bank takes the position that there are substantial policy reasons that require the Judge to receive current information regarding a bank which is the subject of a Section 8(b) hearing. It notes that a limitation to considering conditions that existed a year prior to the hearing could never lead to a fair and equitable decision. In fact the head of the Division of Bank Supervision of the FDIC testified that a cease and desist order, if recommended or issued, must be reasonable for both parties, a determination that cannot be made in a vacuum "looking only at a stale report of examination." The Judge is reminded that a cease and desist {{4-1-90 p.A-362}} order must be supported by substantial evidence and not be arbitrary and capricious when viewed in the context in which it was issued. First Nat. Bank of Bellaire v. Comp. of Currency, 697 F.2d 674 (5th Cir. 1983). The Bank stresses that for policy reasons as well as because the FDIC recognized that current events were to be part of the administrative hearing, the Judge properly overruled the FDIC's motion to limit the scope of the hearing. After a reading of the transcript and the briefs—the Judge affirms his previous rulings.
   The Bank emphasizes that this Section 8(b) proceeding was instituted without consultation with the Examiner in Charge. In fact, the Review Examiner who commenced the proceeding was not even from the * * * Regional Office. Finally, the Bank points out most of its classified loans have been outstanding since well before the present officer became president in early 1982. The new Bank management appears to be dealing with the loan problems and is committed to a gradual reduction of the Bank's loan to deposit ratio. The * * * Commissioner of Financial Institutions testified that he is satisfied with management's attitude and approach.
   The Judge agrees that no better evidence of management's commitment to solve its problems and restore its profitability could be found than that * * * and * * * invested $1.2 million into the capital of the Bank in December 1983 to provide the level of capital which management felt desirable.
   In its reply brief, among other things, FDIC reminds us that there is no merit in the Bank's objection to sending a copy of the proposed order to the Judge. "This is particularly true in this case where the Judge rules on the record that he was not influenced by the document." As noted previously the Judge affirmed his prior rulings.
   In its latest brief FDIC takes specific exception to the Bank's requested finding of fact numbered 11 indicating deterioration in the Bank's loan portfolio was caused by the current economic conditions in the surrounding agricultural community. FDIC notes that the area's economic problems commenced in 1982 and continued through 1983 and that it (FDIC) was commenting on problems in the Bank's loan portfolio as of August 10, 1980, "well before the local economic problems are described as have commenced."
   Also, FDIC refers to the fact that the Bank argued that the FDIC did not follow its own procedures when it elected not to use Examiner * * * recommended method of correction for the Bank's problems. Witness * * * explains that he could make all the recommendations in the world but the ultimate responsibility for that is not his. "It's either the Regional Director or the Director of our Board of Directors in Washington."
   The Bank, in its reply brief, is critical of FDIC's proposed finding that loans have been made without adequate security, the FDIC lists 19 loans which were mentioned in the 1983 report of examination. Of this group, the Bank points out that the * * * loan is the only loan about which the FDIC offered testimony at the hearing.
   Also the FDIC cites 25 loans that were allegedly secured by collateral subject to substantial prior liens of such magnitude that they "inhibit" the Bank's ability to realize on its collateral. However, at the hearing, the FDIC testified only as to three of these loans, * * * , * * * and * * * . The FDIC testified only that these loans were subject to senior liens. As discussed previously herein—junior liens are prevalent in agricultural communities and "sufficient equity exists before" the Bank makes such loans. This record is clear that the Bank had not encountered problems dealing with loans secured by collateral subject to senior liens.
   The Bank emphasizes that there is no foundation for FDIC asserting that it (Bank) has operated with inadequate capital. As observed previously herein the Bank's ratio of equity capital and reserves to total assets was 7.5 percent at January 14, 1983, and 8.5 percent at December 31, 1983. It stresses that the record demonstrates that the present condition of its loan portfolio results not from banking practices but from the state of the local economy. The Bank insists that it does not engage in "unsafe or unsound practices."
Discussion and Conclusions —Based upon this record, including briefs of FDIC and the Bank, the Judge finds and concludes that this action should be dismissed. The evidence will not support a finding that the Bank now engages in unsafe or unsound banking practices.
   The principal examiner for FDIC did not recommend a "cease and desist" order. {{4-1-90 p.A-363}} Rather it was recommended by an examiner who had never visited the Bank of * * * and who overruled the examiner. In fact, the memorandum of understanding, dated May 5, 1982, noted that the Bank is in substantial compliance with most of the provisions of the memorandum. As spelled out early in this decision—the memorandum concluded that it does not appear that any material improvement in asset quality is likely until economic and agricultural improvements take place.
   Here, however, the record indicates a great deal of improvement. The Judge does not agree with FDIC that unsafe and unsound practice shall apply only to such conditions that existed as of January 14, 1983. To close one's eyes to any improvement since that date would only ignore the Bank's constant improvement. While both the Bank and FDIC refer to the Eden proceeding regarding "unsafe and unsound" banking conditions—the court therein referred to accepted standards of banking operations. Herein we had testimony by both the auditor and the * * * banking official indicating that a cease and desist order was not necessary. In fact, the banking auditor insists that such an order would inform any investor looking at the report and would be very detrimental to the Bank.
   As suggested in Franklin Nat. Bank Sec. Litigation, supra, substantial evidence would be needed to support a cease and desist order. FDIC has the burden of proof and the Judge finds and concludes it has not sustained this burden. For example, as of December 31, 1983, the Bank's total equity capital and reserves to total assets equalled 8.5 percent. The auditor notes that the Bank has sufficient capital with the addition of $1.2 million in December 1983. The record is clear there are larger banks running with a lot lower capital ratio, 4 to 5 percent.
   Although there have been numerous loan problems, they primarily are of a local nature. Such problems revolve around a depressed local economy and the Bank's area is in the midst of the worst agricultural depression since early 1930. As observed previously, a Federal Reserve System official stated that borrowers and lenders may find that the most prudent policy is to stretch out payments and exercise forbearance rather than to take more precipitous action. Also, the FDIC director of bank supervision perceives his job as a regulator is to preserve the private banking system, and that means keeping the industry supported by private capital.
   The Bank is proud of the fact that it has not been nor is involved in any fraudulent or illegal activities. Also, among its improvements is the creation of a Compliance Department and evaluating collateral for new loans, plus the remark of an FDIC examiner that a Memorandum of Understanding will achieve the necessary corrections. Moreover, it is proposing a new loan policy which incorporates all of the suggestions mentioned in the Report of Visitation filed by an FDIC examiner. Its computer department provides needed information to management and in 1984 the Bank will have its own in-house asset-liability management programs. As discussed previously, the Bank would have been in full compliance with the Memorandum of Understanding had the FDIC included certificates of deposit of $100,000 or more in the core deposit ratio referred to in the memorandum. No good reason is apparent why such certificates should not be included.
   Contentions of the parties as to fact or law not specifically discussed have been given due consideration and are found to be either not materially significant or not justified.
   Issuance of a cease and desist order is not supported by substantial evidence and, of course, is not in the best interests of the Bank, its depositors, stockholders, or even the FDIC.
   Upon this record the Judge finds and concludes that this action by the FDIC should be dismissed and it is so ordered.
   At Washington, D.C. by Earl S. Dowell, Administrative Law Judge
/s/ Hoyle L. Robinson
Executive Secretary

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