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[¶5049] FDIC Docket No. FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e (8-19-85).
FDIC ordered an insured state nonmember bank to cease and desist from unsafe or unsound banking practices and from violations of law. FDIC also required the bank to take affirmative action to correct the practices and violations. FDIC also removed several bank directors and officers from office and prohibited their further participation in the affairs of the bank. Specifically, over 42% of the bank's loans were adversely classified, 25.3% of total loans were overdue, 33% of the bank's loan files lacked complete or current documentation, the bank had an inadequate loan loss reserve, the bank's assets subject to adverse classification were 521.9% of its total equity capital and reserves, and the bank's ratio of total equity and capital and reserves to its adjusted total assets was only 4.37%. FDIC also stated that in order for a bank to show that a bank examiner is biased, the bank must prove the relevance of the bias, the existence of the bias, and the results of the bias. Finally, FDIC noted the special expertise of bank examiners and the FDIC itself, and stated that examiners' classifications of loans are entitled to deference, as is the FDIC's selection of remedies for violations of law and for unsafe or unsound banking practices. (This decision was affirmed by the U.S. Court of Appeals for the Eleventh Circuit, 783 F.2d 1580 (1986)).
[.1] CAMEL Rating—Defined
"CAMEL" is an acronym for capital, assets, management, equity, and liquidity. These five key categories are used by bank regulatory agencies to assess the performance of a bank. A uniform rating system, using a number scale of "1" through "5", in ascending order of supervisory concern ("1" being the highest rating, "5" the lowest), has been adopted and is used by all federal financial institutions regulatory agencies.
[.2] FDIC—Supervisory Functions
The FDIC role is to oversee the system of deposit insurance, the primary function of which is stabilizing or promoting the stability of banks.
[.3] Cease and Desist Orders—FDIC Authority to Issue
The primary vehicle available to the FDIC to implement its supervisory powers is the authority to issue and enforce cease and desist orders to stop current and to prevent future unsafe or unsound practices and violations of laws, rules, and regulations pursuant to section 8 of the Federal Deposit Insurance Act.
[.4] Unsafe or Unsound Practices—Statutory Standard
The term "unsafe and unsound banking practices" encompasses conduct which is contrary to the normal and accepted standards of banking operations that may result in abnormal risk of loss or actual loss to a bank or its shareholders.
[.5] Cease and Desist Orders—FDIC Authority to Issue
If a bank has engaged or is engaging in unsafe or unsound practices, or is violating or has violated a statute, rule, or regulation, the FDIC has broad discretion to exercise its expertise in fashioning appropriate relief to halt the practices or violations, to prevent future abuses and to correct the effects of the practices or violations.
[.6] Unsafe or Unsound Practices—Defined Generally
There are certain practices which are inherently unsafe or unsound, including the accumulation of an excessively high volume of adversely classified loans and other assets; making secured loans based on inadequate collateral; making loans without establishing or enforcing repayment programs; renewing loans without collection in cash of interest due (the "capitalization" of interest); maintaining an
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inadequate reserve for loan losses in view of the volume of adversely classified loans; maintaining an inadequate level of equity capital and surplus; making loans without regard for the borrower's ability to repay; and maintaining inadequate liquidity. Certain other practices also constitute unsafe or unsound banking practices, including failure to maintain adequate or current information on borrowers; making unauthorized insider loans; and failure to charge off loans classified loss.
[.7] Examiners—Weight Given to Opinion
The unique expertise of bank examiners leads the FDIC to conclude that the examiners' classifications of loans are entitled to deference, and may not be overturned unless they are shown to be arbitrary and capricious or outside a "zone of reasonableness."
[.8] Examiners—Powers
Bank examiners have the power to make a thorough examination of all of the affairs of the bank and its affiliates, and to make full and detailed reports of the condition of the bank to the FDIC.
[.9] Examiners—Loan Classifications—Review by ALJ
Bank examiners' conclusions are reviewable. An ALJ may not substitute his own subjective judgment for that of the bank examiner, but may set aside the classification if it is without objective factual basis or is shown to be arbitrary and capricious.
[.10] Accounting—Bank Examiner's Function—CPA's Function
Accounting procedures are almost totally unrelated to the functions performed by a commissioned bank examiner conducting a safety or soundness examination. The CPA's function is primarily limited to auditing the bank's controls, while internal controls play a different role in the bank examiner's assessment of the bank's safety and soundness.
[.11] Accountants—Expertise
Accountants do not have any training or experience assessing a bank's overall safety or soundness and do not assign classifications to individual loans. Bank accountants do not assess the significance of a bank's financial figures for the bank's safety and soundness.
[.12] Loans—Classification of Adverse—Generally
Loan classification requires the application of expert judgment to objective facts.
[.13] Examiners—Loan Classification—Review by ALJ
Unless loan classifications by bank examiners are shown to be arbitrary and capricious, or without factual basis, such classifications should be upheld by an ALJ.
[.14] Earned Interest, Uncollected—Classification
The interest earned and not collected on loans should not be classified more severely than the underlying loan.
[.15] Lending and Collection Policies and Procedures—Unsafe or Unsound Practices—Excessive Risk of Loss
The willingness and ability of a debtor to perform as agreed remains the primary measure of the risk of a loan. The borrower must have earnings or liquid assets sufficient to meet interest payments and provide for reduction or liquidation of principal as agreed at a reasonable and foreseeable date.
[.16] Lending and Collection Policies and Procedures—Unsafe or Unsound Practices—Inadequate Collateral
There are dangers in purely collateral-based lending. Collateral may decline in value, may not be readily marketable, and accumulating unpaid interest may diminish the collateral margin.
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[.17] Lending and Collection Policy and Procedures—Unsafe or Unsound Practices—Inadequate Collateral
In determining whether collateral is adequate, the following factors must be considered: risk; acquisition costs; and disposition costs of acquiring and marketing the collateral to be applied to the debt.
[.18] Directors—Duties and Responsibilities—Supervision of Lending Practices
Failure of a bank's management to give proper attention to credit files makes sound credit judgment difficult, if not impossible.
[.19] FDIC—Rulemaking Authority
All persons must conduct their banking affairs in accordance with the standards promulgated by the agency statutorily entrusted with protecting the safety and soundness of insured, state-chartered nonmember banks.
[.20] Examiners—Bias
If a bank can show the relevance of an alleged bias and show that the bias existed and that the bias caused a bank examiner to classify or more severely classify a loan, then an ALJ would be justified in setting aside specific classifications that were shown to have resulted from that bias.
[.21] Examiners—Bias
An ALJ's application of a presumption that the bank examiners were biased, without making specific findings, supported by evidence, that a specific examiner was biased and that specific classifications were the result of that bias, was erroneous.
[.22] Examiners—Bias
The mere occurrence of certain events, including the institution of criminal proceedings against bank directors and the issuance of a temporary cease and desist order against a bank for violations of law, is not sufficient to show bias of a bank examiner. To show evidence bias, it must be shown that such events occurred; that the examiner classifying a loan participated in (or at least was aware of) those events; that there exists some factual basis for concluding that the examiner actually acquired an adverse bias as a result of those events; and that there was the opportunity for the bias to have resulted in the examiner either classifying a loan which should not have been classified or classifying a loan more severely.
[.23] CAMEL Rating—"5" Defined
A bank with a "5" composite rating is considered unsatisfactory. The bank's performance is critically deficient and in need of immediate remedial attention. Such performance, by itself or in combination with other weaknesses, threatens the viability of the bank.
[.24] FDIC—Rulemaking Authority
The FDIC Manual of Examination Policies constitutes a general statement of policy and/or interpretive rule rather than a substantive rule that has the force of law. Therefore, the FDIC need not follow the notice and comment procedures of the Administrative Procedure Act in preparing the Manual.
[.25] Cease and Desist Orders—When Appropriate
The FDIC may order a bank to cease and desist from an unsafe or unsound practice if it is established that the bank has engaged in such a practice on even a single occasion.
[.26] Lending and Collection Policy and Procedures—Unsafe or Unsound Practices—Hazardous Lending
Hazardous lending and lax collection practices constitute unsafe or unsound banking practices.
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[.27] Lending and Collection Policy and Procedures—Unsafe or Unsound Practices—Borrowers Unable to Repay
Extending credit without regard to the ability of the borrower to make repayment is an unsafe or unsound banking practice.
[.28] Assets—Unsafe or Unsound Practices
Failing to charge off non-bankable assets is an unsafe or unsound banking practice.
[.29] Loan Loss Reserve—Unsafe or Unsound Practices
Failure to maintain an adequate reserve for loan losses constitutes an unsafe or unsound banking practice. A loan loss reserve should be large enough to cover all loans classified "Loss" and one half of those loans classified "Doubtful."
[.30] Lending and Collection Policy and Procedures—Unsafe or Unsound Practices—Failure to Charge-off Losses
Although Substandard loans need not be charged off against current income, failure to include some provision for future losses generated by such loans is an unsafe or unsound banking practice.
[.31] Definitions—Substandard Loan
Substandard loans are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
[.32] Capital—Adequacy—Time for Determination
It is error to consider post-examination events in determining the bank's level of capital. Consideration of post-examination evidence can only result in a distorted picture of the bank's true condition.
[.33] Capital—Adequacy—Capitalization Should Reflect Risk
Perhaps the single most important factor in assessing the adequacy of a bank's capital is the quality, type, liquidity, and diversification of assets, with particular reference to assets adversely classified.
[.34] Capital—Debt Capital—Debt to Equity Ratio
A higher level of capital is required for those banks that have volatile deposit accounts, concentrations in the deposit structure, and rapid deposit growth unaccompanied by sufficient earnings retention.
[.35] Liquidity—Unsafe or Unsound Practices
Failure to maintain adequate liquidity is an unsafe or unsound banking practice.
[.36] Cease and Desist Orders—FDIC Authority to Issue—State Remedies
The authority of a federal banking agency to issue a cease and desist order supersedes the authority of state banking regulatory agencies if a conflict as to the appropriate remedy and its enforcement develops between the two. A federal order prevails over a conflicting order of a state agency.
[.37] FDIC—Supervisory Functions
The FDIC functions as a federal banking supervisory agency that examines and regulates banks that are insured state nonmember banks. The FDIC also functions, unlike a state chartering authority which may also examine and regulate banks, as an insurer of deposits in banks with a fiduciary duty and statutory responsibility to protect the federal deposit insurance fund from risk of loss.
[.38] FDIC—State Banking Authorities—FDIC Not Bound
The FDIC is not required to follow a state's remedy and may formulate its own remedy.
[.39] Cease and Desist Orders—Defenses—Cessation of Violation
It is well established that the abandonment or cessation of an unlawful practice or compliance with a proposed order does not deprive an agency of the right to secure enforcement or issue a cease and desist order.
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[.40] Cease and Desist Orders—Affirmative Remedies—Unsafe or Unsound Practices
The FDIC may issue a cease and desist order for violations of law and unsafe or unsound practices that are ongoing at the time of the issuance of the order and those which have already occurred or may occur in the future. There need not be violations of law or unsafe or unsound practices occurring at the moment of issuance of a cease and desist order.
[.41] Cease and Desist Orders—Affirmative Remedies—Unsafe or Unsound Practices
The objectives of a cease and desist order are twofold: to correct existing conditions and to prevent the recurrence of unsafe or unsound practices and violations of law in the future.
[.42] Cease and Desist Orders—FDIC Authority to Issue
Both Statutory and Case Law authorize the FDIC to order a bank to take affirmative action to correct violations of law and unsafe or unsound banking practices.
[.43] Cease and Desist Orders—FDIC Authority to Issue
The FDIC should be accorded special deference in its selection of remedies for violations of law and for unsafe or unsound practices, since the fashioning of remedies requires expertise and policy judgments regarding how to maintain a safe and sound banking system.
[.44] Deposits—Brokered—Problems Associated
The problems associated with brokered deposits include the following: they are very rate sensitive and extremely volatile; they tend to undermine market discipline; they often represent consistent and heavy borrowings to support unsound or rapid expansion of loan investment portfolios, and tend to extend artificially the life of poorly managed banks; and they are general short-term, highly volatile liabilities which are often used to fund long-term assets. This poses a risk of severe liquidity problems in the event that assets are not available to meet a sudden withdrawal by a deposit broker.
[.45] Deposits—Brokered—Problems Associated
An increased volume of brokered deposits representing over 25% of total deposits of a bank raises the specter of "abnormal risk of loss" to the bank should the level of brokered deposits continue or increase.
[.46] Capital—Adequacy—Dividend Distribution
Since the distribution of excessive dividends will have a direct effect on the bank's capital adequacy, the FDIC may prohibit the distribution of dividends to shareholders without prior approval.
[.47] Prohibition, Removal, or Suspension—Liability—Breach of Fiduciary Duty
The FDIC may remove directors whose actions are seriously damaging an insured institution. The FDIC may also prohibit directors from further participation in the affairs of the bank.
[.48] Directors—Duties and Responsibilities—Standard of Care
Directors who are responsible for violations of law and for unsafe or unsound banking practices have breached their fiduciary duties as directors of the bank.
[.49] Directors—Duties and Responsibilities—Standard of Care—Fiduciary Duties
Directors of a bank have a fiduciary duty to the bank. They must act as prudent and diligent persons would act to safeguard the bank's property, comply with state and federal banking statutes and regulations, and ensure that the bank is operated properly.
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[.50] Directors—Duties and Responsibilities—Supervision of Lending Practices
Directors of a bank are legally responsible to see that the business and assets of the bank are managed in a prudent manner.
In the Matter of * * * (INSURED
STATE NONMEMBER BANK), AND
* * * , * * * and * * * (Individually and
as Officers, Directors and/or as Persons
Participating in the Conduct of the Affairs
of * * * Bank, * * *.
FDIC-83-252b&c
FDIC-84-49b
FDIC-84-50e
(Consolidated Action)
DECISION OF BOARD OF
DIRECTORS
August 19, 1985
INTRODUCTION
These proceedings arise under sections 8(b)(1), (c)(1), and (e)(1) of the Federal Deposit Insurance Act (the "Act"), 12 U.S.C. § 1818(b)(1), (c)(1), and (e)(1).
On August 3, 1983, the Federal Deposit Insurance Corporation (the "FDIC" and "Proponent") issued a Notice of Charges and of Hearing (the "First Notice") against the * * *, * * * (the "Bank"), pursuant to section 8(b)(1) of the Act and to Part 308 of the FDIC Rules of Practice and Procedures (12 C.F.R. Part 308). The First Notice, based upon the results of the February 4, 1983 examination of the Bank by the FDIC, charged the Bank with engaging and having engaged in unsafe or unsound banking practices (in particular, hazardous lending and lax collection practices), and with committing and having committed violations of law.
On November 22, 1983, the FDIC issued a second Notice of Charges and of Hearing (the "Second Notice") pursuant to section 8(b)(1), and a Temporary Order to Cease and Desist (the "Temporary Order") pursuant to section 8(c)(1). The Second Notice was based upon the preliminary findings of a second FDIC examination of the Bank, begun on September 30, 1983, but still under way as of November 22, 1983, and charged the Bank with having engaged in further unsafe and unsound banking practices, and with having committed further violations of law.
On March 12, 1984, the FDIC issued a third Notice of Charges and of Hearing (the "Third Notice") against the Bank, pursuant to section 8(b)(1) of the Act. The charges in the Third Notice were similar to those in the First Notice, except that the FDIC alleged that the conditions complained of in the First Notice had worsened, e.g., the volume of adversely-classified loans had substantially increased. Also on March 12, 1984, the FDIC issued a Notice of Intention to Remove from Office and to Prohibit from Further Participation (the "Removal Notice") against * * * , director and chairman of the board of the Bank; * * * , director and president of the Bank; and * * * , director and executive vice president of the Bank (hereinafter referred to collectively as "the * * *" or "the Respondents"). The Removal Notice charged the Respondents, in their capacities as officers and directors of the Bank, with engaging in unsafe or unsound banking practices, violations of laws and regulations, or breaches of their fiduciary duties evidencing a willful or continuing disregard for the safety and soundness of the Bank. The Removal Notice also alleged that the Bank had or probably would sustain substantial financial loss or other damage as a result of the Respondents' conduct. The Removal Notice was based upon findings of both the September 30, 1983 FDIC examination and the February 4, 1983 FDIC examination.
On March 26, 1984, the FDIC issued an Amended Notice of Charges and of Hearing (the "Amended Third Notice") against the Bank, as well as an Amended Notice of Intention to Remove from Office and to Prohibit from Further Participation (the "Amended Removal Notice") against the Respondents. The amended notices were intended to correct technical matters.
A pre-hearing conference was held on March 27, 1984. Following the pre-hearing conference, on April 10, 1984, Administrative Law Judge Alan W. Heifetz (the "ALJ") issued an Order directing consolidation of the actions initiated by the First, Second, Third, and Amended Third Notices and the Removal and Amended Re-
{{4-1-90 p.A-486}}moval Notices. Hearing of the consolidated actions was to be limited to the allegations of the Second Notice, the Amended Third Notice, and the Amended Removal Notice.1 The FDIC withdrew the First Notice on April 23, 1984.
A formal hearing was held on the consolidated charges from June 11 to July 11, 1984, in * * *. The ALJ issued his Initial Decision (hereinafter, the "Recommended Decision") on November 20, 1984. The FDIC, the Bank, and the individual Respondents all submitted exceptions to the Recommended Decision. Pursuant to Orders of February 4 and February 25, 1985 of the FDIC's Board of Directors (the "Board"), each side also submitted a brief in response to the other side's exceptions to the Recommended Decision. The record closed and the matter was certified to the Board of Directors of the Federal Deposit Insurance Corporation on March 19, 1985. On May 23, 1985, the Board set aside the notice of certification, pursuant to Section 308.18(a) of the FDIC's Rules and Regulations (12 C.F.R. § 308.18(a)), reopened the record and remanded the matter to the ALJ for a further hearing to take testimony and evidence on the issue of violations by Respondents of the Temporary Order. The supplemental hearing was held on June 19, 1985, the ALJ submitted his supplemental recommended decision ("SRD") on July 15, 1985, and the parties filed exceptions to the SRD on July 25, 1985. The record closed and the matter was again certified to the Board of Directors on July 30, 1985.
STATEMENT OF THE CASE2
The Bank is a state chartered commercial bank, which is not a member of the Federal Reserve System. Its one office is located in * * *. The Bank's deposits are insured up to $100,000 by the FDIC, which has the federal regulatory responsibility for the Bank (12 U.S.C. § 1811 et seq.). Bank was first organized in 1972 and acquired by the * * * family in May 1978. Since acquiring control of Bank, * * * and * * * have each served as officers and directors of the Bank through the time of the hearing. (RD at 5, 7-8; PFF 1.1, 2.1, 2.5; RPFF 0.0 - 0.1, 0.4, 1.1, 2.1 - 2.5)
In November 1982, the State of * * * conducted an examination of the Bank. That examination resulted in the Bank being assigned by the FDIC a CAMEL3 rating of 3. (Tr. 2203) However, that examination was very abbreviated in that it was conducted only over a two-week time period. The examiners were limited by instructions from their superiors to review only large lines of credit, past-due loans, and loans to officers and directors of the Bank. (Tr. 2204, 4880-81) Furthermore, the state's examiner-in-charge of the November 1982 examination testified that he "didn't feel real confident" about the results of that examination. (Tr. 4882-83)
1 On December 13, 1984, the Board issued a Notice and Order of Suspension and Prohibition ("Notice"), pursuant to section 8(g)(1) of the Act, 12 U.S.C. § 1818(g)(1), to * * * and to * * *. The basis for those two Notices were the indictments on December 11, 1984, of * * * in the Southern District of * * * for violations of 18 U.S.C. § 2 (aiding and abetting), 18 U.S.C. § 1341 (use of mail for fraud), and 18 U.S.C. §§ 1962(c) and (d) (racketeering). Respondents requested a hearing which was held on March 11 and 12, 1985. On April 16, 1985, the presiding administrative law judge filed his Recommended Decision with the Board. On April 30, 1985, the Board adopted the recommendation of the administrative law judge and ordered that the Order of Suspension and Prohibition be continued in effect. Therefore, at the present time * * * have been suspended from their positions with the Bank pending the outcome of the criminal proceedings. * * * who was not indicted, continues as an officer and director of the Bank.
2 For convenience, the Board has utilized certain forms for citation to the record in this proceeding:
| RD at — |
ALJ's recommended decision at a specific page, |
| PPF — |
Proponent's Proposed Findings of Fact, |
| RPFF — |
Respondents' Response to the Proposed Findings |
|
of Fact and New Proposed Findings of Fact |
| P. Exceptions — |
Proponent's exceptions to the ALJ's recommended |
|
decision, |
| R. Exceptions — |
Respondents' exceptions to the ALJ's recommend- |
|
ed decision, |
| Tr. [followed by specific page — |
The Hearing Transcript at a page, |
| reference] |
|
| P.Ex. — |
Proponent's Exhibit, |
| R.Ex. — |
Respondents' Exhibit. |
[.1]3 "CAMEL" is an acronym for capital, assets, management, equity and liquidity. These five key categories are used by bank regulatory agencies to assess the performance of a bank. A uniform rating system, using a number scale of "1" through "5", in ascending order of supervisory concern ("1" being the highest rating, "5" the lowest), has been adopted and is used by all federal financial institutions regulatory agencies. (P.Ex. 1—Manual of Examination Policies, Federal Deposit Insurance Corporation)
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Following the February 19, 1982 FDIC examination, the Bank entered into a Memorandum of Understanding ("MOU") with the FDIC. The MOU was an informal agreement under which the Bank undertook to correct deficiencies uncovered by the FDIC examination, including increasing the Bank's capital, improving its credit administration and poor loan collection practices, increasing its liquidity and eliminating violations of law and regulations.4 (Tr. 377-78; R.Ex. 2 at 1 and 1-a) From December 13, 1982 to December 21, 1982, FDIC examiner * * * accompanied by two senior examiners, made a visitation to the Bank to review the overall compliance with the MOU agreed to by the Bank with FDIC following the FDIC's February 9, 1982 examination of the Bank and to perform a general review of its overall liquidity and capital position. (RD at 8; Tr. 377) The FDIC examiners found that the Bank had made attempts to comply with the MOU but in at least some instances compliance was untimely. The examiners had concerns, however, about the Bank's credit administration, principally inadequate overdue loan reports and deficiencies in the monitoring of overdrafts in American Express accounts and over limits in so-called * * * (overdraft) Checking Accounts. (Tr. 377-78) On the final day of the visitation, the examiners met with the * * * to discuss their findings. During the course of that meeting, the examiners identified the following four large lines of credit that could be a source of problems:
(1) * * * and related interests;
(2) * * *;
(3) * * * and related interests; and
(4) The * * * group and related interests.
In that regard, the examiners warned the * * * that they should make certain that each of the four identified lines was in compliance with the state lending limit statute and further warned that the heavy concentration of loans in any one group represented a substantial risk to the Bank's financial health and its capital. (Tr. 379-83)
On February 3, 1983, the FDIC began a full-scale examination of the Bank in accordance with its policy to review 3, 4 and 5 - rated banks on at least an annual basis. The examination was conducted with a full-time staff of six under the supervision of * * * as the examiner-in-charge (hereinafter "EIC"), although at times as many as seven examiners and four assistant examiners were involved. (Tr. 383-84)
Mr. * * * met with * * * on March 30, 1983, and orally reviewed, with minor exceptions, the loan classifications up to that point. (Tr. 485) While the record is not clear, it appears that the meeting continued on April 1, at which time the discussions centered on violations of law related to assets other than loans. (Tr. 492-93)
On April 27, 1983, officials of the FDIC5 met at the Bank with all members of its board of directors, including the * * *. Also in attendance was a representative of the State of * * *, * * *. The purpose of the meeting was to review with the Bank's board the results of the FDIC examination and to discuss the major problems and criticisms. (RD at 10; Tr. 501-02, 506-09, 791, and 936-37) During the course of the 4½ to 5 hour meeting, the FDIC presented a letter dated April 22, 1983, to the Bank's board ("management letter") that set forth the findings of the examination in substantial detail, including extracts from the February Report of Examination and a list of preliminary loan classifications. (P.Exs. 10, 11, and 68; Tr. 509-11, 790-91, 2310) Examiner * * * reviewed the April 22 management
4 Among the findings as to the Bank's financial condition as of the February 19, 1982 examination were (R.Ex. 2):
| Classified Assets— | |
| Substandard | $639,500 |
| Doubtful | $165,300 |
| Loss | $173,200 |
| Total | $978,000 |
Classified Assets/Total Capital and Reserve—30.9%
Overdue Loans/Total Loans—12%
Adjusted Capital and Reserves/Adjusted Total Assets—5.6%
Large Liability Dependence—57%
5 Those officials included the EIC * * * , Examiner * * * , Review * * * , acting field office supervisor * * * , Assistant Regional Director for Compliance * * * , and Regional Counsel * * *
{{4-1-90 p.A-488}}letter in detail discussing the findings and conclusions of the examination and responding to questions from the Bank's board of directors. (Tr. 511, 791, 799, 2209) The Bank's board was also advised of a tentative corrective and rehabilitative program that was likely to be incorporated in a proposed cease and desist order. (P.Exs. 11 and 68; Tr. 657-58, 793-96, 2216-18) The Bank's board took issue with the FDIC's loan classifications (Tr. 512, 792) and asked whether they could provide a response to the points raised by the FDIC after they had an opportunity to review the Management Letter. The FDIC officials informed the Bank's board that they could provide information but made no commitment to alter any loan classifications or conclusions as to violations of law. (Tr. 799-800) The Bank submitted its response to the FDIC's Management Letter by a letter dated May 27, 1983. (P.Ex. 12)
A second meeting was held at the Bank's request at the FDIC offices in * * * on June 2, 1983.6 The principal spokesperson for the Bank was * * * , then a member of the board of directors. Mr. * * * presentation addressed the Bank's willingness to agree to all but one part of the FDIC's rehabilitative program, as outlined in the Management Letter and at the April 27 meeting. The Bank, however, argued strenuously against the need to bring in an outside chief executive officer and a senior lending officer. The Bank also argued for the use of an informal program utilizing a memorandum of understanding rather than a formal cease and desist order. Both the FDIC and the State representatives informed the Bank's board that in view of the volume of classified assets and the number of violations of law, a formal, legally enforceable cease and desist order was necessary. The FDIC also took the position that the outside management expertise of a CEO and a qualified lending officer was also necessary. (P.Exs. 13 and 68; Tr. 822-25, 2234-41, 2312-15, 3041-44, 3380-84, and 3394-95)
By letter dated June 8, 1983, * * * , FDIC Regional Director, transmitted to the Bank's board a copy of the final February 4, 1983 Report of Examination. (P.Ex. 14) The letter requested that the Bank respond to the Report of Examination within 30 days of receipt, to the extent not already covered in the May 27 letter (P.Ex. 12) from the Bank. (Id.) The FDIC's letter (P.Ex. 14) and the Report of Examination (P.Ex. 9) were received by the Bank on June 11, 1983. The Bank responded that its letter of May 27 (P.Ex. 12) also constituted its response to the Report of Examination.
The February 4, 1983 Report of Examination found, in part, that the Bank's assets subject to adverse classification were an astounding 521.9% of its total equity capital and reserves. Adversely classified loans constituted the bulk of the classified assets with $485,000 classified "Loss," $472,000 "Doubtful" and $21.5 million7 "Substandard." Over 42% of Bank's total loans were adversely classified and 25.3% of total loans were overdue. Furthermore, 33% of the Bank's loan files lacked complete or current documentation. The Bank's reserve for loan losses was only $577,000 before loans classified loss were charged off ($92,000 assuming charge off). This was found to be inadequate in view of the high volume of classified loans. The Report also outlined 52 separate violations of law and regulations. Finally, Bank's ratio of total equity capital and reserves to its adjusted total assets was only 4.37%.
On August 3, 1983, the FDIC Board of Directors issued the first Notice of Charges and of Hearing to the Bank, a proposed Order to Cease and Desist ("Order") and a Proposed Consent Agreement. (P.Ex. 15; Tr. 854 and 864)
On September 9, 1983, a meeting was held at the offices of the Bank's counsel in * * * which was attended by representatives of the FDIC * * * Regional Office, the State Division of Banking, most of the Bank's board (except Mr. * * *), and the * * * , to discuss the FDIC's First Notice. (Tr. 847-48, 854-55, 2241-42, 2250-51) At this meeting and throughout the period beginning with the April 27, 1983 meeting with the Bank's board of directors, the State Division of Banking was supporting and joining in the FDIC's enforcement activities with regard to the Bank. (Tr. 855, 2201-02, 2242, 2217-18, 2250-52) During the
6 The meeting was attended by the Bank's board of directors (except * * * ), its attorneys * * * and * * *, and an outside consultant, * * * * * * and attorney * * * represented the * * * Division of Banking and Assistant Regional Director * * * , Regional Counsel * * * , Regional Attorney * * * and Review Examiner * * * represented the FDIC at the meeting.
7 The exact figure shown in the Report was $21,545,000. (P.Ex. 9 at 1)
{{4-1-90 p.A-489}}
September 9 meeting, the two principal points of disagreement between the FDIC and the Bank were the provision requiring the employment of an outside chief executive officer and senior lending officer and the need for a formal cease and desist order as opposed to an informal memorandum of understanding. (Tr. 879-80) The Bank's counsel expressed the view that the FDIC's management provision was tantamount to removing the * * * from the Bank. (Tr. 880-81)
While the record is somewhat ambiguous, there were apparently several telephone conversations between the * * * and the Bank's counsel and FDIC officials between the time the Bank received the First Notice in early August through September 1983. (Tr. 832, 853-54) One such conversation occurred on September 12, 1983, during which Assistant Regional Director * * * informed the Bank's counsel, * * * , that an informal corrective program was not acceptable to the FDIC. (Tr. 880-82) Another such telephone conversation occurred on September 20, 1983, between Mr. * * * , the * * * , Assistant Regional Director * * * and Regional Counsel * * *. In that conversation, Mr. * * * proposed that * * * be permitted to retain his title as chief executive officer but that his duties and authority be limited to public relations and the international department and that he not have any responsibility for or authority with respect to overall bank operations or lending decisions. Mr. * * * discussed the proposal with Regional Director * * * and both agreed that it was not acceptable. Mr. * * * communicated that decision to Mr. * * *. (Tr. 886-91)
On September 30, 1983, the FDIC and the State Division of Bank Supervision began concurrent examinations of the Bank. The State's examination was full-scope while the FDIC conducted a special, limited-scope examination focusing primarily on the problem loans identified during the February 1983 examination. Representations had been made by the Bank to the FDIC following the issuance of the First Notice that improvements had been made over the summer months. The FDIC wanted to confirm those representations and to assess the extent of the improvements alleged to have taken place. (RD at 13; Tr. 832-33, 893-95, 937–938, and 2521-22)
The FDIC's examination team was headed by * * * , the examiner-in-charge. Mr. * * * was the principal examiner for the * * * Regional Office and its most experienced examiner who headed the examination teams dealing with the region's most troublesome and complex problem banks with 4 and 5 composite CAMEL ratings. Mr. * * * was assisted by a hand-picked group of the most senior and experienced examiners in the region—* * *. (Tr. 833-35)
During the first several weeks of the special examination, there was frequent telephone contact, usually on a daily basis, between Mr. * * * and Assistant Regional Director * * * and others in the * * * Regional Office to report on the progress of the examination. There were also several progress meetings in * * *. (Tr. 108-86, 2519, 2521, 2525-27; P.Exs. 87 and 88) As a result of those discussions and the early findings of the FDIC examination team, it was decided in late October to expand the limited purpose examination to a full-scope examination. (Tr. 2527.) On the basis of the findings of the full-scope September examination, on November 22, 1983, the FDIC Board of Directors issued a Second Notice of Charges and a Temporary Order, which were mailed to the Bank on November 23, 1983. (P.Ex. 95 at 2-3; Tr. 2532-35)
On November 28, 1983, a meeting was held at the offices of the Bank's counsel in * * *. 8 The meeting had been requested by the FDIC for the purpose of discussing the Second Notice and Temporary Order with the Bank's board of directors. At the meeting, the Bank was served with the State's Emergency Temporary Order to Cease and Desist. (P.Ex. 71) The meeting involved a point-by-point discussion of the FDIC's Second Notice and Temporary Order. The Bank's representatives were also put on notice that the FDIC Temporary Order was effective immediately, and that, if the order were violated, the FDIC would institute removal proceedings against the offending
8 In attendance at the meeting for the FDIC were Assistant Regional Director * * * , Examiner-in-Charge * * * and Regional Counsel * * *; representing the State Division of Banking were * * * , Examiner-in-Charge * * * , and attorneys * * * , * * *; for the Bank, the * * * and counsel * * * (Director * * * joined the meeting later). (P.Ex. 95 and 96; Tr. 1201-02, 2535; RD at 17)
{{4-1-90 p.A-490}}parties, possibly levy civil money penalties or terminate the Bank's insurance. (P.Ex. 96)
By a letter dated December 2, 1983, the Bank was notified by the state that it had violated three provisions of the State's Emergency Cease and Desist Order of November 28, 1983. (P.Ex. 98; Tr. 2431-34) On January 25, 1984, the State and the Bank entered into a Memorandum of Understanding. The State MOU placed restrictions on the Bank's loan activities and required the Bank to take certain action to improve its financial condition and management, including:
1. approval from Bank's board of directors was required for all loans greater than $250,000;
2. overdrafts were to be limited to $5,000 per account or $20,000 per borrower;
3. no additional extensions of credit were permitted to borrowers with loans classified loss or doubtful without State approval;
4. no further credit extensions to any borrower with a classified loan unless all interest due was paid in cash, additional collateral was obtained or an independent guarantee of the loan was obtained;
5. Bank was to adopt a new comprehensive loan policy including additional control mechanisms;
6. total deposits were to be reduced to $100 million or less within 90 days, no increase was permitted without prior State approval or attainment by the Bank of a 6.5 percent capital to deposits ratio;
7. submit a monthly report to the State of Bank's loan to deposit ratio and the daily report of condition for the last day of the month;
8. maintain a loan to deposit ratio of 70 percent;
9. reduce brokered deposits to 10 percent of total deposits within 45 days and maintain them at that level and file a report with the State every 30 days setting forth all brokered deposits in excess of 5 percent of total deposits;
10. inject $2 million in new capital within 30 days and additional $1 million within 270 days;
11. * * * was required to resign as president, and from all operating committees of the Bank, and to relinquish all lending authority within 5 days;
12. Bank was required to employ a qualified new president and chief operating officer but no other senior officers without prior State approval;
13. Bank was required to file with the State within 30 days, a plan for the reduction of statutory violations cited in the State's September 30, 1983 examination and to make no further loans in violation of federal or state law; and
14. after 6 months, Bank was required to place all loans classified doubtful on which no principal or interest payments had been received in non-accrual status and to initiate legal enforcement proceedings on such loans.
(RD at 24-26; R.Ex. 9) On December 16, 1983, the FDIC concluded its examination of the Bank. (RD at 22, Tr. 2542-43) A copy of the Report of Examination was forwarded to the Bank on February 10, 1984, along with a letter from Regional Director * * *. In this letter, Mr. * * * advised the Bank that he would be recommending to Washington that the Bank be retained on the formal problem bank list and that formal enforcement actions be instituted under Sections 8(a), (b) and (c) of the FDI Act. The letter also requested a response from the Bank within 30 days. (P.Ex. 106)
The September 30, 1983 Report of Examination showed that the Bank's condition was even worse than at the February 4, 1983 examination. Among other findings, the September 30 examination revealed that the Bank's assets subject to adverse classification had increased from 521.9% classified to 581% of its total equity capital and reserves. Adversely classified loans again constituted the bulk of the classified assets with $3,710,000 classified "Loss," $1,285,000 "Doubtful" and $25,822,000 "Substandard." About 17% of the Bank's total loans were adversely classified and 17% of the loans were overdue (not including loans on nonaccrual status). As in the February report, large numbers of loans still contained incomplete or out-of-date documentation. The Bank's reserve for loan losses had fallen to $400,000 (from $577,000 in the February report) and its assets classified loss were 1,180% of its loan loss reserves. The report cited violations of law in ten loan lines equaling a total of 25 separate violations of law. The Bank's ratio
{{4-1-90 p.A-491}}of total equity capital and reserves to total adjusted assets was 5.5%. However, after subtraction of the assets classified loss and 50% of those classified doubtful, the capital dropped to 0.17% of adjusted total assets.
STATUTORY AUTHORITY
[.2—.3] The statutory scheme established by the Congress in the Federal Deposit Insurance Act, as amended, provides a comprehensive system of federal regulation of banks. The FDIC role is to oversee the system of deposit insurance, "the primary function of which is `stabilizing or promoting the stability of banks.'" First State Bank of Hudson County v. United States, 599 F.2d 558, 562 (3d Cir. 1979), affirming 471 F.Supp. 33 (D.N.J. 1978).9 As such, the FDIC is responsible for the protection of the insurance fund against undue risk of loss. One of the principal supervisory tools to achieve that end is the bank examination, which seeks to identify practices that could result in losses to banks and ultimately, perhaps, claims against the insurance fund. First State Bank of Hudson County, 471 F. Supp. at 35. The primary vehicle available to the FDIC, as well as the Comptroller of the Currency and the Federal Reserve System, to implement its supervisory powers is the authority to issue and enforce cease and desist orders to stop current and to prevent future unsafe or unsound practices and violations of laws, rules and regulations pursuant to Section 8 of the Act, 12 U.S.C. § 1818. First National Bank of Scotia v. United States, 530 F. Supp. 162, 166 (D.D.C. 1982).
[.4] Section 8(b)(1) of the Act, 12 U.S.C. § 1818(b)(1), provides, in pertinent part:
If, in the opinion of the appropriate Federal banking agency, any insured bank...is engaging or has engaged...in an unsafe or unsound practice in conducting the business of such bank, or is violating or has violated...a law, rule, or regulation...the agency may issue...
. a notice of charges in respect thereof.
* * *
.... if upon the record made at any such hearing, the agency shall find that any violation or unsafe or unsound practice specified in the notice of charges has been established, the agency may issue...
. an order to cease and desist from any such violation or practice. Such order may...require the bank...to cease and desist from the same, and, further, to take affirmative action to correct the conditions resulting from any such violation or practice.
As provided in section 3(q)(3) of the Act, 12 U.S.C. § 1813(q)(3), the FDIC is the "appropriate Federal banking agency" in the case of an insured state nonmember bank for purposes of enforcing Section 8. The phrase "unsafe or unsound banking practices" is not specifically defined in the statute. This was intended "to commit the progressive definition and eradication of such practices to the expertise of the appropriate regulatory agencies." Groos National Bank v. Comptroller of the Currency, 573 F.2d 889, 897 (5th Cir. 1978). Thus, the determination of what practices are unsafe or unsound has been left to the discretion of the federal bank regulatory agencies on the basis of their expertise in banking. Independent Bankers Association of American v. Heimann, 613 F.2d 1164, 1168-69 (D.C. Cir. 1979). In general, the term "unsafe and unsound banking practices" encompasses conduct that is contrary to the normal and accepted standards of banking operations that may result in abnormal risk of loss or actual loss to a bank or its shareholders. First National Bank of Lamarque v. Smith, 610 F.2d 1258, 1265 (5th Cir. 1980); First National Bank of Eden v. Department of the Treasury, 568 F.2d 610, 611 n.2 (8th Cir. 1978).
[.5—.6] Once the appropriate federal banking agency has found that a bank has engaged or is engaging in unsafe or unsound practices, or violating or has violated a statute, rule or regulation, the agency has broad discretion to exercise its expertise in fashioning appropriate relief to halt the practices or violations, to prevent future such abuses and to correct the effects of the practices or violations. First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 680 (5th Cir. 1983); del Junco v. Conover, 682 F.2d 1338, 1340 (9th Cir. 1982), cert. denied, 459 U.S. 1146 (1983); Groos, 573 F.2d at 897. The Board and the other federal banking agencies have determined that there are certain practices which
9 See also, Doherty v. United States, 94 F.2d 495, 497 (8th Cir.), cert. denied, 303 U.S. 658 (1938); Federal Deposit Insurance Corporation v. Godshall, 558 F.2d 220, 221 (4th Cir. 1977).
{{4-1-90 p.A-492}}are inherently unsafe or unsound banking practices and the courts have sustained such determinations. Included in such practices have been the accumulation of an excessively high volume of adversely classified loans and other assets,10 making secured loans based on inadequate collateral,11 making loans without establishing and/or enforcing repayment programs,12 renewing loans without collection in cash of interest due (the so-called "capitalization" of interest),13 maintaining an inadequate reserve for loan losses in view of the volume of adversely classified loans,14 maintaining an inadequate level of equity capital and surplus,15 making loans without regard for the borrower's ability to make repayment,16 and maintaining inadequate liquidity.17 In addition, the Board has held, in other administrative proceedings not subjected to appellate court review, that certain other practices also constitute unsafe or unsound banking practices, e.g., failure to maintain adequate or current information on borrowers, making unauthorized insider loans, and failure to charge off loans classified loss. In this case Respondents are charged with many of these same practices.
LOAN CLASSIFICATIONS
A threshold issue which assumed singular importance in the ALJ's decision was the accuracy of the loan classifications18 contained in the FDIC's September 30, 1983 Report of Examination of the Bank. Bank examiners for the FDIC classify loans with some defined risk of nonrepayment as "substandard", "doubtful" or "loss", with loans classified "loss" representing the greatest risk.19 The ALJ disagreed with a number of the FDIC examiners' loan classifications, and essentially conducted his own "examination" of the Bank, assigning to each loan the classification which he deemed appropriate. For reasons which follow, the Board finds that (1) the ALJ erred in re-examining the Bank and assigning his own loan classifications; and (2) based upon the objective record, the classifications that the ALJ assigned to a number of the loans are erroneous.
The ALJ devoted a great deal of attention to the factors involved in the classification process, and made an attempt at arriving at his own conclusions regarding the appropriate classifications in this case. The results of the ALJ's efforts, however, graphically demonstrate the dangers of "second-guessing" the expert judgments of those entrusted with loan classification responsibilities on a full-time basis —commissioned bank examiners. In the September 30, 1983 examination conducted by the state of * * * , the state's commissioned examiners classified a total of $30,438,000 of the Banks assets. The FDIC's classifications in its September 30, 1983 examination report totaled $32,246,000. The state of * * * examination report of May 18, 1984 concluded that the Bank's classified assets had grown to $33,375,00. The ALJ's independent analysis of the bank's assets as of the September 30, 1983 examination led him to conclude that the state of * * * examiners and the FDIC examiners should only have classified assets in the amount of $18,614,300. (See Table IV, RD at 78) The ALJ's "de novo" review of the loan classifications at issue required him to find that three teams of experienced bank examiners from two separate bank regulatory agencies each made a mistake of almost 12 million dollars in arriving at their loan classifications.20 The gross disparity between the to-
10 First National Bank of Eden v. Department of the Treasury, 568 F.2d at 611 n. 1 (unsafe assets in the amount of 37% of the bank's gross capital funds); Groos National Bank v. Comptroller of the Currency, 573 F.2d at 892, 896 (high percentage of "high-risk" loans).
11 Bank of Dixie V. FDIC, No. 84-4737, slip op. at 3 (5th Cir., March 12, 1985), motion to publish pending.
12 Id.
13 Id.
14 Id. at 4
15 Id. at 5.
16 Gulf Federal Savings and Loan Assoc. of Jefferson Parish v. Federal Home Loan Bank Board, 651 F.2d 259, 264 (5th Cir. 1981).
17 Id.; Bank of Dixie, slip op. at 5–6.
18 The term "loan classifications," as used in this opinion, refers to classifications of both loans and other assets (such as "other real estate"), except where otherwise noted.
19 P.Ex. 1, § A, p.12. Loans which contain some questionable features, but which do not present sufficient risk to warrant classification are designated as "special mention" loans. Id.
20 Both the ALJ and Respondents found great significance in the fact that examiners from the state and the FDIC differed with respect to the severity of some classifications. Initially we note that the examiner-in-charge of the state's September examination had essentially reached the same classification conclusions as the FDIC. (Tr. 1227, 4894-97) Only later, after being pressured to change the classifications by state officials who had not even participated in the
(Continued)
{{4-1-90 p.A-493}}tal asset classifications of the ALJ, and those of the FDIC and the state of * * * , vividly demonstrates the danger of an ALJ conducting a de novo review of each loan classification.
A. The ALJ was Required to Give Deference to Matters Peculiarly Within the Examiners' Expertise
The ALJ found that the loan analysis and classifications of the FDIC bank examiners who participated in the September examination were "entitled to the weight ordinarily given to the testimony of any other `expert' witness." (RD at 35) The ALJ further ruled that "[t]heir conclusions, however, have not been presumed to constitute a prima facie case for upholding any classification." (RD at 36) Finally, the ALJ held that "the burden of proof is on the agency to show by a preponderance of evidence that the examiners' conclusions should be upheld as being reasonable, logical and persuasive." (RD at 35)
[.7] The Board finds that the ALJ erred in refusing to give proper weight to the examiners' loan classifications, and in substituting his own judgment for that of the examiners. A brief review of the nature of loan classifications, and the unique expertise of the bank examiners involved in the September examination, leads the Board to conclude that the examiners' classifications are entitled to deference, and may not be overturned unless they are shown to be arbitrary and capricious or outside a "zone of reasonableness."
Although there are no court opinions addressing the weight to be given examiners' loan classifications, the Board's inquiry on this point is guided by several decisions addressing agency functions which require similar exercises of expert judgment and informed discretion. The courts have uniformly recognized that certain types of agency judgments are not susceptible to strict "proof" because they involve the exercise of discretion, technical expertise and informed prediction about the likely course of future events. One court's explanation of the deference accorded such judgments is equally applicable to the judgments made by FDIC commissioned bank examiners in assigning loan classifications:
[T]he Commission's projection of carrier economic conditions three years into the future is a kind of agency function that the Supreme Court has recognized to be primarily a question of probabilities, and thus peculiarly subject to the expert experience, discretion, and judgment of the Commission. In making a predictive judgment, the expertise of the Commission supplements, and may supplant, the projections placed in the record by the parties. ... To hold otherwise would paralyze agencies merely because the future is not subject to proof. While an agency cannot make a projection that is without any reasonable basis, the role of substantial evidence is greatly diminished.
Missouri-Kansas-Texas Railroad Co. v. United States, 632 F.2d 392, 406 (5th Cir. 1980) (emphasis added) (citations omitted). The United States Supreme Court has also consistently recognized the deference which should be afforded to judgments and predictions made by an agency within its area of special expertise. See, e.g., Baltimore Gas & Electric Co. v. Natural Resources Defense Council, Inc., 103 S. Ct. 2246, 2256 (1983); Federal Communications Commission v. National Citizens Committee for Broadcasting, 436 U.S. 775, 813-814 (1978).21
[.8] Congress has instructed this Board to "appoint examiners", and has provided that "[e]ach examiner shall have power to
20 Continued: examination, did he agree to change the totals to the figures which ultimately appeared in the state examination report. (Tr. 4894-4905) Indeed, it appears that state officials ultimately decided to exclude from the state examination report several pages of supervisory comments which were prepared by the state examiner-in-charge of the September 1983 examination. * * * , the Assistant Director of the State Division of Banking, testified that he had never seen an examination report which did not contain the supervisory comments of the examiner-in-charge. (Tr. 2288-91) Mr. * * * conceded that, if such comments had been prepared, it would have been improper to exclude them. (Tr. 2400-01) The examiner-in-charge testified that he had, in fact, prepared 4 or 5 pages of such comments. (Tr. 4905)
Furthermore, regardless of any differences in severity of classification, each regulator found that over $30 million of bank assets contained sufficient weaknesses and risk of nonrepayment to warrant classification. The Board finds much greater significance in the fact that the ALJ recommended "passing" almost $12 million in assets that both regulators considered sufficiently risky to merit classification.
21 Other decisions recognizing that deference should be given to informed predictions and judgments of administrative agencies include: Telocator Network of America v. F.C.C., 691 F.2d 525, 538 (D.C. Cir. 1982); N.A.A.C.P. v. F.C.C., 682 F.2d 993, 1001 (D.C. Cir. 1982); American Meat Institute v. Bergland, 459 F. Supp. 1308, 1316 (D.D.C. 1978).
{{4-1-90 p.A-494}}make a thorough examination of all of the affairs of the bank and its affiliates, and shall make a full and detailed report of the condition of the bank to the Corporation." 12 U.S.C. § 1820(b). After extensive training, lengthy apprenticeship and careful evaluation, FDIC examiners are appointed as "commissioned examiners", and thereby vested with authority to make informed predictions about the risk inherent in a bank's assets. This exercise of informed judgment on the part of commissioned examiners is entitled to deference, and should not be disregarded in the absence of compelling evidence that it is without rational basis.
The Board does not, of course, mean to suggest that the examiners' conclusions are unreviewable. Despite their extensive training and experience, commissioned examiners are by no means infallible, and it is both necessary and appropriate that their classifications be subject to some degree of scrutiny. However, the appropriate degree of scrutiny will vary depending upon whether the ALJ is reviewing strict factual findings or discretionary decisions requiring the exercise of informed judgment.
Asset classifications are based upon objectively verifiable facts. For example, an examiner might find that a loan has been delinquent for six months; that collateral for the loan is a certain parcel of land; and that the borrower's annual salary is $30,000. Because each of these conclusions consists of objectively verifiable facts requiring no particular training or expertise, the ALJ as fact finder is entitled to reach his own de novo conclusions as to the correctness of these underlying factual findings.
[.9] After ascertaining the relevant facts, the examiner then applies his expertise and training to those facts to reach certain conclusions about the likelihood of a particular loan being repaid. It is with respect to this second step, where certain expert inferences and judgments are made, that the ALJ is required to defer to the examiner's expertise in reviewing the examiners' classification conclusions. The ALJ may not substitute his own subjective judgment for that of the examiner, but may set aside the classification if it is without objective factual basis or is shown to be arbitrary and capricious. The Board finds that in many cases the ALJ failed to meet either of these tests.22
B. The ALJ's Rejection of the Examiners' Classifications Was Not Supported By Sufficient Evidence in the Record
It should be noted that, with respect to loan classifications, none of the FDIC examiners taking part in the September examination were simply equivalent to "any other `expert' witness testifying in this matter", as the ALJ suggested. (RD at 35) The FDIC examination team spent 3,074 hours in a detailed examination of the Bank's assets. (Tr. 628) * * * , the FDIC examiner-in-charge of the September examination, had participated in approximately 500 bank examinations, and had served as examiner-in-charge of over 150 of those examinations. (Tr. 979-80) The other five examiners from the September examination who testified at the hearing in this matter had collectively participated in over 1650 bank examinations, and had served as examiner-in-charge on over 515 of those bank examinations.23
Of the loan lines which these examiners classified during the September examination, the Bank contested 106 adverse classifications. Of these 106 disputed classifications, the ALJ rejected the fdic examiners' conclusions with respect to 75 loan lines. Even this extraordinary number of reclassifications would not necessarily be cause for alarm if the ALJ had rejected the examiners' conclusions based upon persuasive testimony by disinterested experts with background, training and experience in bank
22 The ALJ's decision to reject 75% of the disputed classifications assigned by the examiners was expressly based upon his conclusion that a "de novo" standard of review of those classifications was appropriate. (RD at 36, 41) As will be seen in Section E, infra, the majority of the ALJ's classifications would have been incorrect even if he were entitled, as a matter of law, to substitute his own judgment for that of the commissioned examiners. Since most of the classifications should be upheld even under a de novo standard of review, then a fortiori, they should have been sustained under a more deferential "arbitrary and capricious" standard of review.
23 * * * , 150-200 bank examinations, over 50 as examiner-in-charge (EIC) (Tr. 1661-62); * * * 675 exams, over 200 as EIC (Tr. 1626-27); * * * , 300 exams, over 60 as EIC (Tr. 1686-87); * * *, 300 exams, 30 as EIC (Tr. 373-74); * * * , 225-250 exams, 75 as EIC. (Tr. 1602) The bank examiner witnesses who took part in the September examination had each undergone a rigorous training and apprenticeship program under the guidance of seasoned bank examiners. (Tr. 370-73) Each had also attended a number of formal training courses addressing various aspects of the bank examination process. (Tr. 374-76) Finally, after approximately five years of full-time on-the-job experience examining banks, and following successful completion of a three-and-a-half day test, each examiner achieved commissioned bank examiner status. (Tr. 370-73)
{{4-1-90 p.A-495}}examination and loan classification equivalent to that of the FDIC examiners. This, unfortunately, does not appear to be the basis for the ALJ's decision to reject more than seventy percent (70%) of the disputed FDIC examiners' classifications.
The footnotes to Table I, which explain the ALJ's reasons for reaching the classification conclusions that he did, reveal that a great many of the examiners' classifications were rejected based on nothing more than the Respondents' own explanations of their reasons for disagreeing with the classifications,24 which to some extent must be considered self-serving.
The ALJ overturned another fifteen of the FDIC examiners' classifications without citation to any evidence, persuasive or otherwise.25 Other evidence cited to support reversal of the FDIC examiners' classifications included Bank counsel's recitation, out of context, of part of an unrelated statement allegedly made on the NBC "Today" show by FDIC Chairman William Isaac.26 Aside from testimony of the * * * , however, the ALJ's decision to reject the FDIC examiners' conclusions seems to be based primarily upon the testimony of * * * , a certified public accountant retained by the Respondents to testify in this case. The ALJ expressly relied upon Mr. * * * opinions, contained in almost 200 pages27 of testimony, in rejecting twenty-seven of the classifications assigned by the FDIC bank examiners.28 Because the ALJ relied so heavily upon Mr. * * * testimony in overturning the classification conclusions of the FDIC bank examination team, the Board must give careful consideration to Mr. * * * qualifications, training and experience with respect to loan classifications. Mr. * * * testified that, thirteen years ago, he worked for a bank for two years. (Tr. 4540-4542) He "went through an abbreviated training program with them," advanced in the credit department, and eventually was given authority to make unsecured loans up to $25,000 and secured loans up to $50,000. (Tr. 4540-4542)29 Mr. * * * brief experience as a junior officer with modest lending authority does not, however, provide any sort of significant background in the skills
24 See, e.g., footnote (1) to ALJ's Table I, RD at 47, which cites as evidence for overturning one classification * * * testimony that "With * * * I would disagree" with the classification assigned by the FDIC "based on the record of performance and on the collateral existing." (Tr. 3035) It will be noted that the ALJ repeatedly refers to the Respondents' Response to the FDIC Proposed Findings of Fact ("RPFF"). According to a stipulation of the parties, certain Proposed Findings of Fact of the FDIC ("PFF") and the Respondents' responses thereto ("RPFF") were "sponsored" by a particular witness. The parties agreed that a "sponsored" finding would be regarded as admitted into evidence to the same extent as if the "sponsoring" witness had actually testified to those matters. (Tr. 1003-1005; 2931-2936) A review of the footnotes to the ALJ's classification conclusions reveals that the ALJ relied in whole or in part on testimony or findings "sponsored" by the * * * to overturn 43 of the FDIC examiners' classifications. (Findings "sponsored" by * * * are cited as support in footnotes (22), (23), (25), (26), (28), (29), (30), (31), (32), (33), (35), (37), (38), (44), (45), (48), (49), (51), (55), (61), (62), (63), (64), (65), (66), (69), (70), (71), (72), (73), (74), (75), (76), (77), (78) Findings "sponsored" by * * * are used to support reversal of FDIC examiner classifications in footnotes (40), (41), (56), (60), (68). See Tr. 2933-38 for a listing of findings sponsored by * * * and * * *. The following footnotes explaining the ALJ's rejection of FDIC classifications rely at least in part on testimony of the * * * - (31), (44), (63), (73), (78); * * * - (1), (40), (41), (70).) The Board does not suggest, of course, that the * * *' opinions of the accuracy of the FDIC examiners' loan classifications are irrelevant. The Respondents are certainly entitled to express their opinions about the manner in which they believe loans should be classified. The Board merely suggests that the opinions of the Respondents in this case, absent any other evidence that the FDIC examiners' conclusions were arbitrary or capricious, should not be permitted to automatically override the conclusions of a highly experienced examination team.
25 See footnotes to ALJ's Table I: (2), (3), (4), (5), (7), (10), (27), (34), (36), (42), (43), (46), (47), (57), and (58). (RD at 47-51) Because the ALJ has not cited to any testimony, proposed findings or responses thereto, or exhibits in support of his decision to reject the classifications of these fifteen lines of credit, we have found it extremely difficult to assess the accuracy or basis for these conclusions. Nevertheless, every attempt has been made to carefully consider each of the ALJ's classification conclusions, including those unsupported by citation to the record.
26 The ALJ permitted Mr. * * * , one of seven attorneys for Respondents, to state for the record a comment which he said he had heard FDIC Chairman Isaac make on the "Today" show. The relevance of Mr. Isaac's alleged general statement on bank ratings (as opposed to loan classifications), taken out of context, is not readily apparent. Nevertheless, the ALJ cited this alleged statement as "evidence" to support his rejection of the examiners' classifications on three separate loans. (See ALJ's footnotes (72), (76), and (77), RD at 51)
27 See Tr. 4537–4731.
28 The ALJ cited Mr. * * * testimony as a basis for rejecting the FDIC examiners' conclusions in the following footnotes to the ALJ's classification conclusions: (12)-(25), (30), (31), (33), (44), (50), (63), (64), (70), (72), (73), and (76).
29 Mr. * * * also testified that he worked in the bookkeeping and computer departments of another bank while he was attending college. (Tr. 4539-4540)
{{4-1-90 p.A-496}}and knowledge required of a commissioned bank examiner.
Mr. * * * has practiced as a certified public accountant for the last thirteen years. (Tr. 4542-4545) He testified that, during the course of his accounting career, he has been involved to some degree in performing audits or other related accounting services for approximately 75 banks. (Tr. 4552-53) Mr. * * * further testified that, in connection with performing his bank audits, he has had occasion to review 50–75 reports of examination, although he has not, himself, ever actually prepared a safety and soundness report of examination which contained loan classifications. (Tr. 4547, 4662-63) This background demonstrates Mr. * * * considerable experience in accounting and bank auditing, and he was, in fact qualified as an expert in those areas. (Tr. 4553-54) He was not, however, qualified as an expert at classifying loans or at performing any other tasks associated with preparing a safety and soundness report of examination.30
[.10] Mr. * * * apparently does not believe that there are any major differences between performing an accounting audit and conducting a safety and soundness examination. (Tr. 4657) Perhaps if he were better acquainted with the functions performed by a commissioned bank examiner he would have a greater understanding of the very fundamental differences.31 Accounting procedures are almost totally unrelated to the functions performed by a commissioned bank examiner conducting a safety or soundness examination.
The commissioned bank examiner evaluates the bank's capital adequacy, asset quality, management, liquidity position, and earnings capacity. (R.Ex. 1, Basic Examination Concepts and Guidelines, p. 1) "An appraisal of lending and collection policies, the bank's adherence thereto, and the evaluation of individual loans are among the most important aspects of the examination process." (R.Ex. 1, § A, p. 1)32 Although both a certified public accountant conducting an audit of the bank and a commissioned bank examiner conducting a safety and soundness examination may be concerned about the bank's internal controls, as detailed in section N of the Manual of Examination Policies ("Manual"), (see supra, note 32), the certified public accountant's function is primarily limited to auditing the bank's controls, while internal controls play a different role in the bank examiner's assessment of the bank's safety and soundness.
[.11] Accountants do not have any training or experience assessing a bank's overall safety or soundness and do not assign classifications to individuals loans. Bank accountants may ensure that the figures relating to the bank's financial position are accurately stated in the bank's books and records, but they do not assess the significance of those figures for the bank's safety and soundness.
Accordingly, the Board gives little weight to Mr. * * * testimony, to the extent that it consists of his personal opinion about those functions ordinarily performed by a commissioned bank examiner conducting a safety and soundness examination. To the extent that Mr. * * * testimony is limited to
30 It does not appear that Mr. * * * has ever received any of the specialized training routinely given to FDIC bank examiners. (Tr. 374-75, 981, 4664) He has not participated in the several years of rigorous apprenticeship and three-and-a-half day test which are required of all examiners before they become qualified commissioned bank examiners.
31 To be sure, the bank examiner is aware of accounting principles and procedures. The examiner is kept informed of pertinent accounting rulings through the regular distribution of an accounting newsletter. The FDIC position on these rulings and other accounting issues is communicated through directives, policy statements and memoranda. The Internal Routine and Controls chapter of the FDIC Manual of Examination Policies (P.Ex. 1, Section N, pp. 1-14) outlines both broad accounting concepts and specific procedures which should be followed by a bank to ensure that acceptable accounting and audit controls are in place. Examiners are advised about appropriate internal accounting controls for a bank, and the Manual further suggests that the examiner review the adequacy of the bank's audit procedures, both internal and external.
32 Of course, the examiner relies on the accuracy and completeness of the bank's records in making his loan appraisals. (R.Ex. 1, § A, p. 10) To that extent, the quality of the bank's internal and external accounting and audit procedures, designed to ensure the accuracy of those records, is relevant to the bank examination process. Furthermore, during the performance of standard "safety and soundness" examination procedures, the examiner may incidentally become aware of deficiencies in the bank's accounting and audit controls: "These procedures are not necessarily designed for the exclusive purpose of evaluating the internal control environment. In many cases the principal objective of a particular examination procedure is to ascertain any adverse safety or soundness implications of the activity. [Nevertheless], .... [a]s the examiner undertakes these standard examination steps, an assessment of the bank's controls relating to those areas is usually possible." (R.Ex. 1, § N, p. 9, emphasis added)
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internal controls or other accounting procedures, his testimony is entitled to the same weight given to an expert accounting witness.
It appears, then, that the ALJ overturned more than 70% of the disputed classifications made by the FDIC examination team as a result of the testimony of the Respondents, statements by a certified public accountant who has never classified a loan or conducted a safety or soundness examination, and the ALJ's own "re-examination" of the Bank.33
The Board therefore concludes that the ALJ erred in not giving proper deference to the classifications of the examiners. In the Board's opinion, this was plain error and cannot be sustained.
[.12] C. Loan Classification Requires the Application of Expert Judgment to Objective Facts
The ALJ points to the "subjective" nature of the loan classification process to support his disregard for the judgments of the commissioned bank examiners. The ALJ stated: "It is because of the highly subjective nature of the FDIC examination process, as opposed to the more rigorous, formalized and objective approach, detailed by the Comptroller of the Currency for example (Tr. 4573), that such close scrutiny is required." (RD at 36) The ALJ's conclusion that the Comptroller of the Currency's ("OCC") classifications are "objective" while the FDIC's are "subjective" is based solely upon CPA * * * statement that he believes that to be the case. (Tr. 4573) For reasons previously detailed, Mr. * * * has no experience which would qualify him to make authoritative pronouncements on the subject of safety and soundness examinations. The basis for his "expertise" in comparing the safety and soundness examinations of the OCC and the FDIC is similarly unclear. Mr. * * * states that he has "reviewed" the FDIC's Manual (Tr. 4572), although his apparent inability to locate an entire chapter on internal routines and controls in that Manual suggests that his review must have been rather cursory.34 He has presumably read the few sentences of the OCC manual quoted during his testimony. It is virtually impossible, however, to ascertain which other portions of the OCC Manual he may have reviewed, as his comparisons of the two manuals generally consisted of broad generalizations unsupported by citation to any specific section of either manual. Furthermore, the ALJ would not have had an opportunity to evaluate the reliability of Mr. * * * representations, since no part of the OCC Manual was offered or admitted into evidence.
Contrary to Mr. * * * suggestion that the OCC and the FDIC apply different standards, the record shows that both the OCC and the FDIC (as well as the Federal Reserve Board and the Conference of State Bank Supervisors) have adopted a uniform statement on classification of bank assets, which contains identical classification definitions. (See R.Ex. 1, § A, p. 12) Although the wording of the OCC and FDIC manuals (and perhaps even their methodology) may differ in some respects,35 the Board finds no merit in the conclusion that the FDIC
33 The record does not reflect whether the ALJ, an administrative law judge for the U.S. Department of Housing and Urban Development, has any background in bank regulation. Although absence of any expertise in banking regulation would certainly not preclude the ALJ from reaching his own conclusions about the appropriateness of FDIC standards of credit analysis, in the absence of such expertise it would not be unreasonable to expect that any drastic departure from such well-settled standards would be supported by substantial, impartial evidence that such standards are without rational basis.
34 Mr. * * * opinion that the OCC's examination procedures are more "objective" than those of the FDIC is apparently based upon the inclusion in the OCC manual of a section addressing internal and external audits. Mr. * * * testified: "[T]he Comptroller of the Currency's comments regarding the evaluation of controls and the use in this case of an audit program...allows an examiner to organize his thoughts and to be total and complete to a greater extent than as presented under the guidelines of what the FDIC Manual of Examination policy says." (Tr. 4570) Yet section N of the FDIC Manual of Examination Policies entitled "Internal Routine and Controls," serves the same function: "The overall assessment of a bank's system of internal control is...an important examination function. In most cases, such an appraisal can be accomplished by an overall evaluation of the internal control system, a specific review of audit systems and reports, performance of standard examination procedures, and recommendations to management." (Manual, § N, p. 8) This detailed 14-page chapter contains extremely specific instructions for evaluating internal controls, reviewing audit systems and reports and, where necessary, conducting verification procedures. This chapter directly rebuts the basis for Mr. * * * conclusion that OCC procedures are more "objective" than those of the FDIC.
35 Sometimes certain language appears in the OCC manual and not the FDIC manual, but it expresses a concept that is actually followed by both the FDIC and the OCC. (See, e.g., Tr. 650-651)
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classification process is somehow more "subjective" than that of the OCC.36
It is true that there is a "subjective" element in the loan classification process, regardless of whether that process is carried out by examiners of the state, the FDIC, or any other regulatory body.37 Although the examiner's attention is drawn to a particular loan based on objectively verifiable weaknesses in the loan, the ultimate decision about whether to classify the loan, and the severity of the classification assigned, are necessarily the product of the examiner's exercise of informed judgment. (Tr. 592)
The ALJ relied upon this necessarily "subjective" aspect of loan classifications to justify his "de novo" review of each loan classified by the FDIC examination team. (RD at 35–36) The Board finds, however, that the exercise of judgment required by the classification process militates in favor of giving greater, not less, weight to the informed judgment of the team of commissioned examiners. Because of their extensive training, lengthy apprenticeship and collective experience in 2,225 examinations, the FDIC examiners were uniquely qualified to engage in the weighing of alternatives and ultimate predictions required by the classification process. The extreme disparity between the total classifications assigned by the ALJ on the one hand, and by the FDIC and state examiners on the other, confirms the wisdom of delegating classification decisions to those who have acquired the expertise such decisions require.
D. The Majority of the ALJ's Asset Classifications Were Incorrect
[.13] As the Board has already noted, the ALJ erred in substituting his judgment for that of the commissioned examiners with respect to the loan classifications.38 Unless such classifications were shown to be arbitrary and capricious, or without factual basis, they should have been upheld. The Board finds, however, that even if the ALJ had been entitled to second-guess every loan classification, the majority of his "de novo" classifications were erroneous. Because the ALJ conducted a "de novo" review of each loan classification, the Board has found it necessary to do the same.
As previously noted, Respondents contested 106 of the loan classifications assigned by the examiners.39 Of these disputed classifications, the ALJ upheld only 31. (See RD at 43–46)40 The Board has reviewed the evidence with respect to these 31 loans, and finds itself in agreement with the ALJ's conclusion that the classifications assigned should be upheld. The findings of fact relating to these loans,41 coupled with parts of the ALJ's footnotes addressing
36 We note that the FDIC Board of Directors is uniquely qualified to make comparisons between OCC and FDIC procedures, as the Comptroller of the Currency is, by law, both the head of the OCC and one of three members of the FDIC Board of Directors. (See 12 U.S.C. § 1812)
37 The Board is unimpressed by the testimony of * * * (a finance professor retained by Respondents to testify at the hearing) that he tentatively believes "that the case for the accuracy of bank classifications cannot be made." (Tr. 4432) He cites no authority and no statistics to support this vague "hunch" about an examination process utilized by every state and federal banking authority in the United States. If Mr. * * * is suggesting that the banking regulators cease examining banks until a scientifically precise method of predicting loss has been developed, we respectfully decline that invitation.
38 The only instance in which the ALJ may have been correct in applying a more exacting scrutiny was with respect to the * * * credits classified by examiner * * * (See pp. 196–200, infra.)
39 Table I of the ALJ's decision, RD at 43-46, contains a column indicating the FDIC classifications which were admitted by the Bank. The record shows that the Bank admitted the accuracy of the FDIC classifications assigned to the * * * loan (Series #162) and the * * * loan (Series #164), although the ALJ's "Admitted" column does not reflect that fact. (See RPFF 162.1-.5 and RPFF 164.1-.4)
40 The "FDIC Proposed Findings Upheld" column, RD at 44, does not indicate that the FDIC's classification of the * * * line (Series #92) was upheld. Reference to the ALJ's classification conclusion figures for * * * (RD at 44) and footnote 46 (RD at 49) reveals that the ALJ did, in fact, uphold the FDIC classifications assigned to * * *. The same is true with respect to the * * * loan. (Series #26 - See RD at 43 and footnote 10, RD at 47); and the * * * loan (Series #104 - See RD at 45 and footnote 53, RD at 50). The ALJ also upheld the FDIC classification of the * * * loan (Series #87), although his classification chart fails to reflect that fact. (See RD at 44.) The ALJ cites footnote 43 in support of his classification conclusions for the loans represented by series ##85, 86 and 87. That footnote explains that no "Loss" classification is warranted. It is clear, however, that the FDIC did not assign a "Loss" classification to the * * * line. The FDIC classified $301,000 Substandard and the ALJ reached the same conclusion. Accordingly, the ALJ's failure to reflect that the FDIC * * * classification was upheld, and his citation to footnote 43 with respect to that loan, appear to have been inadvertent errors.
41 See the following series of findings relating to these 28 loans, all of which were sponsored by * * * (see note 24, supra, and Tr. 1005): 14, 17, 18, 26, 27, 29, 31, 56, 66, 88, 91, 105, 112, 116, 118, 120, 125, 130, 132, 138, 149, 150, 151, 154, 157, 169.
{{4-1-90 p.A-499}}those loans,42 confirm that the loans were properly classified by the FDIC.
The ALJ rejected, in whole or in part, 75 of the disputed loan classifications. The Board has carefully reviewed the evidence in the record, and has considered the ALJ's reasons for rejecting those 75 classifications. The Board's review of the evidence leads us to agree with the ALJ's decision to reject eighteen of the loan classifications assigned by the FDIC examiners,43 although we do not necessarily agree with the ALJ's reasons for reaching that decision.
[.14] The Board has also upheld the ALJ's conclusion that the interest earned and not collected ("IENC") on several classified loans should not have been classified more severely than the underlying loan. The ALJ reclassified the IENC to correspond to his reclassifications of the underlying loans, except that he did not adversely classify any IENC that was reported by the Respondents as being paid prior to December 16, 1983. The ALJ did not find sufficient evidence that interest classified "Loss" on a "Substandard" loan was less likely to be collected than the principal loan balance.
In sum, the Board agrees with the ALJ's determination that, based upon asset quality alone, there is insufficient evidence to support classifying IENC more severely than the underlying loan. However, on those loans on which the Board disagrees with the ALJ's reclassifications, the Board also disagrees with his IENC classifications. A comparative summary is shown below:
| IENC | Substandard | Loss |
| September 30, 1983 | - | 875,060 |
| Examination | | |
| ALJ | 464,315 | 33,884 |
| Board | 667,770 | 153,284 |
There are, however, circumstances in which a bank may be required to charge off IENC even when the underlying loan has not been classified "Loss." There was abundant testimony in the record explaining that it is improper to accrue uncollected interest which is overdue for ninety days or more as income unless it is both well secured and in the process of collection. (See, e.g., Tr. 4799-4806) The ALJ's discussion of this rule (RD at 41), known as the "Call Report Standard", contains a number of inaccuracies. Nevertheless, the Board agrees that there is insufficient evidence in this record to require the Bank to charge off IENC as "Loss" based solely upon failure to follow call report standards.44 The FDIC charged that IENC should be adversely classified "Loss" based on poor credit quality. Because the FDIC did not expressly charge the Bank with failure to follow Call Report Standards, and most of the evidence presented by both parties therefore focused on credit quality rather than the Bank's adherence
42 See the following footnotes to the ALJ's classification conclusions: (3), (4), (5), (10), (46), (54), (59). With respect to footnotes (3), (4) and (5), the Board agrees that repayment of the loans is dependent upon action by the Nigerian government, and that this is a factor (although by no means the only factor) supporting classification of the lines to which they refer. The Board finds the balance of footnotes (3), (4) and (5) to be incorrect, and unsupported by the evidence in this case. The Board generally agrees with the content of footnote (10) as it relates to the * * * and * * * lines, except that we decline to decide whether the Bank has improved its position since the exam, as such post-examination developments would be irrelevant. The conclusion in footnote (59) that "collateral is apparently adequate" is unsupported and incorrect. Pages 128-129 of the exam report set forth abundant evidence to support the examiner's conclusion that the * * * Corporation's "repayment ability is totally lacking" on this loan, "which is regarded as unsecured." (P.Ex. 17, p. 129) (emphasis added).
43 See Section D.5., infra - The Board Agrees with the ALJ's classifications with respect to the loans designated by the following findings numbers: 16, 30, 49, 51, 54, 62, 64, 65, 70, 75, 76, 83, 84, 100, 111, 124, 134, 152. The Board's reasons for agreeing with the ALJ's conclusions about these loans are set forth in the individual loan write-ups of each of these credits contained in Section D.5., infra.
44 If the FDIC had expressly applied Call Report Standards to each loan, Loss classification of IENC in most instances would have been substantiated. Comments supporting adversely classified loans are replete with illustrations of more than ninety day delinquency and the masking of nonperformance through adding unpaid interest to renewal notes, granting new loans to pay interest on existing notes and extending overdrafts for the payment of loan interest. Most of the loans containing adversely classified IENC are not considered both well secured and in the process of collection, as required for accrual of interest under the Call Report Standards.
{{4-1-90 p.A-500}}to such standards, the Board finds that any "Loss" classification of IENC must be sustainable on the grounds of credit quality alone.45
The Board finds that the ALJ erred, however, in reversing an additional 57 of the examiners' loan classifications. Both the ALJ's general discussion of asset classification and his explanations for rejecting specific loans demonstrate the ALJ's fundamental misconceptions about asset classification.46 Section D. 5, infra, contains summaries addressing each disputed loan classification rejected by the ALJ. Although each individual summary addresses the specific errors made by the ALJ with respect to the particular classification at issue, the Board will briefly address here a number of general misapprehensions which repeatedly appear in the ALJ's loan classification conclusions.
1. Collateral
[.15-.16] Probably the most frequent mistake made by the ALJ was his over reliance on collateral. The FDIC Manual of Examination Policies explains the factors which must be considered in assessing the credit quality of a loan:
Each loan is appraised on the basis of its own characteristics. Consideration is given to the risk involved in the project being financed; the nature and degree of collateral security; the character, capacity, financial responsibility, and record of the borrower; and the feasibility and probability of its orderly liquidation in accordance with specified terms. The willingness and ability of a debtor to perform as agreed remains the primary measure of the risk of the loan. This implies that the borrower must have earnings or liquid assets sufficient to meet interest payments and provide for reduction or liquidation of principal as agreed at a reasonable and foreseeable date. However, it does not mean that borrowers must at all times be in a position to liquidate their loans, for that would defeat the original purpose of extending credit.47
(R.Ex. 1, § A, p. 11—emphasis added) The ALJ ruled that the presence of collateral alone was a sufficient basis for rejecting a classification, without regard to any of the other factors required to be considered in assessing credit quality. (See, e.g., series numbers 22, 23 & 24 ( * * * Group), infra, pp. 66–70) If the ALJ is suggesting that prudent lending principles permit the extension of credit without regard to anything but the collateral pledged, that suggestion is clearly mistaken. There was abundant testimony explaining the dangers of purely collateral-based lending. Collateral may decline in value, and a bank may be faced with a choice between selling the property at a loss or carrying substantial nonearning assets on its books.48 (Tr. 418-19) Other types of collateral, such as restricted shares in small, closely-held corporations may not be readily marketable. Furthermore, if it appears that a borrower will be unable to repay the loan for quite some time, accumulating unpaid interest will diminish the collateral margin. (Tr. 643-44)
It is true, however, that a borrower's financial condition may have deteriorated since the inception of the loan, and it may therefore be necessary to look to the collateral pledged as a possible source of repayment. Under those circumstances, an examiner need not classify the loan if it is "so amply collateralized as to protect against all loss." (RD at 40) The ALJ erred, however, in ascertaining the adequacy of collateral in a number of instances.
45 This does not condone the Bank's practice of not adhering to Call Report Standards. The realistic accounting treatment of IENC, as called for in the Call Report instructions, is necessary to accurately report a bank's income and capital accounts. The Bank's income is significantly overstated relative to other banks that properly adhere to reporting standards.
46 The Board does not mean to suggest that these misconceptions are the result of inattention, as the ALJ seems to have devoted considerable time to his review of the asset classifications. The errors in the ALJ's classification conclusions are most likely attributable to his lack of familiarity with bank regulatory concepts which are only truly understood by commissioned bank examiners after years of rigorous training and extensive practical experience conducting actual bank examinations.
47 The ALJ has focused on the last sentence and cited it as justification for removing classifications on all loans supported by collateral, regardless of any other indicia of risk. (RD at 40) Read in context, however, it clearly means that the borrower need not have sufficient liquid assets to liquidate the entire principal and interest balance of the loan at every moment throughout the term of the loan. It does not, as the ALJ suggests, excuse a borrower's failure to make scheduled principal and interest payments when they are due.
48 The type of collateral securing a loan is also of obvious relevance. Collateral consisting of U.S. Treasury obligations, gold or a time deposit in a bank clearly does not present the same risks associated with other types of collateral. (Tr. 1581)
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[.17] In several cases, the ALJ ignored the risk, acquisition costs and disposition costs of acquiring and marketing the collateral to be applied to the debt. (See, e.g., Series #107, * * * infra, p. 136; Series #90, * * * , infra, p. 126) By failing to take these factors into account, the ALJ often erroneously determined that collateral was sufficient to protect the Bank against risk of loss when it was not.49
In other instances, the ALJ gave little consideration to the Bank's established lien position. (See, e.g., Series #28, * * * infra, p. 70; Series #94, * * * , infra, p. 127; Series #99, * * * , infra, p. 130) Collateral which might be sufficient if the Bank had a first lien may be wholly inadequate if the Bank holds a third or fourth mortgage on the property.
Finally, the ALJ placed undue emphasis upon collateral appraisals, some of which were of dubious quality and some of which were rebutted by other evidence in the record. In some instances, the appraisals were by interested parties. (See, e.g., Series #36, * * * , 1 infra, p. 81) In other cases, appraisals were made for the borrower rather than for the Bank. (See, e.g., Series #114, * * * , infra, p. 142) In either case, one could expect a more optimistic appraisal than would be obtained if the Bank had retained its own appraiser.
In addition, the ALJ flatly refused to consider a commissioned examiner's valuation of collateral when it differed from that of an M.A.I. appraiser. (RD at 40; See, e.g., Series #35, * * * , infra, p. 79) Although bank examiners do not apply for M.A.I. certification, their duties do require them to independently assess the value of collateral pledged to secure a loan. (See R.Ex. 1, § A, p. 3)
The Manual of Examination Policies explains one major reason why examiner evaluation of collateral is so vital:
The potential sale price of a property may or may not be the same as its appraised value. The current potential sale price or liquidating value of the property is of primary importance and the appraised value is of secondary importance.
There may be little or no current demand for the property at its appraised value and it may have to be disposed of at a sacrifice value.
(R.Ex. 1, § A, p. 3—emphasis added) Accordingly, the ALJ erred in refusing to consider the examiners' conclusions regarding the current potential sale price or liquidation value of collateral.
The Board does not, of course, suggest that examiners are free to ignore reliable M.A.I. appraisals of collateral. In certain circumstances, however, the examiner may find evidence that an appraisal does not accurately reflect the potential sale price of the collateral. For example, the recent actual sale price of a similar unit in the same project is clearly more probative of the actual potential sale price than an abstract appraisal.50
In addition, recently acquired appraisals which exceed prior appraisals by an unreasonable amount may be questionable. (See, e.g., Series #61, * * * , infra, p. 103)
In summary, the Board finds that the ALJ erred in concluding that substantial collateral was the only significant consideration in loan classification; erred in assessing the adequacy of collateral; and erred in refusing to even consider the examiners' conclusions regarding collateral value.
2. Performance
The Manual of Examination Policies provides that a borrower's willingness and ability to perform as agreed is the primary measure of the credit quality of a loan. (R.Ex. 1, § A, p.11.) As previously noted, the ALJ did not generally place sufficient emphasis on performance in conducting his own "de novo" review of the disputed classifications. (See, e.g., Series #41, * * * , infra, p. 86) Furthermore, even when the ALJ did consider performance he frequently failed to consider the source of funds for payments and whether payments made upon lines of credit were truly indicative of the borrower's ability to service the debt. (See, e.g., Series #63, * * * , infra, p. 106)
The ALJ frequently confused satisfactory debt performance with continual refinanc-
49 Examiner * * * testified that real estate collateral value should generally exceed the amount of the loan by 20-30 percent to ensure that there is sufficient collateral margin to cover these expenses. (Tr. 644) The Board finds this to be a not unreasonable margin.
50 See, e.g., the evidence in the record discussing the * * * real estate held by the Bank. (Tr. 1604–1609; loan summary #170, p. 172, infra.)
{{4-1-90 p.A-502}}ing, continual capitalization of interest which was due or past due, and offset of deposit accounts and/or forced sale of collateral with application of proceeds to the debt. (See, e.g., Series ##94, 96, 99, 100, 102, 103, * * * , infra, pp. 127–136; Series #119, * * * , infra, p. 145) In addition, the ALJ too readily accepted extremely liberal use of overdraft checking as a means of debt performance. (See, e.g., Series #55, * * * , infra, p. 96) Finally, the ALJ failed to appreciate the significance of extensive use of third party and/or interrelated party borrowing to meet various debt obligations. (See, e.g., Series #63, * * * , infra, p. 106)
These practices are relevant to the classification process because they give the appearance of satisfactory debt performance when such performance is actually lacking. By ignoring the source of repayment, the ALJ frequently missed clear warnings of a borrower's inability to service his debt obligations.
3. Credit Information
[.18] The Manual of Examination Policies explains the importance of obtaining and properly evaluating pertinent credit information: "Failure of a bank's management to give proper attention to credit files makes sound credit judgment difficult if not impossible." (R.Ex. 1, §A, p. 9) The ALJ failed to appreciate the importance of adequate credit information, and in many instances failed to properly evaluate the credit information which was available.
In several instances the ALJ relied too greatly upon self-stated net worths, and overlooked obvious misstatements as to liabilities and asset values. (See, e.g., Series #109, * * * , infra, p. 139) In other cases, the ALJ failed to consider omissions of income information or failed to assess the adequacy of stated income to support the borrower's debt load. (See, e.g., Series #96, * * * , infra, p. 129) In addition, the ALJ frequently failed to analyze the composition of net worth. (See, e.g., Series #37, * * * , infra, p. 82) Even a borrower with a large net worth may have difficulty making principal and interest payments as they become due if his net worth consists primarily of illiquid assets and very little cash. (Tr. 1548-49, 1656)
Perhaps the most significant error of the ALJ was his conclusion that * * * Bank was a "* * * bank", and was therefore not required to meet the same standards applied to all other banks regulated by the FDIC. The Board unequivocally rejects the suggestion that the ethnic character of a bank has any bearing whatsoever on the safety and soundness standards which must be applied to that bank.
The Board is unsure what the ALJ had in mind when he ruled that FDIC examiners were required to show "consideration and sensitivity" and "some degree of forbearance in reviewing [ * * * ] loans." (RD at 39–40) THe ALJ seems to imply that a * * * borrower's "reluctance to reveal all personal assets on financial statements" and "concern for family name and reputation" justify the absence of adequate collateral and net worth statements which demonstrate the borrower's ability to repay the loan.
This surprising assertion is perhaps a product of the ALJ's misunderstanding about the requirements of prudent banking. The ALJ stated that examiners are required to show "consideration of, and sensitivity to those characteristics of * * * or * * *; banks which differ from those of other banks, yet which do not impair safety or soundness." (RD at 39—emphasis added) The ALJ fails to recognize, however, that the standards set forth in the Manual of Examination Policies do have a direct relationship to the safety and soundness of the bank. The FDIC has determined, as a result of fifty years of experience in regulating banks, that a handshake and a smile is no substitute for adequate collateral, demonstrated repayment ability, and complete and accurate credit information which fully documents a borrower's financial condition. The soundness of this determination was amply demonstrated by the volume of overdue loans held by the Bank during the September examination.
The ALJ's suggestion that the FDIC Manual of Examination Policies requires, or even permits, ethnic exemptions from these requirements is baseless. The language quoted by the ALJ at RD 38–39, when read in context, refers merely to the content of a bank's written lending policy, and in fact contradicts the ALJ's suggestion that any group is exempt from providing reliable and complete credit information:
A bank's lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as
{{4-1-90 p.A-503}}well as changes that may occur within the bank itself. To a large extent, the economy of the community served by the bank dictates the composition of the loan account. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
* * *
(8) Maintenance and review of complete and current credit files on each borrower;. . . .
(R.Ex. 1, §A, p. 1—emphasis added)
The record is replete with evidence that the "* * * banking" exemption urged by the ALJ is inappropriate. Indeed, Respondents' own "* * * banking" witness agreed "absolutely" with the FDIC's position on the importance of adequate credit documentation. (Tr. 2144) * * * , the Assistant Director of the * * * State Division of Banking, was asked whether there were any special rules or regulations or statutes in effect in * * * that take "special cognizance of the fact that a bank may have certain ethnic affiliations such as * * * affiliations", and replied "None whatsoever." (Tr. 2206) Mr. * * * also testified that he was not aware of any special considerations which were given to banks that have a particular ethnic affiliation so far as the standards of examination are concerned. (Tr. 2207)
It may be true that the Bank's customers are "not accustomed to providing complete statements" (RD at 39), but if they wish to conduct their banking business in the United States they must conform to the standards set by U.S. banking regulators. In Groos National Bank v. Comptroller of the Currency, 573 F. 2d 889 (5th Cir. 1978), the Court explained that no person has a right to conduct business with a federally regulated bank without abiding by the standards set by the appropriate federal bank regulatory agency:
The banking laws, of which all citizens are no notice, regulate banks' conduct of business generally, and if bank customers have any interest in or expectation of doing business with a bank, that interest or expectation is subject to the Comptroller's [or in this instance the FDIC's] legitimate regulatory authority over the bank.
573 F.2d at 897 (emphasis added; citation omitted).
[.19] In summary, the Board rejects the ALJ's suggestion that the FDIC examiners were required to "show some degree of forbearance" in classifying so-called "* * *" loans. All persons, regardless of ethnic or other affiliation, must conduct their banking affairs in accordance with the standards promulgated by the agency statutorily entrusted with protecting the safety and soundness of insured, state-chartered nonmember banks.
4. Post-Examination Events
In several instances, the ALJ's decision to reject an examiner's classification was based at least in part on information which was not available to the examiner during the examination. It is clear, however, that a bank's financial condition may be accurately assessed only in the context of a complete examination conducted during a discrete time period. The FDIC cannot feasibly conduct continual examination of the Bank. (Tr. 2543-44) Subsequent payments do not necessarily mean a classification was wrong. (Tr. 2421-22) Fragments of new information selectively presented after the close of an examination may convey a limited, and extremely distorted picture of the bank's overall financial condition. Obviously, the Bank, which is the repository for such postexamination information, will present information most favorable to its position, i.e., information showing improvements, but has no incentive to present other information reflecting areas of deterioration. Accordingly, the Board finds that the ALJ erred in considering post-examination evidence in determining the accuracy of the examiners' loan classifications.
5. The Board's Classification Conclusions
As previously noted, the ALJ's "re-examination" of the Bank has made it necessary for the Board to conduct its own "de novo" review of each individual loan classification. The Board's analysis of each disputed classification which was rejected, in whole
{{4-1-90 p.A-504}}or in part, by the ALJ is set forth in the following individual "write-ups" of each such loan.51The name of each borrower is preceded by the "series number" of the FDIC's Proposed Findings of Fact, and the Bank's Responses thereto, which address that particular loan. Each write-up sets forth a summary of the classifications assigned to that loan by the FDIC in the February and September, 1983 examinations; by the State of * * * in the September, 1983 and May, 1984 examinations; the ALJ's classification conclusion; and the Board's classification conclusion. Each write-up then contains a brief explanation and summary of the Board's classification conclusions, followed by a more detailed discussion of the reasons for the Board's classification.
Loan Write-ups
#15 * * *
| February 4, 1983 | FDIC - | $593,000 Substandard52 | | September 30, 1983 | FDIC - | $604,000 Substandard | | September 30, 1983 | State - | $604,158 Substandard | | May 18, 1984 | State - | $663,000 Substandard53 | | ALJ - | None | | Board - | $604,000 Substandard |
SUMMARY
The ALJ disagreed with the "Substandard" classifications assigned by the state of * * * and the FDIC. His conclusion was based on the presence of collateral, * * * "credit history with the Bank", and funds received from * * * Bank which were applied to this line.
For reasons which have been explained in Section D.1. of the Board's decision, supra, the presence of collateral54does not preclude assignment of an adverse classification where other indicia of risk are present. In the instant case the presence of such other factors supports the "Substandard" classifications assigned by the state of * * * and the FDIC. In addition, the ALJ is in error to the extent that he holds that the application of funds from * * * Bank provide a basis for not classifying this line. In fact, the portion of the debt repaid by the funds from * * * Bank was not classified by the FDIC examiners.
Mr. * * * is also obligated for an additional $840,000 of debt as a guarantor for * * * Corporation and * * * which has also been classified substandard.
DISCUSSION
The ALJ notes the borrower's credit history with the Bank, but fails to recognize that such credit history is quite poor with respect to the classified lines. A substantial portion ($466,000) of the amount classified was delinquent at both the February and the September FDIC examinations. The borrower's apparent inability to service the debt as agreed is demonstrated by several factors. Certain loans were repeatedly renewed without reduction of principal, and
51The board's reasons for agreeing with 31 of the classifications upheld by the ALJ are adequately set forth in the portions of the record cited in footnote 24 and 25, supra.
52The accuracy of the classifications contained in the February 14, 1983 FDIC report of examination was not one of the issues litigated in this proceeding. (Tr. 445–451) Nevertheless, the Board finds that the classifications contained in the February report are relevant to the extent that they show that the Bank was warned of an adverse trend in the quality of specific loans. Furthermore, to the extent that examiners on the September examination have been accused of bias in their classification, an adverse classification of the same loan at a different examination is of obvious relevance. Despite the relevance of the February examination as noted, it should be emphasized that the Board's decision in this matter is based solely upon the classifications contained in the September examination report. Accordingly, the Board has found sufficient evidence to uphold each of its classifications even if the February examination report is excluded entirely from consideration.
53For reasons which are explained more fully in Section F.4 of this decision, the Board does not find that events subsequent to the close of the September 30, 1983 examination period are relevant to the instant proceeding. In the event that a Court should find them relevant, however, and because the ALJ seems to have relied heavily upon them in reaching his conclusions, the Board has decided to include evidence of such events where pertinent. It should, however, be noted that the conclusions reached in this decision are not dependent upon the inclusion or exclusion of such evidence.
54At least $97,490 of the credit extended was originally totally unsecured. (P.Ex. 17 at 53 and 56, respectively) The State of * * * had initially classified $47,490 of this line "Loss". (P.Ex. 17 at 53) Approximately two months after the September 30, 1983 state and FDIC examinations were begun, the Bank obtained an agreement modifying a mortgage it held on * * * residence, for the purpose of securing those loans which had previously been unsecured. (R.Ex. 15.38) The state then changed its "Loss" classification to "Substandard." The FDIC contends that this modification agreement was subject to a second mortgage in the amount of $29,000, thereby providing the Bank with a first lien on only $641,000 of the collateral. The Bank, however, contends that it has a first mortgage for the entire amount, thus giving the Bank a first position with respect to all $670,000 worth of collateral. The ALJ did not expressly address this issue, which essentially presents a question of * * * State law. Because this FDIC classification does not rest wholly, or even primarily, on the adequacy of collateral, and a $29,000 difference in the Bank's first lien position would therefore not be determinative, the Board finds it unnecessary to decide whether the mortgage modification agreement was subject to a $29,000 second mortgage.
{{4-1-90 p.A-505}}occasionally without payment of interest. (P.Ex. 17 at 55 and 56) Payments of past due interest and past due installments were frequently made with overdrafts from the borrower's * * * account. (Id.) On at least one occasion, * * * used proceeds of a Bank loan to pay the interest due on the loan. (Id. at 55) The borrower's self-prepared financial statement reveals that his assets are concentrated in illiquid real estate and closely held investments of limited marketability. (P.Ex. 17 at 60) In fact, the borrower stated that he had only $2,500 cash available as of February 28, 1983.
During the hearing in this matter, * * * testified that the Bank had advanced additional funds to * * * between February and September of 1983, despite the delinquent status and FDIC classification of the preexisting loans to * * *. (Tr. 3032)
* * * also testified that the Bank had not collected any portion of the * * * loans between the close of the September 30, 1983 FDIC examination and the day he testified (June 26, 1984).55The ALJ also found that the FDIC had not given "appropriate consideration" to an $85,000 advance from the Bank to * * * Bank, the proceeds of which were applied to * * * loans. It is unclear what this comment signifies. The FDIC examination report does acknowledge the $85,000 payment on various * * * loans, and the indebtedness thus paid was not included in the $604,000 classified. Accordingly, the $85,000 was taken into consideration in determining the * * * classifications.
Because the Board finds that the borrower's poor performance history and apparent inability to service his debts outweighs the presence of collateral, we uphold the Substandard classification initially assigned by the State of * * * and the FDIC.
#16 * * *
| February 4, 1983 | FDIC - | $518,000 Substandard | | September 30, 1983 | FDIC - | $510,000 Substandard | | September 30, 1983 | State - | $510,039 Substandard | | May 18, 1984 | State - | $555,000 Substandard | | ALJ - | $500,000 Substandard | | Board - | $500,000 Substandard |
SUMMARY
The Board agrees with the Recommended Decision of the Administrative Law Judge to classify $500,000 of the debt substandard and to pass on $10,000.
DISCUSSION
The ALJ agreed with the Substandard classification assigned to the $200,000 loan and the $300,000 loan. As he correctly noted, repayment of those loans is dependent upon the Nigerian government's approval of the transfer of dollars out of Nigeria. Such approval has not, thus far, been forthcoming.56No payment of principal has ever been made on either loan, and each loan has been renewed twice. (P.Ex. 17) Because performance has been lacking in these lines, collateral is not readily available, and source of repayment is uncertain, the Board agrees with the ALJ's conclusion that $500,000 of * * * indebtedness to the Bank should be classified "Substandard." The ALJ also concluded that a $10,000 installment loan to * * * should not have been classified. The basis for this conclusion was the ALJ's determination that the loan was "adequately collateralized" by a 1981 Cadillac of indeterminate value. The Board upholds the ALJ's conclusion that the loan should not have been classified, but does not uphold his reasoning. As previously noted, the mere presence of collateral does not preclude an adverse classification where other indicia of risk are present. In the instant case, past performance and likely ability to repay, coupled with the presence of collateral, support the ALJ's conclusion that the loan should not be classified. The loan in question was originated on August 12, 1981 at $24,887, and by the close of the September 30, 1983 FDIC examination had been reduced to $11,925 ($10,039 payoff balance). This past performance, coupled with the borrower's apparent ability to service this rather insubstantial debt and the presence of collateral, lead the Board to conclude that $10,000 of the $510,000 originally scheduled as "Substandard" should not have been classified.57
55See note 53, supra.
56The Board disagrees with the ALJ's comment that "[N]o appropriate consideration was given to funds received from * * * Bank, A.G. which were applied to this line." (RD at 47 footnote 1) The indebtedness was reduced by the $210,000 transfer from * * * Bank and only the remaining debt was classified.
57The Board notes that the State's May, 1984 examination report includes the $10,000 debt in its classification of this line. If the Board was to consider post-examination events, it might be justified in classifying this remaining
{{4-1-90 p.A-506}}
#21 * * *
| February 4, 1983 | FDIC - | Not indebted to the | | | bank | | September 30, 1983 | FDIC - | $68,000 Substandard | | September 30, 1983 | State - | None | | May 18, 1984 | State - | None listed | | ALJ - | None | | Board - | $68,000 Substandard |
SUMMARY
The Board determines that a "Substandard" classification is warranted due to the existence of only a nominal equity investment by the borrowers, the limited margin of collateral protection, the extremely lenient loan terms, and the absence of a financial statement on the borrowers.
DISCUSSION
The loan represents the financing of the sale of previously foreclosed property in the name of * * * Inc. The latest appraisal indicates a property value of $75,000 as of March 24, 1983, although the purchase price for the townhouse unit was only $70,000 on September 23, 1983. Scheduled monthly payments do not even cover interest. The loan will increase to $73,755 at the end of a three-year term. The borrower has only a nominal equity investment due to a down payment of only $3,000, (PFF 21.5) The facts and exhibits cited in the FDIC's Brief of Exceptions (P. Exceptions at 41) support the assigned "Substandard" classification.
* * * GROUP
#22 * * * $32,000
#23 * * * $874,000
#24 * * * $29,000
| February 4, 1983 | FDIC - | $842,000 Substandard | | September 30, 1983 | FDIC - | $935,000 Substandard | | September 30, 1983 | State - | 903,047 Substandard | | | $32,291 Loss | | May 18, 1984 | State - | $945,000 Substandard | | ALJ - | None | | Board - | $935,000 Substandard |
SUMMARY
The above three lines are direct and guaranteed debts of * * * and make up the " * * * Group".
The Board classification is based on unsatisfactory performance and the poor financial condition of the companies which are the major investments of the borrower and collateral deficiencies. The original collateral on * * * and * * * was not sufficient to preclude adverse classification and the direct debt of * * * is entirely unsecured.
Additional collateral obtained during the examination consisted of the contract rights on two acres of land on the Boardwalk in Atlantic City ("Boardwalk" property) which was not initially supported by a formal appraisal. The appraisal obtained subsequent to the examination, was on "hypothetical" property which raised the question as to the protection provided by the Contract Rights. The Boardwalk property was assigned to the debt of * * * Corporation and * * * Group in addition to the "* * * Group". Total debt of the two groups increased from $8,864,000 to $10,329,000 during the examination. The uncertain realizable value of the collateral coupled with unknowns regarding its ultimate development and disposition were deficiencies that evidenced risk and warranted the adverse classification.
#22 * * *
DISCUSSION
The line was comprised of two loans extended on an unsecured basis. No performance on the $27,500 loan occurred as interest was paid during the examination with a check on an overdrawn checking account of * * * , a related interest of the borrower. (P.Ex. 17 at 66) The remainder of the line was a $4,790 * * * Account which was overdue three payments. The financial condition of the borrower was questioned due to a concentration of assets in closely held businesses which were also adversely classified as part of the "* * * Group". Those interests included * * * and * * * Inc. The failure of the borrower to properly make interest payments or principal reductions caused concern for his ability to repay. The purpose of the $27,500 loan was to cover personal expenses and overdrafts which could have indicated cash flow problems. The ALJ's analysis of the borrower's financial capacity failed to note these facts.
A more severe classification of the line would have been appropriate had the Bank not obtained additional collateral in the form of the Boardwalk property. However, collateral alone should not have been con-
$10,000, based on its extended nonperformance coupled with the uncertain value of the collateral. In keeping with the principle that classifications must be based on information available during the examination, however, we find that the $10,000 debt should not have been classified in the September 30, 1983 examination.
{{4-1-90 p.A-507}}sidered a substitute for satisfactory performance in assigning the classification.
#23 * * *
DISCUSSION
The ALJ states that a "Substandard" classification is unwarranted since the overdraft used to pay interest on the $815,000 loan was later covered and a "large amount of collateral was pledged" PFF 23.9 states the subject overdraft was covered at a later date. However, there is no indication that the overdraft was cleared during the time period covered by the examination and, in fact, the overdraft increased from $58,621 to $66,848 on December 6, 1983.
In regard to the large amount of collateral, the Bank's appraisal dated January 18, 1983 indicates a value of $4,037,000. Liens known to exist against the property are the Bank's $815,000 mortgage and the $2,500,000 note payable to the parent company, * * *. This valuation would leave net equity of $722,000 in the property. However, consideration should have been given to the fact that the Bank was not receiving any principal reduction on its first mortgage note and the terms of the parent company note called for annual installments of $500,000 beginning 24 months from date of closing (October 31, 1981). (P.Ex. 17 at 67) The ALJ also seems to have failed to recognize that repayment of the debt was to come from land sales of the * * * property on which there was no supporting information to indicate that there had been sales in recent periods. Liquidation of the debt could not be accomplished without lot sales.
The examiners recognized the added collateral protection gained from the Boardwalk property which prevented the assignment of a more severe classification to the line. Having recognized the protection of collateral obtained during the examination, the line nevertheless remained a nonperforming asset deserving extra attention.
#24 * * *
DISCUSSION
Exceptions and comments (pages 44 and 45) of the Brief of Exceptions of the Federal Deposit Insurance Corporation to the Recommended Decision of the ALJ adequately describes the rationale for the "Substandard" classification of the line. The ALJ did not adversely classify the line because of the existence of a financial statement and collateral that he deemed to be adequate. The Board finds that the financial statement is not actual but is projected, and that the purported values of assigned accounts receivable and inventory are not supported by the Bank. A more severe classification would have been assigned were it not for the assignment of the contract rights for the Boardwalk property.
The loan was guaranteed by * * * whose loss classified loan was upheld by the ALJ. The collateral was a seventh mortgage on undeveloped property with an appraisal of $1,300,000. (P.Ex. 17 at 73) RPFF 28.6 indicates the vacant site has a value of $1,400,000 according to real estate brokers, * * * Associates (there is no indication that this was a formal appraisal). Plans for reorganization under Chapter XI of the bankruptcy laws (P.Ex. 17 at 75) indicated recovery through development of the property was highly contingent on a number of factors and at best was a long-term solution to debt liquidation. The ALJ's inconsistent classification of this line as "Doubtful," without explanation, while others related interests which rely on the same source of repayment were considered "Loss," does not appear warranted.
#28 * * *
| February 4, 1983 | FDIC - | 250,000 Substandard, | | | $14,000 Loss | | September 30, 1983 | FDIC - | $250,000 Loss | | September 30, 1983 | State - | $250,000 Loss | | May 18, 1984 | State - | None listed | | ALJ - | $250,000 Doubtful | | Board - | $250,000 Loss |
SUMMARY
The company filed for Chapter XI bankruptcy. Guarantor * * * added no support due to his weak financial condition and his own loan classified "Loss," which was upheld by the ALJ. The collateral for the loan was a seventh mortgage on 2.6 acres of land for which development was necessary to realize value and obtain a possible recovery of the debt. Such a recovery was highly contingent on a number of factors, including the bankruptcy proceedings. The loan appeared to be of no better quality than related debt on which the ALJ justifiably upheld "Loss" classifications.
{{4-1-90 p.A-508}}
#30 * * *
| February 4, 1983 | FDIC - | None | | September 30, 1983 | FDIC - | $202,000 Substandard | | September 30, 1983 | State - | $196,834 Substandard | | May 18, 1984 | State - | $190,000 Substandard | | ALJ - | $202,000 Special | | | Mention | | Board - | $202,000 Loss | | | Mention |
SUMMARY
Numerous documentation deficiencies existed, repayment terms were liberal, and performance had been less than satisfactory as indicated by renewals and late payments. Nevertheless, monthly payments had been made for many months and cash flow appeared adequate to permit their continuation. The Board agrees with the ALJ's finding of Special Mention.
DISCUSSION
Credit terms appear liberal, especially in regard to the automobile portion of the debt, and the loans contained numerous documentation deficiencies. The property statement of the borrower contained certain errors in preparation (P.Ex. 17 at 76) but it was self-prepared, which may account for these inconsistencies. The FDIC examiner did not appear to have given adequate weight to the payment history. Included in the classification is $5,000 which was a loan funded subsequent to the examination date. The borrower's cash flow appears sufficient to make scheduled installment payments.
The structure of the line and support information leaves much to be desired. However, these items are the responsibility of the bank management and do not directly impact on the borrower's ability to repay. The ALJ's recommendation of Special Mention for this loan appears to be warranted.
| * * * | | | #32 | * * * | $1,098,000 | | #33 | * * * | 1,250,000 | | #34 | * * * | 800,000 | | #35 | * * * | 331,000 | | #36 | * * * | 1,000,000 | | #37 | * * * | 1,250,000 | | #38 | * * * | 250,000 | | #39 | * * * | 250,000 | | #41 | * * * | 67,000 | | #42 | * * * | 128,000 | | #46 | * * * | 96,000 | | #48 | * * * | 48,000 | | #49 | * * * | 24,000 | | #50 | * * * | 9,000 | | | $6,601,000 |
| February 4, 1983 | FDIC - | $3,544,000 Substandard | | September 30, 1983 | FDIC - | $6,601,000 Substandard | | September 30, 1983 | State - | $6,569,068 Substandard | | | $8,624 Loss, $24,000 | | | None | | May 18, 1984 | State - | $8,061,000 Substandard, | | | $8,000 Doubtful | | ALJ - | $6,404,000 Special Men- | | | tion, $195,000 None | | Board - | $6,577,000 Substandard, | | | $24,000 Special Men- | | | tion |
SUMMARY
Excluded from the above figures are five separate lines of credit totaling $1,257,000 on which the ALJ agreed to the "Substandard" classifications. The ALJ recommended Special Mention on all of the borrowers listed above except for * * * and * * * on which he recommended no classification. The Board entirely disagrees with the ALJ by upholding the "Substandard" classification on all borrowers except * * * who is considered Special Mention.
The key factors for classification of the loans are a combination of uncertain collateral protection, poor performance, inadequate financial information, and speculative loan purposes and/or repayment sources.
Weaknesses in the collateral protection included the lack of adequate documentation, inferior lien positions, inadequate equity, extensive litigation, inflated appraisals on real estate, appraisals by insiders, lack of appraisals, collateral consisting of stocks of closely-held companies, and the Boardwalk property which consisted of assigned contract rights on a "hypothetical" two acres of vacant improved property appraised at $15 million. Eventually realizing an amount approaching the appraised value was dependent on many factors as discussed under the * * * line. The Boardwalk property also secured the * * * Group, $935,000 of which was classified "Substandard".
In regard to performance, the noted deficiencies included delinquent payments, slow repayment, payment from sources other than the original obligor, and providing additional funds to previously identified high credit risks (i.e., borrowers with previously classified loans).
Financial information was entirely lacking in some instances or was not supported by operating statements (profit and loss information) in others. Financial information was also found to be stale (out of date) and
{{4-1-90 p.A-509}}asset/liability information was not factually supported. In some instances, the financial statements did not contain a complete list of all the borrower's liabilities.
Undesirable purposes identified for this group of loans included funds extended for payment of checking account overdrafts or interest payments on other loans. There are also examples cited of loan proceeds being used for purposes other than those stated on the loan documents.
#32 * * *
DISCUSSION
The ALJ recognizes that the line contains "unique circumstances" but believes a less severe treatment of the line is in order due to value of the collateral. Therefore, a difference of opinion appears to surround the protection provided by the collateral that is described as follows:
(1) 320 acres of land in * * * carried on the borrower's books at a cost of $166,000. (PFF 32.6) RPFF 32.6 states that the value far exceeds the cost, but support for a higher value is not indicated. The December 31, 1981 10-K report of * * * indicates in the description of the sale of * * * , that the borrower received "approximately 320 acres of property with a market value of $160,000." (P.Ex. 17 at 67) Thus, the actual cost and the indicated market value are closely related according to facts contained in these documents.
(2) 130-acre parcel of land in * * * , known as * * * and appraised by the Bank at $6,750,000. The bank is in a third-lien position although RPFF 32.7 (a) indicates the second mortgage has been assigned to the Bank (the assignment was obtained during April, 1984 and therefore has no relevance for classification purposes in the subject report). RPFF 32.8 indicates a "recent offer" of $4,000,000 cash for the property by the State of * * * under the * * * program. The ALJ also fails to recognize that the protection provided by this property is somewhat clouded by the fact that the first lien holder, * * * Bank of * * * , * * * has taken action to foreclose on the property due to the $1,600,000 first mortgage which is in default. (PFF 32.9) Equity available to the Bank may be far less than the appraisal would indicate.
(3) Contract rights on two acres of real estate located on the Boardwalk in Atlantic City, New Jersey, known as the Boardwalk property. A hypothetical two acres on the Boardwalk was appraised at $15,000,000. (RPFF 32.36(a)) The appraisal by * * * Realty Company dated January 17, 1984 occurred after the examination was closed. Eventually obtaining title to an actual two acres worth $15,000,000 is dependent on the ability to actually acquire the property, develop it into a casino, and numerous other legal conditions precedent (such as obtaining liquor and gambling licenses). Nevertheless, the property rights appear potentially to have substantial value. The property is not only assigned to the entire * * * Group, but also, is assigned as collateral to the * * * , and * * * Group, Inc. loans.
However, the ALJ has ignored the detracting factors regarding the collateral. The collateral bears little relationship to the original purpose of the credit extended. Repayment is now anticipated from sale or refinancing of that collateral. Extensive litigation relating to the collateral is involved which will at a minimum slow the ultimate repayment of much of the debt. "Substandard" classification is a generous evaluation by the examiners and can only be justified by the additional collateral obtained during the examination consisting of the contract rights to the Boardwalk property.
#33 * * *
DISCUSSION
The ALJ apparently reclassified the line based on (1) additional collateral obtained in the form of the Boardwalk property valued at $15 million,58(2) the fact that the debt was not classified prior to the February 1983 examination, and (3) improvement in the financial condition of the company.
Classification of the debt in prior examination reports has no relevance to the facts or circumstances in the September 30, 1983 examination report.
Finally, as to improvement in the financial condition of the borrower, the record contains no facts to indicate any such im-
58In regard to the uncertainty of the protection afforded by the Boardwalk property which supports the entire * * * Group, as well as * * * and his interests, refer to the discussion of the * * *.
{{4-1-90 p.A-510}}provement. The debt consists of (1) an $800,000 note which has existed without reduction since July 21, 1982; (2) a $200,000 loan which was a renewal of a March 24, 1983 note in the same amount; and (3) a $250,000 loan extended July 29, 1983, which was used in part to service the interest on the two prior credit extensions. Financial information on the company in the Bank's files was out of date, unsupported, and indicated a heavy debt to net worth position. Operating income figures were unsupported and the fact that the company used additional borrowings to service the debt at this Bank indicated a weak capacity to repay.
The existence of the contract rights to the Boardwalk property was the only fact that precluded a more severe classification.
#34 * * *
DISCUSSION
The company is part of the "* * * Group". The ALJ based reclassification as Special Mention on (1) collateral of 50 shares representing 100% of the stock of * * * Investment Company and assignment of two notes of $500,000 each from * * * respectively, (2) at the time of the extension of credit, * * * directed $3,000,000 in deposits to the Bank; and (3) hypothecation of the Atlantic City Boardwalk property worth $15 million.
Collateral consisting of 750,000 shares of * * * Class A Common Stock worth $562,500 on the examination date was released during the examination. The ownership of the stock of * * * Company was in litigation and was carried in the * * *'s statement as of December 31, 1982 as "equity in net assets of former subsidiaries transferred under contractual agreements". (P.Ex 17 at 84, 93) The assignment of the two notes of the insiders also provided little support since * * * Corporation was also considered a weak credit.
The deposits directed to the Bank by * * * were escrow funds and were later withdrawn by the trustees of the escrowed deposits. The Boardwalk property contract rights were discussed in connection with the * * * Corporation loans, supra. Were it not for the consideration given to the Boardwalk property, a "Loss" classification for the line would have been appropriate. The extension of an additional $400,000 to the line during the examination period is an indication of the poor judgment by the Bank's management.
#35 * * *
DISCUSSION
The ALJ took exception to the assigned classification based on the added protection of the contract rights to the Boardwalk property obtained at the conclusion of the examination and the $600,000 equity value in the * * * restaurant property. (RPFF 35.5(a) and 35.19) However, the ALJ failed to recognize:
(a) The Bank was in fifth position on the restaurant property with prior liens totaling $296,121 which, based on payments made from borrower's account during the examination, were believed to be in arrears.
(b) The restaurant was not in operation and an on-site inspection by the examiner during the examination raised doubt as to the validity of the $900,000 appraised value for the property. (RPFF 35.5(a))
(c) Additional funds of $200,000 extended during the examination for construction of improvements on the property were used instead to clear an overdraft and pay off outstanding judgments in order to obtain the Boardwalk property rights.
(d) The line was nonperforming, collateral was a fifth lien position on nonearning real estate and the debt increased during the examination.
(e) The protection gained from the Boardwalk property was uncertain since it covered all of the * * * group debt, as well as, the debt of * * * and related interests.
Considering all the facts presented, both positive and negative, a "Substandard" classification of the line was fully justified, and, in fact, was probably generous.
#36 * * *
DISCUSSION
The ALJ exception to the assigned classification was based on land valued on November 26, 1982 at $3.5 million consisting of approximately 2,600 acres of timberland (RPFF 36.3(a)) and contract rights to the $15 million Atlantic City Boardwalk property which was acquired during the examination. (RPFF 36.21)
{{4-1-90 p.A-511}}
The debt was secured by a note receivable from * * * Corporation and assignment of a first mortgage on 2,600 acres of unimproved timber land in * * *. Proceeds of the loan were for the stated purpose of clearing a bankruptcy petition for * * * Corporation. However, Bank records indicate that the funds were credited to the account of * * * Corporation and it was uncertain how the bankruptcy claims were settled. The appraisal dated November 26, 1982 by * * * , was not properly considered an independent appraisal due to the relationship of its control shareholder, * * * , with the * * * Corporation which in turned owned * * * Corporation. The appraisal indicated $900,000 in timber value and $2,600,000 in land value for a total of $3,500,000. On a cost basis, * * * Corporation carries 4,400 acres of unimproved land at $1,197,000 on their property statement dated December 31, 1982. That appraisal values the land at $1,346 per acre as opposed to a cost of only $272 per acre. Since none of the proposed site improvements had been made by the date of the examination, the "market value" appraisal was considered to be inflated. The protection gained from the contract rights to the Boardwalk property were discussed in connection with the * * * Corporation line, and provided the only basis for the less severe classification of "Substandard".
Other relevant factors which the ALJ failed to consider in the classification included (1) the line was nonperforming and delinquent according to the terms of the note, (2) the proceeds were not used for the purpose stated in the "Loan Instruction and Approval" sheet (P.Ex. 17 at 96), and (3) proper inclusion of the debt in the company's property statement dated February 28, 1983, would have resulted in insolvency of the borrower.
#37 * * *
DISCUSSION
The ALJ based his Special Mention on (1) collateral of 1,290 acres of land in * * * appraised on November 26, 1982 by * * * (RPFF 37.2(a)), (2) financial information on * * * Land and Timber Corporation which purchased the property and assumed the debt (RPFF 37.8(a)), and (3) additional security provided by the Boardwalk property. The FDIC examiners, who classified the debt "Substandard", indicated there was no appraisal in the Bank's file, documentation was not adequate to determine the number of acres involved, and the Bank's loan files did not contain financial information on the * * * , Land and Timber Corporation, although such information was requested from the Bank's management during the examination. (P.Ex. 17 at 98)
Respondents' Exhibit 37.2 contains an appraisal on 1,290 acres of unimproved land in * * * by * * * (which is controlled by * * * , a borrower whose loans were also classified) dated November 26, 1982. The appraisal states, in part, ". . .the current Fair Market Value of this subject property as of November 26, 1982 is as follows: * * * 1290 acres @ $700/acre = $2,000,000". As can be seen, the calculations of the appraisal are incorrect (1,290 × $700 = $903,000). In regard to the property statement ("PS") dated October 15, 1983 on * * * Corporation, also part of Respondents' Exhibit 37.6 * * * purchased the property for $1,500,000, giving * * * Land Corporation a $250,000 purchase money mortgage. The * * * indicates a net worth of $505,000, including capital stock of $5,000 and a valuation surplus of $500,000. If the * * * were to utilize the appraisal value of $700 per acre, the land and timber would be valued at $903,000 and the company would actually show a deficit shareholders' equity of $592,000. It may be reasonably concluded that (a) the statements and/or appraisal are in error, in which case the documentation does not support the line, or (b) the * * * is correct, in which case, the borrower is heavily leveraged with only $5,000 of capital paid into a company with debt of $1,500,000. In addition, the notes to the financial statement which indicated that the timber would be cleared, christmas trees planted, and christmas tree farms sold at $5,000 per acre with a sellout time of less than 18 months, appeared to be highly speculative. Finally, the value assigned the Boardwalk property, discussed under the * * * Corporation line, is the only factor that prevents the line from being assigned a "Doubtful" classification.
#38 * * *
DISCUSSION
The ALJ based his classification on (1) interest payments of approximately
{{4-1-90 p.A-512}}$17,000 received on the debt (RPFF 38.3), (2) the Bank holding title insurance in the amount of $250,000 (RPFF 38.4(a)), (3) a financial statement of the borrower that indicated a net worth of almost $2.5 million (RPFF 38.4(b)), (4) the assignment of collateral to this originally unsecured debt consisting of two lots in * * * and the contract rights on the Boardwalk property (RPFF 38.10(a)), and (5) the conflicting content of the examination report regarding the classification of the loan. (RPFF 38.12))
Whether the property assigned as collateral was worth $75,000 as indicated by the borrower's financial statement (P.Ex. 17 at 98 and 99) or $250,000 as indicated by the title policy, the Bank had no margin of equity above the amount of the debt. Respondents' Exhibit 38.3 indicates that interest in the amount of $21,590 was paid on the debt during 1982, however, there had been no principal payments and the debt was extended without payment of interest on November 8, 1982. The title insurance policy referred to in RPFF 38.4(a) does not represent an appraisal value for the property and should not be construed as such. In addition, the policy was to * * * Bank, as insured, for the interest of * * * (R.Ex. 38.3) and refers to a mortgage dated July 7, 1982, recorded July 8, 1982, on block 317, lot 2, also known as * * *. The Bank's mortgage covers Block 88, lots 78 and 79 at the same location. It would appear the title policy referred to in Respondents' Exhibit 38.3 does not cover the same property. In regard to the substantial net worth of the borrower as set forth in the property statement dated June 30, 1983 (P.Ex. 17 at 99), the assets are concentrated in illiquid real estate. The lack of principal reduction on the debt and a renewal of the loan without interest payments, indicated a lack of capacity to properly service the obligation. The support gained by the real estate security and the Boardwalk property contract rights did not indicate a "risk free" asset. (See discussion of the Boardwalk property under * * * Corporation.) Finally, the conflicting information in the examination only pertains to the payment of interest during 1982.
#39 * * *
DISCUSSION
Brief of Exceptions of FDIC to Recommend Decision of ALJ adequately sets forth the basis for the assigned classification (at pages 55 and 56). In essence, the loan was seriously overdue since the borrower did not make the April 30, 1982 quarterly principal payment. The $800,000 appraisal on a house and farm held as collateral was not considered independent since the appraiser, * * * , had other financial dealings with the borrowers. Added collateral consisting of contract rights on the Boardwalk property has undeterminable realizable value and lacks liquidity. Without the existing collateral, a "Loss" classification would have been justified.
#41 * * *
DISCUSSION
The rationale for the ALJ's decision to pass the line was discussed in Brief of Exceptions of FDIC to Recommended Decision of ALJ (at pages 56 and 57).
The debt represents a portion of an installment loan which originated August 27, 1982 in the amount of $264,928 ($198,297 net of unearned interest). (PFF 41.3) The Bank claimed that no payments were made for ten months due to a "computer error". This would seem to indicate poor internal operations at the Bank at best, but does not excuse the borrower for not making the scheduled $3,500 per month payments as required by the note.
Upon discovery of the "computer problem" the Bank converted the debt to a commercial loan during the February examination (PFF 41.5), then on July 5, 1983, the debt was split with $67,368 going to the original obligor and $130,000 placed in the name of an affiliate, * * *. The examination report (P.Ex. 17 at 100) indicated that the reason for the split was that * * * held title to the accounts receivable, inventory, furniture, fixtures and shipment that was pledged as collateral for the note.
The facts disclosed a great deal of activity in the account since its origination, both on the part of the obligor and with respect to the collateral pledged. However, the activity did not include reduction in the debt as originally agreed upon. The existence of a computer error provides no legitimate excuse. Of greater importance was (1) the Property Statement of the debtor dated February 23, 1983 which shows a highly leveraged position with no support for collectability of the accounts receivable, (2) interest and principal payments on the original debt having been minimal, (3) the PS of
{{4-1-90 p.A-513}}* * * dated July 31, 1982 (P.Ex. 17 at 101) also being weak. Assignment of contract rights to the Boardwalk property was the only basis for assignment of the less severe "Substandard" classification.
#42 * * *
DISCUSSION
The ALJ's reasons for not classifying the line are set forth and discussed in the Brief of Exceptions of FDIC to Recommended Decision of ALJ (at page 58).
The origination of this debt is described in the comments for affiliate * * *. The line was set up on an amortization schedule of $1,000 per month plus interest with the balance due at the end of one year. Had this schedule been met the principal would have been reduced from the original $130,000 to $118,000. Terms thus appeared to be somewhat lenient. Since the borrower only made the first two payments on the loan and no other payments were forthcoming during the remainder of the examination period, satisfactory performance could not be substantiated. (P.Ex. 17 at 101) The "loan instructions and approval" sheets indicated that the loan was secured by sound equipment with a value of $545,000. (PFF 42.4) The Bank in RPFF 42.4 refers to an equipment list that was in its loan file (R.Ex. 42.2). All that exhibit, however, shows a listing of equipment dated October 6, 1981 provided by the borrower. It would appear to be sheer speculation to assume that the equipment listed as of October 6, 1981 would remain static in view of the nature of the business (one which undergoes rapid technological changes) through the July 5, 1983 loan debt, without some factual support.
The company's earnings record was certainly not supported by the property statement dated July 31, 1981 and was further suspect considering the lack of regular payments on the note. Although the value of the collateral may have previously supported the debt, documentation was too outdated to be reliable. The added protection gained from the Boardwalk property is discussed with respect to the * * * debt. Only this added support prevented a more severe classification at the time of the examination.
#46 * * *
DISCUSSION
The ALJ based his decision not to classify the debt on the fact that the contract rights to the Boardwalk property were assigned to the debt on December 9, 1983 and RPFF 46.3, 46.3(a), 46.6, 46.7(a), 46.8. RPFF 46.3 and 46.3(a) indicate collateral consisting of * * * option to purchase 100,000 shares of * * * common stock at $0.50 per share. During the preceding year that stock had traded between $1 and $1.50 per share establishing a minimum value of the collateral of $50,000 to $75,000.
RPFF 46.6 details the borrower's financial statement as of February 28, 1982. Apparently the ALJ meant to refer to RPFF 46.6(a), which sets out a more current financial statement as of April 30, 1983 that the Bank claims was available to the examiners in the * * * credit file. RPFF 46.7(a) states that the borrower was not classified prior to the February, 1983 report when the loan balance was higher and credit information was less favorable. RPFF 46.8 references the additional collateral obtained during the September examination in the form of the Boardwalk property, previously discussed.
Respondents' Exhibit 46.4 is a letter dated March 10, 1982 indicating * * * is the owner of options to purchase 100,000 shares of * * * stock at $0.50 per share and acknowledges assignment to the Bank. The exhibit also contains a pledge agreement dated November 26, 1979, signed by the borrower and his spouse indicating a pledge of options to purchase 50,000 shares of * * * common stock. Thus, there seems to be some question as to the actual number of options to purchase that are pledged on the debt, but if the lower number of 50,000 is used then RPFF 46.3(a) would be correct in the minimum value of $50,000 to $75,000 at a trading price of $1 to $1.50 per share. However, based on the poor financial condition of * * * (P.Ex. 17 at 79-90) the marketability of the options or shares to a disinterested informed purchaser would appear unlikely. The ALJ failed to recognize the financial difficulties of the company in valuing the pledged collateral and the limited liquidity which would make it difficult to sell the shares or options.
{{4-1-90 p.A-514}}
Respondents' Exhibit 46.4 also contains a financial statement on * * * dated April 30, 1983 (signed September 27, 1983) which indicated assets of $3,710,000, liabilities of $140,000 and net worth of $3,570,000. (RPFF 46.6(a)) The major asset in the April 30, 1983 statement was securities comprised of 1,170,000 shares and options of * * * with a net market value of $2,569,000. This would indicate that * * * values the stock and options at $2.20 per share. The ALJ failed to analyze the statement which he uses as a basis for support of the line. There is no explanation given in the financial statements as to how * * * was able to increase his assets of $535,000 as of February 28, 1982 to $3,710,000 as of April 30, 1983, while total liabilities declined from $187,000 to $140,000 during the same period since his only known source of income was an annual salary of $100,000 as president of * * * (PFF 46.6 and RPFF 46.6(a)) These questions needed resolutions before any reliance could be placed upon * * * "substantial net worth" to support the debt.
The support provided by the additional collateral of the Boardwalk property was discussed in the * * * Corporation line (PFF 32 Series) and was the only basis for not assigning a more severe classification.
#48 * * *
DISCUSSION
The ALJ based his decision not to classify the debt on the fact that the contract rights to the Boardwalk property were assigned to the debt of December 9, 1983 and RPFF 48.9 and Respondents' Exhibit 48.10. RPFF 48.9 indicated that the classification was unwarranted based on the financial information in the credit file, the collateral value of the automobile and the additional support from the Boardwalk property. Respondents' Exhibit 48.10 is a credit report on the borrowers dated November 10, 1982. The financial statement on * * * dated March 15, 1982 was set out in PFF 48.5. That statement indicated a substantial net worth of $799,500, based on a $750,000 concentration of assets in * * * common and preferred stock and stock options. The * * * stock options represented $600,000 of the total net worth. In addition, the liabilities were admitted to be understated. (RPFF 48.6) The examiner's conclusion that the statement reflected an illiquid position (P.Ex. 17 at 106) was justified. A 1981 Jaguar automobile secured an installment note with a net payoff of $16,066, but the remainder of the line was unsecured until the Boardwalk property rights were hypothecated to secure the line.
The credit report (R.Ex. 48.10) indicated an excellent credit rating as of a year earlier. However, that report only covered consumer debt with a Visa and MasterCard with $1,600 limits each being the largest credit extension. The report would not provide support for the extension of $32,000 on an unsecured basis.
Without the security of the Boardwalk property, a classification of "Doubtful" on the unsecured portion of the line would have been justified.
#49 * * *
DISCUSSION
The ALJ based his decision not to classified the debt on the fact that the rights to the Boardwalk property were assigned to the debt on December 9, 1983 and PFF 49.2. PFF 49.2 indicated the debt is an installment loan in the original amount of $33,175, payable in 23 monthly installments of $400 each and a final balloon payment of $23,957 on March 5, 1984. As of September 30, 1983, the loan was paid ahead with the next installment due January 5, 1984. Collateral for the loan was a 1981 Jaguar automobile.
The examiner does not indicate if the borrower was making the regular monthly payments or if they are being made by * * * who paid off the borrower's $10,161 * * * Account debt on March 25, 1983. In addition, the value of the 1981 Jaguar was not stated.
The line does not appear to be properly structured as most institutions would not extend credit for a used automobile beyond 48 months or 60 months for a new one. The terms of this note with the final balloon payment did indicate monthly payments that are too small to significantly reduce principal.
However, the examination of report comments were too incomplete to determine many of the significant credit factors, and therefore, the "Substandard" classification cannot be substantiated. The unusual circumstances involved, however, do warrant a Special Mention designation.
{{4-1-90 p.A-515}}
#50 * * *
DISCUSSION
The debt represented the balance of the borrower's * * * Account #35-930-8 which was an overdraft line of credit with a maximum credit limit of $10,000. (R.Ex. 50.2) The Bank's records indicated that the account was overdue for four payments on the date of the examination. (P.Ex. 17 at 106) Under the FDIC's policy of uniform classification of consumer loans, open-end consumer installment credit delinquent 90 to 179 days (4 to 6 zero billing cycles) is to be classified "Substandard". (R.Ex. 1, §A, page 15) Facts presented in the examination report do not indicate a situation where an exception to the policy would be warranted.
#51 * * *
| February 4, 1983 | FDIC - | None classified | | September 30, 1983 | FDIC - | $135,000 classified | | | Substandard $9,000 | | | classified Loss | | September 30, 1983 | State - | $134,827 Substandard | | | $8,833 Loss | | May 18, 1984 | State - | $55,000 Substandard | | ALJ - | $144,000 classified | | | Substandard | | Board - | $144,000 classified | | | Substandard |
SUMMARY
The ALJ agreed with the FDIC's classification except for the borrower's overdrawn checking account which was classified as "Loss." The Board believes the "Loss" classification was not justified in that past overdrafts had been properly paid and the credit-worthiness of the guarantor was sufficient to protect against any future loss.
DISCUSSION
The ALJ stated that there was no justification offered for classification of a portion of this line as loss. (See PFF 51.1 - 51.25 and RPFF 51.25(b)) RPFF 51.25(b) indicates that * * * and her family were well known to senior management of * * * Bank and the character of the borrower and her family was a major consideration for making this loan with the knowledge that it would be repaid without undue delay.
While there may be circumstances where an unsecured portion of a line, such as an overdraft, may receive a more severe classification than a secured portion, the examination comments do not support the classification of "Loss". The examiner indicated that $100,000 of the line was reworked during the examination but that portion did not include the overdraft that had increased to $10,972 on November 30, 1983. However, the account had numerous overdrafts in the past, the largest being $19,065 on March 7, 1983. (PFF 17 at 110) Since past overdrafts had been paid there is no indication that the overdraft on the date of the examination was uncollectable.
#54 * * *
| February 4, 1983 | FDIC - | $25,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $19,000 classified | | | Substandard | | September 30, 1983 | State - | $18,861 classified | | | Substandard | | May 18, 1983 | State - | $16,000 classified | | | Substandard | | ALJ - | none classified | | Board - | none classified |
DISCUSSION
The amount classified represents the net payoff balance of two installment loans. A lien was held on a 1981 Mercedes 280 CD automobile with a cost of $24,000. One part of the line was consumer debt and could have passed upon the uniform policy for classification of consumer loans. The Board agrees with the ALJ that the collateral held was sufficient to preclude adverse classification for this loan.
#55 * * *
| February 4, 1983 | FDIC - | $229,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $930,000 classified Loss | | September 30, 1983 | State - | $930,156 classified | | | Substandard | | May 18, 1984 | State - | $942,000 classified | | | Substandard | | ALJ - | $775,000 classified | | | Substandard | | Board - | $930,000 classified Loss |
SUMMARY
The ALJ eliminated $155,000 of loss classification based on the overdrawn checking account being paid during the examination, and reduced the remaining loss classification to "Substandard" based on collateral consisting of the Boardwalk property and financial support of a third party after the conclusion of the examination. The Board agrees with the examiner's classification of "Loss" based on the overdrawn status of the borrower's checking account (at even higher levels) at the conclusion of the examination, the inability of the bor-
{{4-1-90 p.A-516}}rower's or guarantor's financial position to support unsecured credit and the absence of a perfected lien on any collateral.
DISCUSSION
The ALJ takes exception to the "Loss" classification based on RPFF 55.24 which indicates the amount classified should have been $775,000 "Substandard" instead of $930,000 "Loss" because a $155,156 overdraft was cleared during the examination. Additionally, the bank claims the line was secured by the Boardwalk property as a result of a transaction by which * * * obtained an interest in the * * *. While it is true that $155,156 overdraft was paid after a deposit of $200,000 on October 4, 1983, the account reverted back to an overdraft that even increased to $175,306 as of November 30, 1983. Thus, at the time the examiner was writing his comments, the Bank had actually more exposure than the amount on the examination date. The unsatisfactory method in which the account had been handled (including an average year to date overdraft balance of $97,279) (P.Ex. 17 at 117), justified the inclusion of the overdrawn checking account in the borrower's classified line.
* * * was subject to an adverse classification and added no support to this line. Protection provided by the contract rights to the Boardwalk property was discussed in the * * * line. However, the examination report did not address this added protection since the additional documentation received by the examiners on December 15 and 16, 1983 did not mention a pledge of Boardwalk contract rights against * * * debt. Therefore, "Loss" was a proper classification based on the information made available to the examiners.
Financial information does not support unsecured credit in the amount involved. (P.Ex. 17 at 118) The additional information provided the examiners on December 15, 1983 in the form of an unrecorded assignment of a hotel lease, which was later amended but not reassigned, added no support without profitability statements for the hotel. (P.Ex. 17 at 131) The growing debt of * * * , at the Bank and the continuing overdraft is evidence that the company was unprofitable and essentially operating from debt funding.
#57 * * *
| February 4, 1983 | FDIC - | $723,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $723,000 classified Loss | | September 30, 1983 | State - | $722,966 classified | | | Doubtful | | May 18, 1984 | State - | $723,000 classified | | | Substandard | | ALJ - | $723,000 classified | | | Substandard | | Board - | $723,000 classified Loss |
DISCUSSION
The ALJ reduced this classification to "Substandard" based on the Bank's acquiring rights to Boardwalk property collateral after the conclusion of the examination. The FDIC based it's "Loss" classification on the borrower's inability to pay and the worthlessness of the originally pledged collateral. The Board agrees with the "Loss" classification in that the additional collateral was acquired after the examination was closed. If the examiners have been informed by the Bank of the assignment of the contract rights to the Boardwalk property as collateral prior to the close of the examination, the line may properly have been reclassified as "Substandard".
#58 * * *
| February 4, 1983 | FDIC - | Not indebted to Bank | | September 30, 1983 | FDIC - | $950,000 classified | | | Doubtful | | September 30, 1983 | State - | $950,000 classified | | | Substandard | | May 18, 1984 | State - | $900,000 classified | | | Substandard | | ALJ - | $950,000 classified | | | Substandard | | Board - | $950,000 classified | | | Doubtful |
SUMMARY
This line of credit was to enable the borrower to fund loans it extended to minority businesses who were awaiting settlement on direct loans from the Small Business Administration ("SBA"). Corresponding minority business notes and unrecorded collateral in favor of * * * were assigned to the Bank as collateral for this line of credit. The borrower's financial position was inadequate to support this credit and orderly payment was dependent upon SBA payment and/or the minority business performance on the assigned notes. The line had never been reduced and more than a third of the assigned notes were more than a year old. In addition, the examiners reported that many of the loan proceeds were never channeled to the corresponding minority businesses. The ALJ reduced his classifica-
{{4-1-90 p.A-517}}tion to "Substandard" based on eventual SBA funding with some collateral deficiencies. The Board believes the collateral deficiencies to be of major proportion and that any SBA funding forthcoming would be far short of the loan balance. It therefore agrees with the "Doubtful" classification assigned.
DISCUSSION
The ALJ based his "Substandard" classification on the delay of the borrower's funding sources from the SBA and some collateral deficiencies. (Tr. 4623-26; and RPFF 58.8(a)). RPFF 58.8(a)(new) stated that loans to * * * were principally for operating capital for purposes of funding loans pursuant to commitments to minority business enterprises, while * * * awaited funding from the SBA.
The Report of Examination (P.Ex. 17 at 121) indicated that the purpose of the $950M loan was a warehousing line of credit to assist in carrying receivables while awaiting funding from SBA, with repayment expected from assignment of SBA funds and/or payments from loans pledged. (P.Ex. 17 at 121) The examiner did extensive tracing of the loan proceeds and found the following: $150,000 of the proceeds went to renew a note of that amount dated April 7, 1983, (the original note proceeds were paid to * * * also an interest of * * * with loans classified loss), $596,475 went to the ultimate benefit of * * * of * * * by way of a $300,000 extension to * * * and $300,000 to * * * , and $200,000 was deposited into an account of the borrower indicating "escrow for * * * State Bank" with ultimate disposition not determined. (P.Ex. 17 at 124) Eleven loan notes were assigned to the Bank as collateral. The original dates of the notes ranged from July, 1981, to June, 1983. Only one, the note dated April 27, 1983 in the amount of $300,000 to * * * , directly resulted from the warehousing loan. The stale dates on many of the notes raised questions as to the existence of actual SBA commitments to fund the loans. In addition, the examiner pointed out that the total face value of the assigned notes was $906,000 which did not cover the $950,000, advance. Payment terms set out in the assigned notes should have reduced the balances outstanding on the notes, since payment of this debt was to be from SBA funds and/or payments of the loan pledged. (P.Ex. 17 at 126) There was insufficient information to determine if the pledged notes were current or if * * * had used the loan payments for other purposes.
Documentation, financial information and repayment history on the assigned notes was insufficient to determine the value of the underlying collateral. However, it was known that a loan to * * * was classified substandard (PFF 51 Series) and the loan to Mr. * * * , was past due. (P.Ex. 17 at 133)
The certified financial statement, dated December 31, 1982, for * * * showed a significant corporate net worth; however, that net worth was entirely composed of * * * investments and notes receivable from these minority small businesses. Profitability of * * * and its retained earnings had been minimal as of the date of examination. (P.Ex. 17 at 136)
Due to the preponderance of "unknown factors" involved in the line and the nebulous financial condition of the borrower, a doubtful classification was appropriate. The line clearly had greater risk potential than a "Substandard" classified asset.
#61 * * *
| February 4, 1983 | FDIC - | $488,000 Substandard | | September 30, 1983 | FDIC - | $268,000 Substandard | | September 30, 1983 | State - | $268,060 Substandard | | May 18, 1984 | State - | $101,000 Substandard | | ALJ - | None | | Board - | $268,000 Substandard |
SUMMARY
The ALJ did not classify this line because he did not accept the examiners' assessment of the appraisal of the collateral and because the financial statements of the borrowers showed a very liquid position. The Board completely disagrees on both points. The $650,000 appraised value of the dwelling was $200,000 more than the previous appraisal. Considering the nature of the property, a 44% appreciation in only two and one-half years was considered unrealistic, especially since only $180,000 in fire insurance was carried on the property. The September 30, 1982 balance sheet showed $230,000 in cash but either that figure was inaccurate or the borrower's liquidity position had deteriorated since that date because the loan was delinquent from February 6, 1983.
{{4-1-90 p.A-518}}
DISCUSSION
The ALJ based his conclusion not to classify the line on RPFF 61.10 and Tr. 3901-4, 4631-33. RPFF 61.10 indicated that the examiners had second-guessed the fee appraiser and also that the financial statements of * * * showed a very liquid position.
The amount classified was the sum of two separate extensions of credit that were jointly secured by a first mortgage agreement that was modified to increase it to $500,000. The loan file contained an October 22, 1980 appraisal running to the borrower of $450,000 for the dwelling only (80% completed at the time). The Bank obtained an updated appraisal of March 13, 1983 that reflected a value of $650,000 (but it did not provide any breakdown between the land and the dwelling). The file also contained an expired (as of July 14, 1983) fire insurance policy on the dwelling for a value of $180,000. A self-prepared financial statement of the borrower dated September 30, 1982 (P.Ex. 17 at 136) listed the mortgaged property at a value of $400,000. The FDIC examiners believed these documents supported inconsistent valuations for the property. The history of the property indicated that it would have appreciated in value by $200,000, or 44%, in only two and one-half years. The examiners believed that the wide disparity in the available information as to the value of the mortgaged property and the rapid appreciation reflected in the documents raised concerns about the actual value. In an effort to obtain additional insight into the proper valuation for the mortgaged property, the examiners physically viewed it and the neighborhood in which it was located in a "drive-by." The examiners concluded after the drive-by that the $650,000 valuation was high and therefore the loans were only marginally collateralized. The report of examination reflects that the examiner's concerns were discussed with Bank officials who agreed to provide additional evidence as to the value of the mortgaged property (a current fire insurance policy). However, no further documentation was provided.
The borrower's financial condition is discussed in Brief of Exceptions of FDIC to Recommended Decision of ALJ (at pages 63–64). The borrower's property statement ("PS") reflected a highly leveraged position. The ALJ failed to recognize that despite the large cash position displayed in the PS dated September 30, 1982, the $230,000 loan had been delinquent since February 6, 1983, and that an interest payment made during the examination of $11,168 was traced to an account in the name of * * * Corporation in which Mr. * * * reportedly has no interest. Based on the facts available to the examiners during the examination, the Board finds that the "Substandard" classification was warranted.
#62 * * *
| February 4, 1983 | FDIC - | None | | September 30, 1983 | FDIC - | $4,000 Substandard | | September 30, 1983 | State - | $4,060 Substandard | | May 18, 1984 | State - | $4,000 Substandard | | ALJ - | None | | Board - | None |
DISCUSSION
The Board agrees with the ALJ that an adverse classification of this small consumer loan is not warranted. The loan is only one payment delinquent and would not be classified under to the policy governing the uniform classification of consumer debt. The borrower is the son of * * * who have $268,000 of "Substandard" classified debt, but that relationship does not justify adverse classification of this loan.
#63 * * *
| February 4, 1983 | FDIC - | $420,000 Substandard | | September 30, 1983 | FDIC - | $430,000 Substandard, | | | $3,000 Loss | | September 30, 1983 | State - | $432,997 Substandard | | May 18, 1984 | State - | $439,000 Substandard | | ALJ - | None | | Board - | $433,000 Substandard |
SUMMARY
The ALJ decided not to classify any of this debt because (1) at the conclusion of the examination the Bank obtained new collateral consisting of a first mortgage on marina property appraised at $900,000; (2) the borrower's loans declined from $823,000 at the February 1983 examination to $433,000; and (3) the borrower's balance sheet showed acceptable liquidity and net worth. The Board disagrees with the ALJ's conclusions. First, numerous documentation deficiencies undermine the credibility of the support provided by the collateral, which according to a preliminary analysis had an estimated value of $850,000 to $900,000, but that value is necessarily subject to a formal appraisal. Second, the loan reduction came from transferring debt to * * * Corporation, a related company that
{{4-1-90 A-519}}also has adversely classified loans, not from a cash payment. Third, a careful analysis of all available financial statements reveals inconsistencies between statements, a highly illiquid current position and troubling questions concerning net worth. However, the Board does not find support in the record to justify classifying the $3,000 overdraft more severely than the rest of the debt.
DISCUSSION
The ALJ's decision not to classify the line was based on RPFF 63.11(a)(new) which indicates that the Bank obtained additional collateral in the form of a first lien on a marina facility appraised at $900,000; and RPFF 63.18(a)(new) which states that the borrower had loans outstanding of $823,000 as of the February, 1983 examination that were reduced to approximately $433,000 by the September, 1983 examination; and RPFF 63.19 which indicates that in addition to the added security, the borrower's current balance sheet showed acceptable liquidity and net worth. The ALJ also references the hearing transcript at pages 4629-31 and Respondents' Exhibit 63.1. The record shows that the FDIC examiners gave considerable deference to the assignment of a $425,000 unrecorded mortgage note of * * * to * * * , since the line had originally been considered $105,000 "Substandard" and $328,000 "Loss." However, documentation deficiencies were noted and cited by the examiners in regard to the note assignment. (P.Ex. 17 at 140) In addition, there was no loan supporting credit information on * * * in the loan file and the mortgage note was also assigned to secure a $300,000 note from * * * that in turn was assigned to secure the $950,000 debt of * * * Corporation at the Bank. (P.Ex. 17 at 122) The line was classified in the amount of $420,000 at the February, 1983 examination when total indebtedness was $823,065. While it is true that the balance at the September, 1983 examination of $433,000 shows significant reduction, the ALJ failed to recognize that the two $150,000 notes were not paid out, but taken over by * * * Corporation (an interest of Mr. * * *) and were part of the $950,0000 extension in the name of * * * (P.Ex. 17 at 122) In fact, the examiner pointed out that the * * * account was overdrawn in the amount of $475,188 the day before * * * received a $600,000 advance from * * * (P.Ex. 17 at 124) Therefore, rather than receiving a reduction in the line, as claimed by the Bank, the debt was merely transferred to another related company of the guarantor, * * *.
Finally, the ALJ relied on the Bank's judgment that the current property statement as of September 30, 1983, obtained on December 15, 1983, showed acceptable liquidity and net worth. The PS showed cash of $15,000 in relation to total assets of $1,395,000 (P.Ex. 17 at 141); the accounts receivable from * * * and * * * in the amounts of $425,000 and $650,000, respectively, were not considered current assets for purposes of analysis; therefore, the liquidity position of the company was far from acceptable. In addition, the self-prepared statement had no additional factual support for the two receivables which represented $1,075,000 of total assets; therefore, the stated net worth of the company could not be considered acceptable. In addition, the examiner found that there was considerable change in the asset structure and liability mix from the CPA-prepared statement dated March 31, 1982 (Id.). Without profit and loss information on the company and additional information on the changes in the company statement, the figures were meaningless for purposes of analysis.
There does not appear to be ample support provided in the Report of Examination or the record for treatment of the unsecured * * * overdraft of $3,000 as loss. Therefore, the Board finds that the entire line should have been afforded a "Substandard" classification.
#64 * * *
| February 4, 1983 | FDIC - | $275,000 Substandard | | September 30, 1983 | FDIC - | $358,000 Substandard, | | | $18,000 Loss | | September 30, 1983 | State - | $375,602 Substandard | | May 18, 1984, 1984 | State - | $423,000 Substandard | | ALJ - | $376,000 Substandard | | Board - | $376,000 Substandard |
SUMMARY
The ALJ disallowed an $18,000 "Loss" classification on the portion of the loan that represented unpaid interest included in the loan balance because of the value of the collateral securing the loan. The Board agrees that the collateral appears adequate enough to substantiate a "Substandard" classification.
{{4-1-90 p.A-520}}
DISCUSSION
The ALJ agreed with the "Substandard" classification based upon the lack of working capital and the slow turnover of receivables, but took exception to classification of the capitalized interest as loss because of the collateral pledged as security.
The line was secured with company accounts receivable, inventory and equipment. The property statement as of July 31, 1983 (P.Ex. 17 at 143) indicated that the major value was in the inventory, property, plant and equipment. While these assets had a lower collateral value than trade receivables of similar amounts, the line would have been adequately secured, assuming that the inventory and equipment could be sold. The examiner's classification of the capitalized interest as "Loss" actually appears to be an accounting adjustment rather than a credit classification. Although the practice of capitalizing interest could be deemed an unsafe and unsound banking practice due to the increased exposure to the Bank in the event of default, normal procedure would be to classify the interest no worse than the most severe classification of the remainder of the debt. The Board upholds the ALJ's classification.
#65 * * *
| February 4, 1983 | FDIC - | None classified | | September 30, 1983 | FDIC - | $448,000 Substandard | | | and $39,000 Loss | | September 30, 1983 | State - | $487,335 Substandard | | May 18, 1984 | State - | $487,000 Substandard | | ALJ - | $487,000 Substandard | | Board - | $487,000 Substandard |
SUMMARY
The ALJ rejected the "Loss" classification on the $39,000 portion of the debt that constituted unpaid interest. The Board agrees with the ALJ's treatment of the entire debt as "Substandard" since the estimated liquidation value of the collateral appears sufficient to preclude a "Loss" classification.
DISCUSSION
The amount of the loan classified "Loss" represented the amount of interest that had been capitalized and added to the loan balance for both * * * and * * *. The two companies were related and both debts were guaranteed by * * * and * * *.
The Bank believed the ultimate collection of the line would come from foreclosure on the real property and the sale of gems held as collateral. The portion classified as "Loss" represented an accounting adjustment rather than a credit judgment. While it would have been prudent for the Bank to have placed the line on non-accrual status and not included the interest in its income, the classification of the portion of the total debt which was used to pay interest in a more severe manner than the remainder of the line was not supported by the record.
#70 * * *
| February 4, 1983 | FDIC - | $164,000 Substandard, | | | $10,000 Loss | | September 30, 1983 | FDIC - | $199,000 Substandard, | | | $46,000 Loss | | September 30, 1983 | State - | Not classified | | May 18, 1984 | State - | Not listed | | ALJ - | $245,000 Substandard | | Board - | $245,000 Substandard |
SUMMARY
The examiner classified as "Substandard" the $199,000 portion of the loan that constituted loan proceeds paid to the borrower. The $46,000 portion of the loan comprised of unpaid interest and a loan extension fee was classified "Loss". The examiner based the split classification on collateral consisting of second mortgages on two properties with combined equity of $158,000, an amount inadequate to protect the entire debt, and the undesirable and objectionable banking practice of including in its income the uncollected extension fee and interest on the loan. The ALJ classified as "Substandard" the entire $245,000 balance because of poor payment performance. The Board agrees with the ALJ because the degree of non-performance was sufficient to justify a "Substandard" classification.
DISCUSSION
The Report of Examination (at page 153) indicated that a substantial amount of interest was capitalized and that the letter of credit extension fee was also capitalized. The value of the collateral serving the loan was not sufficient to cover the capitalized interest and fees and that amount was classified "Loss" in order to adjust the Bank's income for these amounts included but not collected in cash. The ALJ stated that a "Substandard" classification was justified by the past performance on the debt. However, the ALJ felt the "Loss" classification of $46,000 for the capitalization of interest was not justified and was in reality a punitive measure. While the Board does not agree that the "Loss" classification was a
{{4-1-90 p.A-521}}"punitive measure" the classification does appear to be an accounting adjustment rather than based on a credit judgment.
The examiner stated (P.Ex. 17 at 153) that the line was not sufficiently protected by assigned collateral. However, he also noted that there had been some performance on the loan noted in the form of a $120M principal reduction during the February, 1983 examination that led him to classify the unsecured portion of the line as "Substandard". The capitalized interest was part of the unsecured portion of the line and should not have been treated as being a greater risk than the remainder of the unsecured portion of the line.
#75 * * *
| February 4, 1983 | FDIC - | $750,000 Substandard | | September 30, 1983 | FDIC - | $7,000 Substandard | | September 30, 1983 | State - | $7,501 Substandard | | May 18, 1984 | State - | $7,000 Substandard | | ALJ - | None | | Board - | None |
SUMMARY
The examiner classified $7,000 "Substandard" due to the questionable source of six payments made on September 22, 1983. The ALJ did not classify and the Board agrees. The loan was current and appeared to be secured by the title to an automobile.
DISCUSSION
The balance classified represented the net payoff of an installment loan secured by a 1983 Toyota station wagon with a purchase price of $13,600. Six payments had been made, bringing the loan to a current status on September 22, 1983 (prior to examination date). The payments came from the checking account of * * *. The examiner apparently had some question as to whether the company was the same as the company which was the source of the payments. The line of * * * was not classified (although originally scheduled as "Substandard") due to the repayment of their $1,200,000 line with proceeds from * * * Company. The $7,000 automobile loan was current and appears adequately secured. Therefore, the "Substandard" classification does not appear justified.
#76 * * *
| February 4, 1983 | FDIC - | Not indebted to Bank | | September 30, 1983 | FDIC - | $70,000 Substandard | | September 30, 1983 | State - | $70,000 Substandard | | May 18, 1984 | State - | $65,000 Substandard | | ALJ - | None | | Board - | None |
SUMMARY
The ALJ did not classify this debt because of a $150,000 note assigned as collateral, the borrower's satisfactory performance on other loans and his payment history on this loan which originated at $100,000. The examiner classified $70,000 "Substandard" partially because the assigned note from * * * had little, if any, collateral value as a result of the maker's weak financial statement and also because of * * *'s questionable financial strength substantially linked to the same company. The Board agrees with the ALJ not to classify since substantial performance had occurred and there appeared to be sufficient cash flow to permit servicing of the debt.
DISCUSSION
The loan originated at $100,000 on April 7, 1983 and was renewed in the amount of $75,000 on August 5, 1983. The renewal note called for monthly payments of $5,000 plus interest with the first payment due October 5, 1983. The first payment was made during the examination and thus the balance classified was $70,000. RPFF 76.8(new) indicated that the line had been further reduced to a balance of $65,000. The value of the note assigned to the debt by * * * from the * * * in the amount of $150,000 may have had limited, if any, value based on the February 28, 1983 financial statement of the company. It was further noted that the financial strength of * * * was also highly dependent on the strength of the company since $1,000,000 of his own assets were in notes receivable and investment in that company, amounting to half of his net worth. (P.Ex. 17 at 160)
Even though the financial strength of the company, and therefore the collateral note, was weak as depicted in the financial statements, the borrower had made significant reductions since the original date of April 7, 1983 and payments continued during the examination. There was no indication that the borrower was utilizing other borrowed
{{4-1-90 p.A-522}}funds to pay the debt and it appeared that he had sufficient cash flow to service the required monthly amortization. The Board agrees with the ALJ in this instance.
#77 * * *
| February 4, 1983 | FDIC - | $100,000 Substandard | | September 30, 1983 | FDIC - | $30,000 Substandard | | September 30, 1983 | State - | $30,000 Substandard | | May 18, 1984 | State - | $30,000 Substandard | | ALJ - | None | | Board - | $30,000 Substandard |
SUMMARY
The ALJ rejected the FDIC's classification because the borrower had a net worth of $7 million. The Board agrees with the examiner's $30,000 "Substandard" classification. The only reduction in the debt since its inception was from the sale of collateral leaving the remaining unpaid portion of the loan totally unsecured. Analysis of * * *'s balance sheet revealed questionable support since his major assets were in receivables and shares of closely held companies that also have loans from the Bank which are classified "Substandard".
DISCUSSION
The loan was unsecured as a result of the sale of stock of * * * Corporation which had been held as collateral. The payment from the sale of the collateral was the only reduction in the debt since its inception. The ALJ stated that the "Substandard" classification was not warranted since the borrower had a net worth of $7 million. (PFF 77.15) In order properly to analyze the financial information the ALJ should have gone one more step and looked at the assets that represented the major portion of that $7 million net worth. In the case of Mr. * * * the major assets on his property statement dated July 1, 1983 (P.Ex. 17 at 162) were receivables and stocks of closely held companies, i.e. * * *; * * * (wholly-owned subsidiary of * * *) and * * * Each of those companies also had adversely classified loans which indicated a higher than normal degree of risk in these investments.
The line should be considered "Substandard" until such time as the borrower demonstrates an ability to make reductions on the debt through normal operations or provides sufficient collateral to protect the Bank. Sale of the collateral was considered the exhaustion of a secondary source of repayment leaving a deficiency balance that was void of collateral protection.
#78 * * *
| February 4, 1983 | FDIC - | $20,000 Substandard | | September 30, 1983 | FDIC - | $40,000 Substandard | | September 30, 1983 | State - | $40,000 Substandard | | May 18, 1984 | State - | $40,000 Substandard | | ALJ - | None | | Board - | $40,000 Substandard |
The ALJ did not classify this loan because automobiles pledged as collateral were valued at $40,000 and a guarantor with a net worth exceeding $7 million. The examiner classified $40,000 "Substandard" because one automobile was confiscated by the IRS leaving an estimated residual value in the remaining two automobiles of approximately $20,000. The borrower's performance had been unsatisfactory and its financial condition was weak. Loans to guarantor * * * were also classified "Substandard". The Board finds the "Substanddard" classifications to be justified.
#79 * * *
| February 4, 1983 | FDIC - | $195,000 Substandard | | September 30, 1983 | FDIC - | $180,000 Substandard | | September 30, 1983 | State - | $180,000 Substandard | | May 18, 1984 | State - | $180,000 Substandard | | ALJ - | None | | Board - | $180,000 Substandard |
SUMMARY
The ALJ did not classify this line of credit because of the existence of adequate collateral. The examiner classified $180,000 "Substandard" because the collateral lacked liquidity, the company was financially weak and loan repayment terms were not extremely liberal. The Board agrees with the "Substandard" classification.
DISCUSSION
The debt was part of the "* * * Group" and comments in regard to * * * and * * * (PFF 77 and 78 Series) also relate to * * *. The loan lacked a proper repayment schedule, the company was financially weak when analyzed in conjunction with * * *, and collateral value was limited by the lack of an existing market for it. P. Exceptions (at 72-73) adequately discuss the credit weaknesses and we will not restate them here. Those weaknesses fully support the "Substandard" classification.
{{4-1-90 p.A-523}}
#83 * * *
| February 4, 1983 | FDIC - | Not indebted to Bank | | September 30, 1983 | FDIC - | $117,000 Substandard | | | $42,000 Loss | | September 30, 1983 | State - | $155,000 Substandard | | May 18, 1984 | State - | $155,000 Substandard | | ALJ - | $159,000 Substandard | | Board - | $159,000 Substandard |
SUMMARY
The examiner assigned a "Loss" classification to the amount representing interest which was not substantiated by credit considerations. The ALJ classified the entire debt "Substandard based on collateral protection. The Board agrees with the ALJ because the examiner gave credit for purported additional collateral that is not formally pledged to the debt. Even so, realizable equity in both the primary and purported additional collateral may be less than the amount of the debt. This, coupled with documentation deficiencies and unsatisfactory performance, indicates a high risk loan.
DISCUSSION
The "Loss" classification assigned by the examiner to the $42,000 portion of the line used to pay (capitalize) interest was in reality an accounting adjustment rather than a credit quality judgment. However, the inability of the borrower to adequately service the debt was a significant credit factor.
The ALJ was of the view that the line was adequately collateralized. The primary collateral was a second lien position in a condominium unit with equity of $56,000. In order to realize this value, the prior lien of $219,000 and interest would have to be paid out. The Bank refers to the existence of additional collateral consisting of real estate at * * *. However, it was difficult to justify use of that property as collateral since * * * , its owner, was not personally liable on the * * * debt and the property was not pledged to the debt. In addition, the property had a prior lien with a pay-off balance of $118,933 (RPFF 83.7) and the reappraisal by * * * on June 1, 1981 (P.Ex. 17 at 171) at $300,000 was considered to be inflated. The $120,000 increase in appraised value over the original appraisal dated March, 1979, represented an extraordinary 66% increase in the appraised value in slightly over two years. A classification more severe than "Substandard" was averted only by taking into consideration the purported additional collateral.
#85 * * *
| February 4, 1983 | FDIC - | Not classified | | September 30, 1983 | FDIC - | $51,000 Substandard | | | $35,000 Loss | | September 30, 1983 | State - | $86,019 Substandard | | May 18, 1984 | State - | $87,000 Substandard | | ALJ - | $86,000 Substandard | | Board - | $86,000 Substandard |
SUMMARY
The examiner classified as "Loss" the $35,000 portion of the line representing unpaid interest. Adding interest to debt principal in an undesirable banking practice but the "Loss" classification was not substantiated by the credit information presented. The Board agrees with the ALJ's finding of "Substandard for the entire $86,000 debt.
DISCUSSION
The amount classified "Loss" represented the capitalization of interest on the lines of * * * and * * *. While this practice is considered to be undesirable, the classification was in reality an accounting adjustment rather than a credit quality judgment. The classification comments did not indicate evidence that the portion of the line used to cover the interest due had any greater exposure than the remainder.
#86 * * *
| February 4, 1983 | FDIC - | $240,000 Substandard | | | $9,000 Loss | | September 30, 1983 | FDIC - | $232,000 Substandard | | | $8,000 Loss | | September 30, 1983 | State - | $239,850 Substandard | | May 18, 1984 | State - | $232,000 Substandard | | ALJ - | $240,000 Substandard | | Board - | $232,000 Substandard | | | $8,000 Loss |
There was disagreement only as to the $8,000 * * * overdraft portion of the line; the examiner classified the overdraft "Loss" while the ALJ classified it "Substandard." The remainder of the line was secured by real estate but the overdraft portion is totally unsecured and overdue from June 1981. It is not a bankable asset and that fact was ultimately recognized by the Bank which charged it off in April 1984. The Board agrees with the examiner that $8,000 should be classified "Loss" and the remainder "Substandard."
{{4-1-90 p.A-524}}
#89 * * *
| February 4, 1983 | FDIC - | Not indebted to Bank | | September 30, 1983 | FDIC - | $459,000 classified | | | Substandard | | September 30, 1983 | State - | none classified | | May 18, 1984 | State - | $100,000 classified | | | Substandard | | ALJ - | none classified | | Board - | $459,000 classified | | | Substandard |
SUMMARY
This debt included $100,000 extended to pay off a loan from another bank and $359,000 to purchase, renovate and pay the interest and the loan fees for commercial property. No principal reductions were ever made. The collateral held was a real estate sales contract of questionable value and a mortgage covering the purchased property which was appraised at $530,000. The Bank's mortgage lien status was questionable. The guarantors' net worths were highly suspect based on inflated asset values and questionable asset interests. A "Substandard" classification was warranted based on the absence of interest and principal payments on the loan, the uncertainty surrounding the value of the collateral, limited financial support available from the guarantors and the uncertain prospects for future loan payments.
DISCUSSION
This classification concerned two separate lines to the same borrower. A $100,000 loan was originally extended in May 1983, to pay off another bank. An expired real estate sales contract was assigned as collateral and the debt was guaranteed by * * *. (P.Ex. 17 at 177) A similar contract with a different buyer and a February 15, 1984 expiration date was acquired near the close of the examination. However, that contract was not properly assigned to the Bank. (PFF 89.3) By letter dated December 13, 1983, the Bank's attorney indicated he had documents showing that the Bank's interests were fully protected. The ALJ declassified the loan based on the sufficiency of the collateral and the * * * guaranty. (RPFF 89.12) The Board is of the opinion that a "Substandard" classification was totally justified by (1) the questionable performance of the sales contract dated December 12, 1983, and (2) the guarantors' obviously inflated net worth of $3,100,000. (P.Ex. 17 at 177)
The second portion of this line concerned two notes totaling $359,000 used to purchase and renovate an apartment. A $400,000 real estate mortgage on property appraised at $530,000 was held as collateral. However, a title search predating the recording of the mortgage disclosed over $150,000 in prior tax liens. The Bank's present lien status was unknown. The Bank also held a note of * * * and * * * as additional collateral. (P.Ex. 17 at 177-178)
The ALJ declassified these loans based on purported December 16, 1983, pay out. (Tr. 3915; R.Ex. 89.1) The pay out date was supported by a handwritten Loan Payment Card (R.Ex. 89.1) but questions are raised by the * * * testimony that the pay off occurred on the day before the examiners left the Bank (Tr. 3915) and Examiner * * * testimony that "I believe it was reduced $100,000, I'm not sure of the date." (Tr. 1317) Since the FDIC examiners had given substantial credit for collateral received the last day of the examination in the case of other loans (See, e.g., * * * , Series #94 through #103), it appears the examiners were not presented with bona fide evidence of pay out before they left the Bank.
A "Substandard" classification of the $359,000 was also warranted based on (1) the questionable lien status of the real estate collateral, (2) the existence of prior tax liens (although later negated by P.Ex. 89.8), and (3) the limited value of the note of Mrs. * * * and * * * as collateral. Although not discussed by the examiners, the $7,273,000 net worth shown on the December 12, 1982 financial statement of Mr. and Mrs. * * * had limited value since Mr. * * * was not liable on the collateral note. (PFF 89.7; RPFF 89.7) The Brief of Exceptions, page 76, addresses only the pay out of the second portion as ". . . after the conclusions of the examination date."
The subsequent pay off of the loan has no bearing on the validity of the "Substandard" classification as of the close of the examination.
#90 * * *
| February 4, 1983 | FDIC - | $99,000 classified | | | Substandard | | | $14,000 classified | | | Doubtful | | | $11,000 classified Loss | | September 30, 1983 | FDIC - | $74,000 classified | | | Substandard | | | $30,000 classified Loss |
{{4-1-90 p.A-525}}
| September 30, 1983 | State - | $99,000 classified | | | Substandard | | | $4,709 classified Loss | | May 18, 1984 | State - | $99,000 classified | | | Substandard | | ALJ - | $99,000 classified | | | Substandard | | | $5,000 classified Loss | | Board - | $74,000 classified | | | Substandard | | | $30,000 classified Loss |
SUMMARY
The debt was a $4,500 deficiency balance remaining after the sale of collateral, and a $99,200 note collateralized by a junior mortgage lien on the borrower's residence on which the first lien holder was in the process of foreclosing. The classification was based on a March 1983 real estate appraisal, from which prior lien balances and the costs of liquidating the collateral were deducted. A new appraisal received in the last days of the examination reflected an inordinate amount of appreciation which was believed not to accurately reflect the likely market conditions in the event of a forced liquidation sale.
DISCUSSION
This line consisted of a junior lien on real estate and a deficiency balance on an auto loan. The ALJ reduced the "Loss" classification to include only the deficiency balance, after taking into account the new $150,000 real estate appraisal dated December 12, 1983. (R.Ex. 90.4) The new appraisal was received one day before the examiners left the Bank. The 20% appreciation in the value of the property reflected in the new appraisal over the appraisal six months earlier on March 18, 1983, raised questions as to the accuracy of the new appraisal. The examiner's position that "[s]ince this property is being foreclosed the market will determine the actual value of the Bank's junior lien mortgage . . ." was reasonable. The FDIC alleged that the ALJ failed to consider the prior liens and the acquisition and the inherent costs involved in liquidating the collateral in determining his classification.
#94 * * *
| February 4, 1983 | FDIC - | not indebted to Bank | | September 30, 1983 | FDIC - | $402,000 classified | | | Substandard | | September 30, 1983 | State - | $402,454 classified | | | Substandard | | May 18, 1984 | State - | not listed | | ALJ - | none classified | | Board - | $402,000 classified | | | Substandard |
The ALJ declined to accept the examiners' "Substandard" classification of the loan stating that the "borrower has cash in excess of the loan balance and the loan is well collateralized." The Board finds that the evidence does not support either conclusion.
First, the ALJ's conclusion about the cash position of * * * was apparently based on an unverified cash statement prepared by the borrower itself. That statement was dated March 5, 1983, more than six months prior to the examination. On September 23, 1983, the date of the examination, the checking account of * * * was overdrawn by $2,454. In the absence of timely contrary information, the existence of the overdraft adequately supported the examiner's conclusion that the borrower's cash position was weak at the time of the examination.
Collateral for the loan was an assigned note of * * *. The assigned note is secured by a fourth mortgage on real estate. The three senior mortgages established a total claim of $8,560,000 against the property, which exceeded the amount for which * * * purchased it by $513,000. (P.Ex. 17 at 185-86) The Bank asserted that the underlying property may be developed in the near future. The Board agrees that development could enhance the value of the underlying collateral but there was insufficient evidence in the record to establish a specific enhanced value or, indeed, to determine when or whether development of the property would in fact occur.
The Board finds that the record supports the classification of "Substandard."
#96 * * *
| February 4, 1983 | FDIC - | $125,000 classified | | | Substandard ($40,000 of | | | which was delinquent) | | September 30, 1983 | FDIC - | $40,000 classified Loss | | September 30, 1983 | State - | $40,000 classified | | | Substandard | | May 18, 1984 | State - | not listed | | ALJ - | $40,000 classified | | | Substandard | | Board - | $40,000 classified Loss |
The ALJ concluded that the $40,000 loan to * * * should be classified as "Substandard" rather than as "Loss." He based his conclusion on the borrower's employment, assets, "demonstrated performance capability," and assertions about Mr. * * * previ-
{{4-1-90 p.A-526}}ous financial statements and a possible partial reduction in his indebtedness after the September 30, 1983 examination.
We find that the ALJ did not have an adequate factual basis for disagreeing with the FDIC examiner's classification of the loan as "Loss." Mr. * * * income and other assets are inadequate to support this debt. His performance can be characterized as spotty at best.
Mr. * * * may have been financially stronger in the past, but out-of-date financial statements are irrelevant to the current status of this loan. Mr. * * * conceded that the loan was unsecured. (Tr. 3898) The record reflects that Mr. * * * had not been able to keep current with his debt obligations. This loan was the third renewal of a prior note and was already delinquent at the time of the February 4, 1983 FDIC examination. Mr. * * * admitted net worth was only $62,700 on $230,900 in total assets which were mostly illiquid. His annual income was only $30,200. There was no basis in the record for the Bank to expect repayment of this loan. We find that the loan was properly classified as "Loss."
#99 * * *
| February 4, 1983 | FDIC - | (See * * *.) | | September 30, 1983 | FDIC - | $78,000 classified | | | Substandard ($264,000 | | | delinquent) | | September 30, 1983 | State - | none classified | | May 18, 1984 | State - | not listed | | ALJ - | none classified | | Board - | $78,000 classified | | | Substandard |
The ALJ declined to accept the examiner's classification of $78,000 of this loan as "Substandard" because he concluded that a substantial portion of the debt was paid in September, 1983, the property was appraised at $4 million and the entire debt was eventually paid in full.
Considering the facts as they existed at the time of the examination, however, the Boards finds that the loan was properly classified as "Substandard." In fact, the record raised so many questions that a larger portion of the delinquent loan could have been classified. Careful examination of the loan repayment card (R.Ex. 99.1), indicated that $18,000 of the principal was paid during the September, 1983 examination. The balance of the $31,248 which the Bank received during September, 1983, was overdue interest. This debt was formerly in the name of * * * Corporation. The * * * note was the second renewal of a note dated November 9, 1981 in the same amount. It had been overdue since its maturity date of May 9, 1983. Collateral for the debt were two assigned notes and an assigned mortgage in the total amount of $264,000. The assigned mortgage was a leasehold estate on 72 condominium units. There was no evidence of title insurance and there was ongoing litigation relating to land leases. It was impossible to determine the value of the Bank's financial interest in the collateral because of the absence of an independent appraisal of the underlying collateral in the loan file at the time of examination. (PFF 99.8, RPFF 99.8) Although the examiner did not rely on it, the Bank's Mortgage Deed dated November 15, 1979, (R.Ex. 99.1) indicated that three senior mortgages made the Bank's partial interest junior to those three prior liens. Even if the value of the collateral was $4,200,000, the Bank had only a fractional interest in it.
Thus classification of $78,000 of the loan substandard was supported by the uncertainties of the land lease litigation and apparent absence of title insurance, (Tr. 1687-1703), the fact that repayment depended on the sale of the 72 condominium units and the lack of a formal appraisal of the collateral's value. The examiners took into account the sale of some units by reducing the portion of the loan classified and by reducing the classification from "Doubtful" to "Substandard." The fact that more of the units apparently were sold and the loan was repaid in full after the close of the examination is relevant only to compliance with the formal order. The Board is of the opinion that these events cannot be considered as a basis for not classifying the loan.
#100 * * *
| February 4, 1983 | FDIC - | $133,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $41,000 classified | | | Substandard | | September 30, 1983 | State - | $41,379 classified | | | Substandard | | May 18, 1984 | State - | not listed | | ALJ - | none classified | | Board - | none classified |
We agree with the ALJ that the loan need not have been adversely classified. The loan file was not as complete as it should have been. However, the note was apparently secured by 20 lots in an active * * * development. It was evident at the time of the examination that the original $260,000 note dated June 15, 1983 had been paid to an
{{4-1-90 p.A-527}}amount less than $45,000 by September, 1983. (PFF, 100.3, RPFF 100.3(a)) Although there was no independent appraisal of the lots, there was a large cushion between the amount of the debt ($44,000) and the alleged value of the assigned collateral notes ($174,000). Considering the apparent value of the collateral and the borrower's record of adequate performance, (P.Ex. 17 at 189; Tr. 4626-27), the Board agrees that adverse classification was unjustified.
#102 26-12 * * *
| February 4, 1983 | FDIC - | $215,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $211,000 classified | | | Substandard ($13,000, | | | delinquent more than | | | six months) | | September 30, 1983 | State - | $211,414 classified | | | Substandard ($12,811, | | | delinquent more than | | | six months) | | May 18, 1984 | State - | not listed | | ALJ - | none classified | | Board - | $211,000 classified | | | Substandard |
This debt, totaling $211,000, consisted of five notes and an overdrawn checking account. Contrary to the ALJ, the Board finds that classification of the debt as "Substandard" was justified.
The ALJ based his finding on the payment history and allegation of ample collateral. The evidence is to the contrary. Two assigned notes (one for $100,000 and one for $50,000) from * * * provided collateral for part of the loan. However, only the $100,000 assigned note had been performing. (P.Ex. 17 at 194) There was no other payment history on this $100,000 debt except the admission that Mr. * * * obtained a new loan from the Bank to pay some interest due on the * * * Corporation debt. (PFF 102.19; RPFF 102.19; P.Ex. 17 at 194) In addition, payments on the $50,000 assigned note were apparently made directly to Mr. * * * without the Bank's knowledge. (P.Ex. 17 at 194) The ALJ cites no evidence in the record establishing that * * * Corporation had the ability to repay the debt by any means other than by sale of the property and collection of the assigned notes and mortgages which collateralized the debt.
The Board is of the opinion that the debt should be classified "Substandard" because it was supported only by collateral and no other identifiable means to repay the debt.
#103 * * *
| February 4, 1983 | FDIC - | none classified | | September 30, 1983 | FDIC - | $10,000 classified Loss, | | | ($10,000 delinquent | | | more than 6 mos.) | | September 30, 1983 | State - | $10,429 classified Loss, | | | ($10,429 as delinquent | | | more than 6 mos.) | | May 18, 1984 | State - | not listed | | ALJ - | $10,000 classified | | | Substandard | | Board - | $10,000 classified Loss |
This debt originated as a $10,429 overdraft on the debtor's checking account on February 1, 1983 and increased to $26,243 during the examination. The ALJ found that the classified * * * debt should have been considered as "Substandard" rather than "Loss" because of a new appraisal on the collateral underlying Mr. * * * loans. The new appraisal was relied on by the examiner to upgrade the other * * * Group loans which had initially received classifications even more adverse than the final September, 1983 classifications, but not this overdraft. The Board disagrees with the ALJ.
Presumably the ALJ was relying on the new $1,000,000 appraisal of units 2207 and 2208 of the * * *.;(P.Ex. 17 at 194) This appraisal did not enhance the * * * Incorporated debt because the new mortgage on it did not explicitly collateralize that debt. It only collateralized the debts of * * * and * * *. (P.Ex. 17 at 194) Moreover, there were prior liens on the units for $628,000 of debt leaving only $372,000 to collateralize total debt of $405,110 which was specified in the new mortgage. The new appraisal, then, provided no real basis for improving the loan classification.
The most recent financial statement of * * * in the bank's files at the time of the examination did not reflect any interest in * * *. The financial statement of * * * , dated December 31, 1981 was too old to be relevant at the time of the September 30, 1983 examination.
The $10,429 overdraft originated nearly eight months prior to the examination, and then nearly tripled. The Board finds that based on the record a classification of $10,000 as "Loss" was entirely justified and upholds the classification.
#107 * * *
| February 4, 1983 | FDIC - | $22,000 classified | | | Substandard |
{{4-1-90 p.A-528}}
| September 30, 1983 | FDIC - | $137,000 classified | | | Substandard $29,000 | | | classified Loss | | September 30, 1983 | State - | none classified | | May 18, 1984 | State - | $183,000 classified | | | Substandard | | ALJ - | $166,000 classified | | | Substandard | | Board - | $137,000 classified | | | Substandard $29,000 as | | | Loss |
The record clearly reflects that these loans were very poor performers. The total debt was $166,000. The Bank classified the entire amount as "Substandard." The FDIC examiner classified $29,000 as "Loss" and $137,000 as "Substandard." The ALJ based his opinion on an assertion that collateral values were higher than the FDIC report indicated. However, the Boards finds no support in the record for this conclusion. The examiner did not challenge the Bank's appraised values for the collateral. He classified as "Loss" only that portion of the loan that exceeded the value of the collateral after the estimated expenses of foreclosing on the loan and selling the real estate collateral for the loan were deducted.
The Board agrees that the estimated expenses of foreclosure and sale of the collateral should be deducted from the expected proceeds. It, therefore, finds that the amount by which the net sale proceeds exceeds the debt, $29,000, was properly classified as "Loss."
Two properties were assigned as collateral for these loans. One was 2.08 acres of improved property appraised in October, 1982 at $150,000.59The second was a townhouse valued at $80,000. After other loan lines were accounted for, the Bank's equity interest in the unimproved property was $108,000 and its equity interest in the townhouse was $44,000. (P.Ex. 17 at 200)
The Board believes that a 10% reduction in equity value from $152,000 to $137,000 to cover expenses was reasonable. Contrary to the assertion of the Bank in RPFF 107.8, this 10% figure is not merely an estimate of the real estate agent's commission. The Examination Report plainly states that the 10% deduction was for "real estate commissions, attorneys' fees etc." (P.Ex. 17 at 199) In fact, the 10% figure probably understates the likely cost of liquidating, the collateral. Accordingly, it was properly deducted from the Bank's alleged equity to determine how much of the loan should be classified as "Loss."
#108 * * *
| February 4, 1983 | FDIC - | $9,000 classified | | | Substandard ($10,000 | | | delinquent 30 days-six | | | months). | | September 30, 1983 | FDIC - | $4,000 classified | | | Substandard $6,000 | | | classified Loss | | September 30, 1983 | State - | $9,856 classified | | | Substandard | | May 18, 1984 | State - | $10,000 classified | | | Substandard | | ALJ - | $4,500 classified Loss | | | $5,500 classified | | | Substandard | | Board - | $6,000 classified Loss | | | $4,000 classified | | | Substandard |
This $10,000 debt consisted of a non-performing automobile loan and an overdrawn checking account. There was no dispute that the amount by which the debt exceeded the value of the collateral (a 1980 Chevrolet station wagon) should have been classified as "Loss" and the balance "Substandard." The ALJ accepted the Bank's assertion that the NADA Official Used Car Guide (R.Ex. 108.2) retail value of $5,500 should be the basis for the classification determination. The Board disagrees. The Bank ordinarily would not net full retail value for the car. It would incur expenses connected with repossessing the vehicle, repairing it if necessary, preparing it for sale, and selling it. Moreover there was no evidence in the record as to the current condition or mileage of the vehicle. Therefore, the Board finds that it was reasonable for the examiner to estimate that the Bank would net only $4,000 for the vehicle and to classify the balance of the debt as "Loss."
#109 * * *
| February 4, 1983 | FDIC - | not indebted to Bank | | September 30, 1983 | FDIC - | $4000 classified Loss | | September 30, 1983 | State - | $4209 classified | | | Substandard | | May 18, 1984 | State - | $9000 classified | | | Substandard | | ALJ - | $4000 classified | | | Substandard | | Board - | $4000 classified Loss |
This $4,000 debt was unsecured. It was partially used to cover an overdraft of a * * * Group company and partially to cover personal investments. (P.Ex. 17 at 202) The Bank conceded that the debt was "Sustandard" (RPFF 109.6), and the ALJ classi
59The same property was appraised at $110,000 just six months earlier. The apparent 36% increase in appraised value in such a short time would have been grounds for some discounting of the appraisal by the examiner, but he did not do so. His estimate of the Bank's equity assumes the $150,000 appraisal is accurate.
{{4-1-90 p.A-529}}fied it as "Substandard." The FDIC examiner classified it as "Loss." The Board agrees with the examiner's classification.
The ALJ based his conclusion on assertions that no performance problem was noted and the borrower's net worth was sufficient to cover this loan. We find no support in the record for either assertion. Performance had not been adequate and the loan became overdue during the September 30, 1983 FDIC examination. The Bank conceded that the loan had been subjected to renegotiation and an extension. (RPFF 109.6) The Borrower's net worth was apparently hopelessly overstated. For example, the property statement of * * * (in which Mr. * * * was a partner) reflected a deficit partnership investment of $8,100, with total debts of $1,740,400, in contrast to Mr. * * * alleged $600,000 valuation for his 50% interest in the partnership. (PFF 109.4; RPFF 109.4) Moreover, Mr. * * * guaranteed or was directly obligated for debts totaling some $845,000 for * * * Group entities. (P.Ex. 17 at 202-10)
The Board finds and the record adequately supports the fact that this $4,000 was properly classified as "Loss."
#110 * * *
| February 4, 1983 | FDIC - | $264,000 classified | | | Substandard ($54,000 | | | delinquent more than | | | six months) | | September 30, 1983 | FDIC - | $360,000 classified | | | Substandard $6000 | | | classified Loss | | September 30, 1983 | State - | $360,000 classified | | | Substandard $5625 | | | classified Loss | | May 18, 1984 | State - | not listed | | ALJ - | $366,000 classified | | | Substandard | | Board - | $360,000 classified | | | Substandard $6000 | | | classified Loss |
The $6,000 classified as "Loss" by the FDIC examiner resulted from an unsecured checking account overdraft which had existed since June 21, 1983. (P.Ex. 17 at 203) Although other * * * loans may have had some collateral protection there was no basis in the record to support the ALJ's apparent conclusion that there was enough collateral to cover this unsecured overdraft. (P.Ex. 17 at 203) The Board believes that the financial condition of * * * was so weak and the ability of Mr. * * * to pay was so doubtful that any debt not secured by adequate collateral must be classified as "Loss." Accordingly, we cannot accept the ALJ's classification of the entire $366,000 debt as "Substandard." Indeed, the Board finds that the $6,000 overdraft was properly classified "Loss."
#111 * * *
| February 4, 1983 | FDIC - | $115,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $180,000 classified | | | Substandard; $9,000 | | | classified Loss | | | ($132,000 delinquent 30 | | | days - six months) | | September 30, 1983 | State - | $189,761 classified | | | Substandard | | May 18, 1984 | State - | $180,000 classified | | | Substandard | | ALJ - | $189,000 classified | | | Substandard | | Board - | $189,000 classified | | | Substandard |
The $9,000 classified as "Loss" by the FDIC examiner resulted from a checking account overdraft which had existed since June 21, 1983. (P.Ex. 17 at 204-05) This debt, however, was secured by the assignment of a $135,000 * * * Corporation real estate equity position during the last few days of the examination. (P.Ex. 17 at 208-09) The assignment was made to secure "all existing indebtedness owed the Bank by * * *. It therefore provided collateral for the $9,000 checking account overdraft. Under these circumstances, the Board agrees with the ALJ's classification of the entire $189,000 as "Substandard."
#113 * * *
| February 4, 1983 | FDIC - | none classified | | September 30, 1983 | FDIC - | $100,000 classified | | | Substandard | | September 30, 1983 | State - | $100,000 classified | | | Substandard | | May 18, 1984 | State - | $50,000 classified | | | Substandard | | ALJ - | none classified | | Board - | $100,000 classified | | | Substandard |
The ALJ based his conclusion that none of this $100,000 debt need be classified on the alleged existence of adequate collateral, absence of performance deficiencies and a January 4, 1984 payment which reduced the debt to $50,000. The Board disagrees with his conclusion. Although collateral may have been sufficient at the time of the examination, there was a very poor likelihood of repayment by any means other than liquidation of the collateral. * * * and its affiliates had financial statements on file at the Bank which showed a negative net
{{4-1-90 p.A-530}}worth and sustained losing operations. (RPFF 113.10 and 113.11) Furthermore, the January 4, 1984 payment occurred after the examiners left the Bank. (RPFF 113.14) We find that it was incorrect for the ALJ to base his classification conclusion on events which occurred after the close of the examination. The $50,000 reduction in the outstanding principal of the loan would of course be relevant to the issue of compliance with a formal order. The Board finds that the loan was properly classified as "Substandard" as of the close of the September 30, 1983 examination.
#114 * * *
| February 4, 1983 | FDIC - | not indebted to Bank | | September 30, 1983 | FDIC - | $150,000 classified | | | Doubtful | | September 30, 1983 | State - | $150,000 classified Sub- | | | standard | | May 18, 1984 | State - | $150,000 classified Sub- | | | standard | | ALJ - | $150,000 classified Sub- | | | standard | | Board - | $150,000 classified | | | Doubtful |
The FDIC examiner classified the $150,000 loan as "Doubtful." The ALJ accepted the Bank's classification of it as "Substandard." This loan was disbursed in two installments—$125,000 was disbursed on May 6, 1983 and $25,000 on July 29, 1983. Of the second disbursement $3,889 was used to pay the interest due on the first disbursement. Of the second disbursement $15,925 was used to pay up the interest through the maturity date of the loan. (PFF 114.2; RPFF 114.2) Extending credit to pay interest due is not a sound lending practice. Furthermore, the record indicated that the borrower was apparently in jail at the time of the examination. (PFF 114.6; RPFF 114.6) Repayment of the loan was dependent upon sale of the collateral—real estate located in * * * and subject to * * * state law with which Bank officers were not personally familiar.
FDIC argued that the appraisal of the real estate collateral was inadequate. The real estate collateral included two properties. The first was the borrower's business property acquired October 29, 1982, for a purchase price of $65,000. The seller of the property had acquired it through foreclosure by sheriff's deed dated June 16, 1982. (R.Ex. 114.5)60The FDIC correctly contended that the July 28, 1980 appraisal of $110,000 was too out of date to accurately indicate current market values. (Pr. Exceptions at 82) The second property was land with purported improvements appraised at $134,000 on March 25, 1983. (R.Ex. 114.3) The title policy to that property excludes "Possible claims of a spouse of the insured seeking equitable distribution of marital property." (R.Ex. 114.5) While the FDIC was apparently incorrect in questioning the value of that appraisal for not citing any comparable sales, the cloud presented by the spouse's claim would severely limit its value as collateral. Both properties were subject to a $74,500 first lien of * * * National Bank. Additional partial collateral was a lien on a liquor license, furniture and fixtures, and equipment. The priority of the Bank's lien on those items and whether transfer of the liquor license was possible were matters in dispute. (PFF 114.5) At combined face value, the $170,000 equity in the second real estate lien would provide only minimal margin for the $150,000 total debt. The Board believes that the 1980 appraisal of the subsequently troubled business property was not indicative of actual market value, and that there was a sufficient cloud on the deed to the second property as to require litigation to clear the cloud. The Board, therefore, agrees with the examiners and assigns a "Doubtful" classification.
#119 * * *
| February 4, 1983 | FDIC - | not indebted to Bank | | September 30, 1983 | FDIC - | $10,000 classified | | | Substandard ($20,000 | | | delinquent more than | | | six months) | | September 30, 1983 | State - | $10,000 classified | | | Doubtful ($20,000 | | | delinquent more than | | | six months) | | May 18, 1984 | State - | $10,000 classified Loss | | ALJ - | none classified | | Board - | $10,000 classified | | | Substandard |
SUMMARY
The ALJ declined to accept classification of any portion of this loan. To support his conclusion the ALJ cited assertions that prior to the end of the September, 1983 examination, the loan was renewed in connection with a $10,000 payment of one-half of the principal and $1,300 interest (RPFF 119.1(a) and 119.2(a)), and the fact that the borrower "has had net worth exceeding $1,500,000." (RPFF 119.7) The Board
60 Although not specified in the proponents' findings of fact or its brief of exceptions, this information was included in the respondents' exhibits and was material to determining the collateral value for this loan.
{{4-1-90 p.A-531}}finds that the loan should have been classified "Substandard."
DISCUSSION
The loan was overdue at the time of the examination. The borrower was a resident of * * *. The reduction in the principal was made by debiting the borrower's checking account. (PFF 119.5; RPFF 119.5) The loan extension was made by the Bank, pending Mr. * * * return to * * *. (R.Ex. 119.2(a)) Collateral for the loan was the assignment of an unsecured note dated February 15, 1983 from * * *. The Bank admitted that $332,000 of another * * * debt was properly classified as "Substandard." (RPFF 117.20) The ALJ accepted the FDIC's finding that the $650,000 * * * debt which * * * guaranteed was also classified "Substandard." Under these circumstances, the assignment of the unsecured * * * note was inadequate collateral for Mr. * * * loan. There was also no evidence in the record on Mr. * * * current financial position with the only information in the Bank's loan file being 18 months out of date. The fact that Mr. * * * may have had substantial assets at some time in the past was not relevant to the prospect of repayment of this debt. Therefore, the Board finds that the $10,000 was properly classified "Substandard."
#122 * * *
| February 4, 1983 | FDIC - | $412,000 classified | | | Substandard in name of | | | * * * | | September 30, 1983 | FDIC - | $206,000 classified | | | Substandard | | September 30, 1983 | State - | $206,250 classified | | | Substandard | | May 18, 1984 | State - | $206,000 classified | | | Substandard ( * * *) | | ALJ - | none classified | | Board - | $206,000 classified | | | Substandard |
This loan was taken out to pay $8,295 of past due interest and the $197,955 principal of the loan of * * * (See #121). (P.Ex. 17 at 20; PFF 122.5; RPFF 122.5) The collateral for this loan consists of the same five vacant lots which collateralized the * * * loan. The borrower, a former limited partner of * * * , was a corporation registered in the * * * apparently owned by * * * investors. (P.Ex. 17 at 218, Tr. 3924) The ALJ declined to acknowledge classification of the loan because of the alleged adequacy of the collateral that secured the loan, the alleged financial condition of the borrowers and the performance as represented by interest payments made at the end of the examination.
"Substandard" classification of this loan was warranted at the time of the examination. There was no current appraisal of the collateral in the Bank's file. (PFF 122.4; RPFF 122.4) Based on an appraisal report in the * * * file dated April 1, 1981 (ten vacant lots at $550,000), the value of the collateral was placed at $275,000 by the examiners. The Bank admitted that the lots were vacant and undeveloped (RPFF 122.3), yet the ALJ relied on testimony that the lots had "water and sewer, streets and sidewalks". (Tr. 3922-23.) No explanation for the inconsistency was given. The Board finds that this unexplained inconsistency raised doubts about the value of the collateral. The lots were not released from the * * * mortgage because the Bank did not want to release the borrower until * * * debt was totally satisfied. $58,000 of that debt remained which the Bank admitted was properly classified as "Substandard." There was no financial statement on the borrower in the loan file. (P.Ex. 17 at 218) There were no guarantees on file. One of the owners of the borrower, * * * was reportedly worth "over a million dollars" (Tr. 3924), but without verification of that fact and a binding obligation upon him to assume responsibility for the loan, contrary to the ALJ's conclusion, his possible wealth was irrelevant to the classification of this loan. The fact that interest was paid during the examination was not a sufficient basis to declassify the loan under these circumstances. The fact that additional financial information about borrowers may also have been received by the Bank after the examination was irrelevant to the proper classification of the loan at the close of the examination and should not have been considered by the ALJ.
The Board finds that the record establishes that the loan was properly classified as "Substandard."
#124 * * *
| February 4, 1983 | FDIC - | none classified | | September 30, 1983 | FDIC - | $44,000 classified | | | Substandard | | September 30, 1983 | State - | $43,698 classified | | | Substandard | | May 18, 1984 | State - | not listed | | ALJ - | none classified | | Board - | none classified |
{{4-1-90 p.A-532}}
SUMMARY
The FDIC classified this remaining balance due after a payment received during the examination based on the belief that the collateral had been released and that the guarantor offered no financial support because he was admittedly liable on other classified loans. The Board agrees with the ALJ that the record does not show that the collateral was released and that there was, therefore, sufficient equity in the real estate collateral to preclude adverse classification.
DISCUSSION
The classified balance was the residual of a debt remaining after a principal payment was received during the examination ". . . in satisfaction of that (corresponding) mortgage . . . ." (R.Ex. 124.1) The ALJ reduced his classification based on the loan payment and the collateral's appraised value. The appraised value was substantiated by the borrower's testimony of a $900,000 purchase price for the pledged acreage. The FDIC justified its classification on the basis of * * * guarantee as being either admitted or upheld "Substandard" elsewhere in the report. The FDIC gave no consideration to the value of the collateral held, which does not appear to have been obligated to * * * other loans. That collateral was not released and was of sufficient value ($900,000 versus $407,000 first and second lien debts) to support this line. Also, the substantial payment received during this examination would indicate that additional financing would be available to pay out this smaller portion. The Board agrees with the ALJ's declassification of this loan.
#126 * * *
| February 4, 1983 | FDIC - | (in name of * * * Other | | | Real Estate) | | September 30, 1983 | FDIC - | $84,000 classified | | | Substandard | | September 30, 1983 | State - | $84,498 classified | | | Substandard | | May 18, 1984 | State - | none listed | | ALJ - | none classified | | Board - | $84,000 classified | | | Substandard |
SUMMARY
The debt was the amount owed on the $100,000 purchase of the * * * condominiums. The ALJ declassified this loan based on a 15% equity in the property from the down payment and six months of satisfactory payment performance by the borrower. The Board finds that the FDIC properly classified this loan "Substandard" based on insufficient equity in the business property and the financial problems related to the * * * condominium project.
DISCUSSION
The ALJ reduced this classification based on the $15,000 down payment, or 15% cash equity, and about six months adequate payment history. The FDIC adequately addressed the basis for this classification in that the payment history was considered too short a period of time, in connection with the absence of a known credit history for the borrower, to establish a satisfactory performance on a property previously held by the Bank as "Other Real Estate." (Pr. Exceptions at 84) The ALJ failed to recognize the seriousness of the business problems involved in "* * *" commercial condominium project. Three major items reflective of at least a "Substandard" classification include: (1) the eight unit project was previously unsuccessful and required foreclosure by the Bank on seven of the units at a book value of $648,000, (2) only four of the units were occupied, and (3) appraisals are based on sale prices for each of the five units sold that totaled $663,000; accuracy of the appraisals is considered questionable since the values cannot be supported by an income approach to value. (P.Ex. 17 at 220-221) While * * * appeared to be the best of the purchasers of project units, continued successful operation appeared to be questionable and a 15% equity position in the property, based on an apparently inflated sales price, was not a sufficient margin of protection for a property formerly in the Bank's Other Real Estate category.
#127 * * *
| February 4, 1983 | FDIC - | (in name of * * * Other | | | Real Estate) | | September 30, 1983 | FDIC - | $149,000 classified | | | Substandard | | September 30, 1983 | State - | $149,073 classified | | | Substandard | | May 18, 1983 | State - | not listed | | ALJ - | none classified | | Board - | $149,000 classified | | | Substandard |
SUMMARY
The debt was the amount owed on the purchase price for Unit 4 of the * * * condominiums. The property was vacant and had produced no income for the borrower. The ALJ declassified the loan based on a 25% equity in the property from the down
{{4-1-90 p.A-533}}payment on the property and the incorrect belief that the borrower had substantial deposits in the Bank. The FDIC properly classified the loan "Substandard" based on the non-income producing nature of the business property and the financial problems related to the * * * business condominium project.
DISCUSSION
The ALJ reduced this classification based on a substantial down payment and loan reductions (RPFF 127.5), and the borrower's purported substantial checking account balances at the Bank. (RPFF 127.3(b)(new) and R.Ex 127.1) The FDIC adequately addressed this classification. (P. Exceptions at 84) Additional facts surrounding this line included (1) borrower's checking account did not reflect a substantial balance ($3,522 on November 28, 1983; $219 on December 27, 1983; $411 on January 26, 1984; $5,411 on February 27, 1984, $5,000 of which was in uncollected deposits; and $7,799 on March 26, 1984), (R.Ex 127.1), (2) The property had been vacant since purchase, and (3) the down payment and reductions amounted to only 25.5% of the sale price. The discussion under * * * (PFF 126 Series), supra, concerning the unsuccessful history of this project, its current lack of operations and prospects, and the actual value of these units versus Other Real Estate ("Ore") book value and/or income approach to evaluation also apply to this loan and undercut the "substantial" down payment and loan reduction factors. Therefore, the Board finds that this loan was properly classified "Substandard."
#131 * * *
| February 4, 1983 | FDIC - | $941,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $1,096,000 classified | | | Substandard $87,000 | | | classified Loss ($72,000 | | | delinquent) | | September 30, 1983 | State - | $1,096,013 classified | | | Substandard $87,321 | | | classified Loss | | May 18, 1984 | State - | $1,243,000 classified | | | Substandard (in the | | | name of * * *) | | ALJ - | $1,183,000 classified | | | Substandard | | Board - | $1,183,000 classified | | | Substandard |
SUMMARY
The borrower was an international concern whose financial position showed a high level of debt, relatively low capital and the existence of cash flow problems. The collateral pledged appeared to be extensive, at least in terms of book values, but was restricted by CPA opinion and was subject to foreign exchange and transfer risks. The ALJ agreed with the "Substandard" classification but not the $87,000 classified "Loss." The amount classified "Loss" represented interest charged to the borrower's checking account but not covered by sufficient funds in that account. That interest charge was included in the Bank's income despite the fact that it had not been collected. The Board does not find any reason for treating the $87,000 representing interest earned but not collected differently from the rest of the debt. The ALJ's classification of the entire debt as "Substandard" is accordingly upheld.
DISCUSSION
The ALJ reduced the "Loss" classification to "Substandard" because he considered it collectible. Determining collectibility of this loan requires analysis of the value of the collateral securing the debt and the financial condition of company owner * * * who had $154,000 in loans classified "Substandard" (which classification was upheld by the ALJ). (RD at 45) The collateral consisted entirely of accounts receivable, inventory, furniture and fixtures, and machinery and equipment, assigned proceeds of letters of credit, a $50,000 certificate of deposit, a $200,000 mortgage on property appraised at $140,000 (but without a supporting title search or other documents), and a $50,000 assignment of a real estate second mortgage with $88,000 in equity. (RPFF 131.59; 131.73; 131.74; 132.6; and 132.7) Evaluation of the value of this collateral centers primarily on domestic controlled inventory with an $886,000 book value (RPFF.61), and $2,808,000 primarily on foreign accounts receivable (RPFF 131.62), which would appear to be sufficient for this line. However, prudent banking procedures limit the amount advanced against collateral consisting of inventory to a percentage of its book value based on risk factors such as staleness, control, "shopwear," obsolescence, marketability, etc. Industry percentages normally range between 50% to 60%. The level of control over the collateral in this instance could probably support loans up to 60% of book value.
{{4-1-90 p.A-534}}The same procedures are generally applicable to account receivables, but these include the additional risk factors, third party concentrations, right of offset, third party's ability to pay, and, in this case, foreign exchange and transfer risk. Industry percentages normally range from 60% to 90%. The risk factors involved in collateral consisting of both inventory and accounts receivable are generally considered very high. The accounts receivable collateral was further complicated by substantial amounts, $2,313,700 as reported July 31, 1983, of accounts receivable representing nonrecourse financing provided by the Bank to * * * customers and accounts receivables which the Bank's CPA eliminated from the parent company property statement of July 31, 1983. (RPFF 131.64) These facts raised serious questions about the value of the accounts receivable collateral for the line. A conservative estimate would have been that $2,000,000 of the accounts receivable were actually not available as collateral. The eligible accounts receivable should then have been utilized only to the extent of 60% of book value to take into account the associated risk factors, for a net $485,000 estimated collateral value. In summary, the Board finds that the collateral protection afforded this and the * * * lines of credit was marginal and justified a "Substandard" (but not a Loss) classification.
#133 * * *
| February 4, 1983 | FDIC - | $101,332 classified | | | Substandard $2,000 | | | classified Loss | | September 30, 1983 | FDIC - | $98,000 classified | | | Substandard | | September 30, 1983 | State - | $101,332 classified | | | Substandard | | May 18, 1984 | State - | none listed | | ALJ - | none classified | | Board - | $98,000 classified | | | Substandard |
SUMMARY
This was a nonaccrual loan whose source of repayment was the liquidation of the pledged collateral. The ALJ reduced the classification based on the Bank's absolute collateral values. The Board, however, recognizes the financial and acquisition risks involved in disposing of collateral consisting of a junior lien and properly classified the reduced loan balance as Substandard.
DISCUSSION
This was a nonaccrual line whose principal was reduced to $98,000 during the examination from the proceeds of the sale of another real estate property. The classification was based on the liquidation of the collateral held. The ALJ declassified the line based on the Respondents' evaluation of the collateral. (RPFF 133.7(new)) The FDIC adequately addressed the risk involved in liquidating such collateral and the application of $106,000 insurance proceeds which are to be received by the court for distribution. Additional considerations indicating that this line was at least "Substandard" included: (1) there is a $30,000 claim by * * * Pictures against the insurance proceeds (addendum information, P.Ex. 17 at 237); (2) the Bank's interest in a second mortgage lien against the * * * property is limited to a half interest (PFF 133.3; RPFF 133.3) estimated to be worth approximately $19,500, (the ALJ accepted Respondents' $45,000, estimate); and (3) the difference between the FDIC's estimated $12,000 equity value in the second lien on 20 acres of land and the estimated $46,000 value by the Bank raised questions as to the value of the collateral. The Bank's estimate was based on a "new" appraisal which was apparently not introduced into evidence. (RPFF 133.3) The Board finds that a "Substandard" classification is warranted based on the questionable value of this junior lien position on the collateral.
#134 * * *
| February 4, 1983 | FDIC - | None classified | | September 30, 1983 | FDIC - | $7,000 classified | | | Substandard | | September 30, 1983 | State - | $7,134 Substandard | | May 18, 1984 | State - | $3,000 Substandard | | ALJ - | none classified | | Board - | none classified |
This debt included two installment loans. A total of nine payments —six prior to the examination and three during the examination —were made by creating or increasing an overdraft on the borrower's checking account. Nevertheless, the Bank held the title certificates on a 1979 Mercedes and a 1981 Pontiac. The margin of collateral protection appears sufficient to limit the Bank's exposure. Therefore, the Board agrees with the ALJ.
#135 * * *
| February 4, 1983 | FDIC - | none classified | | September 30, 1983 | FDIC - | $367,000 classified | | | Substandard | | September 30, 1983 | State - | $158,212 Substandard, | | | $209,288 Doubtful | | May 18, 1984 | State - | $48,000 Substandard | | ALJ - | none classified |
{{4-1-90 p.A-535}}
| Board - | $367,000 classified | | | Substandard |
SUMMARY
The essentially unsecured loan was made to enable the borrower to purchase a one-half interest in * * * developmental property from * * *. All interest and principal payments had been made by Mr. * * * through checking account overdrafts at this Bank. The borrower had not demonstrated either an ability or a willingness to service this line. The ALJ declassified these loans primarily based on the borrower's stated net worth of $1,523,000, and the reported acquisition of a financing package from another source to begin development of the * * * property. The Board finds this insufficient to justify removal of the "Substandard" classification for an unsecured credit.
DISCUSSION
The debt was for the purchase of a one-half interest in * * * (classified "Substandard" under Series #136 in this report) from * * *. The proceeds of the unsecured $350,000 loan went into * * * account and * * * made the overdue interest payment on the loan on November 11, 1983. * * * continuing guaranty appeared to cover both loans. However, the guaranty was orally modified to exclude the $350,000 loan according to the ALJ. (RD at 71)
The commercial loan that originated at $25,000 in 1981 was reduced to $17,500 during the examination. However, * * * , not * * * , made the interest and principal payments at the last two renewals. Collateral pledged was stock registered in * * * name, but was of unknown value and liquidity.
The borrower's self-prepared financial statement was not sufficiently detailed to provide support for an unsecured debt of this magnitude since his total assets of $2.2 million consisted o $1.8 million of real estate for which no details were known. His net worth of $1.5 million reported on the statement was, therefore, impossible to verify. His reported income was $93,000.
Mr. * * * had not demonstrated an ability or willingness to service either of the two loans nor were his proven assets sufficient to eliminate the risk inherent in these unsecured loans. The Board finds that the record supports the "Substandard" classification.
#136 * * *
| February 4, 1983 | FDIC - | Not indebted to Bank | | September 30, 1983 | FDIC - | $1,089,000 classified | | | Substandard | | September 30, 1983 | State - | $1,018,500 classified | | | Substandard | | May 18, 1984 | State - | $500,000 classified | | | Substandard | | ALJ - | none classified | | Board - | $1,089,000 classified | | | Substandard |
SUMMARY
This line was to finance the purchase of property for speculative development and to provide for payment of the interest and principal due to the first lien holder and this Bank. The original financing package exceeded the purchase price by $513,000 and was expanded another $469,000 by a letter of credit and acceptances issued. The Bank holds a second mortgage on the purchased property. The ALJ declassified the entire line based on a $12 million development financing package acquired at another institution during the final days of the examination. However, the funds from that package were insufficient to pay out the first lien holder. In addition, there were numerous other impediments to development noted by the examiners. The Board recognizes those problems and assigns a "Substandard" classification.
DISCUSSION
The ALJ found that the FDIC has not proven that classification was warranted. This was apparently based on purported collateral protection since numerous weaknesses cited by the examiners were not refuted. The collateral was a second mortgage on one block of property fronting * * *. The purchase price and appraisals for the property were:
| August 13, 1982 Appraised | $7,950,000 | | Value (AV) | | | February 5, 1983 Updated AV | 8,650,000 | | Purchase Price | 8,047,000 |
The purchase price was financed as follows:
{{4-1-90 p.A-536}}
| $6,480,000 | 1st mortgage loan at * * * | | 620,000 | 2nd mortgage loan at | | * * * | | 1,460,000 | 3rd mortgage note taken | | back by seller of property | | $8,560,000 | |
Present value of a sale transaction is a function of both price and terms offered. A substantial discount from the $8,047,000 was necessary to equate the purchase price to a cash deal since the seller placed himself at considerable risk in taking a third position on financing that exceeded the purchase price by $513,000. What the property recently sold for on a cash equivalent basis would normally be a truer indication of actual value than would be an appraisal.
The ALJ was mistaken in stating that funding occurred. All that occurred was an arrangement for construction financing in the amount of $12.8 million. An allocation of funds sheet showed that $3.2 million of the amount would pay down existing liens, but no breakdown was given. Usual banking practice is to apply reductions first to the most senior debt in which case * * * Bank would receive no funds. In addition, if this was a typical construction loan, * * * Bank and the seller of the property would be required to subordinate their positions to that of the $12.8 million loan. This would result in the already questionable collateral protection prior to subordination becoming junior to the substantial new debt and make pay out of the Bank's loans contingent on successful completion of the construction project. Under these circumstances, the Board finds that the "Substandard" classification was justified.
#140 * * *
| February 4, 1983 | FDIC - | Not indebted to the | | | Bank | | September 30,1983 | FDIC - | $140,000 classified | | | Substandard | | September 30, 1983 | State - | none classified | | May 19, 1984 | State - | none listed | | ALJ - | | ALJ -!none classified | | Board - | $140,000 classified | | | Substandard |
SUMMARY
The ALJ declassified this unsecured credit based on Respondents' findings of fact and exhibits which were erroneous and misleading. The Board classifies the debt "Substandard" based on significant discrepancies in the borrower's financial statement.
DISCUSSION
This adverse classification was based on the "weak financial position" disclosed by the available financial information (P.Ex. 17 at 250) The ALJ reduced the classification to None based on the Respondents' findings of fact and exhibits which he believed successfully rebutted the FDIC contentions. (RD at 51) Debt performance of this relatively new credit was not an issue in the classification. The FDIC addressed the inaccuracy of the Respondents' findings of fact that showed the borrower's total assets of $12,295,000 (RPFF 140.4(b)), but omitted $2,000,000 of the borrower's liabilities. (RPFF 140.4) The $4,251,000 appraisal for the borrower's major asset (* * * undeveloped land) (RPFF 140.4(a)), cited by the Bank, was both misleading and invalid in that it was made "assuming" completion of certain development of the property (R.Ex 140.4), none of which had been accomplished. (RPFF 140.4) The ALJ's declassification of this credit based on such erroneous and misleading facts was unwarranted. The major discrepancies in the borrower's financial statements used to support this unsecured credit were as follows: (1) the financial statement was self-prepared and unsigned, which reduced its credibility, (2) the purchase price of $2,115,800 for * * * undeveloped land was a more accurate valuation for that asset than the misleading appraisal, thus reducing the borrower's stated net worth from $3,663,000 to about $1,663,000, (3) the overevaluation of this major asset raised questions about the accuracy of the valuation of borrower's second major real estate asset at $942,000, (4) the liabilities associated with the listed real estate equities were omitted from the borrower's liabilities, and (5) the borrower's 1981 income of $147,000 was not considered sufficient support to carry his extensive debt load. The Board finds that the examiners' classification of this unsecured credit was valid.
#142 * * *
| February 4, 1983 | FDIC - | $50,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $53,000 is classified | | | Substandard $6,000 | | | classified Loss ($65,000 | | | is delinquent, including | | | $12,000 delinquent | | | more than six months) | | September 30, 1983 | State - | $6,301 classified Loss | | May 18, 1984 | State - | $6,000 classified | | | Substandard |
{{4-1-90 p.A-537}}
| ALJ - | $59,000 classified | | | Substandard | | Board - | $53,000 classified | | | Substandard $6,000 | | | classified Loss |
SUMMARY
The examiners properly classified this line based on the borrower's unwillingness to make scheduled payments on all loans, the severely delinquent status of much of the line, the questionable real estate value of collateral consisting of a junior lien, and the unsecured nature of the overdraft on the borrower's checking account. The unsecured portion was classified "Loss" and $6,000 of the debt was not classified based on the value of an automobile pledged as collateral. The ALJ essentially agreed, but did not classify any "Loss" based on the borrower's position as a policeman and a respected member of the community, and his wife's position as a school teacher.
DISCUSSION
This debt consisted of an unsecured overdraft and two installment loans, collateralized by a junior real estate mortgage lien with an appraised value of $38,000, and a six year old cadillac. The overdraft had been delinquent more than two years and the auto loan more than six months. The ALJ reduced the "Loss" classification to "Substandard" because the borrower was a policeman and a respected member of the community, and his wife was a school teacher. (RPFF 142.8) The FDIC did not address this loan. The ALJ failed to recognize that the equity in the real estate collateral was dependent on the amount of prior liens, that the overdraft was unsecured, and most importantly that the borrower had failed to make payments on the loans. The Board agrees that the unsecured portion of $6,000 was properly classified "Loss" and the remainder of the debt "Substandard."
#143 * * *
| February 4, 1983 | FDIC - | $6,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $38,000 is classified | | | Substandard | | | (delinquent) | | September 30, 1983 | State - | none classified | | May 18, 1984 | State - | none listed | | ALJ - | none classified | | Board - | $38,000 classified | | | Substandard |
#143 and #144 * * *
| February 4, 1983 | FDIC - | $100,000 classified | | | Substandard | | September 30, 1983 | FDIC - | $82,000 classified | | | Substandard | | September 30, 1983 | State - | none classified | | May 18, 1984 | State - | none listed | | ALJ - | none classified | | Board - | $82,000 classified | | | Substandard |
SUMMARY
These loans were related by the guarantee of * * * and were in the form of overdraft checking account advances, $38,000 of which was delinquent for more than a year. The FDIC classified the $120,000 combined balances "Substandard" based on the indicated delinquency, questionable lien status of the inventory, accounts receivable and equipment collateral, and the apparent weakened financial position of the borrower and guarantor. The ALJ declassified the entire portion based on testimony that the borrower was wealthy and there was plenty of collateral. The Respondents' allegation that the debt was secured by $60,000 cash collateral in the form of certificates of deposit was refuted by testimony, and it was apparent that a proper assignment of these certificates of deposit was never obtained.
DISCUSSION
#143
This debt was confined to an overdraft originating more than a year prior to examination. The ALJ removed the classification based entirely on Respondents' proposed findings of fact and the testimony of the * * * and the borrower (RPFF 143.1-.5; Tr. 3928-31, 4505-25), which focused on the existence of collateral in the form of certificates of deposit pledged to the Bank. (RPFF 143.1(a) (new)) The FDIC argued that the cash collateral was not presented to the examiners before the conclusion of the examination. However, testimony cited by the ALJ revealed two major items negating the support of the alleged collateral. First, the borrower stated that he only had $60,000 in certificates of deposit at the Bank in support of all his debts (which totalled $120,000). Second, both the Bank and the borrower testified that, in fact, there was no assignment of this purported cash as collateral. It was further stated that there was an understanding between the borrower and the Bank that the certificates could be used by the Bank for any purposes. (Tr. 3928-31,
{{4-1-90 p.A-538}}4513-25) Absent a written assignment, with a proper "hold" on the deposit account, the borrower could exercise his option to withdraw the alleged collateral at any time, and the "understanding" would be meaningless despite the Bank's general right of offset of deposit accounts in the case of loan defaults. The subsequent events of partial pay out, further extension, then a refinancing only indicated that continued cash flow problems persisted. At least a "Substandard" classification was warranted.
#144
This debt was confined to a checking account overdraft. The comments under Series 143 apply equally to this line as both were guaranteed by * * *. Respondents' proposed findings of fact indicated that the Bank had a third lien on inventory, accounts receivable and equipment as collateral, and that the borrower had a strong financial statement. Since this line was classified "Substandard" based on the borrower's weak financial position, unsatisfactory debt performance and questionable perfection of lien status on inventory, accounts receivable and equipment, it would appear that no such documentation was available to the examiners that supported the Respondents' contentions. Respondents' Exhibit 144.3 showed an assignment of a UCC-3 financing statement by * * * Bank * * * to the Bank. However, the filing date for the financing statement was November 6, 1975, which would have expired in five years if not continued. There was no indication of such a continuation, thus raising questions as to whether the lien status of this collateral was perfected. "Substandard" classification was warranted based on the delinquency status of the overdraft checking account in Series 143, a suspected weakened financial position of the borrower and guarantor, and the absence of an assignment of certificates of deposit referred to in Series 143.
#152 * * *
| February 4, 1983 | FDIC - | $44,000 classified | | | Substandard (all | | | delinquent) | | September 30, 1983 | FDIC - | $22,000 classified | | | Substandard (non- | | | accrual) | | September 30, 1983 | State - | $22,419 classified | | | Substandard | | May 18, 1984 | State - | none listed | | ALJ - | none classified | | Board - | none classified |
SUMMARY
The Board finds that the evidence failed to support the FDIC's contention that the borrower was in a weak financial position and had not made payments on its loans.
DISCUSSION
The FDIC classified this debt based on the borrower's weak financial position and an unsatisfactory debt performance. (P.Ex. 17 at 252) The classification was not addressed in the Brief of Exceptions. The ALJ was correct in citing substantial debt performance (PFF 152.1-.3) in reducing the classification. In addition, the FDIC presented no evidence of the borrower's weak financial position. The Board finds that no classification was warranted.
#153 * * *
| February 4, 1983 | FDIC - | $4,000 classified | | | Substandard $3,000 | | | classified Loss | | September 30, 1983 | FDIC - | $2,000 classified | | | Substandard (non | | | accrual) $2,000 | | | classified Loss | | September 30, 1983 | State - | $2,500 classified | | | Substandard $1,920 | | | classified Loss | | May 18, 1984 | State - | none listed | | ALJ - | $4,000 classified | | | Substandard | | Board - | $2,000 classified | | | Substandard $2,000 | | | classified loss |
SUMMARY
The Board classifies $2,000 as "Loss" and $2,000 as "Substandard" based on the Bank's own estimate of collateral value provided during the examination.
DISCUSSION
This debt was a loan on an automobile. The auto was in the shop for repair, apparently to be repossessed and sold. (RPFF 153.1-.4) The basis for the "Loss" classification was the value "Management stated it would settle for . . ." (p.Ex. 17 at 252) The ALJ reduced the entire debt to "Substandard" based on the alleged fact that ". . . FDIC examiners apparently were unaware that the Bank's lien rights would have priority over the body shop bill . . .". (RPFF 153.5) However, the ALJ failed to recognize that the lien rights to collateral were not an issue. The "Loss" classification was based on Bank management's own estimate of the collateral value made during the examination.
{{4-1-90 p.A-539}}
#158 * * *
| February 4, 1983 | FDIC - | none classified | | September 30, 1983 | FDIC - | $8,000 classified Loss | | September 30, 1983 | State - | $7,947 classified Loss | | May 18, 1984 | State - | none listed | | ALJ - | $7,900 classified | | | Substandard | | Board - | $8,000 classified Loss |
SUMMARY
The ALJ reclassified this loan based on the guarantor's financial capacity. However, the guarantor had not responded to the Bank's demand for payment. Therefore, a "Loss" classification was appropriate.
DISCUSSION
This debt consisted of an automobile loan where the borrower skipped with the collateral. A payment demand was issued to the guarantor, but had not been honored. (RPFF 158.1-.3) The ALJ reduced the classification based entirely on the Respondent's proposed findings of fact and testimony that guarantor had sufficient financial capacity to pay. (RPFF 158.5) The ALJ failed to recognize that the guarantor had not responded to the Bank's demand. The Board finds that the classification of the loan as "Loss" was justified.
#163 * * *
| February 4, 1983 | FDIC - | none classified | | September 30, 1983 | FDIC - | $5,000 classified | | | Substandard $2,000 | | | classified Loss | | September 30, 1983 | State - | none classified | | May 18, 1984 | State - | none listed | | ALJ - | $6,700 classified | | | Substandard | | Board - | $5,000 classified | | | Substandard $2,000 | | | classified Loss |
The classification was based on an estimated value of a repossessed automobile. The ALJ reclassified the total based on the testimony that the collateral was sold after the examination and the loan was paid in full. The Board finds that the classification was warranted based on information that was available at the conclusion of the examination.
#170 * * *
| February 4, 1983 | FDIC - | $634,000 classified | | | Substandard $14,000 | | | classified Loss | | September 30, 1983 | FDIC - | $200,000 classified | | | Substandard $110,000 | | | classified Loss | | September 30, 1983 | State - | $240,000 classified | | | Substandard $64,763 | | | classified Loss | | May 18, 1984 | State - | $250,000 classified | | | Substandard | | ALJ - | $310,000 classified | | | Substandard | | Board - | $200,000 classified | | | Substandard $110,000 | | | classified Loss |
SUMMARY
The FDIC classification of this property was based on an estimated market value between the actual sale price for a similar property in the same condominium project and the sale price offered by the Bank to its present tenant. The ALJ rejected that estimate in favor of an appraisal of $315,000 received the last few days of the examination. However, there was no documented basis provided for that evaluation. The classification was warranted because actual sales transactions are a truer indication of value than an appraisal.
DISCUSSION
This property held by the Bank as "Other Real Estate" included two units in a business condominium project which were currently rented to one tenant. Only three of the seven total units foreclosed on by the Bank were occupied. The FDIC estimated its market value between $187,000 (the most recent sale price per square foot of another unit in the same project) and $240,000 (the contract price offered by the Bank to the present tenant). (R.Ex. 4 at 244-45) The amount in excess of the more conservative $200,000 was classified "Loss." The ALJ reduced that classification to "Substandard" based on a Bank appraisal of $315,000 received the last few days of the examination. (PFF 170.3, RPFF 170.3) The FDIC argues that the ALJ's acceptance of the appraisal was unwarranted in view of the actual sales price of similar units. (P. Exceptions at 89) The Bank charged-off $55,000 of the debt in April, 1984, which was a subsequent event that had no bearing on this classification.
The FDIC Manual of Examination Policies provides guidelines for evaluation, "other real estate." These guidelines include: "(1). . . reason for acquisition. . .and the bank's intentions as to its disposition; (2) analyze its carrying value in relation to its appraised value, the bank's asking price, and offers received; (3). . . length of time
{{4-1-90 p.A-540}}property has been held and the reasons(s) it has not yet been sold; and (4) review of other pertinent factors including. .... present occupancy, rentals, etc." (P.Ex. 3, at §1, p. 1)
The following factors would support the FDIC's evaluation of this property: (1) the property was acquired through foreclosure because there were no bids higher than the Bank's carrying value (Tr. 3919), (2) the Bank offered it for sale by contract dated January 12, 1983, to its present tenant for $240,000 (RPFF 170.5), (3) the pre-foreclosure appraised value was $205,000 (R.Ex. 4 at 244; R.Ex. 170.6) a $315,000 appraisal of December 12, 1983, which was minimally higher than its carrying value, did not explain the basis for the evaluation, i.e. income capitalization approach, replacement costs, construction costs, or recent like transaction comparisons, (4) the property was currently occupied and rented at $9.26 per square foot (RPFF 170.2), and (5) the ALJ accepted an accountant's testimony that evaluation based on his speculated rental rate of $30-$50 per square foot for the successful * * * (located across the street), whose capitalization was eight times higher, would provide a minimum of $400,000 appraised value for * * *. (Tr. 4640-42) The ALJ's acceptance of this accountant's evaluation and/or the new appraisal appears ludicrous in view of the many assumptions involved and the contradictions. The examiner's evaluation of this property was careful and thorough and his classification was within the guidelines of the Manual of Examination Policies. The Board finds that based on the record, $200,000 was properly classified as "Substandard," and $100,000 as "Loss."
6. Summary of the Board Classifications
In the table below, we set forth the Board's conclusions with regard to the dollar volumes of loans classified "Substandard, Doubtful and Loss," together with the amount placed in a "Special Mention" Category.
SUMMARY OF BOARD CLASSIFICATIONS - 9/30/83
| Substandard | Doubtful | Loss | Special Ment | | BOARD CONCLUSIONS | | | | | | RE CONTESTED | | | | | | CLASSIFICATIONS | 16,997,000 | 1,100,000 | 2,251,000 | 226,000 | | ADMITTED OR | | | | | | UPHELD BY ALJ | 8,775,000 | 185,000 | 586,000 | 586,000 | | TOTAL ADVERSELY | | | | | | CLASSIFIED LOANS | | | | | | AND OTHER REAL | | | | | | ESTATE ("ORE")61 | 25,772,000 | 1,285,000 | 3,619,000 | 812,000 | | INCOME EARNED | | | | | | BUT NOT COLLECTED | 668,000 | -- | 153,000 | -- | | OTHER ASSETS | | | | | | (REPOSSESSIONS) | 17,00062 | ------- | 51,000 | ------- | | TOTAL ASSETS CLASSIFIED | | | | | | BY THE BOARD | 26,487,00063 | 1,285,000 | 3,619,000 | 812,000 | | TOTAL CLASSIFIED ASSETS AS A PERCENTAGE | | | | | | OF ADJUSTED TOTAL ASSETS: | | | | 32.65% | | TOTAL CLASSIFIED ASSETS AS A PERCENTAGE | | | | | | OF TOTAL EQUITY CAPITAL AND RESERVES: | | | | 569.4% |
61The * * * was repossessed real estate carried on the Bank's books as "Other Real Estate."
62The ALJ classified $67,400 in repossessions as "Loss" because the Bank admitted such classification. (RD at 46) However, we note that the FDIC only classified $51,000 of that amount as "Loss" and $17,000 "Substandard." We do not find that the evidence supports a total classification of "Loss" since the repossessed collateral does have some salvage value. Just how much could be recovered in a forced sale of the collateral was not clear. The FDIC based its amount classified "Loss" on the deficiency balances remaining after subtraction of the estimated market value of the collateral from the outstanding principal and interest on the loans. The Board finds this to be a reasonable approach and therefore agrees with the FDIC.
63We note that Bank had an additional $176,000 in "Substandard" loans based on "Transfer Risk" or "Country Risk," which has not been included in these totals. (See R.Ex. 1, §R, at 8–10.)
{{4-1-90 p.A-541}}E. Allegations of Bias - Relevance to Loan Classifications
One reason given by the ALJ for rejecting the commissioned examiners' loan classifications was his concern about Respondents' allegations that the FDIC was biased. Although the ALJ properly paid careful attention to these serious charges, the Board finds that Respondents' allegations of bias are both unfounded and irrelevant to the issues in this case. Furthermore, the ALJ's analysis of these allegations was at best imprecise, and at worst factually and/or legally erroneous.
[.20-.21] In the instant case Respondents admitted a great many of the factual findings underlying the examiners' classifications, but nevertheless contended that the classification conclusions should not be upheld. Respondents' affirmative defense essentially alleged that the FDIC was biased against the Respondents, and that, despite the admission of many of the factual bases and certain of the adverse classifications by Respondents, the ultimate classification conclusions were nevertheless a product of that bias. If the Respondents were able to demonstrate the relevance of an alleged bias and show that the bias existed and that the bias caused the examiner to classify or more severely classify a loan which would not otherwise have been classified or would have been less severely classified, then the ALJ would have been justified in setting aside each specific classification which was shown to have resulted from that bias. It does not, however, appear that this was the analysis followed by the ALJ in considering the effects of the allegations of bias. The ALJ seems to have considered all of the evidence which purportedly could have led to bias on the part of any FDIC employee, then attributed that possibility of bias to the subconscious of each and every FDIC examiner participating in the September examination. The ALJ did not consider the relevance of any particular allegation of bias, but simply treated the allegations, in the aggregate, as raising a presumption that the classifications were the product of bias.64The ALJ's application of a general presumption that the examiners were biased, without making specific findings, supported by the evidence, that a specific examiner was biased and that specific classifications were the result of that bias, was erroneous as a matter of law.
[.22] As previously noted, the only legally sufficient allegation of bias which Respondents could make would be that the FDIC examiners participating in the September examination were biased as a result of certain events, and that they classified loans which should not have been classified or classified loans more severely as a direct result of that bias.65Logically, then, the only
64The ALJ ruled that "any assessment of the judgments rendered by those examiners must be made in light of the circumstances surrounding the examination and any factors which may affect their analysis, opinions and conclusions." (RD at 35) The ALJ explained that "the rationale for each [classification] conclusion has been examined in light of . . . factors and circumstances which may have affected the subjective judgment of the examiners." (RD at 36) The ALJ found that the examiners "all devoted their best efforts to conduct themselves with the highest intentions of fairness, impartiality and thoroughnes." Nevertheless, he went on to "note a number of events peculiar to this case which, perforce, affect the final placement of the planchette as it comes to rest on that classification matrix, called the `Oiuja Board'". (RD at 36) Nowhere, however, does the ALJ make specific findings that would, in the Board's view, justify a finding of bias on the part of any one or all of the examiners. For example, there are no specific findings that: (1) a certain event occurred which could have resulted in bias; (2) Examiner X took part in (or at least was aware of) that specific event prior to assigning his loan classifications; (3) the evidence demonstrates that Examiner X did, in fact, become biased as a result of that event; and (4) as a direct result of his bias, Examiner X classified a loan which would not otherwise have been classified. (The latter point may be demonstrated by a showing that there is no reasonable basis to support the classification assigned.) Unfortunately, the ALJ's opinion addresses only step (1) above, then skips to a general presumption that every examiners' conclusion with respect to every classification must have been affected by the occurrence of the general events.
65In Biscayne Federal Savings & Loan Association v. Federal Home Loan Bank Board, 720 F.2d 1499 (11th Cir. 1983), the United States Court of Appeals for the Eleventh Circuit held that once the statutory grounds for FHLBB receivership had been met, a court had no authority to set aside that receivership, despite the FHLBB's "outrageous", "outlandish" and "egregious" behavior which was "wrapped in a shroud of deception." Id. at 1502. It is true that the bank in Biscayne conceded that the statutory grounds had been met, whereas Respondents claim that the alleged bias of the FDIC may have affected the FDIC's ability to ascertain whether the statutory grounds had been met (by affecting the examiners' loan classifications). Accordingly, the alleged bias of the FDIC may be relevant if it is shown that as a direct result of that bias an examiner classified a particular loan which would not otherwise have been classified. Such a determination would be relevant because it would go directly to the issue of whether the statutory ground-unsafe or unsound practices-had been met. (Continued)
{{4-1-90 p.A-542}}events which would be relevant to the bias issue are those events which the examiners took part in (or at least were aware of) prior to assigning a classification. From this perspective, the Board finds that the ALJ erred in considering a number of events because there was no showing that any of the examiners at the September examination were aware of those events, or because such events occurred after the examiners had classified the loans, or both.66Accordingly, the Board holds that all events occurring after December 9, 1983 are irrelevant with respect to the loan classification issue, and we therefore decline to address any such events.
With respect to the other events alleged by Respondents to evidence bias, it must be shown that such events occurred; that the examiner classifying a loan participated in (or was at least aware of) those events; that there exists some factual basis for concluding that the examiner actually acquired an adverse bias as a result of those events; and that there was the opportunity for the bias to have resulted in the examiner either classifying a loan which should not have been classified or classifying a loan more severely. The Board finds that there is no evidence that any examiner acquired an adverse bias as a result of any of the events alleged.
Initially, we note that several of the events which the ALJ cited in support of his "presumption of bias" theory consist of routine, well-established procedures which are followed in virtually every instance when the FDIC is faced with a bank whose financial condition has deteriorated to the extent that * * * Bank's had. We therefore do not agree that such events are in any manner "events peculiar to this case" (RD at 36) which may have had any impact on the examiner's classifications.
[.23] In the instant case, the FDIC had conducted a full-scale examination of the Bank in February of 1983. The FDIC was alarmed by the deterioration in the Bank's financial condition, and particularly the deterioration in the quality of the Bank's assets.67The Bank had grown rapidly, but a significant part of that growth was attributable to excessively risky extensions of cred
65 Continued:Once it is shown, however, that the statutory grounds have been met, any alleged bias on the part of the FDIC becomes wholly irrelevant. The Biscayne court recognized that agency determinations about "unsafe and unsound" practices may be subjective, and accordingly stated that a court could inquire into "whether there were facts before the Board, when it acted, on which the Board could reasonably have concluded that `a' statutory ground existed. . . . The abuse of discretion standard referred to in Washington Federal therefore focuses on whether the facts before the Board supported one or more of the . . . statutory grounds. . . . It does not, as plaintiffs contend, sanction the second-guessing of Board judgment once such statutory grounds have been satisfied." 720 F.2d at 1505. Accordingly, except to the extent that it is shown that the alleged bias "caused" the classification of a loan which would not have otherwise been classified or "caused" a more severe loan classification (thus impacting on whether the statutory grounds have been met), any allegations of bias are irrelevant to this proceeding.
66The evidence shows that Respondents were supplied with a written list of classifications on November 30, 1983 which was supplemented on December 2 and December 9, 1983. (Tr. 1093, 1101-1102) Accordingly, the ALJ's recitation of events allegedly occurring from December 12, 1983 - May 22, 1984 (see RD at 21-33) was both unnecessary and inappropriate, as such events could not possibly have had any bearing on the examiners' loan classifications. We hold that events occurring after December 9, 1983 were entirely irrelevant to the issue of the appropriate loan classifications, and we accordingly decline to make any findings with respect to such events. We note in passing, however, that even a brief review of the record reveals several omissions and mistakes in the explanation of such events. In light of our conclusion that such events are irrelevant, however, we find it unnecessary to address those points in this decision.
Furthermore, there is no evidence in the record which demonstrates that some or all of the examiners assigning the loan classifications were even made aware of a number of the events recited by the ALJ. For example, the ALJ noted that the FBI sent the FDIC's * * * Regional Office information about certain borrowers of the Bank. (RD at 19) There is, however, no indication that this information was ever transmitted to the examiners who assigned classifications to those borrowers' loans. Furthermore, even if the examiners had been aware of this information, the ALJ does not seem to believe that the information led to biased classifications. We reach this conclusion because the Respondents themselves admitted the accuracy of the classification assigned to two of those borrowers(* * * and * * * - RD at 44 and 45); and the ALJ upheld, in whole or in part, the classifications assigned to the other borrowers ("Loss" classifications assigned to loans to * * * , * * *, and * * * were upheld; ALJ classified the loan to * * * * * * as "Doubtful"—RD at 43).
67More than 25% of the Bank's gross loans were overdue at the time of the February examination, which was more than double the percentage which had been overdue in the FDIC's February 1982 examination, and four times the percentage of overdue loans in the FDIC's July 1981 examination. (R.Ex. 3 at 2; Tr. 466-69) The percentage of total assets which were adversely classified had similarly increased from 1.9% in 1982 to 29% in 1983. (R.Ex. 3 at 2) More than $11 million of the adversely classified assets consisted of new credit which had been extended between the examinations. (R.Ex. 3 at 1) The ratio of adjusted equity capital and reserves to adjusted total assets had also deteriorated from 6.85% in 1980 to 5.64% in 1982 and 4.37% in February of 1983. (R.Ex. 3 at 3) The Bank's volatile liability dependence ratio had increased from 54.84% in 1981 to 71.62% at the end of 1982, as compared with the peer group average of 3.92%. (R.Ex. 3 at 5)
{{4-1-90 p.A-543}}credit. (Tr. 782–783) Along with the rapid growth came decreasing earnings, insufficient capital, excessive reliance on volatile deposits, and a number of violations of lending limit laws designed "to force the containment of excessive risk." (Tr. 782-786) As a result of its extreme financial deterioration, the Bank was given a "5" composite rating, in accordance with the Uniform Financial Institutions Rating System ("UFIRS").68Under this uniform rating system, a "5" composite rating (the worst possible rating) designates a bank with the following characteristics:
Considered unsatisfactory; performance that is critically deficient and in need of immediate remedial attention. Such performance, by itself or in combination with other weaknesses, threatens the viability of the institution.
(R.Ex. 1, "Concepts and Guidelines", p. 1 -emphasis added)
As a result of the Bank's alarming financial condition, the FDIC met with Respondents in June, 1983 to ascertain whether they would be willing voluntarily to enter into a cease and desist order to correct the Bank's problems. Respondents asked whether a cease and desist order would be necessary if the Bank were able to reduce the classified loans by half. (Tr. 800)
* * * , the FDIC Assistant Regional Director in * * * , replied that he thought it would be a miracle if Respondents were able to achieve a 50 percent reduction in its classified loans (a reduction equal to over $11,500,000)69within the short period of time left before the examination report was finalized and processed. (Tr. 800, 970-71) Nevertheless, Mr. * * * assured Respondents that "the door was open for them to provide input to the Regional Office prior to the completion and transmittal of that examination report." (Tr. 800–801)
The Respondents apparently disagreed with some of the provisions which would be contained in the proposed cease and desist order, and in addition stated that they would prefer an informal agreement.70Because of the severity of Bank's problems, and in accordance with well-settled FDIC policy on 5-rated banks,71the FDIC declined to accept the Respondents' offer to enter into an informal agreement rather than a formal cease and desist order. (Tr. 820-21, 824) Accordingly, a proposed formal cease and desist order was issued on August 3, 1983. (P.Ex. 15).72
Throughout this time period, Respondents contended that the Bank had made substantial improvements since the close of the FDIC's February 1983 examination. In
68The Uniform Financial Institutions Rating System has been adopted by the Office of the Comptroller of the Currency, the FDIC, the Federal Home Loan Bank Board, the Board of Governors of the Federal Reserve System and the National Credit Union Administration. (R.Ex. 1, "Concepts and Guidelines", p. 1) The uniform composite rating is based upon an analysis of pertinent performance indicators with respect to capital adequacy, asset quality, management, earnings and liquidity. (Id.) We note that the state of * * * uses the same composite rating system (Tr. 2427), and in fact assigned a "5" rating to the Bank as a result of its own September, 1983 examination. (Tr. 2319)
69See R.Ex. 3 at 2.
70 The ALJ found that "[i]n September 1983, the Bank refused to sign a consent agreement, and that refusal was taken to evidence non-cooperation." (RD at 37) However, the ALJ's statement was unsupported by any citation to the record and the Board found no evidence to support that conclusion. The ALJ may have been referring to a memorandum prepared on February 10, 1984. (See R.Ex. 462) If so, the ALJ's error was extremely significant. The memorandum was cited to support his "presumption of bias" on the part of the examiners conducting the September examination. Yet the event evidencing the bias did not occur until February 10, 1984, and therefore could not possibly have affected the examiners' classifications, as the September exam had been completed almost two months prior to that event. In any event, a full reading of the memorandum demonstrates that the author was merely nothing that the Bank asserted that the FDIC was judging the Bank too harshly, and predicting that the proceeding would be contested by the Bank through the administration hearing.
71The FDIC Manual of Examination Policies contains these instructions on "5" rated banks:
Banks with composite ratings of "4" or "5" will, by 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. . . . Mere belief that bank management has recognized the problems and will implement corrective action is not a sufficient basis to preclude action if the bank is still deemed to warrant a composite rating of "3", "4", or "5".
(R.Ex. 1, §V, p. 1-emphasis added)
72The ALJ found that the state of * * * issued a Confidential Emergency Cease and Desist Order on August 3, 1983. (RD at 12) We note that this finding is incorrect. The state did not even begin its examination of the Bank until September 30, 1983, and the evidence reflects that the state's Confidential Emergency Cease and Desist Order was not issued until November 28, 1983. (P.Ex. 71 at 9) The State, however, did agree with the FDIC that formal corrective action was necessary. (Tr. 802, 2242, 2250)
{{4-1-90 p.A-544}}order to ascertain the nature and extent of such improvements, the FDIC began a special, limited scope credit examination of the Bank on September 30, 1983. (Tr. 832-33)73Instead of radical improvements, however, the FDIC discovered a worsening situation. In several instances the Bank had extended additional credit to borrowers whose loans had been adversely classified at the February examination. (Tr. 1037-39) The Bank had continued to capitalize interest and extend credit in excess of the legal lending limits, despite criticisms of such practices in the February examination report. (Tr. 1042-43) As a result of these troubling developments, the FDIC's special, limited scope examination was converted to a complete, full-scope examination (Tr. 2527) and a Notice of Charges and of Hearing and a Temporary Order to Cease and Desist were issued by the FDIC on November 22, 1983. (Tr. 1043-44, P.Ex. 16) The state of * * * was equally alarmed by the results of its own examination of the Bank, and issued a Confidential Emergency Cease and Desist Order on November 28, 1983. (P.Ex. 71)
As the examination progressed, it became increasingly clear that the large volume of questionable loans threatened the viability of the Bank. In early November 1983, the examiner-in-charge of the state examination relayed to his superiors his belief "that "Loss" and half of Doubtful classifications will exceed the bank's total capital" (P.Ex. 69), thus rendering the Bank insolvent. On November 10, * * *, the Chief of the state's Bureau of Examinations, advised his superior that "[w]hen the bank is forced to charge-off its Loss classifications and when the bank's actual earnings and solvency becomes public knowledge, large CD's may be expected to leave the bank." (P.Ex. 69) On November 17, 1983, * * * called the FDIC Assistant Regional Director in * * * and advised him that "there is a 50-50 chance
the bank will fail." (P.Ex. 92) The following day, an FDIC review examiner in Washington noted the possibility of insolvency, and advised that the FDIC would begin gathering information for a bid package, in preparation for such a contingency. (R.Ex. 452) On December 6, 1983, * * * , an official from the State Comptroller's Office, visited the Bank and reached the following conclusion: "After discussing the bank's financial and operating condition with the EIC [* * * , the examiner-in-charge of the state examination], reviewing the bank's financial statements, and inspecting the property securing a large loan, I concurred with the EIC's preliminary conclusion that the bank was in an impaired condition." (P.Ex.-emphasis added) Mr. * * * concluded that "time was of the essence." (P.Ex. 72) In December the FDIC also reached the conclusion that "Loss" and one half of "Doubtful" classifications might exceed the Bank's capital. (R.Ex. 456)
In light of all the warnings that the state might declare the Bank insolvent, in December, 1983 the FDIC * * * Regional Office provided the appropriate FDIC officials with the information customarily provided whenever it is learned that a bank failure is possible (Tr. 2547-59),74to enable those officials to move quickly in carrying out their statutory responsibilities should the bank fail.
The Board finds nothing in the foregoing events to "evidence a highly charged atmosphere of charges and countercharges." (RD at 38) On the contrary, the Board finds that this sequence of events demonstrates a fairly typical, and entirely appropriate, regulatory response by the state of * * * and the FDIC to a bank with critical financial deficiencies.75Accordingly, the Board finds nothing in this sequence of events that evidences bias on the part of the seasoned FDIC examination team.76This conclusion
73The state of * * * began its own independent full-scope examination of the Bank on the same date.
74For example, the * * * Region was asked to provide information "like deposit totals, if we could give an estimate of how many deposits are uninsured and so forth, pretty much normal operating procedure.
If we have indications that there is a potential failure, either in the short term or if it is a longer term, we have certainly a lot more information that our Division of Bank Supervision and the Division of Liquidation need in connection with meeting our insurance responsibilities." (Tr. 2548-49) * * * , the Assistant Director of the FDIC * * * Regional Office, testified that FDIC policy requires that such information be provided so that the FDIC can "get some contingency plan started in the event we ha[ve] to move, and we ha[ve] to move fast for our liquidation aspects." (Tr. 2548)
75Fortunately, a capital infusion in February of 1984 helped to avert the Bank failure which state officials had predicted might occur in February or March. (Tr. 1147-48; P.Ex. 92)
76There is, in fact, no evidence that all of the examiners in the Bank were even aware of most of these events. For example, the ALJ cites a discussion in December, 1983 between the two most senior managers in the * * * Regional Office, regarding the possible necessity of a removal action and/or a termination of insurance action. (RD at 38) There (Continued)
{{4-1-90 p.A-545}}is strengthened by the complete lack of any record evidence suggesting that any FDIC examiner was at all affected by these events.77
A number of other events cited by the ALJ are, admittedly, a bit more unusual. It is true that it is not every examination in which a Bank official advises an examiner that the room in which he is working may be monitored (Tr. 1089-90, 1488); the FBI advises the FDIC that there may be criminal wrongdoing on the part of Bank borrowers (R.Ex. 453 and 454); the FBI plans further to investigate evidence it has uncovered of a possible money laundering scheme at the Bank (P.Ex. 100; Tr. 2647-48);78and there are other indications of possible improper activities by the Bank. (Tr. 989-90, 1242) Both FDIC examiners * * * and State Examiner * * * testified that referrals of apparent criminal irregularity are a fairly routine part of an examiner's job, and would not impair the examiner's ability to assess the credit quality of a bank's loan portfolio. (Tr. 3445-47, 1250, 1253, 1260-61, 1494) The FDIC Manual contains an entire chapter on criminal violations, including instructions for completing the FDIC's standardized referral form. (R.Ex. 1, §S) Thus the Board finds that there is simply no evidence to suggest that any examiner was influenced by these unusual events. On the contrary, there is abundant evidence that the objectivity of the examiners was not, in fact, affected by the occurrence of these events.
In the ALJ's view, no evidence of actual bias or biased classifications is required, and neither evidence of objectivity nor the examiners' professionalism will be considered adequate to rebut the "presumption of bias." The Board finds this "presumption of bias" theory to be untenable, and its public policy implications are disturbing.
The fallacy of this "presumption of bias" theory is evident from the record in this case. Initially, it should be noted that most of the FDIC examiners were not, apparently, even aware of most of the incidents cited in support of the allegations of bias. The ALJ frequently relied upon one isolated sentence of a routine memorandum, relating the substance of a routine telephone conversation between Examiner * * * and Assistant Regional Director * * * to support a presumption that every examiner participating in the FDIC examination was biased in his classification of every loan. It appears, however, that Examiner * * * personally analyzed only a very few of the classifications which were in dispute in this case. Furthermore, some of the "events" cited by the ALJ appear to consist of nothing more than offhand comments made by * * * to * * * during the course of a routine telephone conversation. Moreover, only three of the twenty-two alleged "incidents" cited by the ALJ are in any way
76 Continued:is no evidence whatsoever that these high-level discussions were ever communicated to the examiners in the Bank. Indeed, such a communication would be highly unlikely to occur. Accordingly, we fail to understand how such discussions could have had any impact upon the examiners' classification conclusions.
77We note several disturbing inaccuracies and omissions in the ALJ's "Chronology of Significant Events." For example, the ALJ states that "* * * , Chief, State Bureau of Bank Examiners, received a telephone call from the FDIC requesting the removal of State Examiner * * * from the September 30, 1983 examination team. Mr. * * * removal was sought because he had voiced criticism of the FDIC examination approach." (RD at 13) This finding is wholly unsupported by the evidence in the record. The record clearly shows that * * * , the examiner-in-charge of the * * * State examination team, called * * * to request Mr. * * * removal. (Tr. 4892-4893) The FDIC did not request Mr. * * * removal, and FDIC examiners were never even made aware of the reason or reasons for the state decision to remove him. (Tr. 1473) The state examiner-in-charge testified that he had criticized Mr. * * * for his failure to do a thorough review of the information contained in the Bank's loan files. (Tr. 4891-92)
When Mr. * * * was instructed to conduct an independent review of credit quality, rather than relying upon the Bank's representation that an account was good, he charged both the State and the FDIC with "leaving no stone unturned." (Tr. 4891-4893) The State Examiner-in-Charge testified that the FDIC did not have an influence on his decision to have Mr. * * * removed. (Tr. 4893);
With respect to another incident, the ALJ found no evidence that files had been purged of information prior to them being turned over to examiners. The record does, however, contain such evidence. The FDIC Examiner-inCharge saw a Bank officer remove information from a file which had been requested by examiners. (Tr. 989-90) Indeed, the State of * * * November 1982 examination report states that "[s]ome difficulty was encountered working commercial loans as all files were reviewed by Chairman * * * and all negative information was removed before the files were given to examiners. `(R.Ex. 5, Supervisory Section, p. A) These are only examples of several errors we have found in the ALJ's recitation of events. We decline, however, to correct every misleading point made by the ALJ because we find that the majority of such points are irrelevant to the issues which are properly to be decided in this case.
78The ALJ stated that "[n]o evidence of any laundering scheme was introduced at trial." (RD at 38) As previously noted (supra, p.4 n. 1), * * * and * * * were subsequently indicted on charges of racketeering.
{{4-1-90 p.A-546}}connected with any specific borrower or loan. Even if incidents involving a particular borrower could possibly lead to bias in an examiner's classification of that borrower's loans,79we find it difficult to see how an unrelated incident could have any impact on a specific loan classification.80
The examination team that conducted the September examination was made up of highly skilled professionals. The Board does not believe that the analytical abilities of these seasoned professionals would be impaired by a few isolated events that they would be unable to discharge their duties in an unbiased, objective manner. Indeed, all of the available evidence demonstrates that they were, in fact, most careful and fair throughtout the examination process.
The ALJ "closely observed the demeanor of the examiners as they testified," and found that "[t]hey were candid and forthright, both on direct examination and on what was obviously an eye-opening and unfamiliar, if not wholly new experience, cross-examination by seasoned counsel." (RD at 36) The content of those "candid and forthright" answers is instructive. When asked whether there had ever been any special instructions or directions given with respect to this Bank, or whether they were attempting to find as much adverse information as possible, each and every examiner queried replied with an unequivocal "No." (See Tr. 834-35; 982-84; 1682; 1872)
Examiner * * * was also questioned by Respondents' counsel about the referral to Washington concerning over one million dollars of unmounted gems which were pledged as collateral for a loan at the Bank. After * * * testified that he had reported the existence of the unusual form of collateral to his superiors, Respondents' counsel made the following inquiry:
Q. But you still want this Judge to sit here and believe that you could sit there for the remainder of the examination, which is another period of almost two months, and be a fair and impartial examiner?
A. Absolutely.
(Tr. 1196 - emphasis added) Mr. * * * had similar responses to direct questions regarding his ability to be impartial following other events cited by the ALJ. (Tr. 1260-61, 1488, 1491-94, 1506-07, 1582)81
The most persuasive evidence of the examiners' objectivity, however, is not their words but their actions. Respondents alleged that the examiners acquired a bias against the Bank, and as a result of that bias were not fair and impartial in their loan classifications. Yet Respondents were unable to produce a single shred of evidence of that bias "in action" during the loan classification process. Indeed, the only evidence regarding the actual classification process demonstrates that the examiners took great
79In general, the record does not even support a finding that incidents involving specific borrowers had any effect on the classifications assigned to such loans. One such incident involved a loan to * * * , an interest of * * * , which was secured by unmounted previous gems. (See P.Ex. 17 at 145-146) The ALJ agreed with the "Substandard" classification assigned to that loan by the FDIC examiner. (RD at 44) Another "incident" noted by the ALJ was an FBI report on * * * , Vice President of * * *. (Rd at 19, 38) It is interesting to note, however, that the Respondents admitted the accuracy of the "Substandard" classifications assigned to both the * * * and * * * loans. (Rd at 44–45) The final "incident" relating to specific borrowers noted by the ALJ was an FBI report on * * * and * * *. (RD at 19, 38) Once again, reference to the ALJ's classification conclusions reveals that the ALJ upheld the "Loss" classifications the FDIC examiners had assigned to the * * * and * * * loans. (RD at 43, 47) In light of the fact that the ALJ upheld (or the Respondents admitted) the classifications assigned to each of the aforementioned loans, it is evident that the effect, if any, of the "incidents" regarding these borrowers was obviously not prejudicial.
80 Perhaps if the Respondents had been able to present evidence of events which could really have resulted in bias -an instruction to classify as many loans as possible, for example - the `presumption of bias' theory based on general incidents would be tenable. It is clear that Respondents made every effort to locate such a "smoking gun", but that despite the FDIC's production of 31,000 pages of documents, not a scintilla of such a evidence was found. (See Transcript of the Pre-Hearing Conference at pp. 125, 134, 140-41) That is apparently why the allegations of bias are based on nothing more than isolated, unrelated general incidents which have no apparent relationship to the subject of loan classification.
81In reaching his "presumption of bias" conclusion, the ALJ relied upon the testimony of * * * that he believed that the events in this case could affect the impartiality of the examiner's classifications. (Tr. 4323-24) We find Mr. * * * testimony was groundless speculation and is therefore entitled to no weight. When Mr. * * * served on the FDIC Board of Directors, he relied upon a staff of highly skilled expert examiners with regard to classification conclusions. He has never examined a bank, trained as an examiner, or classified a loan. (Tr. 4311-4312; 4325-4328) Now that he no longer has the benefit of expert examiner's advice, his speculation about any possible effect on the impartiality of a hypothetical examiner assigning hypothetical classifications to hypothetical loans in hardly adequate grounds for discounting the "candid and forthright" testimony of the most experienced bank examiner in the * * * region.
{{4-1-90 p.A-547}}pains to ensure that their loan classifications were fair and correct.
There is abundant evidence in the record that on numerous occasions FDIC examiners changed several loan classifications as a result of conversations with the * * * and the provision of documentation, even after the classifications had been assigned. (See Tr. 1098, 1116, 1272, 1471, 1544-45) This accommodation demonstrates that the examiners went to great lengths to give the Bank the benefit of any doubts. Examiner * * *, who specializes in examining banks with exceptional financial problems, testified as follows:
Q. So that, can you describe then the circumstance under which you would go back and re-evaluate the loan after loan discussions had been completed?
A. Well, we don't do that except in very unusual situations.
Q. Were any of those unusual situations, did any of those occur here during this examination?
A. Yes; because we changed our classifications on several loans.
(Tr. 1542) The record further demonstrates that the examiners considered a letter from Bank counsel presenting additional documentation after the close of the examination. (Tr. 1269) As a result of the additional information, $115,000 which had been classified "Loss" was changed to "Substandard," despite the fact that the examination was over. (Tr. 1269-70, 1544) Surely a biased examiner would not have taken these extraordinary steps to reconsider and reduce loan classifications which had already been assigned.
Therefore, the Board finds no credible evidence in the record that the FDIC examiners were biased by the events in question, or that they classified loans which should not have been classified or classified loans more severely as a result of any such bias. Accordingly, we find no basis for the ALJ's conclusion that the examiner's classifications should be subjected to greater than usual scrutiny.
We do, however, wish to address one piece of evidence which, although clearly not sufficient to demonstrate "bias", may nevertheless require greater attention by the Board. The record shows that in January, 1983 the FDIC * * * Regional Office instructed Examiner * * * to go to * * * in * * *. (Tr. 2106-07) The * * * Regional Office had been advised by the FDIC * * * Regional Office that examiners visiting the * * * Bank in * * * had found evidence of a possible "check kite" between * * * Bank, where * * * had served as ViceChairman of the Board, and * * * Bank. (Tr. 2108, 2063) It appeared that the "kite" involved * * * and * * *, all of which are borrowers of * * * Bank. (Tr. 2107) Mr. * * * obtained statements and copies of checks for several accounts, but did not advise * * * Bank that a "kite" was suspected. (Tr. 2108) Several junior officers of * * * Bank also reviewed the accounts and advised * * *, the Executive Vice President, of their findings. (Tr. 2106-08) Examiner * * * testified that "I didn't tell Mr. * * * it was a `kiting' at that time. He's the one that said to me, `It looks like we have a "kite'."' (Tr. 2108) As a result of his findings, Examiner * * * filed a report of apparent criminal violation with the U.S. Attorney's Office, as required by the FDIC Manual of Examination Policies. (See Tr. 2109; R.Ex. 1, §S, pp. 4–8) Examiner * * * later met with * * *, the Chairman and President of * * * Bank, who advised Examiner * * * that he intended to contact the FBI and the bonding company. (Tr. 2111) Mr. * * * was unaware of any followup to the criminal referral. (Tr. 2110-11)
Mr. * * * reviewed a number of loans during subsequent FDIC examinations of * * * Bank, including the September, 1983 examination. Among the loans which he reviewed were several loans collectively known as the "* * *" group. (See P.Ex. 17 at 78) The * * * group included loans to several related interest of * * *, including those companies suspected of involvement in the kite between * * * Bank and * * * Bank. (See P.Ex. 17 at 78) With respect to his subsequent review of those lines of credit, Examiner * * * gave the following testimony on cross-examination:
Q. Can you tell me if the information that you had uncovered about a potential check "kiting" scheme back in January of 1983 also affected your view of * * * and the * * * arguably related lines, when you were participating in the September of 1983 exam?
{{4-1-90 p.A-548}}
A. I'm sure that it still carried over. (Tr. 2116-17) Mr. * * * testimony on redirect examination, however, suggests that the prior information involving * * * and his interests did not cause Mr. * * * to classify loans which he would not otherwise have classified: (Tr. 2128)
* * *: I am going to ask this witness whether or not whatever effect it had, did it have any effect on his liability to analyze and appraise on an impartial basis, and on a professional basis, the credit quality of the loans made to * * *, to * * * and/or any of the related interests of * * * or * * *.
THE WITNESS: No.
The Board concludes that the ambiguous question by Respondent's counsel on cross examination and Mr. * * *'s answer provides no rational support to any claim of bias. Nor is there sufficient evidence in the record that would justify any inference of an connection between the prior alleged check-kite and the assessment of Mr. * * * loans from the Bank. Furthermore, the Board considers it to be perfectly proper for an examiner, in appropriate circumstances, to utilize information from external sources obtained pursuant to his duties in connection with a bank examination. To the extent that knowledge of Mr. * * * prior alleged check-kite caused Mr. * * * to exercise a greater degree of care in evaluating the * * *-related loans, the Board supports that result.
Nevertheless, the Board has reviewed Examiner * * * classifications of the * * * loans with particular care, to ensure that those classifications are absolutely justified by objective facts, without regard to any extraneous matters. After an exhaustive review of these loans, the Board has concluded that the majority of classifications assigned to them during the September examination were absolutely correct.82The Board has, however, chosen to remove the Substandard classification assigned to one loan in the * * * group because we did not find sufficient basis for classifying that loan.83
In summary, the Board finds no credible evidence to suggest that the FDIC commissioned examiners taking part in the September examination were biased, classified loans more severely or classified loans which should not have been classified, as a result of events taking place prior to or during the examination. On the contrary, the available evidence demonstrates that the examiners took great pains to ensure that their classifications were fair and impartial. The Board also categorically rejects the ALJ's application of an automatic "presumption of bias".
We do agree, however, that greater scrutiny of examiner * * *'s * * * classifications was warranted. However, after careful review of the evidence regarding the * * * group loans, we have concluded that all but one of those loans were properly classified "Substandard."
In any event, even assuming arguendo that FDIC examiners were in fact biased against the Bank, the Board has conducted its own de novo review of each of the contested loan classifications (and contested violations of law) and we have independently reached our own conclusions based solely on the evidence in the record and our experience and expertise. This would cure any taint resulting from the alleged examiner bias and eliminate any prejudice to Respondents. Corning S&L Ass'n v. Fed. Home Loan Bk. Bd., 571 F.Supp. 396, 405 (E.D. Ark. 1983), Skokie Fed. S&L Ass'n v. Fed., Home Loan Bk, Bd., 400 F. Supp. 1016, 1019-20 (N.D. Ill. 1975); Fidelity Financial Corp. v. Federal Sav. & L. Ins. Corp., 359 F. Supp. 324, 326 (N.D. Cal. 1973)
F. The FDIC Manual - Applicability of Notice and Comment Procedures of the Administrative Procedure Act
[.24] The ALJ found, and the Board agrees, that the FDIC's September 30, 1983 examination was conducted in accordance with the guidelines set forth in the FDIC Manual of Examination Policies ("Manual"). (RD at 34) The Manual constitutes a
82The State of * * * September 1983 examination report included certain loans in the * * * group that were excluded by the FDIC, and vice versa. The State and the FDIC agreed, however, that 18 loans should be included in the * * * group. Of those 18 loans, the FDIC classified $7,846,000 as "Substandard." It is interesting to note that the State classified $7,815,114 of these 18 loans: $7,806,490 as "Substandard" and $8,624 as "Loss." (Compare P.Ex. 17 at 78-79 and R.Ex. 6 at 2-b-28 through 2-b-29) There is no evidence which suggests that any state examiner was aware of the evidence of a * * * "kite" between * * * Bank and * * * Bank.
83See Section D. 5, p. 92-93, supra, discussing the * * * loan. Although we did not decide to assign an adverse classification to that loan, we did find that certain extraordinary aspects of the loan warranted special mention. The ALJ also found that the circumstances surrounding this loan warranted special mention.
{{4-1-90 p.A-549}}general statement of policy and/or interpretive rule rather than a substantive rule which has the force of law. First State Bank of Hudson County v. United States, 599 F.2d 558, 564 (3d Cir. 1979). Accordingly, contrary to the Bank's contention, the Board was not required to follow the notice and comment procedures of the Administrative Procedure Act in preparing the Manual. Guardian Federal Savings and Loan Association V. FSLIC, 589 F.2d 658 (D.C. Cir. 1978).84
Although the FDIC's interpretations as contained in the Manual are not binding on a court, they "are to be accorded considerable weight and are to be construed as a body of experienced and informed judgment; they are not to be disregarded by the court unless `there are compelling indications that [the interpretation] is wrong.'" Donovan v. Sutherland, 530 F. Supp. 748, 750 (E.D. Mich. 1982), quoting Red Lion Broadcasting Co. v. F.C.C., 395 U.S. 367 (1969). See also Guardian Federal Savings & Loan Association v. FSLIC, 589 F.2d 658, 665 (D.C. Cir. 1978); Haddon Township Board of Education v. New Jersey Department of Education, 476 F. Supp. 681, 693-94 (D.N.J. 1979). Accordingly, the Board finds no merit in Respondents' argument that the Manual is invalid, and further finds that the precepts contained in the Manual are entitled to deference.
UNSAFE OR UNSOUND PRACTICES
[.25Section 8(b) of the Federal Deposit Insurance Act provides in pertinent part:
If, in the opinion of the appropriate Federal banking agency, any insured bank. . .has engaged. . .in an unsafe or unsound practice. . .the agency may issue and serve upon the bank. . .a notice of charges in respect thereof. . . [I]f upon the record made at any such hearing, the agency shall find that any. . . unsafe or unsound practice specified in the notice of charges has been established, the agency may issue and serve upon the bank. . .an order to cease and desist from any such. . .practice.
12 U.S.C. §1818(b)(1). Under this standard, the FDIC may order a bank to cease and desist from an unsafe or unsound practice if it is established that the bank has engaged in such a practice on even a single occasion.
The notice of charges in this case charged the Bank with having engaged in a variety of unsafe or unsound practices. With respect to some of those charges, the ALJ clearly found that at least some of the practices had been established. (RD at 56–57) With respect to other charges, however, it is difficult to ascertain precisely what the ALJ's ruling was. In some instances he found that an unsafe or unsound practice existed in September of 1983, but seemed to find that fact irrelevant because, in his view, the problems had been remedied. (RD at 66-67) In other cases the ALJ simply stated that a certain unsafe or unsound practice "may" have occured in September 1983, but apparently believed it unnecessary to rule on that issue in light of his belief that subsequent improvements had taken place. (RD at 65–66) The lack of clarity in some of the ALJ's findings in this regard may be explained by his belief that
84Respondents alleged that the Manual was a substantive rule, and that because the notice and comment procedures of the Administrative Procedure Act ("APA") were not followed prior to its preparation, the Manual and all examination reports prepared thereunder were invalid. (R. Exceptions at 9-11) We disagree.
The Manual clearly falls within 5 U.S.C. §553(b)(A), which exempts "interpretive rules, general statements of policy or rules of agency organization, procedure, or practice" from the notice and comment procedures of the APA. Like the guidelines at issue in Guardian Federal Savings and Loan v. FSLIC, 589 F.2d 658 (D.C. Cir. 1978), the FDIC Manual has some characteristics of a general policy statement, interpretive rule and rule of agency procedure. It interprets the FDIC's mandate, under section 10(b) of the Federal Deposit Insurance Act, to "appoint examiners who. . . shall have power to make a thorough examination of all of the affairs of the bank [insured State nonmember banks and their affiliates],. . .and [who] shall make a full and detailed report of the condition of the bank to the Corporation." 12 U.S.C. §1820(b)
Certain portions of the Manual merely address agency procedure (see, e.q., "Basic Examination Concepts and Guidelines," p. 4, subsection entitled "Preexamination Activities".) A substantial part of the manual also constitutes a policy statement which "advise[s] the public prospectively of the manner in which the agency proposes to exercise a discretionary power." U.S. Department of Justice, Attorney General's Manual on the Administrative Procedure Act, p. 30 n.3. Here, even more than in Guardian, the policy statement clearly and explicitly contemplates the exercise of an examiner's discretion. The very real discretion which exists is demonstrated in this case, where FDIC examiner * * * changed some loan classifications as a result of explanations by counsel for Respondents. (Tr. 1544-46)
Here, as in Guardian, "an opportunity for an individualized determination is afforded." 589 F.2d at 667. Accordingly, the FDIC Manual constitutes a bona fide policy statement/interpretive rule which is not subject to the notice and comment procedures of the APA.
{{4-1-90 p.A-550}}whatever the Bank's problems were in September, the State of * * * was dealing with them and it was unnecessary for the FDIC to exercise its own regulatory responsibilities. Since the "order" recommended by the ALJ essentially parroted the State's memorandum of understanding (MOU) with the Bank,85the ALJ did not give the FDIC's charges the attention which would have been required if the FDIC's proposed order had been given serious consideration. Nevertheless, we will attempt to address the ALJ's findings regarding unsafe or unsound practices in spite of our occasional difficulty in ascertaining the nature of those findings.
A. Hazardous Lending and Lax Collection
Practices
[.26] The FDIC Notice of Charges alleged that the Bank had engaged in ten separate hazardous lending and lax collection practices.86The ALJ agreed with the FDIC that the Bank had engaged in each one of these practices. The ALJ noted that, in his view, there was not a great deal of explanation regarding the rationale for concluding that the alleged practices were "unsafe and unsound." We believe that even a layperson should readily understand the danger of making loans without ascertaining whether the borrower had the capacity and willingness to repay the loan and whether there was sufficient collateral support. Furthermore, the record contains extensive evidence of the dangers of hazardous lending and lax collection practices.87In light of the substantial evidence in the record in this regard, we find that each of the hazardous lending and lax collection practices alleged constitutes an unsafe or unsound practice.
1. Excessive Poor Quality and Overdue Loans
Although the ALJ did not uphold all of the FDIC loan classifications, he found that the Bank had almost $18 million in classified loans, equaling at least 319.67% of the Bank's total capital and reserves. (RD at 78) He also found that as of September 30, the bank had $4,298,000 in loans that were overdue for six months or more, and more than $7 million in additional loans that were overdue between 30 days and six months. (RD at 55) Significantly, he found that a substantial portion of those overdue loans were the result of "Bank inaction or inattention." (RD at 55) Accordingly, despite his disagreement with some of the conclusions reached by the FDIC,88the ALJ apparently upheld the FDIC's charge that "The Bank has extended and maintained an excessive and disproportionately large volume of poor quality and overdue loans." (Amended Third Notice, p. 3) We agree that this charge has been fully substantiated by the record in this case.
Accordingly, the FDIC is entitled to the relief sought-an order requiring the Bank to
85See RD at 80-81. The ALJ's recommended order includes one additional clause (addressing the reserve for loan losses), but in other respects so closely follows the State MOU that the State (rather than the FDIC) is given responsibility for monitoring the Bank's condition in the FDIC's order. (See RD at 96)
86The FDIC charged the Bank with the following hazardous lending and lax collection practices: Extending credit without regard to the ability of the borrower to make repayment (77 instances alleged, 42 upheld by ALJ); Failing to enforce programs for the repayment and liquidation of loans (28 instances alleged, 17 upheld); Extending credit without adequate security or other collateral (18 instances alleged, 7 upheld); Failing to effectively document loans (43 instances alleged, 33 upheld); Accepting separate notes from borrowers for the purpose of financing the payment of interest due on other loans (10 instances alleged, 3 upheld); Renewing loans without collecting interest due thereon, but adding such interest to the balance of renewed loans (12 instances alleged, 10 upheld); Extending credit by paying overdrafts to provide funds for the payment of interest due on loans (15 instances alleged, 9 upheld); Accruing interest income on loans notwithstanding the overdue status of such loans and the doubtful collection of interest on such loans (7 instances alleged, 2 upheld); Extending credit through the payment of overdrafts without adequate controls and without the collection of principal and interest or other fees thereon (23 instances alleged, 12 upheld). The FDIC also charged the Bank with having an excessive volume of poor quality and overdue assets. Although the ALJ disagreed with the FDIC regarding the magnitude of such assets, he did agree that the Bank had engaged in this hazardous lending and lax collection practice.
87A great many hazardous lending and lax collection practices are explained in the FDIC Manual itself. See, e.q., R.Ex. 1, §A, p. 8, "Poor Selection of Risks" (addressing the subject of findings 10.0 and 12.0); pp. 8-9, "Incomplete Credit Information" (addressing the subject of finding 232.0); p. 8, "Failing to Establish or Enforce Liquidation Agreements" (addressing the subject of finding 11.0); pp. 8, "Potential Problem Indicators by Document" (addressing the subject of findings 12.0 and 234.0, pp. 9–10.) Furthermore, there is abundant testimony explaining the hazards of those questionable practices not explained in detail in the Manual. See, e.q., the following evidence on Finding 233.00 (Tr. 505-506, 722-24, 1014-16, 1485, 1530-31); Finding 234.0 (Tr. 1014-16, 1485); Finding 235.0 (Tr. 505-06, 722-24, 1485); Finding 236.0 (Tr. 422-23, 504-05).
88WE note that the actual dollar volume involved is relevant with respect to the remedy (e.g., the appropriate amount of charge-off), but has no bearing on the existence of the violation and the concomitant authority of the Board to order the Bank to cease and desist from this particular hazardous lending and lax collection practice.
{{4-1-90 p.A-551}}cease and desist from this unsafe and unsound practice and requiring the Bank to take appropriate corrective action.89
2. Extending Credit Without Regard to
the Ability of the Borrower to Make
Repayment
The FDIC charged the Respondents with 77 separate instances of extending credit without regard to the ability of the borrower to make repayment. The ALJ found that 42 of these charges had been substantiated.
The basis for the ALJ's conclusion that several of the charges should not be sustained is unclear. For the most part, he merely cites his footnotes to Table 1, which explain his classification conclusions. The problem with this approach is evident: the majority of those footnotes merely cite the presence of collateral as justification for striking down a loan classification.90
As previously noted, the presence of collateral does not preclude classification of a loan if there are other indicia of risk present. Yet, even if the ALJ were correct in concluding that the presence of adequate collateral justified "passing" a loan which should otherwise have been classified, it is difficult to ascertain the relevance of collateral to the issue of whether the Bank extended credit without regard to the ability of the borrower to make repayment. Indeed, the only charges which would logically be affected by a finding that collateral was adequate were those alleging that the Bank had extended credit without adequate security or other collateral.
[.27] If the ALJ is suggesting that a bank may reasonably extend credit to anyone who has collateral, regardless of whether or not that borrower has any source of income or liquid assets, we unequivocally reject that suggestion. For reasons which were explained in the section on asset classifications, it is evident that purely collateral-based lending is almost by definition an unsafe and unsound practice. The Manual of Examination Procedures notes:
The willingness and ability of a debtor to perform as agreed remains the primary measure of the risk of the loan. This implies that the borrower must have earnings or liquid assets sufficient to meet interest payments and provide for reduction or liquidation of principal as agreed at a reasonable and foreseeable date.
(R.Ex. 1, §A, p. 11-emphasis added) Accordingly, when a Bank extends credit without regard to these factors, it has engaged in an unsafe or unsound practice.91The FDIC is therefore entitled to an order prohibiting the Bank from continuing to engage in this unsafe and unsound practice.
3. Other Hazardous Lending and Lax Collection Practices
The ALJ seems to believe that many of the FDIC allegations of hazardous lending and lax collection practices were grounded on the underlying loan classifications: "In cases where the alleged practice is based on the fact that a loan has been classified, the allegation of hazardous lending or lax collection has not been upheld where the classification has not been upheld." (RD at 55) Unfortunately, this methodology is based on a mistaken premise. Although the presence of hazardous lending and lax collection practices may have led an examiner to classify a certain loan, a conclusion that such classification was erroneous does not necessarily negate the examiner's conclusion that a particular hazardous lending and lax collection practice occured. Indeed, most of the ALJ's decisions to reject examiners' classifications were based upon his conclusion that the collateral was sufficient
89In the instant case appropriate corrective action includes a requirement that the Bank charge off all assets classified "Loss" and 50 percent of all assets classified "Doubtful"; a prohibition on extending additional credit to borrowers whose loans were charged off or are adversely classified; a provision requiring the reduction of classified assets; a provision requiring adoption of, and compliance with, adequate loan policies.
90 See RD at 47-48, 55. Paradoxically, the ALJ has declined to uphold findings of hazardous lending and lax collection practices even with respect to loans which he has classified. See, e.g., the * * * line (RD at 60), where the ALJ refuses to uphold three of the four charges of hazardous lending practices, and cites as support for this conclusion footnote (36), RD at 49, where the ALJ finds that a Substandard classification was justified.
91Since pure collateral-based loans are by definition dependent on liquidation of the collateral for repayment, one might reasonably question why the borrower does not obtain required funds by the outright sale of the asset thereby obviating the need to pay interest for the funds and providing the availability of the funds otherwise used to pay the interest. One explanation may well be that the asset pledged was not readily marketable and therefor resort to loan financing was necessary. That, however, only serves to further underscore the dangers inherent in such lending since the bank could be stuck with a non-income producing asset that is unmarketable or is marketable only at a discount from its book value.
{{4-1-90 p.A-552}}to support the debt in spite of other unfavorable features, not upon a conclusion that the cited unfavorable features did not exist. The ALJ's failure to uphold many of the hazardous lending and lax collection practice charges was erroneous, then, because: (1) he incorrectly assumed that most of the charges were based on the underlying classifications and therefore rejected such charges whenever he rejected the underlying classifications; (2) even if the charges had been based on the underlying classifications, we have concluded that the ALJ erred in rejecting many of those classifications; and (3) even a cursory review of the ALJ's explanations for rejecting the evidence supporting the charges demonstrates that such explanations are, in fact, largely irrelevant, mistaken and/or inadequate.
We have concluded, however, that it is unnecessary for us to review those charges of hazardous lending and lax collection practices which were rejected by the ALJ because the ALJ found substantial evidence in the record to uphold 13592of the charges. The ALJ found sufficient evidence to uphold from two to forty-two charges in each category of hazardous lending and lax collection practices alleged. We agree with the ALJ that the record contains sufficient evidence to uphold at least those charges upheld by the ALJ in each category of hazardous lending and lax collection practice alleged. Since the Bank has clearly engaged in more than one instance of each alleged hazardous lending and lax collection practice, there is sufficient statutory basis for the FDIC to order the Bank to cease and desist from engaging in such practice.93Accordingly, we find it unnecessary to review those charges of hazardous lending and lax collection practices which were not upheld by the ALJ.
B. Failure to Properly Charge Off or
Eliminate Non-Bankable Assets
[.28] The FDIC charged that the Bank failed to properly charge off or eliminate non-bankable assets from its books. In particular, the FDIC noted 23 separate instances in which the Bank failed to charge off or eliminate assets which had been classified "Loss." (See PFF 238.0-238.23) In its reply to these proposed FDIC findings, the Bank does not generally deny that it failed to charge off many of these assets, but alleges that its failure to charge them off was not "wrongful" because it did not believe that the "Loss" classifications assigned to these loans were justified.94
The ALJ found that "of the 23 instances where the Bank is alleged to have failed to charge off or eliminate assets from its books
. . .four. . .concerned Loss classifications
which were not upheld [by the ALJ]." (RD at 64) The Respondents contested seven of the "Loss" classifications assigned to assets which the FDIC claims should have been charged off. (See RPFF 238.1-238.7) We have found substantial evidence to uphold six of the seven disputed "Loss" classifications referred to in PFF 238.0-238.23.95Accordingly, we find that with respect to the assets listed in PFF 238.2-238.7, the Bank engaged in the practice of failing to properly charge off or eliminate non-bankable assets from the books of the Bank.96
In addition to the seven instances of failure to charge off commercial loans set forth in PFF 238.1-238.7, the FDIC charged the
92The FDIC charged the Bank with 233 separate instances of hazardous lending and lax collection practices, in addition to the charge that the Bank had an excessive volume of overdue loans and poor quality assets. (RD at 56)
93In addition, the FDIC may order the Bank to take appropriate corrective action. In the instant case, the Bank's failure to effectively document loans is appropriately addressed by a requirement that a designated Bank officer review the adequacy of documentation on all substantial new loans.
94See RPFF 238.0-238.6. The Bank also defends its failure to charge off non-bankable assets by alleging that it had not been legally required to charge off even items properly classified "Doubtful" in the September exam. (RPFF 238.0 and 392.0-394.1) A brief review of the record, however, reveals that the instant charge (failure to charge off nonbankable assets) refers only to "Loss" items. (See Tr. 1017-19) Each of the 23 assets which should have been charged off was classified "Loss." Since the FDIC did not charge that the Bank committed an unsafe or unsound practice in failing to charge off assets classified "Doubtful", we find it unnecessary to address the Bank's claim that it should not have done so. We note, however, that the charge off of "Doubtful" items, although not a basis for the instant allegation, may be relevant with respect to other charges or remedies.
We also note that the ALJ was similarly confused, and found that the Bank had an "obligation" to charge off 100% of "Loss" and one half of "Doubtful" assets. Once again, since the FDIC did not charge that failure to charge off one half of Doubtful was unsafe or unsound, we decline to decide that issue.
95We uphold the "Loss" classifications assigned to the assets listed in PFF 238.2-238.7, but decline to uphold the "Loss" classification assigned to the asset listed in PFF 238.1 (* * *)
96The six separate loans classified "Loss" (the classifications of which we have upheld) which the Bank failed to charge off totaled $581,000. (See PFF 238.2-238.7 and citations to September 30 report cited therein.) The ALJ agreed that three of those six loans contained some amount which was properly classified "Loss" and therefore found that $76,000 of these three loans should have been charged off. (See RD at 43-46)
{{4-1-90 p.A-553}}Bank with failure to charge off two additional groups of loans. The first group, consisting of Other Assets-Repossessions shown on page 249 of the exam report, is made up of those assets listed in PFF 238.8-238.17 ("Group I".) The second group, consisting of Installment Loans shown on page 254 of the exam report, is made up of those assets listed in PFF 238.18-238-23 ("Group II".) The Bank's response to the charge that it failed to charge off the "Loss" items in Group I merely consists of a reference to RPFF 226.0-.14. RPFF 226.0-.14 admits that the assets were properly classified Loss, but claims that they were charged off during the examination. The ALJ accepted this defense. (RD at 64) We do not, however, find persuasive evidence to support this finding. Page 249 of the exam report, which was prepared after the close of the examination, explains that the "Loss" items in Group I were discussed with the bank's officers, but makes no mention of any charge-off of such items. We find that if such items had been charged off during the examination, the examiner would have noted that fact in his write-up, in accordance with well-settled FDIC practice. This conclusion is supported by a brief review of page 254 of the exam report, where the same examiner notes that several items "were approved for charge-off during the examination." Accordingly, we find that the Bank engaged in the unsafe or unsound practice of failing to charge off the ten nonbankable assets in Group I (PFF 238.8-238.17), totaling $31,185.
The Board is puzzled by the Bank's response to the charge that it improperly failed to charge off, or otherwise eliminate the non-bankable assets contained in Group II (PFF 238.18-238.23.) In its response, the Bank merely refers to other responses, which admit that the assets were properly classified "Loss". (See RPFF 238.18-238.23) The Bank does not appear to claim that these assets were charged off, and the ALJ appears to have found that they were not. We find, however, that the assets in Group II were in fact approved for charge-off during the examination. The assets in Group II are listed on page 254 of the September exam report. The examiner notes that the loans in Group II "were approved for charge-off during the examination." Furthermore, underneath the write-up for each of these loans appears the following statement: "Deficiency balance, approved for charge-off 12-2-83" (emphasis added). Accordingly, despite the Bank's failure to allege that these assets were charged off,97we disagree with the ALJ and find that the assets listed in Group II (PFF 238.18-238.23) were, in fact, charged off during the September examination. We therefore hold that the Bank did not engage in the unsafe or unsound practice of failing to charge off the non-bankable assets listed in PFF 238.18-238.23.
In summary, we find that the Bank engaged in the unsafe or unsound practice of failing to charge off or otherwise eliminate from its books non-bankable assets in sixteen separate instances. Accordingly, the FDIC is entitled to an order requiring the Bank to cease and desist from this unsafe or unsound practice and an order further requiring the Bank to charge off those assets classified "Loss" by the Board.
C. Failure to Provide and Maintain an Adequate Reserve for Loan Losses
[.29] The ALJ correctly notes that, as of September 30, 1983, the Bank's reserve for loan losses was concededly only $400,000. (RD at 64) The ALJ found that this reserve for loan losses was wholly inadequate. (RD at 64) We agree, and expressly find that failure to maintain an adequate reserve for loan losses constitutes an unsafe or unsound practice.98
[.30] The ALJ correctly noted that the Bank's loan "Loss" reserve should have been large enough to cover all loans classified "Loss" and one half of those loans classified "Doubtful." (RD at 64)99We disagree, however, with the ALJ's conclusion
97In light of the Bank's vigorous defense on all other charges, we are puzzled by the Bank's failure to allege that it had charged off the Group II assets, when it appears that it had, in fact, done so. This curious failure to defend may, perhaps, be explained by reference to another of the Bank's responses. As previously noted, the Bank alleged that it had charged off the Group I assets, despite the lack of any evidence that this had in fact occurred. Conversely, it failed to claim that it had charged off the Group II assets, despite clear evidence that it had done so. It seems probable that when the Bank claimed it had charged off the Group I assets, it really meant that it had charged off the Group II assets.
98See Tr. 1018-1026; R.Ex. 1, §A, p. 12.
99The ALJ calculated the amount of deficiency to be $1,194,000, based upon his own loan classifications. (RD at 64) This figure is, of course, erroneous in light of the Board's classification conclusions, and the Board's determination that the loan loss reserve should contain some provision for potential losses from loans classified "Substandard."
{{4-1-90 p.A-554}}that the loan loss reserve need not make any provision for potential losses from loans classified "Substandard." Although it is true that Substandard loans are not required to be charged off against current income, we find that failure to include some provision for future losses generated by such loans, when loans classified "Substandard" had reached the volume that they had in the instant case, constitutes an unsafe or unsound practice.
[.31] The Official definition of "Substandard" assets is that such loans "are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected." (R.Ex. 1, §A, p. 12) By definition, then, there will almost certainly be some ultimate loss in some of the loans classified "Substandard." The ALJ correctly notes that the FDIC is unable to predict, in advance, precisely which of the "Substandard" loans will result in loss, or the exact dollar figure of that loss. (RD at 64) It is true that these forecasts, like all predictions, are regrettably not capable of precise determination without benefit of hindsight. But the FDIC has concluded, based on fifty years of experience examining banks, that a certain amount of the loans classified "Substandard" will, ultimately, result in loss. The Board is therefore unpersuaded that the inability to predict the precise amount of ultimate loss justifies making no provision for any ultimate loss on "Substandard" loans. This is particularly true where, as here, "Substandard" assets have reached the alarming total of $26,487,000.
In summary, the Board finds that the Bank engaged in the unsafe or unsound practice of failing to establish and maintain an adequate reserve for loan losses. Accordingly, the Board finds that an order prohibiting the Bank from continuing to engage in this unsafe or unsound practice, and requiring affirmative corrective action, was appropriate. The ALJ also found that such an order was appropriate. We note that the loan loss reserve provision is the only part of the ALJ's recommended order which does not follow the State's MOU. This provision is identical to that contained in the initial order proposed by the FDIC, with three exceptions:
Paragraph 8(ii) of the ALJ's recommended order (RD at 97) applies only to Reports of Condition and Income requested by the FDIC, while the original order proposed by the FDIC applied to all such reports submitted to the FDIC and the State of * * *. Although the State of * * * was not, apparently, concerned about the Bank's loan loss reserve (as evidenced by the absence of any applicable provision in the State MOU), we nevertheless find that our order must address reports submitted to the FDIC and the State. This is because, in the absence of such a provision, the Bank's reports to the State might be inconsistent, and reflect an inaccurate picture of the Bank's true financial condition.
The second difference in the ALJ's recommended order is a suggestion that amended reports be filed within 30 days. (See paragraph 8(ii)) The FDIC's proposed order contained no time limit. We agree with the ALJ that 30 days is an appropriate period of time in which to file an amended report, and accordingly adopt that time provision.
The third difference in the ALJ's proposed order is the complete exclusion of the third paragraph contained in the FDIC's proposed order. This paragraph required the Bank's board of directors to review the adequacy of the Bank's loan loss reserve prior to submission or publication of future Reports of Condition and Income. The minutes of the board meeting at which such review was undertaken were required to explain the specifics and results of such review. The ALJ gives no explanation for his exclusion of this paragraph in his recommended order. In light of the inadequate reserve for loan losses as of February, 1983,100and the grossly inadequate reserve for loan losses in September, 1983, the Board concludes that the third paragraph of the FDIC's proposed order should not have been excluded. The provisions set forth therein are designed to ensure that the Bank's board of directors complies with the provisions of the first two paragraphs. In light of the Bank's past failure to establish and maintain an adequate reserve for loan losses, we believe that such corrective measures are warranted.
D. Inadequate Capital Protection
The FDIC'S Notice of Charges alleged that the Bank was being operated with an inadequate level of capital protection for
100 See R.Ex. 3, p. 1-a-1.
{{4-1-90 p.A-555}}the kind and quality of assets held by the bank. In particular, the Notice charged that the Bank's adjusted equity capital and reserves equaled only 0.17 percent of its total adjusted assets of $95,847,000. Adversely classified assets of $5,389,000, consisting of all assets classified "Loss" and one half of all assets classified "Doubtful", were considered in computing the Bank's adjusted equity capital and reserves. The computation did not take into account an additional $26,858,000 in adversely classified assets, consisting of all "Substandard" assets and one half of "Doubtful" assets. The total adversely classified assets of $32,246,000 equaled 581.1 percent of total equity capital and reserves of the bank as of September 30, 1983. In the Board's experience, such a large number of classified assets in relation to total equity capital and reserves is unprecedented.
The ALJ used his own "de novo" classifications to arrive at his conclusion that total adjusted equity capital and reserves of the Bank on September 30, 1983 equaled 3.87 percent of adjusted total assets. Because the Board's classification conclusions differ from those of the FDIC and the ALJ, we have re-computed the figures which are relevant to capital adequacy.
The Board finds that, as of September 30, 1983, the Bank's adjusted equity capital and reserves equaled 1.12 percent of its adjusted total assets of $96,769,000. As of the same date, all assets classified "Loss" and one-half of assets classified "Doubtful", equaled $4,466,000. These assets, which were considered in computing the Bank's adjusted equity capital and reserves, equaled 80.48 percent of the total equity capital and reserves of the Bank. An additional $27,130,000 of adversely classified assets which were not considered in computing the adjusted equity capital and reserves of the Bank, exceeded the Bank's adjusted equity capital and reserves by $26,047,000. As of September 30, 1983, the Bank's total adversely classified assets of $31,595,000 equaled almost 569.4 percent of total equity capital and reserves of the Bank.
The ALJ concluded that the 3.87 percent level of capital which he determined the Bank had as of September 30, 1983 "may have been inadequate." (RD at 66) The ALJ chose, however, to consider the two million dollars in capital allegedly injected into the Bank two months after the close of the examination.101He found that this infusion of capital brought the Bank's adjusted equity capital and reserves to "5.88 percent of adjusted total assets, well within the range contemplated by FDIC minimum standards and consistent with the ratio of 5.97 percent found by the State in its May 18, 1984 examination." (RD at 66) The ALJ went on to note that if the Bank were to inject another $1 million in October, pursuant to the State MOU, the Bank's adjusted equity capital and reserves would equal 6.88 percent. In light of these conclusions, and because he found that "the answer to the question of what constitutes adequate capital is as elusive as the Holy Grail" (RD at 65), the ALJ rejected those provisions of the proposed order requiring the Bank to increase total equity capital and reserves. We find that the ALJ's discussion of capital is riddled with factual errors and legal misconceptions, and accordingly decline to accept his conclusions on that subject.
[.32] The first major error made by the ALJ was in even considering post-examination events in determining the Bank's level of capital. The Notice of Charges is based upon the state of affairs in the Bank as of the close of the September 30, 1983 examination. It is clear that consideration of post-examination evidence can only result in a
101The FDIC presented evidence that the net effect of this capital infusion was a loss to the Bank. * * * infused $2 million cash into the Bank in February of 1984. The manner in which * * * secured the $2 million was questioned by the FDIC. * * * "swapped" property which he owned (the * * *) for property which was owned by the Bank. He then used the Bank property which he had received as collateral for a $2 million loan from a savings and loan association. The proceeds of that loan were used for the aforementioned capital infusion.
The FDIC presented evidence that an independent appraiser had valued the * * * property * * * gave up at almost $1 million less than the Bank property that he received in return. An appraiser retained by the Respondents stated that the * * * property was worth much more. Footnote 14 of the FDIC's Brief notes that the Respondent's appraiser's conclusions were based on a number of predictions which were unsupported by sufficient evidence in the record.
We find it unnecessary, however, to resolve the issue at this time. Since the infusion of capital occurred after the conclusion of the examination, it has no bearing on whether the FDIC may issue a cease and desist order. Any capital infusion occurring after the close of the examination will be relevant to compliance with that order, and may be litigated if and when the FDIC contests the Bank's compliance with the order ultimately issued. (Tr. 801)
{{4-1-90 p.A-556}}distorted picture of the Bank's true condition. This is particularly true with respect to capital percentages, the accuracy of which are wholly dependent upon the accuracy and completeness of the data with which they are computed, which the FDIC has no ability to verify until the next full-scale examination.
The adjusted equity capital and reserves figure is computed by deducting all assets classified "Loss" and one-half of assets classified "Doubtful" from total equity capital and reserves. The ALJ's capital percentages are based upon an alleged $2 million capital infusion in February and a predicted $1 million capital infusion in October. Yet these figures are meaningless unless the other part of the equation - all "Loss" and one-half of "Doubtful" assets - is also adjusted to reflect the state of affairs in February and October. This was not done, and could not be done without another full-scale credit examination being conducted at those times. The State's 5.97 percent capital figure for May is similarly suspect since it presumes the accuracy of the underlying classifications, and since the May examination was concededly limited to those assets previously classified.
Furthermore, it should be noted that all of the capital percentages quoted by the ALJ were premised upon his own "de novo" classifications. Because those classifications were largely erroneous, the capital percentages calculated by the ALJ were also in error.102
Even if the ALJ's classifications were all correct, and even if capital percentages based upon partly-new and partly dated figures had any meaning, we would still find that the Bank was operating with an inadequate level of capital protection for the kind and quality of assets held by the Bank. The FDIC Manual of Examination Policies mandates that a bank's management be required to submit a written capital plan whenever a bank's adjusted equity capital falls below 6 percent. (R.Ex. 1, §G, p. 4) "When the adjusted ratio falls below 5%, the Corporation will insist on a specific program for promptly remedying the equity capital deficiency." (Id.) The Manual emphasizes, however, that the foregoing percentage guidelines "apply only to financially sound, well-managed, diversified institutions with established records of adequate capital formation relative to asset growth. Clearly, banks that are exposed to greater degrees of risk, as determined by analysis of all those qualitative and quantitative variables set forth above, must have higher equity capital levels. . . . Banks rated `4' or `5' [for capital] are clearly inadequately capitalized, the letter representing a situation of such gravity as to threaten viability and solvency." (Id. -emphasis added) There is also testimony in the record explaining why "4" or "5" rated banks require higher capital percentages than do well-managed "1" or "2" rated banks. (Tr. 725-26)
The ALJ acknowledged that capital adequacy depends upon a particular bank's financial circumstances, but stated that "the examination report and the testimony offered by experts for the Proponent speak only to the numbers and ratios. The other concerns. . .are not addressed." (RD at 66) The ALJ then proceeded to cite evidence of capital percentages of financial sound, well-managed banks in support of his conclusion that a 5.88% capital level is adequate for this Bank. * * * Bank is not such an institution. The entire focus of the month-long hearing in this matter was the financial and management deficiencies of the Bank. Even a cursory review of the factors bearing upon capital adequacy demonstrates that this Bank is critically in need of at least an eight percent capital ratio.
[.33] Perhaps the single most important factor in assessing the adequacy of a bank's capital is "[t]he quality, type, liquidity and diversification of assets, with particular reference to assets adversely classified." (R.Ex. 1, §G, p. 2) One-half of "Doubtful" assets and 100% of "Loss" assets are deducted from book capital to arrive at adjusted equity capital. That is not, however, the only relevance of adversely classified assets. "[S]ubstandard assets. . .are identified because these may have the potential of resulting in losses and a weakened capital position at some future point." (R.Ex. 1, §G, p. 1) Indeed, there was testimony that a certain percentage of "Substandard" assets inevitably do result in losses to the Bank. (Tr. 1056, 2255-57) The State's May 1984 examination report classified $31,998,000 in assets "Substandard." The Assistant-Di
102Based upon the Board's classifications, after the alleged $2 million capital infusion in February, 1984 the capital level would have been 3.19 percent. If the Bank ever made the October 1984 $1 million capital infusion required by the MOU, the capital level would still be only 4.22 percent.
{{4-1-90 p.A-557}}rector of the State of * * * Division of Banking testified that the 488% ratio of adversely classified assets to capital revealed by the State's May report was "[e]xcessive, highly excessive." (Tr. 2383) Nevertheless, the ALJ completely ignored this alarming volume of "Substandard" assets in assessing the capital adequacy of the Bank.
[.34] The Bank's declining earnings103and inadequate liquidity104further demonstrate the need for a higher level of capital. (R. Ex. 1, §G, p. 2) The Manual also requires higher levels of capital where, as here, there are volatile deposit accounts, concentrations in the deposit structure, and rapid deposit growth unaccompanied by sufficient earnings retention. (R.Ex. 1, §G, p. 2) "The general type of clientele" is another factor to be considered in assessing capital adequacy. Id. The ALJ's conclusion that "monetary controls, raging inflation and currency devaluations. . .obviously caused cash flow problems among many of the Bank's * * * customers" (RD at 40) reinforces the conclusion that the Bank has a need for higher capital levels. Finally, the "record of management is of utmost importance in the assessment of a bank's capital adequacy." (R.Ex. 1, §G, p. 2) The appalling condition of the Bank, as demonstrated by both State and FDIC examination reports, speaks eloquently about the "record of management" in this Bank. Management's further extensions of credit to already classified borrowers105raises doubt about their willingness to improve that record. Accordingly, the "record of management" in the Bank also suppo |
