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FDIC Enforcement Decisions and Orders

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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 {{4-1-90 p.A-481}}
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)
{{4-1-90 p.A-497}}
    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)
{{4-1-90 p.A-498}}
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:

IENCSubstandardLoss
September 30, 1983-875,060
Examination
ALJ464,31533,884
Board667,770153,284

   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)
{{4-1-90 p.A-501}}

   [.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, 1983FDIC -$593,000 Substandard52
September 30, 1983FDIC -$604,000 Substandard
September 30, 1983State -$604,158 Substandard
May 18, 1984State -$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, 1983FDIC -$518,000 Substandard
September 30, 1983FDIC -$510,000 Substandard
September 30, 1983State -$510,039 Substandard
May 18, 1984State -$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, 1983FDIC -Not indebted to the
bank
September 30, 1983FDIC -$68,000 Substandard
September 30, 1983State -None
May 18, 1984State -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, 1983FDIC -$842,000 Substandard
September 30, 1983FDIC -$935,000 Substandard
September 30, 1983State -903,047 Substandard
$32,291 Loss
May 18, 1984State -$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, 1983FDIC -250,000 Substandard,
$14,000 Loss
September 30, 1983FDIC -$250,000 Loss
September 30, 1983State -$250,000 Loss
May 18, 1984State -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, 1983FDIC -None
September 30, 1983FDIC -$202,000 Substandard
September 30, 1983State -$196,834 Substandard
May 18, 1984State -$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 supports the need for higher levels of capital.
   After careful consideration of all of the foregoing factors, it is the conclusion of the Board that, at minimum, the adjusted equity capital and reserves of the Bank should equal 8% of adjusted total assets.106The Board finds substantial evidence in the record that the Bank has been, and is being, operated with an inadequate level of capital protection for the kind and quality of assets held by the Bank. We find that the minimum acceptable capital level that the Bank may maintain, consistent with applicable safety and soundness principles, is eight percent.107

E. Failure to Maintain Adequate Liquidity

   [.35] The ALJ did not dispute that "as of September 30, 1983, the Bank was dependent upon potentially volatile deposit liabilities to fund loans and other assets of the Bank." He also agreed that at that time the Bank had short term, rate sensitive certificates of deposit of $100,000 or more equaling more than 61 percent of the Bank's total deposits, which resulted in a liability dependency ratio of 54.8 percent. From this evidence the ALJ stated that one may conclude that the Bank's liquidity was "unsatisfactory." (RD at 66) The ALJ concluded, however, that "it does not warrant a finding of an unsafe and unsound practice since this `snapshot" taken as of September 30, 1983 does not place the picture in proper perspective." (RD at 66) The ALJ noted that


103During the State's September, 1983 examination of Chief of the * * * State Bureau of Bank Examinations noted that the "profit" reported by the Bank was largely illusory: "The analysis of earnings is not simple, since the bank did not charge off the loss classifications from FDIC Report of Examination, dated February 4, 1983. . . . If the Bank had charged-off "Loss" and half of Doubtful loan classifications, and if it had replenished the Reserve for Loan Losses to the one percent benchmark, it would have shown a loss exceeding $340M [$340,000], instead of the reported profit of $318M [$318,000]. If the calculation of the Reserve for Loan Losses is changed to provide for 20 percent of "Substandard" loans [expected to result in loss - Tr. 2255-57], the loss for the first half would have exceeded $4MM [$4,000,000]." (P.Ex. 69 at 1)

104See Section E, infra p. 228.

105See Tr. 1037-39.

106The Board's legal authority to determine the appropriate minimum capital level for this Bank, and to order the infusion of additional capital to reach that level, is clear. In the International Lending Supervision Act, Pub. L. No. 98181, 97 Stat. 1153 (November 30, 1983) ("ILSA"), Congress reaffirmed the banking regulatory agencies' broad discretion to set minimum capital levels for individual banks. Section 908 of ILSA, now codified at 12 U.S.C. §3907, provides in pertinent part:
    . . .(a)(2) Each appropriate Federal banking agency shall have the authority to establish such minimum level of capital for a banking institution as the appropriate Federal banking agency, in its discretion, deems to be necessary or appropriate in light of the particular circumstances of the banking institution.
   (12 U.S.C. §3907 (a)(2)).

107It is interesting to note that the bank in Bellaire was rated "1" for asset quality, "1" for liquidity, "1" for earnings and "2" for management. First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 685 (5th Cir. 1983.) Nevertheless, Congressional support of the Comptroller's discretion to order a 7% capital level in a cease and desist action was sufficiently strong to prompt legislation explicitly entrusting capital decisions to the discretion of the appropriate federal banking regulators.
{{4-1-90 p.A-558}}figures provided by the respondents "show a dramatic improvement in this area."
   The Board disagrees with the methodology used by the ALJ in drawing his conclusion that a finding of an unsafe and unsound practice is not warranted. If a proper analysis had been conducted by the ALJ, it is the Board's opinion that the unsafe and unsound charge would have been substantiated. The reasons for the Board's disagreement with the ALJ are as follows:
   1. The ALJ cited a decrease in the percentage of large deposits from 61 percent on September 30, 1983 to 48 percent on December 31, 1983 and 38 percent on April 30, 1984. He also cited an improvement in the volatile liability dependency ratio on those dates from 54.8 percent to 35.2 percent and 31.6 percent, respectively. These figures are irrelevant, however, since the September 30, 1983 examination was completed on December 16, 1983. The findings must be based on information that was available prior to the close of the examination. The September 30, 1983 figures are sufficiently unsatisfactory to constitute evidence of the occurrence of an unsafe or unsound practice. It is not relevant of logical to lessen the impact of these figures through the use of data that was not available at the time.
   2. Even if the figures cited on December 31, 1983 and April 30, 1984 would be considered relevant, the conclusion drawn indicating improvement is specious. Granted, the volatile liability dependency ratio (VLDR) improved considerably. The improvement in this ratio, however, is not proof of an improvement in the sensitivity of the bank's liabilities to interest rate changes. A study of the manner in which bank management lowered the VLDR points out the illusory nature of the improvement.
   Essentially, the bank management replaced brokered deposits with above market rate community-generated deposits. Evidence of this is found in the * * * Comptroller's examination report of May 18, 1984, which attributed to the improvement in the bank's liquidity to a campaign designed to attract core deposits that offered interest on certificate of deposit accounts at 1/2% above the then current market rate. (R.Ex. 441, Examiner's Comments and Conclusions, Liquidity and Funds Management, at 5) The FDIC examination report of September 30, 1983 supports this finding, stating that during the examination the bank inaugurated a program to decrease its reliance on brokered time deposits by paying above-market rates to attract community-generated deposits. (P.Ex. 17, at 21) Further evidence of this campaign for above market rate deposits comes from the testimony of * * *. (Tr. 3118-19) In addition, between September 30, 1983 and April 18, 1984, there was little change in total deposits-from $91.3 million to $91.9 million-while during the same period brokered deposits declined from $25.1 million to $2.9 million. (P.Ex. 17, at 14; R. Ex. 441, at 1 - 2)
   By replacing brokered deposits with above market rate deposits the bank did not decrease the sensitivity of its liabilities to fluctuations in the market interest rate. These above market rate deposits are rate sensitive and consequently more volatile than market rate deposits obtained in the normal course of business. The reason for this is that the bank's ability to retain rate sensitive deposits (either brokered deposits or other above market rate deposits) is contingent upon its ability to continue paying the above market interest rates. The * * * Comptroller's examination report of May 18, 1984 indicated that the Bank probably could not continue paying more for funds than its competitors. That report indicated that the Bank experienced a 1983 operating loss of $842,000 and a 1984 operating loss of $458,000, as of April 30, 1984 (R. Ex. 441, at 4) Losses could continue indefinitely due to the poor quality of the Bank's assets, which necessitate increased funding of loan loss reserves, legal expenses, and bad-debt collection expenses, and because of the level of non-accrual loans and nonearning real estate assets.
   3. The data cited by the ALJ also indicated an improvement between March 31, 1983 and September 30, 1983 in the ratio of assets to liabilities maturing within one year. An analysis of these figures shows that the assets maturing in one year or longer are mostly securities, while those maturing within one year include the bulk of the loan portfolio. Since the loan portfolio consists of an inordinate volume of adversely classified loans-$23.8 million as of February 4, 1983, escalating to $30.8 million as of September 30, 1983-the ALJ's figures are illu- {{4-1-90 p.A-559}}sory. (P.Ex. 17, at 14 and 15)108The large amount of classified loans included among the assets maturing within one year are not truly short-term, despite the language on the notes, because the fact that they are classified indicates that the ability and/or willingness of the borrower to repay and the Bank to collect such loans on a timely basis is at least questionable, if not highly improbable.
   By subtracting the amount of adversely classified loans from the assets maturing within one year, an entirely different picture is revealed as set forth below:

ALJ's Figures (Adopted From RPFF 247.1-4)

In # Millions

9-30-83 3-31-83
Assets maturing within one year 70.5 74.8
Liabilities maturing within one year 56.7 62.7
Liabilities as a percentage of assets 80.4% 85.6%
Adjustments for Adversely classified loans
Assets maturing within one year 70.5 74.8
Less adverse loan classifications 9-30-83
and 2-4-83 (30.8) (22.5)
Adjusted Assets maturing within one year 39.7 52.3
Liabilities maturing within one year 56.7 62.7
Liabilities as a percentage of assets 142.8% 119.9%

   As the adjusted figures clearly show, the bank's ability to cover short-term liabilities with genuinely short-term assets actually worsened, with short-term liabilities being 42.8% larger than the short-term assets available to support them. Therefore, as of September 30, 1983, the Board finds that the Bank's liquidity position was indeed unsafe or unsound, contrary to the finding of the ALJ, as were the Bank's practices which led to this condition.

VIOLATIONS OF LAW

   Section 8(b) of the FDI Act, 12 U.S.C. §1818(b), authorizes the FDIC to initiate an administrative enforcement action with a view to the entry of an order to cease and desist whenever in its opinion "any insured bank, bank which has insured deposits. . . is violating or has violated, or the agency has reasonable cause to believe that the bank. . .is about to violate, a law, rule, or regulation . . . ." In this proceeding, the FDIC alleged eight categories of violations of * * * state law arising out of the September 30, 1983 and the February 4, 1983 examinations. Evidence was admitted at the administrative hearing with respect to those violations and the ALJ's recommended decision deals separately with each of the eight. The eight categories of state law violations alleged were:

    1. Loans in excess of the legal lending limit - Section 658.48(2)(a) of the * * * Statutes;
       2. Loans to bank officers without prior approval of the bank's board of directors - Section 658.48(1)(a) of the * * * Statutes;

108This results from the inherent nature of adversely classified loans:
   Loan classifications are expressions of different degrees of a common factor, risk of non-payment. . . . Adverse classifications should be confined to those loans which are unsafe for the investment of depositors funds. . . . ["Substandard" loans] must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. . . .
   Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. . . .
   Loans classified Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.
   (R.Ex. 1, Manual of Examination Policies, §A, at pp. 12–13; P. Ex. 2, §A, at 12–13)
{{4-1-90 p.A-560}}
    3. Loans secured by junior mortgages in excess of the legal limit - Section 658.48(4)(d) of the * * * Statutes;
       4. Assets booked and carried by the bank in excess of the legal limit - Section 655.044 of the * * * Statutes;
       5. Carrying loans required to be charged off on the bank's books as assets - Section 658.52 of the * * * Statutes;
       6. Failure to maintain minimum liquidity reserves - Section 658.68 of the * * * Statutes;
       7. Sale of Federal funds in excess of the legal limit - Section 658.67(1)(h) of the * * * Statutes; and
       8. Deposits of bank in a savings and loan association in excess of the legal limit - Section 658.67(1)(i) of the * * * Statutes.

   The Board has reviewed the violations charged in the eight categories, the ALJ's recommended decision and the parties' exceptions to the decision. We set forth separately below our discussion, findings and conclusions with respect to each violation charged in this proceeding in each category.109

A. Loans of the Bank in Excess of the Legal Lending Limit

   The first category of violations alleged by the FDIC is based upon Section 658.48(2) of the * * * Statutes, which imposes limits on the amount that a bank may lend to any person or entity (other than an officer or director of the bank). Section 658.48 of the * * * statutes provides, in pertinent part:
   (2) Loans to other persons.-
   (a) No bank shall lend to any person [not an officer or director of the bank] any amount which would exceed the following limitations:
   (1) Ten percent of the capital accounts of the lending bank for loans and lines of credit which are unsecured and 25 percent of the capital accounts for loans and lines of credit all components of which are amply and entirely secured; and
   (2) When outstanding loans consist of both secured and unsecured portions, the secured and unsecured portions of the loans together may not exceed 25 percent of the capital accounts of the lending bank, and the unsecured portion of the loan may not exceed 10 percent of the capital accounts of the lending bank.
   * * *
   (3) Computing total liabilities - In computing the total liabilities of any person, partnership, or corporation subject to the limitations provided in this section, there shall be included all loans endorsed or guaranteed as to repayment and all loans to any person, partnership, or corporation if such person, partnership, or corporation directly or indirectly or acting through or in concern with one or more persons, partnerships, or corporations.
   (a) Owns, controls, or has the power to vote 25 percent or more of any class of voting securities of the borrower; or
   * * *
   (c) Has the power to exercise a controlling influence over the management or policies of such borrower.
   * * *
   (5) Applicability of loan limitation-the loan limitations otherwise provided in this section shall not apply to:
   (a) Loans which are fully secured by assignment of a savings account or certificate of deposit of the lending bank;
   * * *
   Subsection 3 of Section 658.48 specifically provides for the aggregation of loans of a person, partnership or corporation, including loans endorsed or guaranteed and loans to corporations controlled by the borrower, for purposes of determining violations of the legal lending limitation. At issue in this proceeding with regard to several lines of credit is whether a borrower "controls" or "has the power to exercise a controlling influence" over another borrower. If such a relationship exists, their respective debts to the Bank should be aggregated.
   A second fundamental issue in the determination of violations of the legal lending limit involves the Bank's capital accounts. The amount of the capital accounts is important because the higher the Bank's capital accounts, the higher will be its legal lending limit under the * * * law as set


109A threshold difficulty in reviewing the alleged violations of law is the disparity in the number of these allegations. The ALJ took his tally of the violations from the examination reports which contain fewer alleged violations. On the other hand, the FDIC argues in its Exceptions (p. 145) that the correct number of alleged violations is found in Proponent's Findings of Fact, which the FDIC says reflect a more detailed legal analysis of the alleged violations than the examination reports.
{{4-1-90 p.A-561}}forth above. The principal question is on what date did a donation to capital occur and should it have been included in the computation of the Bank's capital accounts for the purposes of determining lending limit violations as of June 14, 1983. The particular addition has been dubbed the "Street Capital" by the parties and the ALJ (reflecting the acquisition by the Bank of a discontinued city street).
   It is undisputed that the property was not reflected on the Bank's books as an asset until August 31, 1983. The ALJ, however, found that a memorandum dated August 31, 1983 and related documents (R.Exs. 250.3 and 419) submitted by the Respondents provided evidence sufficient to justify the retroactive booking of the Street Capital, and the testimony of Messrs. * * * (Tr. 2334-35, 2409-09) and * * * (Tr. 4560-62) established that retroactive booking is proper under * * * law. (RD at 69) The FDIC contests this finding (P. Exceptions at 141-45), on the grounds that nothing in the documents submitted by the Respondents shows when, or if, title to the property was conveyed by the City of * * * to the Bank. The cited resolution of the Mayor and the City Commission of the City of * * *, dated June 14, 1983, which provides for the abandonment and vacating of the Street Property, states that the abandonment would take effect only after certain conditions were met. (R.Exs. 250.3 and 419) The Board finds nothing in the record of this proceeding to demonstrate that these conditions were met before August 31, 1983, or if they ever were met. The Board finds that the ALJ was in error on this point and that the Street Capital should not have been included in the computation of the Bank's capital account as of June 14, 1983.
   We discuss below the specific allegations of lending-limit violations beginning with those alleged in the September 30, 1983 Report of Examination ("September Report"), and continuing with those alleged in the February 4, 1983 Report of Examination ("February Report").

   1. Overlines Alleged in the September Report110

   a. * * * and Related Interests

   The ALJ agreed with the FDIC that * * * owns or controls * * * Corporation * * *. The ALJ based his conclusions upon Securities and Exchange Commission documents signed by Mr. * * * (P.Ex. 53) in which he concedes, explicitly or by necessary implication, ownership or control (explicitly as to * * * and * * *, and by necessary implication as to * * * and * * *). (RD at 70–71) Based upon the record, the Board agrees with the ALJ and finds that Mr. * * * did control * * *, * * *, * * *, and * * * at the time of the examination.
   The ALJ rejected the FDIC's contention that Mr. * * * also controlled * * *, on the grounds that Mr. * * * execution of "two documents as president of * * * does not, standing alone, demonstrate sufficient indicia of ownership or control." (RD at 71) However, the FDIC notes, among other things, that Mr. * * * signed three documents as president of * * * (P.Exs. 53 at 44, 52, and 54); that the address of * * * was the same as that of * * * (P.Exs. 53 at 7, 9–10, 12, 14–15, 21–30, 54, 60–62, 64 and 66); and that Mr. * * * was authorized to borrow on * * * behalf. (P.Ex. 53 at 51-2; P. Ex. at 149) The Board finds that these facts, together with Mr. * * * ownership or control of the other four corporations, as found by the ALJ, are sufficient to infer, absent other evidence to the contrary, that * * * is one of a group of related corporations under Mr. * * * controlling influence. We note that the State examination of September 30, 1983 concluded that Mr. * * * owned or controlled * * * and also found the * * * debt to be in violation of * * * law. (R.Ex. 6; P.Ex. 736) The Board finds that * * * owns or controls * * * and that the debts of these entities should be aggregated for purposes of determining the existence of violations of the state lending limit statute.
   The ALJ concluded that there had been five * * * -related lending limit violations. (RD at 71) The FDIC argues that a total of fourteen * * * -related violations were shown, based upon loans extended to the corporations on dates not discussed by the ALJ in his opinion, upon renewals of such loans, and upon the addition of the debt of * * *. (P. Exceptions at 147–149) The FDIC argues that each renewal of a loan exceeding the legal lending limit counts as a separate violation because "(t)here is no authority. . .to suggest that renewals of


110 "Overline" is a term used to denote a loan that exceeds a bank's statutory lending limit.
{{4-1-90 p.A-562}}loans are not to be treated as extensions of credit for purposes of assessing compliance with that statute; nor is any cited or relied upon by the ALJ." (P.Exceptions at 148) The Board agrees that each renewal of a loan constitutes a separate violation since it is a new extension of credit, and, therefore, that fourteen * * * -related lending limit violations have been shown when the debts of the * * * interests are properly aggregated.
   b. * * * as Trustee
   The ALJ concluded (RD at 71) that the obligations of * * * as trustee are separate and not aggregable with his obligations as an individual. The FDIC counters (P.Exceptions at 154) that expert testimony at the hearing established that the debts of a person as trustee should be aggregated with his individual obligations unless he signs the trustee obligations without recourse to himself individually. Both the ALJ and the FDIC cited the testimony of * * *, former General Counsel to the Office of the * * * State Comptroller (Department of Banking and Finance), in support of their conflicting conclusions. Mr. * * * testified (Tr. 2489) that "if (a trustee) doesn't indicate that he is signing in his official capacity as trustee without recourse to him, individually, then it will be attributed to him as an individual." Based upon our review of the record, the Board does not find sufficient evidence upon which to conclude that * * * assumed, in his personal capacity, the obligations attributed to the * * * Trust ("Trust") - viz., the $1 million loan to * * * and the $250,000 obligation to the Trust. While the record is not clear, the only connection we find between * * * and the debts of the Trust is that he is listed as a trustee in various documents. (Tr. 1932-46; P.Ex. 17 at 29 and 50; R.Ex. 262.1) Therefore, the Board agrees with the conclusion of the ALJ and finds that a violation has not been established.
   c. * * * and Related Interests
   The FDIC alleges that four lending limit violations occurred based upon the aggregation of the liabilities of * * *, and Dr. * * * on March 7, 1983, July 8, 1983 and August 18, 1983. The ALJ rejected these allegations on the grounds that the examiners had included loans secured by savings accounts or certificates of deposits, and that the * * * guarantee was modified orally to exclude the $350,000 loan to Mr. * * * (RD at 71) The FDIC argued that since the * * * loan was dated March 7, 1983, and the certificate of deposit was not pledged as security for the loan until March 14, 1983,111 a violation existed at the time the loan was made, and continued for seven days. (P.Exceptions at 151)
   The record in this proceeding establishes that one lending limit violation occurred on March 7, 1983, from the $620,000 loan to * * * (guaranteed by * * *) and one additional violation occurred on July 8, 1983, from the $350,000 loan to Dr. * * *, (also guaranteed by Mr. * * *). (P.Ex. 54) Contrary to FDIC's arguments, the $20,000 loan to Dr. * * * outstanding on July 8, carried over from 1981 and was not a separate extension of credit. Therefore, it does not constitute a separate lending limit violation. Similarly, there were no new extensions of credit that independently created any new lending limit violation on September 30.
   With regard to the allegedly orally modified guarantee of the $350,000 loan to Dr. * * *, the ALJ noted that * * * law provides that the termination or modification of a guarantee of a loan need not be in writing, citing Fidelity and Deposit Co. of Md. v. Tom Murphy Construction Co., 674 F.2d 880, 884-86 (11th Cir. 1982). (RD at 71) That case, however, holds that an oral modification of a contract is effective "only where clear and unequivocal evidence corroborating the existence of an agreement to modify the guarantee appears in the record."
   The Board finds no evidence in the record corroborating the existence of an oral agreement to modify the guarantee in this case. Moreover, normal banking procedures require that the loan file reflect the existence of any such modification, oral or written, but it did not in this instance. The Board finds, therefore, that the record does not establish any modification of the * * * guarantee, and that the $350,000 loan was properly aggregated with the other debts of * * * for lending limit purposes.
   In conclusion, the Board finds that one violation of the lending limit occurred on March 7, 1983, and a second occurred on July 8, 1983.


111 Moreover, the record establishes that the certificate of deposit was not in existence until March 14, 1983. (R.Ex. 255.1 at 11–14)
{{4-1-90 p.A-563}}
   d. * * * and Related Interests
   The ALJ's recommendation decision notes that the FDIC alleged three overline violations concerning * * *. (RD at 71) The FDIC states that only two violations were alleged: a loan of $195,000 to * * *, and a loan of $28,500 to * * *. Since only two violations were alleged, only two will be discussed herein.
   The ALJ found no violations concerning Mr. * * * because he found "no evidence that any guaranty of * * * debts by Mr. * * * was in effect at the time the $195,000 loan was made to * * *, in apparent reliance upon a Memorandum of Credit File, dated August 8, 1983 (R.Ex. 259.2 at 51), stating that at Mr. * * * request the Bank release of his guaranty of * * * debt had been granted. However, this memorandum only establishes that the guaranty of the * * * debt had been released on August 8 but not on August 5. Therefore, the Board finds that it was correct to aggregate the * * * debt with the other * * * debt on August 5. Moreover, even if the * * * debt was excluded, the evidence shows a * * *related debt exceeding the lending limit when the $195,000 additional credit extension to * * * (guaranteed by Mr. * * *) occurred. The FDIC also alleged a second violation on August 8, involving a loan of $28,500 to * * *. However, the record shows that a $28,500 credit occurred on the same date reversing the original loan. (P.Ex 55 at 5) Under these circumstances, we are unable to conclude that a violation occurred. Therefore, the Board finds that one violation of the lending limit occurred on August 5, in the * * * line.
   e. * * * and Related Interests
   The FDIC alleged that six violations of the lending-limit statute occurred on this line on September 30, 1983. (P.Exceptions at 154) The ALJ found that the debt of * * * was improperly aggregated with that of Mr. * * * because control of * * * by Mr. * * * was not proven. The ALJ also held that the advance in the name of * * * Bank was improperly aggregated with the debt of Mr. * * *, but did not explain the reasons for his conclusion. (RD at 72)
   Under section 658.48(3) of the * * * Statutes, ownership, control, or the power to vote twenty-five percent or more of the stock of a borrower or the power to exercise a controlling influence over the borrower are sufficient to allow for debt aggregation. Mr. * * * chairmanship of the * * * board of directors and his ownership of twenty-one percent of that company's stock were held by the ALJ to be insufficient evidence of ownership or control to allow for debt aggregation under the * * * statute. In rebuttal, the FDIC asserted that Mr. * * * testimony "clearly suggested that where an individual is the chairman of a corporation's board of directors and also owns 21% of its stock, that person should be deemed to be in control unless control is actually shown to be in some other person or entity. (P.Exceptions at 156)
   The Respondents admit that $1,114,000 in * * * -related debt was outstanding on September 30, 1983. (RPFF 263.7) The ALJ found that the advance in the name of * * * Bank was improperly aggregated to this amount. The FDIC argues that the extensions of credit in the name of * * * Bank were, in fact, loans to * * * ($85,000); * * * Corporation ($210,000); * * * ($220,000). (P.Exceptions at 155) As evidence of this allegation, the FDIC cites an exhibit (P.Ex. 57 at 72 and 73), which demonstrates that the * * * loan proceeds were deposited in the individual accounts for these three entities, and that interest on the loans was charged to their individual accounts.
   The Board agrees with the ALJ. While technically this could be considered a violation, the record shows that the matter originated with a telex notification, received on Friday, September 30, from * * * Bank, of a wire transfer that would be received the next business day, Monday, October 3 (barring any mistake). In fact, the funds were received by the Bank on October 3. (Tr. 1783-86; 1946-54; and 3092-97) Despite the fact that * * * enjoyed the benefit of the advance credit, the record is devoid of evidence that establishes that the recipients sought or were even aware of the advance crediting of the funds. Nor is there any evidence that would establish a contractual obligation on the part of the recipients had the wire transfer failed to materialize on October 3.112 Indeed, the only evidence in the record tended to establish that recourse by the Bank in the event of nonpayment


112 It is, of course, possible that the Bank could recover the funds under a restitution or unjust enrichment theory.
{{4-1-90 p.A-564}}would have run against * * * Bank. The Board finds that the so-called * * * loan proceeds should not be aggregated with the other debts of Mr. * * *.
   However, the Board finds that the 21% stock ownership of * * * by Mr. * * *, in conjunction with his position as chairman of the board of the corporation (PPF 263.4; RPFF 263.4) and the fact that he apparently transacted business with the Bank on behalf of the corporation (Tr. 3034) is a sufficient and reasonable basis for the FDIC examiners to presume that Mr. * * * "has the power to exercise a controlling influence over the management or policies" of * * *. That presumption is especially strong where the Bank, which has firsthand knowledge and close contact with the customer, as here (Tr. 3030-34), fails to provide the examiners with any evidence to the contrary. In addition, the Board notes that the FDIC requested and obtained an opinion from the * * * Division of Banking relating to whether Mr. * * * 21% ownership and position as chairman constituted control. That opinion supported FDIC. (Tr. 2176-77) Furthermore, the State examination also aggregated the * * * debt with that of Mr. * * * (R.Ex. 6) Therefore, the Board finds that the debt of * * * should have been aggregated with the other debts of Mr. * * *.
   Excluding the * * * debt, the total of * * * -related credit line exceeded the Bank's legal lending limit of $1,279,000 on September 30, 1983. (P.Ex. 57 at 107) The concurrent renewal of the two loans to * * * and the renewal of the loan to * * * each produced a single violation of the State lending limit for a total of two violations. (P.Ex. 57 at 1, 24, 36, 76, and 77)
   f. * * *
   The ALJ concluded that there were no lending limit violations regarding this line because the drafts were secured. (RD at 72) He made this conclusion without analysis, but cited RPFF 264.5-6 and 265.1-2, in which the Respondents contended that the loans were secured because the drafts that created the loans were drawn against "control documents" covering goods in transit. Respondents further contend that such a transaction is "considered to be `secured' as it represents an extension of credit arising from the discount of a trade acceptance ...." (RPFF 264.5)
   The FDIC argued that there was no security for these drafts. (P.Exceptions at 158-159.6) FDIC Examiner * * * testified that he was able to find no indication of any collateral securing these debts. (Tr. 1792) First, the Board notes that Respondents have improperly characterized these three drafts as "trade acceptances." The three drafts upon "acceptance by the Bank became banker's acceptances. Second, while Respondents may consider the acceptances to be secured, the Board finds no evidence in the record that any form of collateral existed as to the goods in transit (e.q., a bill of lading or warehouse receipt in the possession of the Bank and giving it control over the collateral). (P.Ex. 58; Tr. 1790-92) The fact that there may be legal recourse against both the negotiator of the draft and the drawee of the draft does not constitute security. Finally, Respondents' reliance on 12 U.S.C. § 84 is misplaced. That statute does not attempt to establish what constitutes "fully secured." It only establishes a 10% legal lending limit for national banks for secured loans. Furthermore, we note that the State's September examination report also listed violations in the * * * line. (P.Ex. 73 at 3) In the absence of evidence supporting the existence of collateral for this line, the Board finds that the ALJ was in error. The record supports and the Board finds that the extension of credit to this borrower of $770,024.19 exceeds the 10% unsecured lending limit which was $411,700, as of August 24, 1983.
   g. * * * and Related Interests
   The ALJ concurred with the FDIC's allegation of three lending-limit violations under this line, based upon the "two-tiered aggregation" principal, involving a debt guaranteed by a chain of guarantors. The ALJ explained his reasoning, as follows (RD at 72):
       The "two-tiered aggregation theory," whereby violations were alleged as a result of * * * * * * guarantee of the debts of * * * Corporation which, in turn, guaranteed the debts of * * * and * * *, is a perfectly reasonable view of the * * * Statute (§ 658.48(3)), since the guarantees extend to all debts, direct or indirect, and it is clear that the Bank would have recourse back through the chain of guarantors should any debtor default.... [U]nder * * * law, a guarantee may be modified rather easily and it is not unreasonable to expect banks to
{{4-1-90 p.A-565}}
    document any such modification. The record does not warrant a finding that any such modification was made at the time of the violation. I conclude, therefore, that three violations were shown (PFF 266-268).
   In support of its claim that there were no violations in this line, the Bank disputed the propriety of the two-tiered aggregation principle. The Board agrees with the ALJ, and finds that the record establishes three violations. (P.Exs. 17 and 59; Tr. 1793-94)
   h. * * * and Related Interests
   The ALJ found one violation, an extension of credit to * * * Corporation, that was admitted by the Respondents. (RPFF 273.2; RD at 72) The ALJ found that four additional allegations, based upon Mr. * * * ownership or control of * * * and * * *, had not been proven because it was conclusively established that Mr. * * * owned only twenty-three percent of each corporation. (RD at 72) The FDIC argued that a total of eight violations were alleged in the * * * line in its proposed findings of fact, including two violations, a renewal of a loan and a new loan, alleged to be admitted by Respondents in RPFF 273.1. (P.Exceptions at 161)
   As the ALJ found (RD at 72), * * * guaranteed the debt of * * * Corporation (PFF 269.3; RPFF 269.3; P.Ex. 60 at 48) and aggregation of their debts was appropriate. (RPFF 273.2) However, the Board concludes from the evidence in the record that the ALJ was in error in concluding that only a single violation of the lending limit resulted from the aggregation of the debts of * * * and * * *. On June 27, * * * had unsecured commercial loans outstanding from the Bank of $934,538.79113 and received an unsecured advance of $72,250. (P.Ex. 60 at 46 and 98) On June 27, * * * also had an outstanding debt of $68,933.67. (P.Ex. 60 at 1) This resulted in a total aggregated debt of $1,091,306.59 for * * *, which exceeded the 10 percent statutory lending limit.114 On July 18, 1983, * * * continued to have over $68,000 in outstanding loans from Bank. (P.Ex. 60 at 1, 46 and 98) On that date, Bank made an additional advance to * * * of $8,617.80. (P.Ex. 60 at 98) In the aggregate, these loans, equaling $1,083,344, exceeded the $1,029,000 statutory lending limit on July 18. Therefore, the Board finds that one violation occurred on July 18. The Board finds that a second violation occurred on July 19, when the Bank discounted an acceptance of $75,900. (P.Ex. 60 at 1, 46, 47 and 98) Finally, a third violation occurred on September 30, when the Bank made an additional $57,000 loan to * * *. (P.Ex. 60 at 1, 46 and 98)
   In sum, with respect to the aggregation of the debts of * * * and * * * Corporation, the Board finds that three violations of the statutory lending limit occurred involving loans made on July 18, July 19 and September 30.
   Also at issue was whether the debts of * * * and * * * Company also should have been aggregated with those of * * * and * * *. The FDIC argued that Mr. * * * must be deemed to own or control * * * and * * * for the reasons discussed with respect to the * * *, line, supra. However, under * * * law, control of twenty-three percent of voting stock does not constitute prima facie control for purposes of debt aggregation for determination of violations of the lending-limit statute. The FDIC relied upon the testimony of FDIC Examiner * * * that Mr. * * * told him, without consulting his records, that he owned twenty-five percent of * * * stock. (Tr. 2160) The ALJ, however, properly accorded greater weight to the December, 1982 certificate in which Mr. * * * is shown to have 23.3% (14 of 60 shares) of * * * stock. (See RPFF 269.5) If the stock ownership of both * * * and * * * had been the only evidence of control of those companies, the Board would be disposed to agree with the ALJ. However, as we discussed in connection with the * * * credit line, the Board is of the view that substantial stock ownership together with other indicia of control such as positions as officers and directors can be sufficient to permit a presumption of control by the FDIC examiners in the absence of evidence showing the absence of control. In other words, at some point it is appropriate

113 * * * actually had $984,538.79 in outstanding commercial loans. However, we have subtracted $50,000 from those outstanding to account for a certificate of deposit pledged as cash collateral for purposes of lending limit calculations under the * * * law. * * * STAT. § 658.48(5)

114 However, the FDIC did not allege a lending limit violation as of June 27. Therefore, the Board does not rely on this violation to support its conclusions with respect to this credit line.
{{4-1-90 p.A-566}}to shift the burden of persuasion to the Bank which had the opportunity to document such matters in conjunction with its lending relationship to such entities. In this case, * * * was the president and treasurer and a director of * * *. Furthermore, Mr. * * * had signature authority for * * * checking account. (PFF 269.4 and 269.5; RPFF 269.4 and 269.5; P.Exs. 60 at 22-23, and 17 at 142 and 144; Tr. 2490-92 and 2498-2502) Similarly, * * * was president, vice president, treasurer and a director of * * *. (PFF 269.2; RPFF 269.2) The totality of facts are sufficient for the Board to conclude that * * * effectively controlled * * *. Therefore, the debts of those entities should be aggregated with those of * * * and * * *. The effect of this aggregation is that four additional violations of the lending limit are established — on July 11, by a $450,000 loan to * * *; on July 12, by a $20,000 loan to * * *; on September 14, by the renewal of a $160,000 loan to * * *; and on September 14, by a renewal of a $350,000 loan to * * *. (P.Ex. 60 at 1, 14, 37 and 46)
   Therefore, the Board finds that the evidence in the record supports the existence of a total of seven violations of the lending limit by * * * and his related interests.
   i. * * * and Related Interests
   The FDIC alleged two lending limit violations. (PFF 274.1-.10) The ALJ found that two violations had occurred based upon the aggregation of the debts of the * * * (* * *, Trustee), * * *. (RD at 72) This was based on application of the twotiered aggregation principal discussed supra. Based upon our review of the record, the Board agrees with the ALJ and finds that two violations of the lending limit occurred with respect to this line of credit. (P.Ex. 61; PFF 274.1, 274.4, 274.5, 274.7, 274.8, 274.9, 274.10; PRFF 274.1, 274.4, 274.5, 274.7, 274.8, 274.9, 274.10; and Tr. 1803-06) Respondents made no argument against the ALJ's finding here other than their exception to the two-tiered aggregation principal in general.
   j. * * * Corporation
   The FDIC alleged two lending-limit violations. The ALJ rejected these allegations (RD at 72) on the grounds that the debt was secured and that the guarantee of the debt of * * * of * * *, had been released.
   The FDIC argued that the $950,000 loan to * * * "involves collateral documentation deficiencies, requiring that it be treated as unsecured," and that the guarantee of * * * had not been released as of May 13, 1983. (P.Exceptions at 161)
   There are two issues extant with respect to the collateral for the $950,000 loan to * * *. First of all, at the outset of the September 30 examination the loan file only contained references to collateral but not documentation of the collateral. The documentation for the collateral consisting of promissory notes payable to * * * was provided to the examiners. (Tr. 1627-29) The second issue relates to the sufficiency of the eleven promissory notes specified as collateral for the $950,000 loan. As an FDIC examiner testified, the actual value of the notes was dependent on the creditworthiness of the persons obligated to * * * on the notes and the collateral securing those notes. (P.Ex. 17 at 120-24; Tr. 1647-48; 1653) The Bank's file for the $950,000 loan to * * * did not contain current information on repayment of the principal and interest on those notes. (P.Ex. 17 at 120–124; Tr. 1653-55) Furthermore, recourse to these notes by Bank in the event of a default by * * * on the $950,000 loan was extremely limited. It was limited initially to receipt of the monthly payments from the borrowers under those notes. Bank could only reach whatever collateral underlay individual notes if a borrower defaulted on his loan from * * *. (Tr. 1655-57) In sum, the Board finds that the severe documentary deficiencies with respect to the actual value of the notes as collateral and the rather dubious ability on the part of the Bank to collect on the notes in the event of a default by * * * justified the FDIC's position that the $950,000 loan to * * * was effectively unsecured. Consequently, the Board finds that a violation of the 10 percent lending limit did in fact occur on May 13 as a result of the loan to * * *.
   The Board also finds that the record reflects that prior to May 13, 1983, * * * had guaranteed the debts of * * *, up to a limit of $150,000. (P.Ex. 62 at 8–9) The Respondents' alleged and the ALJ found that the guarantee was released at some earlier time. The Board has found no evidence in the record to support such a release. We believe that it is reasonable to expect the Bank to adequately document, in its files, such an important transaction. However, the $150,000 guarantee obligation existed prior to May 13 and no additional {{4-1-90 p.A-567}}credit extension or renewal of that obligation occurred to create an additional violation of the lending limit. (P.Ex. 61 at 7)

   2. Overlines Alleged in February Report

   a. * * * and Related Interests
   The ALJ concluded that the FDIC had failed to establish any violation in the * * * line because there was inadequate proof that Mr. * * * interest in * * * ("* * *."), was more than twenty-five percent. The FDIC's Exceptions (pp. 162-163) discuss three financial statements: those of * * * who also had an interest in * * *, Mr. * * *, and * * * itself. None of the three statements discloses the number of shares involved. The FDIC argued, however, that control by Mr. * * * can be inferred, reasoning that "in order for Mr. * * * interest in * * * to have been less than the statutory control standard of twenty-five percent (25%) the market value of * * * stock would have had to be in excess of $1,000,000, which was nearly seven (7) times its stated book value." (P.Exceptions at 162)
   The Board is unable to conclude that the FDIC sustained its burden of proof that Mr. * * * had control of * * * on the basis of this argument. Accordingly, no violation was proved.
   b. * * * and Related Interests
   The ALJ found three violations (RD at 73), based upon aggregation with the * * * and * * * loans as discussed above under the September Report overlines. Mr. * * * owned or controlled * * * and * * *, and, therefore, it was proper to aggregate their loans. As the FDIC points out in its Exceptions (p. 163), only two violations were, alleged, one on July 23, 1982, and one on November 8, 1982. The Board finds that two violations were proved.
   c. * * * and Related Interests
   The ALJ concluded that two violations had been proved, based upon an aggregation of the debts of Mr. * * *, * * *, and * * *. These debts were properly aggregated since Mr. * * * guaranteed the obligations of * * * and owns six thousand of the nine thousand issued shares of * * *. (RD, at 73) The FDIC notes, however, that only one violation, on July 23, 1982, was alleged. (P.Exceptions at 163) The Board finds that one violation has been proven.
   d. * * * and Related Interests
   FDIC argued that three overline violations were proved: (1) July 23, 1982, because of the aggregation of the debts of * * * and * * *; (2) July 30, 1982, because of the aggregation of the debts of * * *, * * *, the guarantee of * * *'s debt by * * *, and the letter of credit jointly issued to * * * and * * *; and (3) August 10, 1982, because of the aggregation of the obligations of * * *, * * *, * * *, and * * *.
   The ALJ found no violations in this line, on the grounds that Mr. * * * was not personally liable for debts guaranteed by * * * "merely because he is a stockholder," and that paying a bill on behalf of * * * does not demonstrate ownership or control of that company. (RD at 73)
   The ALJ's observations are inapposite. The aggregation of * * *'s debt with that of * * * is proper under the two-tiered aggregation principle, supra, p. 259. (Tr. 2493-94) * * * guaranteed the debt of * * *. Therefore, the debt of * * * was attributable to * * * because he was the undisputed controlling owner of * * *, not because he was "personally liable." (Tr. 1723-26, P.Ex. 23 at 34) The ALJ accepted the two-tiered aggregation principle elsewhere. He does not explain why he did not follow it here in determining whether the * * * line exceeded * * * lending limits.
   the * * * letter of credit was properly aggregated with * * * obligations, because it was a joint obligation of those two companies, one of which Mr. * * * controlled. It was not aggregated because Mr. * * * controlled * * * or paid a bill on its behalf. (Tr. 1723-26, P.Ex. 23 at 34)
   The July 23, 1982 violation arose when * * * drew $150,000. (P.Ex. 23 at 43) When this credit extension was aggregated with the * * * debt the lending limit was exceeded. Respondent argued that * * *'s debt should not be aggregated with * * *'s debt, because * * * did not control * * *. and, even if he did control it, the debt was secured by a certificate of deposit. (R.Ex. 322.3) The Board finds that Mr. * * *'s ownership or control of * * * was established by his personal financial statement which stated that he owned seventy-five percent of * * *'s stock. (P.Ex. 23 at 34) Nor does the certificate of deposit, which collateralized its debt, provide a basis to {{4-1-90 p.A-568}} exclude * * *'s debt from the aggregation. The certificate of deposit matured on May 1, 1982. The loan card indicates that the * * * credit line was to be reduced from $1,200,000 to $800,000 when the certificate of deposit was released. (P.Ex. 23 at 62) The ledger card shows that the credit line was so reduced on June 14, 1982. (P.Ex. 23 at 61) Since the certificate was apparently released as collateral, it cannot be used to defeat aggregation.
   The July 30, 1982 violation arose because of the $100,000 letter of credit issued to * * * and * * *. Respondent argued that it was solely an obligation of * * *. The evidence does not support that argument. The application was made "for account of * * *." (P.Ex. 23 at 55) It was signed by Mr. * * * typed underneath his signature. (P.Ex. 23 at 58) It was issued to "* * * " (P.Ex. 23 at 53) It was paid for by * * *, a * * * controlled company. (P.Ex. 23 at 59) An amendment was paid for by Mr. * * * himself. (P.Ex. 23 at 60) The fact that "as treasurer of * * * * * *" was handwritten on the application beneath Mr. * * *'s signature does not convince the Board that it was a sole obligation of that company given all the other evidence suggesting it was a joint obligation.
   The August 10, 1982 violation arose because of the $270,000 credit drawn by Mr. * * * on that date. (P.Ex. 23 at 1) This, combined with $1,600,000 in * * * obligations and the * * * debt, created the aggregate violation. This would be a violation even if * * * were excluded.
   The Board concludes that three violations were proved.
   e. * * *
   The ALJ concluded that no violation was proved because there was insufficient evidence of Mr. * * *'s control of * * * to justify aggregation of its $800,000 debt with other * * * debt.
   The FDIC argued that Mr. * * * was in control of * * * because he was the only officer with borrowing authority, and because * * * had the same address as Mr. * * *. (P.Exceptions * * * had the same address as Mr. * * *. (P.Exceptions at 165-166) The Board finds that those facts alone are insufficient to prove ownership or control. Therefore, no violations have been established with regard to this line.
   f. * * *
   This overline was alleged to have arisen because of the issuance of a certificate of deposit to * * * in the amount of $900,000 without deposit of funds by * * *. The Bank argued that there was never an extension of credit because the certificate of deposit was never delivered to * * *. The ALJ agreed. (RD at 73) The FDIC argued (P.Exceptions at 166) that since Respondent * * * owned all of * * * stock (Tr. 163-168), and had physical possession of the certificate of deposit "on his desk" (Tr. at 365), delivery to him was the legal equivalent of delivery to * * *.
   The Board agrees and finds an unlawful extension of credit in excess of the ten percent statutory lending limit which applies for unsecured debt.
   g. * * * and Related Interests
   The ALJ found no violation here as of the February 4, 1983 examination because the guarantees of * * * and * * * were dated April 6, 1983. (RD at 73-74) The FDIC countered in its Exceptions (pp. 166-167) that the dates of the guarantees are "totally irrelevant" because the FDIC based this violation upon statements made by Respondent * * * to the FDIC examiners. This assertion referred to a line in the February examination report: "According to President * * *, * * * Corporation has assumed (the subject debts), although documentation to that effect was not available." (P.Ex. 9 at 73) The Board finds that this is insufficient evidence to conclude that the guarantees existed prior to the date of the written documents. Accordingly, the debts should not have been aggregated. No violation was proved.
   h. * * *
   Three violations were alleged in this line. One on February 4, 1982, which the ALJ upheld, and two that he found unsupported, November 9, 1982, and December 17, 1982. The ALJ properly upheld the February 4, 1982 violation triggered by the $200,000 overdraft despite the Bank's assertion that the Bank's ignorance of * * * law, which requires aggregation of the borrower's mortgage debt, excused the violation. He upheld the Bank's position on the other two alleged violations, however, on the ground that a $150,000 obligation should not have been aggregated with the other obligations because it was made by Mr. * * * in his capacity as a trustee. In support of this conclusion, the ALJ cited {{4-1-90 p.A-569}} RPFF 338.4 and RPFF 339.2 (RD at 74) The Board finds no evidence in the record to support the assertion that those obligations were incurred by Mr. * * * in a trustee capacity. The ledger cards in the loan file show when the credits were extended. (P.Ex. 27) They do not show the credits as being extended to him as trustee. The Bank failed to introduce any exhibits contradicting the plain significance of the ledger cards. The Board finds that the violations were proved.
   1. * * * and Related Interests
   The Respondents admitted that a violation in the * * * line occurred on February 4, 1983. (RPFF 342.2) The ALJ thus concluded that one violation had been proved. The FDIC argued that there were three violations totaling $305,000 on February 4. The Board finds three separate violations because there were three loan renewals in the * * * line, any one of which would have exceeded * * * lawful lending limit. (P.Ex. 28)
   The ALJ disallowed the November 19, 1982 violation alleged by the FDIC, which arose out of a $200,000 loan to * * * Corporation. The ALJ reasoned that the lending limit was not exceeded because the guarantee of * * * by Mr. * * * was "not operative." (RD at 74) The FDIC argued that the guarantee was still in effect on November 19, 1982. (Tr. 1740-42) The Respondents urged, however, that the guarantee would become operative only if alternative collateral was not arranged. (RPFF 342.2) The Board finds no evidence to support the Bank's assertion or the ALJ's conclusion. The guarantee itself was unconditional. (P.Ex. 28 at 42; Tr. 1954-58) There were no other documents showing the existence of other collateral (Tr. 1740-42) and there was no evidence that the guarantee was rescinded as of November 19, 1985. (Tr. 2084) The Board finds that the guarantee was an obligation which existed on November 19, 1982 and was properly aggregated with the other * * * debt. It thereby constitutes a fourth violation for this line.
   j. * * *
   This violation was triggered by an unsecured acceptance draft in the amount of $279,515.29 on December 15, 1982 for which both * * * and * * * were liable. The Bank argued that this was a secured transaction under the terms of 12 U.S.C. § 84. However, there was no evidence of any security for this debt in the loan file. (Tr. 2031) The Board finds no basis for a conclusion that 12 U.S.C. § 84 operates to secure the extension of credit. Accordingly, one violation was proved.
   k. * * * and * * * Corporation
   The ALJ found one February 4, 1983 violation which was admitted by the Respondents. (RD at 74)
   Six loans were renewed on January 31, 1983. These were alleged to be violations by FDIC. They were not discussed by the ALJ. The Respondents argued (RPFF 345.6) that no violations occurred on that date because the extensions of credit were "secured" under the definition of a federal statute (12 U.S.C. § 372). The Board finds no authority in that statute to support Respondents' conclusion that these acceptance drafts need not be explicitly secured in order to be exempt from the applicable lending limit. The fact that these extensions of credit may have been part of revolving lines of credit does not mean they should not have been aggregated with other loan obligations. (Tr. 1742-44) It would be illogical to do so. The Board, therefore, finds seven violations were proved.
   l. * * *
   FDIC alleged five violations based on the aggregation of * * * and * * * -affiliated obligations. The Respondents' defense was based on their claim that obligations of affiliated entities or guarantees of guarantees should not be aggregated. (RPFF 346.6) The ALJ found four violations proved here, on the basis of the two-tiered aggregation principle. He gave no explanation for rejecting the fifth alleged violation. It would appear that this was an inadvertent oversight, occurring because the five violations were detailed in only four series of findings of fact (PFF 346, 347, 348, 349). The Board finds that the ALJ counted the violations improperly and that five violations have been proved.
   3. Loans to Bank Officers Without Approval of the Board of Directors of the Bank
   * * * Law restricts loans to directors, officers or other "insiders" of a bank. (* * * Stat. § 658.48(1)) The ALJ concluded that the three "insider" overdrafts alleged to violate this * * * law were not proved because "these were * * * Accounts, {{4-1-90 p.A-570}}approved by the Board of Directors and which required repayment of principal and interest." (RD at 75)
   In fact, six violations were alleged: three discovered during the February 4, 1983 examination (PFF 371.1-373.4), and three discovered during the September 30, 1983 examination. (PFF 278.1–280.5)
   The FDIC contended that the overdrafts at issue did not occur in * * * Accounts approved by the Bank's Board of Directors, and that they did not require collection of interest. In support of its contention that the accounts were not * * * Accounts, FDIC noted that * * * Accounts contained a credit disclosure statement specifying an annual percentage rate of interest, generally 18% (or 1.5% monthly). The record contained examples of * * * Accounts which did contain such a statement. (P.Ex. 42–44) FDIC Examiner * * * testified that * * * Accounts and regular demand deposit accounts were distinguishable by the way in which they were identified on the Bank's records. (Tr. 1982) He testified further that the overdrafts alleged to violate * * * law occurred not in * * * Accounts, but regular demand deposit accounts. (Id.)
   The evidence cited by the ALJ demonstrated that the Bank's board of directors approved revolving unsecured lines of credit and * * * Account lines of credit. (R.Ex. 278.5) The Bank's board did not approve overdrafts on regular demand deposit accounts. Nor was there evidence in the record that interest was charged. The debit charges cited by the ALJ as interest were unrelated to the amount of the overdrafts or the length of the time they were outstanding, and were usually in the amount of ten dollars. (P.Ex. 49 at 3; Tr. 1807-8)
   Mr. * * * testified that, under * * * law, an approval by a bank's board of directors of overdraft privileges in connection with regular demand deposit accounts, without requiring that interest be paid on such advances, lies outside the statutory exception to the general prohibition against "insider" loans. (Tr. at 2488) The September 30, 1983 * * * examination found 14 violations of Section 658.48(1). (R.Ex. 6 at 6-a-13) In addition to four overdrafts, * * * found violations on American Express Accounts for which interest charges were not properly assessed, * * * Accounts for which charges were not assessed and $358,705 in loans to officers without prior Board approval. (Id. at 6-a-14)
   The Board finds that the record establishes that these accounts were not * * * accounts and that the six overdrafts constituted violations of * * * law.
   4. Loans of the Bank Secured by Junior Mortgages in Excess of the Lending Limit of the Bank
   * * * law restricts the amount of debt to a bank which may be secured by junior mortgages. (* * * Stat. § 658.48(4)(d)(4)) The ALJ concluded (RD at 75) that the FDIC had established a violation based upon a loan made to * * * on March 7, 1983, and secured by a second lien on real property. Such a loan, under * * * law, must not exceed ten percent of the capital accounts of a bank. (* * * Stat. § 658.48(4)(d)(4)) The amount of this loan exceeded the statutory standard, so the violation was established. However, this extension of credit already constituted an unlawful overline discussed in Part 2 of this section of our decision in connection with the * * * line. As the ALJ observed, had this loan been unsecured, no violation of this section would have occurred. The Board finds that this is an anomalous situation and that sufficient grounds have not been established that would justify adding on a second separate violation of law based on a single event in this instance. In our view, this violation should have been submitted in the * * * overline violation discussed supra, at pp. 245-47.
   5. Assets Booked and Carried by the Bank in Excess of the Legal Limit
   * * * law limits the amount properly booked in a bank's accounts for repossessed collateral to the lesser of market value of the collateral or the outstanding loan balance plus costs and interest. (* * * Stat. § 658.67(9))
   The ALJ found (RD at 75) that no violations of that requirement existed "as of the close of the examination."
   FDIC argued that the evidence showed that repossessed automobiles were booked in excess of their market values and that the Bank carried repossessed items that had already been sold in the general ledger account "Repossessions - Other Assets." (Tr. 2154–2159; P.Ex. 67) The Bank argued that its normal practice was to transfer to the "repossession" account the balance of the loans collateralized and then make periodic {{4-1-90 p.A-571}}adjustments to that account after comparing the amounts to estimated market value. (RPFF 282.2) The state of * * * apparently does not accept this practice. It also found this practice to be in violation of * * * law. (R. Ex. 6 at 6-a-14)
   The Board finds that the violations were proved. The Bank's practice does not comply with the statutory requirements governing how the assets should be booked after repossession. The Board further finds that the fact that the Bank corrected these unlawful entries during the course of the examination does not alter the fact that these violations of law were established.
   6. Loans Carried As Assets on the Books of the Bank Required to Be Charged Off

   * * * law requires banks to charge off bad debts, as defined by statute. (* * * Stat. § 658.52) The ALJ listed (RD at 76) ten loans admitted by the Respondents to be statutory bad debts. The ALJ concluded that no violation of the statute had been shown concerning the loans to * * *, and * * * "since no consideration was given to the exception in the statute which provides that past due paper may continue to be carried on the books to the extent of the reasonable value of the collateral and, if it is in the process of collection, at its reasonable value as determined by the board of directors," (RD at 75, citing RPFF 350.6-.8, 351.7, R.Ex. 350.7, and Tr. 2034-39)
   The FDIC argued persuasively at page 177 of its Exceptions that the testimony at page 2035 of the transcript that a "paydown" of the * * * loan was made "during or shortly after the examination" was irrelevant to the issue of the extent of collateral securing the loan. Nor does the record establish that this loan was in the process of collection at the time of the examination, as it must have been in order to qualify for the statutory exception.
   As the FDIC argued, there was no evidence in the record to substantiate the Respondents' claim in RPFF 351.7 that the * * * loan was in the process of collection, nor was there evidence that the board of directors of the Bank established a reasonable value for the loan.
   The Board finds that the twelve violations of * * * Stat. § 658.52 were proved. The fact that many of the bad debts were eventually properly charged off does not excuse the violations. (Tr. 2043-44)
   7. Failure of the Bank to Maintain Minimum Liquidity Reserves
   The ALJ noted (RD at 76) that the Respondents admitted liquidity reserve deficiencies totaling eight violations. (RPFF 363.1-370.2) The Board finds eight violations were proved. The fact that the Bank did not actually have to borrow from the Federal Reserve to meet its liquidity needs does not excuse the violations.
   8. Sale of Federal Funds in Excess of Legal Limit
   The ALJ concluded (RD at 76) that the FDIC had established "a minor violation," the Bank having sold $4,250,000 of federal funds, while the legal limit was $4,040,000. The Board finds that two separate violations of * * * Stat. § 658.67(1)(h) were proved: (1) the Bank sold $4,250,000 of Federal funds to the * * * Bank of * * * on February 2, 1983 (P.Ex. 50; Tr. at 1767), and (2) the Bank sold $4,250,000 of Federal funds to * * * on February 3, 1983. (P.Ex. 51; Tr. 1768)
   9. Deposit of the Bank in a Savings and Loan Association in Excess of Legal Limit
   * * * law restricts the amount a bank can invest in a certificate of deposit in a savings and loan association. (* * * Stat. § 658.67(1)(i))
   The Respondents admit having violated this restriction on two occasions, January 28, 1983, and February 4, 1983. (RPFF 378.1-379.2) Neither Respondents' explanation that the savings and loan "was inadvertently treated as a `bank' for investment purposes" (Id.) nor the ALJ's unexplained assertion that "it took steps to reduce the total investment by attrition over the next few months" (RD at 76), excuse the violation. The Board finds two violations were proved.

REMEDIES

   A. Summary of the ALJ's Recommended Decision on Remedies

   The ALJ's point of focus as to relief was on the alleged "significant" improvement in the Bank's financial condition that occurred after the completion of the September 30, 1983 FDIC examination. However, he found that there remained a "disturbingly large volume of classified assets which, in {{4-1-90 p.A-572}}and of itself, warrants imposition of formal corrective action...." (RD at 77) The ALJ further recognized that those alleged improvements were recent and that there was always a risk that improvement would be short-lived without continued strong regulatory oversight and an enforceable cease and desist order. The ALJ thus found that a cease and desist order was necessary to assure "that the Bank will maintain a steady course on the road to long-term financial recovery...." (RD at 77)
   In reaching his decision as to the appropriate terms of the recommended cease and desist order, the ALJ stated that it is of "critical importance" in circumscribing the function and format of an FDIC Cease and Desist Order, "to note that the dual banking system in which the FDIC operates recognizes that the State authority is the Bank's prime regulator...." Accordingly, the ALJ held that "deference should be payed [sic] to [the State's] remedial prescription." (RD at 79) He, therefore, based his recommended cease and desist order on the State's MOU. In fact, the cease and desist order recommended by the ALJ actually authorized the State, rather than the FDIC, to determine whether the Bank's condition has improved sufficiently to permit deviations from the terms of the FDIC's cease and desist order. With the sole exception of the FDIC loan loss provision which the ALJ adopted,115 each clause of the cease and desist order instructs the Bank to continue the specified affirmative action ordered until otherwise notified by the State in writing.
   Similarly, the ALJ refused to order the injection of additional capital to implement the 8% capital to asset ratio urged by the FDIC, because:
   First, by terms of the MOU, $3 million of additional capital will have been infused by the time this initial decision is issued. Adding the $1 million due in October 1984 to the capital figure reached by the State as of May 18, 1984, results in an expected capital to asset ratio of approximately 6.97 percent, well over the minimum the FDIC sets for well-managed banks. Second, there is no evidence of record which would justify the requested level of eight percent, or, for that matter, any amount in excess of that agreed to in the MOU. (Manual, § G/5; Tr. 4436)
(RD at 81)
   The ALJ also did not order the Bank to eliminate from its books all assets classified Loss and one-half of those classified Doubtful, and gave no reason for this other than a conclusory statement that only one additional provision (for loan loss reserves) is justified. (RD at 81)
   Finally, the ALJ refused to adopt the FDIC's provision for reducing violations of law and adverse classifications according to a defined timetable. Although he apparently believed that those reductions should take place, he objected solely to the time constraints so imposed: "There is no evidence which even speaks to the propriety or feasibility of the proposed time limits." (RD at 82)

   B. The ALJ's Proposed Relief is Inadequate

   1. The FDIC is not Required to Follow the State's Remedy

   Although the Board agrees with the ALJ that a cease and desist order is warranted by the record in this proceeding, the Board rejects the ALJ's conclusions as to improvements in the Bank's financial condition. We also strongly disagree with the ALJ's conclusion that the FDIC is required to follow the terms of the State's MOU of January 25, 1984. The ALJ apparently perceived that the alleged improvements in the Bank's condition resulted from the State's MOU, that the MOU is more limited than the FDIC's remedy, and, therefore, that the State's remedy should be given a chance to work.
   Furthermore, since this proceeding under 12 U.S.C. § 1818 is brought to enforce federal law, the Board simply cannot accede to having control over the affirmative provisions of the recommended cease and desist order placed solely in the hands of the State. Since the State is given sole authority to relieve the Bank of any and all obligations under the order proposed by the ALJ, and the FDIC is given no such authority, the


115 The ALJ adopted a modified version of the provision to provide for maintenance of an adequate reserve for loan losses:
   The MOU does not address the problem, but the evidence warrants a finding that the Bank's customary policy for calculating loan loss reserve does not take into consideration the condition of the loan portfolio; rather it would appear to look only to a percentage of total loans. "Since I find that an inadequate reserve for loan los is an unsafe and unsound practice, I conclude that such a provision in a cease and desist order is necessary." (RD at 81)
{{4-1-90 p.A-573}}
order is clearly an attempt to usurp the FDIC's authority over the Bank.
   By applying for federal deposit insurance, the Bank agreed to abide by the rules and regulations established by the FDIC for administering the deposit insurance fund. Section 6 of the FDI Act, 12 U.S.C. § 1816. Obviously, the Bank would prefer to enjoy all the benefits of federal insurance without being subject to the requirements of federal regulatory supervision. Nevertheless, Congress has determined that those who benefit from deposit insurance must accept the corresponding responsibility for adhering to the standards set by the FDIC.
   An examination of the Financial Institutions Supervisory Act of 1966, Pub. L. No. 89–695, 80 Stat. 1028 (1966) and its legislative history reveals a clear intent by Congress that the authority of the "appropriate Federal banking agency" to issue cease and desist orders should supersede the authority of state banking regulatory agencies if a conflict as to the appropriate remedy and its enforcement develops between the two.

   [.36] Indeed, the last sentence of section 1818(m) is undisputable evidence of this Congressional intent that the cease and desist order of the federal agency prevails over a conflicting order of a state agency:

       No bank or other party who is the subject of any notice or order issued by the agency under this section shall have standing to raise the requirements of this subsection [as to consideration of a state order by the federal agency] as ground for attacking the validity of any such notice or order.
   12 U.S.C. § 1818(m)116
   Thus, the Senate committee report on Pub. L. No. 89–695 emphasizes that the remedial powers established by the new legislation are essential to protect the soundness of the nation's financial system, existing remedies having proven inadequate. S. Rep. No. 1482, 89th Cong., 2d Sess. (1966), reprinted in 1966 U.S. Code Cong. & Ad. News 3532, 3536. Congress provided in section 1818(m) that before federal banking authorities exercise the new remedial powers the appropriate state authorities should be notified and afforded an opportunity to take effective corrective measures or to convince the federal authorities that they are mistaken. Id. at 3538. Thus, although section 1818(m) recognizes the duality of federal and state banking authority, there is absolutely no requirement that the FDIC defer to state authorities in the exercise of its powers under this section. On the contrary, federal law will prevail should a state fail to take adequate or effective corrective measures. Id.

   [.37] Therefore, the Board finds that there is no basis, statutory or otherwise, for requiring the FDIC to defer to the state in issuing a cease and desist order. It is important to recognize that the FDIC acts in two different capacities. In one capacity, it functions as a federal banking supervisory agency that examines and regulates banks such as * * * that are insured state nonmember banks. In the other capacity, unlike a state chartering authority which may also examine and regulate banks, the FDIC is also an insurer of deposits in banks with a fiduciary duty and statutory responsibility to protect the federal deposit insurance fund from risk of loss. (Tr. 2754-2758, 4365) its role as an insurer of deposits is unique, but is also uniquely related to its supervisory function inasmuch as the legislative purpose of this supervisory authority to examine banks is to protect the FDIC and the federal deposit insurance system from loss and undue risk. First State Bank of Hudson County v. United States, 471 F. Supp. 33, 35 (D.N.J. 1978), aff'd, 599 F.2d 558 (3rd Cir. 1979).
   Furthermore, the FDIC has other statutory, supervisory, and financial interests that are unique. Since it has "independent jurisdiction" over insured state nonmember banks, the FDIC is the only federal regulator with responsibility for the * * * Bank, a state chartered, nonmember bank. See 112 Cong. Rec. 20,044 (1966). As a result, the FDIC has an obligation to act independently on any matter that might affect the financial integrity of the * * * Bank or the deposit insurance fund administered by the FDIC, or both. The authority and obligation of FDIC to act independently of the * * * Bank's chartering authority was candidly acknowledged by the principal expert witness who testified on behalf of the Bank and Respondents. (Tr. 4378-4379) * * *,


116 Respondents conveniently omit this last sentence in citing section 1818(m) for the proposition that it requires FDIC to defer to state authorities.
{{4-1-90 p.A-574}}assistant director of the * * * State Division of Banking, acknowledged that because the State does not have the financial exposure faced by the FDIC, the concerns of the two regulatory authorities are different. (Tr. 2438)

   [.38] Contrary to the ALJ's suggestion (RD at 79), the FDIC's Manual of Examination Policies does not require deference to a state banking authority's formulation of a remedy under section 8(b). (See R. Ex. 1) Rather, in discussing the exceptions to the FDIC policy requiring formal action against all insured state nonmember banks rated "4" or "5" if evidence of unsafe or unsound practices is present, the Manual states that exceptions to the policy should be considered only "when the condition of a bank clearly reflects significant improvement resulting from an effective program [for example, acceptable preemptive action by a State authority] or where individual circumstances strongly mitigate the appropriateness or feasibility of this supervisory tool." (R.Ex. 1, § V, p.11) This provision clearly contemplates that the acceptability of state action is to be judged solely by the FDIC.

   2. Improved Condition Does Not Overcome the Need for an Order

   [.39] Even assuming arguendo that the Bank's condition had improved, there was and is still a need for a formal cease and desist order, since without such an order there is no assurance that such alleged improvements are real, substantial or likely to continue.117 Furthermore, 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.118 Moreover, evidence regarding practices by the Bank which occurred after the period covered by the reports will not rebut the occurrence of the practices upon which the notice was predicated. A final, enforceable cease and desist order containing the FDIC's provisions will ensure that proper corrective action is taken by the Bank. Return of the Bank to a sound financial condition or at least substantial improvement to its financial health, is, after all, the primary purpose and motivation for an enforcement proceeding and cease and desist order.
   Even assuming arguendo that an improvement in the Bank's condition was somehow relevant to the need for a formal enforcement order, the Board nevertheless rejects the ALJ's conclusion that, in fact, there has been an improvement. This conclusion was predicated on the ALJ's erroneous extrapolation of changes in certain classified assets to the condition of the Bank as a whole. The fact that certain assets may have improved, does not mean that the overall condition of the Bank had likewise improved, nor does it show that other assets had not deteriorated or that violations of law and unsafe or unsound practices had ceased and will not recur. The actual condition of the Bank can only be determined through a full examination. Obviously, it is not practical for the FDIC to conduct a continuous examination of a bank and to be aware of its condition at every moment. Yet, reliance by the ALJ on post-examination evidence required FDIC to, in effect, shoot at a continuously moving target. Furthermore, the ALJ overlooked the fact that the Bank did not even attempt corrective action until confronted with the State MOU and the threat of section 1818(b) enforcement measures. This fact further underscores the need for the authority of a formal cease and desist order, and the FDIC is in the best position based on its expertise and experience to determine the type of relief that would be most likely to result in the appropriate corrective action by the Bank.
   For the reasons set forth above, the Board of Directors considers it imperative not only that a cease and desist order be issued, as recommended by the ALJ, but also, contrary to the ALJ's recommendation, that the order be in a form and contain both prohibitive and affirmative correction provisions that the Board has found through experience will provide the maximum prospects for returning the Bank to sound financial


117 The Board has so held in other enforcement proceedings. See Bank of Dixie v. FDIC, No. 84-4737, slip op. (5th Cir., March 12, 1985) (motion to publish opinion pending).

118 See National Labor Relations Board v. Riley-Beaird, Inc., 681 F.2d 1083, 1088 (5th Cir. 1982); Diener's Inc. v. Federal Trade Commission, 494 F.2d 1132, 1133 (D.C. Cir. 1974); Montgomery Ward & Co. v. Federal Trade Commission, 379 F.2d 666, 672 (7th Cir. 1967); National Labor Relations Board v. Globe-Wernicke Systems Co., 336 F.2d 589, 590 (6th Cir. 1964); Giant Food Inc. v. Federal Trade Commission, 322 F.2d 977, 986-987 (D.C. Cir. 1963); Clinton Watch Company v. Federal Trade Commission, 291 F.2d 838, 841 (7th Cir. 1961) cert. denied, 368 U.S. 952 (1962); Lakeland Bus Lines, Inc. v. National Labor Relations Board, 278 F.2d 888, 891 (3rd Cir. 1960); Automobile Owners Safety Insurance Co. v. Federal Trade Commission, 255 F.2d 295 (8th Cir. 1958).
{{4-1-90 p.A-565}}health. In the view of the Board, the order recommended by the ALJ based upon the State's MOU does not meet our standards and will not adequately achieve that goal.

   [.40] The above conclusion is fully consistent with applicable statutory and case law. Section 1818(b) provides that a notice of charges may be issued for violations and practices that have occurred, are occurring, or may occur and that a cease and desist order may be issued against any bank if, upon the record made, "the agency shall find that any violation or unsafe or unsound practice specified in the notice of charges has been established..." (12 U.S.C. § 1818(b)-emphasis added) Thus, section 1818(b) distinguishes between violations of law and unsafe or unsound practices which are ongoing at the time of the issuance of the order and those which have already occurred or may occur in the future, clearly indicating that there need not be violations of law or unsafe or unsound practices occurring at the moment of issuance of a cease and desist order. Administrative and judicial interpretation of the cease and desist powers of the FDIC and other agencies is in accord. Indeed, ample precedent exists for the issuance of a cease and desist order when respondent relies on a defense of discontinuance of the violations. As long as the order is reasonably related to the conduct alleged in the notice of charges, it is within the authority conferred by section 1818(b).
   In Bank of Dixie v. FDIC, No. 84-4737, slip op. (5th Cir., March 12, 1985), the bank contended that the FDIC Board of Directors erred by not considering evidence of improvements made by the bank in its operating procedures. The court disagreed, holding that determination of whether the offensive practices have actually been abandoned is appropriately made through subsequent enforcement proceedings. Without a cease and desist order, the court held, the FDIC has no assurances that the bank would not continue its former unsafe practices.119 (Id. at 8)

   [.41] As the courts have found, corrective conduct does not nullify the need for the imposition of a remedy. 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. An order to cease and desist from abandoned practices is in the nature of a safeguard for the future. Giant Food Inc. v. Federal Trade Commission, 322 F.2d at 987; Clinton Watch Company v. Federal Trade Commission 291 F.2d at 841.
   If the scope of FDIC's cease and desist order is allowed to be modified on the basis of subsequent practices, the FDIC is left without an effective remedy should the practices recur. Such a result would effectively neutralize FDIC's statutory enforcement powers and would be contrary to the public interest. Where unlawful practices have been discontinued, courts properly leave the question of whether the protection of a cease and desist order is required to the discretion of the responsible agency. Cotherman v. Federal Trade Commission, 417 F.2d 587, 594 (5th Cir. 1969).
   The Fifth Circuit thus recognized that an administrative cease and desist order is a tool not only for stopping abuses but also for deterring and preventing future abuseseven if the original violations have been remedied. Where there is any doubt that individuals will not engage in unlawful practices in the future, an order to cease and desist from such practices is fully justified. Cotherman, 417 F.2d at 595.
   There is clearly room to doubt that the * * * Bank will never again engage in the same or similar practices alleged by the FDIC in the present proceeding. Unless the bank can make a showing that future compliance is assured, acts or omissions by the bank occurring after the close of the pertinent examination periods (February 19, 1982 and December 16, 1983) are irrelevant to the issuance of a cease and desist order and its remedies.

   C. Both Statutory and Case Law Authorize the FDIC's Affirmative Action to Correct Violations of Law and Unsafe or Unsound Practices


119 The Federal Trade Commission has also considered the defense of discontinuance in connection violations of the Truth in Lending Act, 15 U.S.C. § 1601. In J.M. Sanders Jewelry Co., 85 F.T.C. 250, 265 (1975), the Commission adopted as a final order the initial decision of an administrative law judge holding that discontinuation of the violation was not a basis to defend the agency's enforcement action. The Federal Trade Commission's power to impose a cease and desist order notwithstanding discontinuation of the violation even prior to initiation of the FTC action was affirmed in Beneficial Corp. v. F.T.C., 542 F.2d 611, 617 (3rd Cir. 1976), cert, denied, 430 U.S. 983 (1977).
{{4-1-90 p.A-576}}
   [.42] As discussed in the Statutory Authority Section, supra, p. 17, section 8(b) of the Act, 12 U.S.C. § 1818(b), clearly authorizes the FDIC to issue cease and desist orders requiring affirmative action to correct conditions resulting from any violation of state or federal law or any unsafe or unsound practice. Such orders are justified whenever, upon the record made at an administrative hearing, the FDIC finds that the existence of any violation or unsafe or unsound practice specified in the notice of charges has been established.
   Section 1818(b)'s clear statutory authority to require affirmative action is supported by case law. The courts have recognized in cases involving the Comptroller of the Currency, the "appropriate Federal banking agency" for national banks, that section 1818(b) gives the agency:
       broad discretion to fashion a remedy. ... "[O]nce the [the agency] finds a violation [it] may, within [its] allowable discretion, fashion relief in such a form as to prevent future abuses." Similarly, [it] has broad discretion to cure the effect of a violation.
del Junco v. Conover, 682 F.2d 1338, 1340 (9th Cir. 1982), cert. denied, 459 U.S. 1146 (1983) (emphasis added), (quoting Groos National Bank v. Comptroller of Currency, 573 F.2d 889, 897 (5th Cir. 1978)). See First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 680 (5th Cir. 1983); Federal Trade Commission v. Mandel Brothers, Inc., 359 U.S. 385, 392 (1959).120

      [.43] The range of corrective remedies available under section 1818 is necessarily broad so that the federal banking agencies may protect the safety and soundness of our nation's banking system. Groos National Bank v. Comptroller of the Currency, 573 F.2d at 896-97; Independent Bankers Ass'n. v. Heimann, 613 F.2d 1164, 1168-69 (D.C. Cir. 1979). Moreover, 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. See Brickner v. Federal Deposit Insurance Corporation, 747 F.2d 1198, 1203 (8th Cir. 1984); del Junco v. Conover, 682 F.2d at 1340; Securities Industry Association v. Board of Governors of the Federal Reserve System. ____, U.S. ____, 104 S.Ct. 3003, 3009 (1984). Deference is particularly appropriate here because the federal banking agencies asked Congress to enact the exact language in section 1818(b)(1) so that they could cure the effects of violations.121

   In Brickner, the Eighth Circuit affirmed an order issued by the FDIC, pursuant to section 1818(e), to remove individuals from their positions as officers and directors of a state nonmember bank. In upholding the FDIC's order, the court confirmed that section 1818(e)(5) (the pertinent language of which is identical to that of section 1818(b)) grants the agency broad discretion to impose an appropriate remedy. 747 F.2d at 1203. Furthermore, the court rejected the petitioner's assertion that the FDIC's remedy was grossly disproportionate to their culpability and thus an abuse of discretion:

       We disagree. "Administrative agencies have considerable latitude to shape their remedies within the scope of their statutory authority." Canadian Tarpoly Co. v. U.S. Int'l Trade Comm'n, 640 F.2d 1322, 1326, 68 CCPA 121 (1981). Cf. SEC v. Chenery Corp., 332 U.S. 194, 207-09, 67 S. Ct. 1575, 1582-83, 91 L.Ed. 1995 (1947). The relation of remedy to statutory policy is peculiarly a matter for the special competence of the administrative agency. See American Power Co. v. SEC, 329 U.S. 90, 112, 67 S.Ct. 133, 145, 91L.Ed. 103 (1946). Thus, an agency's choice of remedies is generally not to be overturned unless the reviewing court finds that it is unwarranted in law or without jurisdiction in fact. See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 185-86, 93 S.Ct. 1455, 1457-58, 36 L.Ed.2d 142 (1973).
   747 F.2d at 1203.
   In del Junco, the Court recognized the authority of federal banking agencies to fashion remedies requiring affirmative action and upheld an order requiring bank directors who had approved loans in excess of the bank's lending limit to compensate the bank for losses on those illegal loans. Framing the issue as whether "the remedial

120 Since the FDIC is the "appropriate Federal banking agency" for insured State nonmember banks under 12 U.S.C. § 1813(q)(3), it is entitled to the same "broad discretion to fashion a remedy" for an insured state nonmember bank.

121 S. Rep. No. 950323, 95th Cong., 1st Sess. 1 (1977); Mid America Bancorporation, Inc. v. Board of Governors, 523 F. Supp. 568, 576 (D. Minn. 1980).
{{4-1-90 p.A-577}}measures required by the Comptroller [were] appropriate to correct the conditions resulting from the Director's violation of 12 U.S.C. § 84," the Court held that "the Comptroller, in fashioning a remedy, acted within the scope of his authority to correct conditions resulting from the Directors' violation of the banking laws." 682 F.2d at 1340 and 1344.
   A cease and desist order requiring affirmative action also was upheld as an appropriate corrective measure under section 1818(b) in First Nat. Bank of Eden v. Department of Treasury, 568 F.2d 610 (8th Cir. 1978). In Eden, a bank had engaged in an unsafe and unsound practice by paying excessive bonuses to its officers. Acting pursuant to section 1818(b), the Comptroller ordered the bank's president and vice president to reimburse the bank in the amount of $61,000 for bonuses paid to them. The Court held that "[t]he requirements imposed in the order are authorized by the statute [Section 1818(b)(1)] and no abuse of discretion is apparent." 568 F.2d at 611-12.
   Accordingly, the Board has broad discretionary authority here to impose remedies on the Bank to halt the unsafe or unsound practices and violations of law found to have occurred, to correct the resulting effects of those practices and violations, and to prevent such practices and violations from recurring in the future.

   D. The Prohibition Aainst Use of Brokered Deposits is Necessary

   [.44] There are several significant problems associated with brokered deposits.122 First, they are generally in large denominations (e.g., over $100,000) and often carry higher interest rates and shorter maturities than alternative funding from local sources. Consequently, they are very rate sensitive and extremely volatile. (R.Ex. 1, § K, at 6) Second, brokered deposits tend to undermine market discipline by (a) allowing banks to acquire a large volume of deposits from outside their natural market areas regardless of their financial or managerial soundness, and (b) enabling funds which would otherwise be largely uninsured (and hence subject to market risks) to receive full insurance coverage. (Joint New Release, Federal Home Loan Bank Board and Federal Deposit Insurance Corporation, "FHLBB and FDIC Jointly Propose Limiting Insurance of Brokered Deposits," January 16, 1984; 3 Quarterly Journal, Office of the Comptroller of the Currency No. 2, p. 12 (June 1984) (Remarks by C.T. Conover, Comptroller of the Currency, before ABA Leadership Conference, Washington, D.C., February 16, 1984)) Third, brokered deposits 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 (resulting in increased costs to FDIC when market forces eventually cause such banks to fail). (R.Ex. 1, § K, at 6) Finally, brokered deposits are generally short-term, highly volatile liabilities which are often used to fund long-term assets. This mismatch between assets and liability poses a risk of severe liquidity problems in the event that assets are not available to meet a sudden withdrawal by a deposit broker. (Tr. 1144-45, 3110; R.Ex. 1. § K, at 6)
   Experience has shown that brokered deposits are used more frequently and more extensively by poorly rated banks than by highly rated banks. (Statement by William M. Isaac on Proposed Regulation of Brokered Deposits in Financial Depository Institutions, before House Subcommittee on Commerce, Consumer and Monetary Affairs, March 14, 1984; S. Shaffer and C. Piche, "Brokered Deposits and Bank Soundness: Evidence and Regulatory Implications" (Federal Reserve Bank of New York Research Paper No. 8405)) Twenty-nine (29) - nearly 66% - of the forty-five (45) commercial bank failures in 1983 involved banks which held brokered deposits ranging as high as seventy-six percent (76%) of total deposits. Six (6) of the eleven (11) banks which had failed in 1984 as of March 14, 1984 had brokered deposits ranging as high as fifty-three percent (53%) of total deposits.(Id.)


122 "Brokered Deposits" are deposits received by a bank for the account of others (either directly or ultimately) from a person in the business of placing funds or facilitating the placement of funds in return for a commission (a "broker"), but not including a person who is a trustee.
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   [.45] Between February 4, 1983 and September 30, 1983 the amount of brokered deposits at * * *, Bank increased from $12.6 million to $25.1 million, a substantial portion of which were used to fund an expansion in the Bank's loan portfolio. (P.Ex. 17 at 12) This increased volume of brokered deposits represented over twenty-five (25%) percent of total deposits. (Id. at 2 and 12.) Based on our experience with the problems caused by brokered deposits, the Board finds that the Bank's reliance on brokered deposits, in view of its obvious financial difficulties, raises the specter of "abnormal risk of loss" to the institution should the level of brokered deposits continue or increase.
   Furthermore, we note that the provisions related to brokered deposits in the FDIC's proposed cease and desist order clearly pertain to the problem posed by such deposits. In the affirmative provisions of the order, paragraph 8(b)(3) is designed to prevent the problem of mismatching (funding long-term assets with short-term, volatile liabilities,123 while paragraph 11 simply requires notification to FDIC when brokered deposits exceed five percent (5%) of total deposits. The State's MOU and the ALJ's recommended order both contained a provision requiring a monthly report whenever brokered deposits exceed 5% of total deposits. The ALJ also adopted the State's provision prohibiting the Bank from maintaining a level of brokered deposits exceeding 10 percent of its total deposits. The Board's current practice is to require elimination entirely of brokered deposits in financially troubled banks. However, since the Notices in this action did not specify such proposed relief, we decline to place a ceiling on brokered deposits. Thus, there is a clear correlation between the cease and desist order provisions pertaining to brokered deposits and the risks inherent in reliance on brokered deposits. First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d at 680.
   E. The Record Supports a Prohibition Against Dividends to Shareholders Without Prior Approval

   As part of its affirmative relief, paragraph 9 of the FDIC's proposed order prohibited the Bank from paying cash dividends without prior written consent of the Regional Director. Other than his conclusion that the FDIC should defer to the State's MOU because of the Bank's alleged improvement, the ALJ does not address this provision.
   Dividends consist of that portion of a corporation's earnings that are distributed to stockholders. They are shown in the equity section of a balance sheet. If a bank's board of directors decides to forego or limit dividend distributions, the undistributed amount appears in the equity section as retained earnings. Hence, the larger the dividend distribution, the smaller the amount of retained earnings.
   The amount of a bank's retained earnings (also called "surplus") is an important component in determining its capital adequacy, which in turn is an important factor in evaluating the overall financial condition of a bank. As stated in the Manual of Examination Policies:

       A bank's current and historical earnings record is one of the key elements to consider when assessing capital adequacy. Good earnings performance enables a bank to fund its growth and remain competitive in the marketplace while at the same time retaining sufficient equity to maintain a strong capital position.
   (R.Ex.1, § G, at 2)

   [.46] The * * * Bank received the lowest overall CAMEL rating at the September 30 examination, a rating of 5, in part, because of the level of its equity capital, also rated 5. Since the distribution of excessive dividends will have a direct impact on the bank's capital adequacy, the FDIC's concern for the amount of dividends distributed is clearly justified. As the Manual of Examination Policies states:

       Excessive dividends can obviously negate even exceptional earnings performance and result in a weakened capital position.... [I]t is FDIC's view that earnings should first be applied to the elimination of losses, depreciation expense and the establishment of necessary reserves, and that dividends be disbursed in reasonable amounts after full consideration of those needs.
Id.

   The FDIC's proposed cease and desist order does not prohibit the distribution of dividends altogether, nor does it restrict


123 The Board notes that the ALJ's recommended cease and desist order does not contain a provision of this type. In view of the significant problems posed by brokered deposits, we find that this requirement should be included in the cease and desist order.
{{4-1-90 p.A-579}}their size. Rather, it simply places the FDIC in a position to assure that the bank does not undermine its capital adequacy by excessive cash dividends. The Board finds that this provision is a reasonable means of assuring that the bank's dividend policy does not adversely affect its capital adequacy. We therefore find that FDIC's proposed dividend provision should be included in the cease and desist order.

   F. Conclusion

   Based on the foregoing case law and the express statutory language of section 1818(b), it is clear that the FDIC may issue a cease and desist order on the grounds of prior practices even if such practices were later modified. This is particularly true where, as in this case, the Bank's problems remain very substantial and serious. The purpose of the order to cease and desist in this case is to help restore the Bank to sound financial condition; to assure that the unsafe or unsound practices which caused its problems are halted and do not recur; and to assure that the violations of laws and regulations are fully corrected and do not recur. Under the circumstances of this case, the Board concludes that a formal cease and desist order with both the prohibitive provisions and the affirmative relief provisions proposed by the FDIC not only is justified by the record but also is essential to ensure that the proper corrective actions by the Bank are carried out in the future.124 Therefore, the Board adopts and issues the order accompanying this decision.

REMOVAL OF OFFICERS AND DIRECTORS

   A. Statutory Requirements for Removal of Officers and Directors from Banks and Prohibition From Further Participation in the Conduct of Bank Affairs

   [.47] The Federal Deposit Insurance Act authorizes the Board to remove from office bank officers and directors whose actions are seriously damaging an insured institution. (12 U.S.C. § 1818(e))
   Before the Board may order the removal of an officer or director from office and prohibit him from further participation in the conduct of the affairs of a bank, it must make a three part finding. First, the Board must find that the officer or director has done one of the following: (a) committed a violation of law, rule, regulation, or final cease-and-desist order; or (b) engaged or participated in an unsafe or unsound practice; or (c) breached his fiduciary duty. Second, the Board must determine that the bank has suffered or will probably suffer substantial financial loss by reason of such violation, unsafe or unsound practice, or breach of fiduciary duty. Third, the Board must determine that such violation or unsafe or unsound practice or breach of fiduciary duty is one involving personal dishonesty or one which demonstrates a willful or continuing disregard for the safety or soundness of the bank. (12 U.S.C. § 1818(e))
   B. The Recommended Decision of the ALJ

   FDIC sought removal and prohibition from further participation against the following three directors and officers of the Bank:

       (1) * * *, Chairman of the Bank's Board of Directors from May 1978 to February 10, 1984. From February 10, 1984 until he was indicated by a federal grand jury and suspended from his position on December 13, 1984, by the FDIC he was Managing Director and Chief Executive Officer of the Bank.
       (2) * * *, President of the Bank from May 1978 to January 30, 1984. He has been a director since May 1978 and he has served as Chairman of the Board of Directors of the Bank since February 10, 1984.
       (3) * * *, Executive Vice President of the Bank since May, 1978, and a member of the Bank's Board of Directors since July 1978.
   In his recommended decision, the ALJ found that there was ample proof that each

124 The cease-and-desist order proposed by the FDIC requires the injection of $8.2 million in new equity capital into the Bank. While the Board agrees that the record establishes that the Bank is woefully undercapitalized, the substantial elapse of time since the September 30, 1983 examination and changes in circumstances such as a shrinkage of the Bank's assets and state-mandated injections of capital, could render this requirement inappropriate. Therefore, the Board has not included that specific provision in its cease-and-desist order. Furthermore, the order continues to require that the Bank attain and maintain an eight percent (8%) or greater ratio of equity capital and reserves to total assets. This requirement is consistent with the Board's current practice in specifying required levels of equity capital in cease-and-desist orders.
{{4-1-90 p.A-580}}of the Respondent * * * was responsible for violations of law, rules or regulations. (RD at 83-84) He found that each of the Respondent * * * was responsible for originating a substantial number of loans which were adversely classified and each was responsible for managing loan lines subjected to other valid criticisms reflecting unsound lending and collection practices. (Id.) However, the ALJ found no breach of fiduciary duty by any of the three.
   The ALJ found that the FDIC had failed to prove that the Bank's substantial financial losses occurred or probable future losses will occur "by reason of" the * * * conduct. (RD at 85-86) He also found that the * * * conduct does not demonstrate willful or continuing disregard for the safety or soundness of the Bank. (RD at 86-90, SRD at 16–17) Finally, he recommended that the FDIC exercise its discretion and decline to order the removal of the * * *, as officers and directors of the Bank based on his balancing of the interests of the Bank, its officers, its customers, the Government, and the public in general. Part of the basis for this recommendation was a feeling on the part of the ALJ that FDIC was unfairly making an example out of the * * *. (RD at 94-95)

   C. The Board's Decision

   [.48] The Board rejects the recommended decision of the ALJ. We find compelling evidence that * * *, * * * and * * * individually and collectively in their exercise of control of the Bank were responsible for violations of * * * law, including making a large number of loans in excess of the Bank's legal lending limit. The Board finds that * * *, * * * and * * * individually and collectively in their exercise of control of the Bank were responsible for unsafe or unsound banking practices, especially the excessive quantity of poor quality assets, constituting 569.4 percent of total equity capital and reserves of the Bank. The Board finds that each breached his fiduciary duty as an officer and director of the Bank.
   The Board finds that the Bank has suffered and will probably suffer further substantial financial loss by reason of such violations of law, unsafe or unsound practices and breaches of fiduciary duty by all three * * *. The Board also finds that the conduct of * * *, * * * and * * * as officers and directors of the Bank evidences a willful and continuing disregard for the safety or soundness of the Bank. The Board therefore concludes that the public interest requires that * * *, * * *, and * * * be removed from the Bank and prohibited from further participation in the conduct of its affairs.
   D. * * *, * * * and * * * Are Responsible for Violations of * * * Law and Unsafe and Unsound Banking Practices

   Since 1978, the Bank has been managed and controlled by * * *, * * * and * * *. None has attempted to escape responsibility for the Bank's problems by blaming challenged practices on others. The Respondents admit that * * *, * * * and * * * own approximately 70 percent of the Bank's outstanding capital stock and exercise a controlling influence over the management, policies, operations and conduct of the affairs of the Bank. (RD at 5; PPF 2.5; Tr. 3825)
   The preceding sections of this decision contain an extensive discussion of the Board's findings of unlawful and unsafe or unsound practices engaged in by the Bank. All three * * * as owners, directors and officers of the Bank share responsibility for these activities. The evidence also establishes that each was individually responsible for numerous unlawful and/or unsafe or unsound banking practices. Overlines (loans or renewals of loans which exceed the Bank's legal lending limit) are the most serious violations of law relevant to the Board's determination that those officers and directors should be removed. The most glaring unsafe or unsound banking practice engaged in by this Bank under the * * * management and control arises out of the extension and maintenance of an excessive and disproportionately large volume of adversely classified loans. Operation of the Bank with an inadequate level of capital and loan loss reserves, and the crediting as Bank income part of the proceeds of new loans used to pay interest due on prior loans, are additional unsound banking practices considered by the Board in determining that these individuals should be removed from office and prohibited from further participation in the conduct of the affairs of the Bank.
   The following summarizes in tabular form the Board's findings and conclusions with respect to responsibility of the * * * for the largest classified assets which were individually discussed in the September 30

{{4-1-90 p.A-581}}
   Examination Report. (P.Ex. 17 at 53-241) The table reflects the Board's "de novo" loan classifications. Responsibility has been attributed to the person or persons identified in the September 30, 1983 Examination Report as the loan or Account officers for these larger loans.125 (P.Ex. 17 at 50; Tr. 1046) Of the 181 borrowers with adversely classified loans, 162 (89.5% percent) of those borrowers with adversely classified loans amounting to 93.3 percent of the total dollar amount adversely classified were the responsibility of the * * *.

Adversely Classified Loans by

Responsible Officer or Officers

#Borrowers
Originating LoanWith Loans
Officer(s)Classified:SubstandardDoubtfulLossTOTAL
* * *89$6,879,000347,0007,226,000
* * *17$2,868,000950,0001,940,0005,758,000
* * *43$10,989,000150,000818,00011,957,000
* * *4$1,565,0001,565,000
* * *6$752,000752,000
* * *2$184,000184,000
* * *1$211,000211,000
Others19$1,584,000145,000257,0001,986,000
181$25,032,000$1,245,000$3,362,000$29,639,000

   * * * was responsible for adversely classified loans to 89 borrowers, amounting to 24.4 percent of the dollar amount classified. $6,879,000 of those loans were properly classified Substandard, and $347,000 were properly classified Loss.
   * * * was responsible for adversely classified loans to 17 borrowers, amounting to 19.4 percent of the dollar amount classified. $2,868,000 of those loans were properly classified Substandard, $950,000 were properly classified Doubtful and $1,940,000 were properly classified Loss.
   * * * was responsible for adversely classified loans to 43 borrowers, amounting to 40.3 percent of the dollar amount classified. $10,989,000 of those loans were properly classified Substandard, $150,000 were properly classified Doubtful, and $818,000 were properly classified Loss.
   Together * * * and * * * were responsible for an additional $1,565,000 in Substandard loans. * * * and * * * together were reresponsible for $752,000 in Substandard loans. * * * and * * * together were responsible for $184,000 in Substandard loans.
   All three * * * shared responsibility for one loan of $211,000 which was properly classified Substandard.
   As controlling directors and officers, * * *, * * *, and * * * each bears substantial responsibility for the other unsafe and unsound banking practices discussed in this decision. (Supra pp. 203-229) In particular, the Board finds these officers responsible for the operation of the Bank with a woefully inadequate level of capital and loan loss reserves considering the quality of its assets. 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 adjusted by the Board. The adversely classified assets of the Bank totaled $31,595,000 or almost 569.4 percent of the total equity capital and reserves of the Bank. (Supra p. 221) As discussed above, this involves excessive risk of loss to the Bank.
   E. * * * , * * * and * * * Breached Their Fiduciary Duties as Officers and Directors of the Bank

   [.49] Directors and officers of a bank have a fiduciary duty to the bank. They


125 The standard practice at most banks is to assign the senior bank officer who originated a major credit as the account officer. Based upon the testimony of the * * * in this proceeding with respect to specific loans, it seems clear that Respondents follow that practice. In the case of * * * 's loan originations, it may well be that the concurrence of either * * * or * * * was also required but not reflected in every loan file. However, in the Board's view, * * * was sufficiently culpable that it is not unfair to attribute responsibility for such loans to him.
{{4-1-90 p.A-582}}must act as prudent and diligent persons would act safeguarding the bank's property, complying with state and federal banking statutes and regulations, and ensuring that the bank is operated properly. (R.Ex. 1 at § L, 1–9 [FDIC, Manual of Examination Policies], American Bankers Association, Focus on the Bank Director, at 97-125 (1984); Schichting, Rice & Cooper, Banking Law § 6.04 (1984)) The concept of corporate directors' and officers' fiduciary duty is an ancient one which may be traced back to the origin of the corporate form. It encompasses broad responsibility to protect the interests of the corporation. One way to define the scope of the duty in any particular case is to examine relevant statutes and business customs. Where statutes are violated and prudent business customs and standards are not followed the fiduciary duty is breached.
   The fiduciary duty of bank officers and directors have long been established in law. Bank directors have been held to have breached their fiduciary duty for: disregarding agency regulations (Bowerman v. Hamner, 250 U.S. 504 (1919)); failure to institute and secure a sound, supervised loan program (Gamble v. Brown, 29 F.2d 366 (4th Cir. 1928)); knowingly permitting the violation of state statutes regulating banks ( Bowerman; Atherton v. Anderson, 99 F.2d 883 (6th Cir. 1938)); and ignoring warnings from responsible sources (Prudential Trust v. Brown, 271 Mass. 132, 171 N.E. 42 (1930)).
   The ALJ found no breach of fiduciary duty by any of the * * * In the Board's view, the ALJ's recommendation in this regard is unequivocally at odds with his findings that the * * * engaged in unsafe and unsound, and in some cases unlawful, banking practices. Clearly, where such conduct has occurred, the duty has been breached.
   The Respondent * * * breached their fiduciary duties to the Bank by engaging in a pattern of unsafe or unsound lending practices which resulted in the Bank's accumulation of $31,391,000 in adversely classified assets which equaled 569.4 percent of the total equity capital and reserves of the Bank as of September 30, 1983. (Supra p. 221) They breached their fiduciary duties to the Bank by engaging in hazardous lending and lax collection practices. (Supra pp. 204-233) They breached their fiduciary duties to the Bank by permitting the Bank to violate * * * law. (Supra pp. 234–274) Finally, they breached their fiduciary duties to the Bank by their failure to heed repeated warnings from regulators including the issuance of a temporary cease-and-desist order. (Infra pp. 311-319)
   On the basis of the overwhelming weight of the evidence, the Board finds that * * * , * * * , and * * * each breached his fiduciary duty as an officer and a director of the Bank.
   F. The Bank Has Suffered Losses and Will Probably Suffer Further Losses by Reason of Violations of Law, Unsafe and Unsound Banking Practices and Breaches of Fiduciary Duty Committed by * * * , * * * and * * *.

   The ALJ acknowledged that the Bank had sustained net loan losses of more than $1.5 million between January, 1982, and March, 1984. (RD at 85) He stated, however, that the Bank's losses were not proved to be directly caused by the actions and conduct of the * * * as officers and directors of the Bank.
   The Board disagrees with the ALJ's analysis of the causation issue. The Board finds that the Bank has suffered substantial losses and is likely to suffer further substantial losses by reason of the Bank's lending practices for which * * * , * * * and * * * were directly responsible.
   The Board has carefully examined the adversely classified loans at controversy in this proceeding. (Supra pp. 23–176) After examining the circumstances of each loan as they existed during the September, 1983 examination, the Board determined that $3,619,000 should have been classified Loss. Of that amount, * * * was loan officer responsible for $347,000; * * * was responsible for $1,940,000; and * * * was responsible for $818,000. Other Bank employees responsible to these directors were responsible for $257,000 classified Loss. The amount classified Loss must be eliminated from the Bank's books. It is a substantial loss which has occurred by reason of the unsound extensions of credit made by or under the supervision of the * * *.
   The Board has also concluded that $1,285,000 of the Bank's assets are properly classified as Doubtful and $25,772,000 are properly classified Substandard. (Supra pp. 175-76) The Board concludes that it is likely that approximately half of the assets classified Doubtful and 10-15 percent of those {{4-1-90 p.A-583}}classified Substandard will be charged off as loss in the future.
   As discussed above, loans properly classified Doubtful have so many deficiencies that they are not likely to be collected in full. Because of this, it is standard procedure to require that 50% of the amount classified Doubtful be deducted in computing adjusted capital (surplus) and reserves of the bank. (R.Ex. 1 at 12; Tr. 875)
   All loans classified Substandard are also unlikely to be fully collected. In this proceeding, several witnesses testified that 10–15 percent of loans classified Substandard will probably eventually be charged off as loss. This testimony was based on their extensive experience in bank examination and banking. Mr. * * * , now chief executive officer of a bank holding company and a former Director of the FDIC's Division of Bank Supervision, with twenty-eight years of experience in bank examination and supervision, testified that he would expect eventual losses to the Bank of 10-15 percent of loans classified Substandard. (Tr. 2778) Mr. * * * , Assistant Regional Director of the FDIC * * * office with more than twenty years of experience in bank examination and supervision, estimated that 10 percent of the assets classified Substandard are likely to be lost. (Tr. 2669) Mr. * * * , FDIC Examiner-at-Large who has specialized in the examination of "problem" banks and who has nearly twenty years of experience in the examination and supervision of banks, testified that in his experience 10-12 percent of loans classified Substandard will never be collected. (Tr. 1058) Mr. * * * , Assistant Director of the * * * State Division of Banking with twelve years of experience in bank examination and supervision estimated the Bank's loss at 10 percent of loans classified Substandard. (Tr. 4790)
   The ALJ criticized this evidence stating, "[t]he loss prediction `experience' of these witnesses takes into consideration none of the variables which may or may not apply to this Bank or any other bank which is encompassed [sic] in their universe of observations." (RD at 86) The Board finds this criticism as well as the ALJ's suggestion that "multiple regression analysis" be employed to test the examiners' conclusion misplaced. The Board concludes that adversely classified loans of this bank, like adversely classified loans at other banks, including failed banks, have weaknesses which make full repayment improbable.
   The experience of * * * , * * * , * * * and * * * is substantial. It is based on eighty years of involvement with bank examinations. While no one can predict with absolute certainty that there will be loss on any particular classified asset, it is not necessary to make such predictions in order to prove that the Bank is likely to suffer losses by reason of the lending practices engaged in by * * * , * * * and * * *. It is the fact that, in the aggregate, experience has shown that 50 percent of the loans classified Doubtful and 10-15 percent of loans classified Substandard can be expected to result in losses that is the basis for our conclusion that the Bank will probably suffer substantial financial loss by reason of the Bank's lending practices.
   The ALJ characterized the statutory causation requirement, that losses or probable losses occur "by reason of" the officers' or directors' unsafe, unsound or unlawful practices or breaches of fiduciary duty as requiring a showing of "proximate cause." The Board agrees that a nexus must be shown between the officers' or directors' conduct or breach of fiduciary duty and the bank's loss or probable loss, but we decline to characterize it as "proximate cause." Here each of the * * * admitted responsibility for making loans which were adversely classified. Maintenance of such a large number of classified assets and extending further credit to borrowers with adversely classified loans constitute unsafe or unsound banking practices and breach of fiduciary duty by the officers and directors responsible. Further, the unlawful overlines and other unsafe or unsound practices pose additional risks to the Bank which will probably result in losses. These extensions of credit and other unsafe or unsound practices for which the Respondent * * * are responsible are sufficiently related to the Bank's losses and probable losses to provide an adequate nexus.
   Nor do other factors, such as economic decline in South America, which allegedly affected certain borrowers' ability to repay, excuse the * * * ' mismanagement of the

{{4-1-90 p.A-584}}
Bank.126 A sound lending policy aims to spread and limit the risk of loss. Prudent bank management and a sound lending policy would not have permitted the Bank to accumulate so many poor quality assets.
   The Bank has already suffered losses and will probably suffer further loss as a result of the increased number of poor quality assets. We conclude that there is ample evidence that the Bank will probably suffer significant future losses as a result of unsafe and unsound banking practices.

   G. Conduct of * * * , * * * and * * * as Officers and Directors of the Bank Demonstrates Willful or Continuing Disregard for the Safety or Soundness of the Bank

   FDIC argued that continuing disregard for the safety or soundness of the Bank was demonstrated by the evidence that Respondents continued to engage in unsafe or unsound, and in some cases unlawful, lending practices, including extending further credit to nonperforming borrowers whose other debts were already adversely classified, and crediting to Bank income before actually collected in cash from the borrower (interest paid by an overdraft or a new note), despite numerous warnings from FDIC or state regulators that such practices should cease.
   None of the * * * has disputed he received notice from the FDIC that the practices they were engaged in were unsafe, unsound and in some cases, unlawful. Yet, the ALJ found that they had not continually disregarded the safety and soundness of the Bank because "[f]irst, Respondents vigorously contested the allegations of the examiners and, second, they undertook to resolve those differences and the concerns of the FDIC on numerous occasions...." (RD at 87) The ALJ found that violations of the Temporary Order did not evidence willful or continuing disregard for the safety or soundness of the Bank because they allegedly occurred out of excusable misunderstanding or negligence.
   The Board disagrees, and finds that * * * , * * * and * * * evidenced continuing disregard for the safety or soundness of the Bank. Further, although FDIC based its argument on the * * *' "continuing disregard" for the safety or soundness of the Bank, the Board also finds the evidence unequivocally demonstrates that they also willfully disregarded the safety and soundness of the Bank. In short, the Board finds that under either the "willful" or the "continuing" disregard test, the requirements of Section 8(e) have been met in this case.
   In February 1982, an examination of the Bank was conducted which revealed sub stantial problems. A total of $978,000 in adversely classified assets were noted, $639,500 classified Substandard, $165,300 classified Doubtful and $173,200 classified Loss. (R.Ex. 2 at 1) In a Memorandum of Understanding, the Bank agreed to improve its performance.
   In December, 1982, FDIC Examiner * * * visited the Bank to determine the Bank's overall compliance with the June, 1982 Memorandum of Understanding. He notified the Bank that four loan lines posed potential problems: (1) * * * and related interests; (2) * * * and related interests; (3) * * * and related interests; and (4) The * * * Group and related interests. (RD at 8)
   The Bank was examined in February 1983 and a meeting was held April 27, 1983 to discuss the examination. FDIC proposed a fourteen point rehabilitation program to eliminate unsafe and unsound practices. This program included orderly reduction of classified loans, revisions to the Bank's loan policy, no further extensions of credit to borrowers with loans classified Doubtful or Loss and prior Bank board of directors' approval for further loans to Substandard borrowers, establishment and maintenance of an adequate loan loss reserve, elimination of violations of law, injection of capital, and employment of a new chief executive officer and chief lending officer. (P.Ex. 68)
   On June 2, 1983, FDIC representatives met with * * * and other directors of the Bank (except for * * * and * * *) to further discuss the findings, conclusions, criticisms and recommendations contained in the February Examination Report and the need for the adoption of a formal program to correct the practices and violations as


126 The ALJ misread the record when he claimed FDIC Examiner * * * testified that economic conditions in * * * contributed to the increase in classified loans "in large part." (RD at 85) In fact, Mr. * * * testified that the foreign economic conditions contributed to the increase "to some degree, yes, but not totally." (Tr. 550-51) He further explained that prudent banking practice utilizes current country risk studies to minimize exposure in particular countries.
{{4-1-90 p.A-585}}
discussed in the April 27, 1983 meeting. (Tr. 813-25)
   On November 22, 1985, a Temporary Cease and Desist Order ("Temporary Order") was issued which: (1) prohibited the Bank from extending credit to all borrowers who had adversely classified loans (Loss, Doubtful and Substandard) as of February 4, 1983; (2) prohibited the bank from crediting as income interest not actually collected in cash or additional collateral from the borrower; and (3) prohibited the Bank from extending credit in violation of the Bank's lending limit under Section 658.48(2)(a) of the * * * statutes. The Temporary Order also restricted the Bank's acquisition of brokered deposits and extensions of credit in excess of $25,000.
   The evidence demonstrates that even after all of these meetings and warnings, and the issuance of a Temporary Order, the * * * continued to engage in many of the practices which had been identified as unsafe or unsound and in some cases unlawful.
   By the February 1982 Examination, the Bank had $978,000 in adversely classified assets. (R.Ex. 2) By the February, 1983 Examination, the Bank had $23,363,472 in adversely classified assets. (R.Ex. 3) By the September 1983 Examination, the Bank had 31,391,000 in adversely classified assets according to the Board's evaluation of the evidence. (Supra p. 221)
   In February, 1982, classified assets constituted 30.9% of total capital and reserves. (R.Ex. 2) In February, 1983, classified assets constituted 521.9% of total capital and reserves. (R.Ex. 3) By September, 1983, classified assets constituted 569.4 percent of total capital and reserves. (Supra p. 221)
   In many cases, extensions of credit continued to be made by the * * * to borrowers whose loans were adversely classified in the February, 1983 Examination Report. (P.Ex. 17 at 55, 57, 66, 70, 78, 91, 93, 94, 100, 101, 105, 134, 137, 142, 162, 165, 186, 188, 204, 210, 216, 217, 226, 238)
   The intolerably excessive accumulation of poor quality assets did not occur overnight or as a result of one or two instances of poor judgment. One hundred eighty-one borrowers had adversely classified loans as of the September 1983 Examination. Many of those individual borrowers have multiple adversely classified loans. This volume of poor loans could only be accumulated by officers continually disregarding safe and sound banking practices. Even when specifically warned to cease by the regulators, the * * * continued to conduct bank business in an unsafe and unsound manner.
   The evidence discussed in the Violations of Law portion of this decision reveals how the Bank continued to extend credit in violation of its lending limit despite warnings contained in the February examination report that unlawful overlines were occurring when various corporate entities were aggregated as required by * * * law.
   * * * and Related Interests had two violations in the February examination. (Supra p. 259) There were fourteen overlines in this group by September. (Supra p. 239) All three * * * were involved in the lending to these related interests. (P.Ex. 17 at 50)
   There were four * * * overlines proved in the February, examination (Supra pp. 265-66) and two more unlawful extensions of credit by the September examination. (Supra pp. 246-49) * * * was the lending officer for this line. (P.Ex. 17 at 50)
   Seven overlines were reported in the * * * and * * * Corporation line in February (Supra p. 267) and a total of seven additional overlines uncovered in the September examination. (Supra pp. 252-55) * * * was the lending officer involved. (P.Ex. 17 at 50)
   Five overlines were proven of those alleged in February in the * * * line. (Supra p. 268) Two more violations occurred with respect to this line by the September Report. (Supra p. 256)
   The * * * blatant disregard of the Temporary Order provides further evidence of the * * * willful and continuing disregard for the safety and soundness of the Bank.127

   The ALJ upheld FDIC's allegation that three accounts violate the first paragraph of


127 At the initial hearing, the ALJ excluded evidence of violations of the Temporary Order. In an order issued May 23, 1985, the Board overruled that exclusion and remanded the proceeding to the ALJ solely to hear evidence on whether the Temporary Order was violated. A hearing was held June 19, 1985 and the ALJ issued a Supplemental Recommended Decision ("SRD") dated July 12, 1985. SRD contains the ALJ's proposed findings on whether the Temporary Order was violated and whether the violations evidence willful or continuing disregard for the safety or soundness of the bank.
{{4-1-90 p.A-586}}the Temporary Order, prohibiting extensions of credit to classified borrowers. (SRD at 12) He also found five loans in violation of the second paragraph of the Temporary Order which prohibited the Bank from crediting to its income any interest paid by overdraft or other noncash or uncollateralized additional extension of credit to a borrower. (Id.)
   The ALJ properly rejected the Bank's argument that advances to borrowers in their * * * accounts were not new advances of credit within the meaning of the Temporary Order. Clearly such advances constitute an increase in the borrowers' indebtedness and were in violation of the Temporary Order. A closer question is whether use of the * * * Accounts by Messrs. * * * and * * * to pay a portion of their other debts to the Bank violated the Temporary Order. The Board finds those to be technical violations of the first paragraph of the Temporary Order but, where the borrowers were the same entity, there was no net increase of indebtedness to the Bank, so we do not hold those particular violation to evidence willful and continuing disregard for the safety or soundness of the Bank except where the transaction also violated the second paragraph of the Temporary Order.
   The February 1983 FDIC Examination Report classified $593,000 in extensions of credit to * * * as Substandard. He had a " * * *" account with the Bank. Automatic payments of Mr. * * *'s insurance premiums by overdraft extensions from his * * * checking account constituted four violations, two on December 16, 1983 and two on January 24, 1984. Payment of a $1,000 check on December 20, 1983 was a violation. Three checks to * * * Corporation, $15,000, on January 17, 1984, $8,000, on January 23, 1984 and $12,000 on February 2, 1984, were also paid in violation of the Temporary Order. As the ALJ pointed out, in extending credit to * * * in this manner, the Bank was permitting him to borrow for the benefit of a related business interest. (SRD at 11)
   The February 1983 FDIC Examination Report classified $488,000 in extensions of credit to * * * as Substandard. On February 24, 1984, the Bank funded a loan of $68,300 to * * * to be used to pay some of the debt of * * * 's restaurant, another adversely classified borrower. As the ALJ pointed out, although the net indebtedness of the Bank was not increased, the Temporary Order was violated because the individual indebtedness of one borrower, * * *, was substantially increased. (SRD at 11)
   The February 1983 FDIC Examination Report classified $100,000 in extensions of credit to * * * as Substandard. During the month of March 1984, approximately $40,000 was debited from Mr. * * *'s Sunshine account. Approximately $36,000 was used to pay commitments under two letters of credit. Although technically, the Temporary Order was violated, no net increase in the amount of * * * liability to the Bank occurred. The other $4,000 debit, however, clearly increased * * * debt to the Bank in violation of the Temporary Order.
   The FDIC argued that the second paragraph of the Temporary Order was violated on March 15, 1984 when loans totaling approximately $438,000 were made to * * * , * * * , * * * , * * * and * * *. These loans were made to enable these individuals to comply with a state order to restrict insiders' * * * accounts. Part of the proceeds were indisputably improperly credited to the Bank as income in violation of sound banking practice and the Temporary Order.
   The ALJ found no violation of the second paragraph of the Temporary Order reflected by the advances to * * * on the theory that additional collateral, a $105,000 mortgage was pledged by Mr. * * *.128 The Board finds that this collateral cannot excuse this violation because this collateral already secured another $105,000 loan which was not charged by FDIC to be a violation of the Temporary Order. The ALJ acknowledged that the $105,000 loan was not part of the alleged violations elsewhere in his decision. (SRD at 4)
   The ALJ found the violations of the Temporary Order partially excused because of * * * 's testimony that he believed advances of credit in a * * * account did not violate the Temporary Order, and the small dollar value of the violations relative to the Bank's balance sheet. (SRD at 16) The Board finds the officer's and directors' inattention to the details of the Temporary Order even when insider transactions are

128 The second paragraph of the order allowed crediting of income for interest paid by a new loan if it is secured by additional collateral.
{{4-1-90 p.A-587}}involved is part of a well proven pattern of unsound banking conduct.
   The Board finds that the above described pattern of repeated extensions of credit to poorly performing borrowers, repeated violations of the Bank's lending limit and proven violations of the Board's Temporary Order, evidence of a continuing disregard for the safety or soundness of the Bank. Moreover, because the unsound and in some cases unlawful extensions of credit were voluntarily and intentionally made (as distinguished from accidentally) we believe the * * * have also demonstrated a willful disregard for the safety and soundness of the Bank. (See del Junco v. Conover, 682 F.2d 1338, 1342 (9th Cir. 1982); United States v. Murdock, 290 U.S. 389, 394, 395 (1933); FDIC v. Mason, 11 F.2d 548 (3d Cir. 1940.)
   H. * * * Challenges to the FDIC Classifications and Other Examination Findings and * * *' Alleged Attempts to Resolve Differences Do Not Shield Them From Responsibility for Unsafe, Unsound, and Unlawful Conduct.
   The ALJ reasoned that the fact that the Respondents vigorously contested the loan classifications and other bases for the FDIC warnings that the Bank was engaging in unsafe or unsound practices somehow excuses them from responsibility for repeating the same unsafe or unsound practices while the dispute was ongoing. (RD at 87) The ALJ further felt there was no "continuing disregard" because "they undertook to resolve those differences and the concerns of the FDIC on numerous occasions throughout a period in excess of the ten months adverted to by the FDIC." (RD at 87)
   It is indisputable that the Bank and these Respondents had a right to contest the examiners' findings and to challenge enforcement orders against them. They cannot, however, use this right to shield them from responsibility for continuing to engage in the same practices for which they are being challenged. If the Board were to adopt the ALJ's theory, defendants to enforcement proceedings would be free to continue to engage in unsafe or unsound practices increasing the risk to the bank, the bank's depositors and the FDIC insurance fund while the FDIC stands by powerless to stop the practices or hold those whose conduct is culpable responsible even when, as here, after lengthy adjudicator proceedings, the practices are found to be unsafe, unsound, unlawful and in breach of directors' and officers' fiduciary duty. There is no basis in the statutory language or legislative history to conclude that the Congress intended to provide such a period of immunity. To the contrary, Congress intended to provide a means of preventing further unsafe and unsound practices as quickly as possible. To allow a period of immunity for unlawful, unsafe, unsound conduct or conduct in breach of fiduciary duty during the challenge period would provide an incentive for bank officers to challenge every order and would hamper federal efforts to maintain a safe and strong financial system.
   Moreover, although the evidence demonstrates that the * * * expressed a desire to resolve their differences and they expressed a willingness to establish a corrective program (Tr. 3405-07), they nevertheless continued to engage in the same unsafe, unsound, and unlawful conduct. Although they may have said they were "willing" to "bite the bullet" and agree to adhere to 13 of the 14 points in the FDIC proposed rehabilitation program at the June 2, 1983 meeting (Tr. 3405-07), the evidence shows that they did not satisfactorily comply with the proposed plan, nor with the Temporary Order, not did they make corrections to overcome other serious criticisms in the examination reports.
   The ALJ was inexplicably troubled by the fact that the removal action was initiated after the Respondents refused to accede to the FDIC-proposed corrective program discussed at the April meeting or spelled out in the proposed cease-and-desist order. He implied an improper FDIC motive. (RD at 94–95) The Board finds no credible evidence of any improper motive. We find that the conduct of current management was seriously damaging to the Bank. Had the Respondents agreed to the management changes as well as the other proposed action, there would have been no reason to initiate a removal action. The evidence established in this proceeding unequivocally demonstrates that new management is necessary to protect the Bank. We have reached this conclusion only after an exhaustive review of the evidence of violations of law, unsafe or unsound banking practices and breaches of fiduciary duty engaged in by * * *, * * * {{4-1-90 p.A-588}}and * * * , and a very careful consideration of the allegations that FDIC was biased against these Respondents or unfairly sought to make an example out of them.

   I. The Public Interest Requires Removal of * * * , * * * and * * * From the Bank and Their Prohibition From Further Participation in the Conduct of the Affairs of the Bank.

   Having found that each of the Respondents has violated state law, has engaged in unsafe or unsound banking practices and has breached his fiduciary duty as an officer and director of the Bank; that such conduct has caused substantial financial loss to the Bank, and will result in probable future substantial loss to the Bank; and that each of the Respondents has evidenced a continuing disregard for the safety or soundness of the Bank, the Board finds that the public interest requires that the Respondents be removed from their positions in the Bank and prohibited from further participation.
   The practices the Respondent * * * engaged in were not mere technical violations. They go to the heart of sound banking. Violations of the Bank's statutory lending limit are not trivial. Should the Bank suffer losses on these loans, the Bank's directors will be personally liable under * * * law. The longstanding restraint on the total percentage of a bank's assets that may be loaned to any borrower is one of the most well-known statutory provisions governing bank lending activities. (Corsicana Nat'l Bank v. Johnson, 251 U.S. 68 (1919).) This limit is of the utmost importance because it protects the safety and soundness of banks by restricting the impact of default by any individual borrower. It serves other vital public interests by assuring that the financial assistance offered by banks is not monopolized by a few, but is spread throughout the bank's community.
   The accumulation of excessive classified assets has long been identified as an unsafe or unsound banking practice. Every bank will have some classified assets as conditions change and some loans deteriorate. But the volume of classified assets accumulated by this Bank poses an intolerable risk. There is a very real risk that the capital and loan loss reserves of the Bank will be exhausted, and the Bank become insolvent. * * * , * * * and * * * have demonstrated a propensity to continue to make unsound loans in disregard of law and fundamental credit principles despite warnings from the FDIC and state banking regulators.
   The ALJ's Recommended Decision reflects a fundamental misunderstanding of the Board's responsibility over removal of bank officers and directors. He refers to the exercise of that power as a type of "capital punishment." (RD at 82) He implies removal requires or should require evidence of criminal "guilt". (RD at 85) He cites 1966 legislative history which emphasized Congressional concern for preventing undue harm to the individual affected. (RD at 82) He opined, "this is not the usual type of removal proceeding which is based on an allegation of personal dishonesty or criminal conduct and is an easier case to prove". (RD at 85)
   Although the Board exercises its removal authority only after very deliberate consideration, we cannot allow sympathy for the individuals affected to prevent us from performing our statutory responsibility.
   The 1966 law required a removal order be based on personal dishonesty. The 1978 amendments which authorize suspension and removal for willful or continuing disregard for the safety of the institution managed were clearly a response to agencies complaints that the personal dishonesty standard hampered their efforts to take timely action to make certain that individuals whose actions were seriously damaging an institution could be removed from office. (See M. Cobb, Federal Regulation of Depository Institutions: Enforcement Powers and Procedures § 5.02(3)(a) (1984).)

   [.50] The officers and directors of a bank are legally responsible to see that the business and assets of the bank are managed in a prudent manner. They exercise responsibility to safeguard millions of dollars of other peoples' money. No one has an inherent right to be a banker. The Board does not "balance" the individual banker's private rights against the public interest. The Board is obligated to act in the public interest. When statutory criteria for removal have been met as they have in this case and the Board has determined an insured bank requires changes in management to restore it to a safe and sound condition, the Board orders removal. In so doing the Board acts to protect the Bank, its depositors, the exposure of the FDIC insurance fund, and the integrity of the nation's financial system {{4-1-90 p.A-589}}regardless of whether individuals may be personally adversely affected.

   J. Conclusion

   The Board concludes that * * *, * * * and * * * have each individually and collectively as officers and directors of the Bank (1) committed or been responsible for violations of law, participated in and engaged in unsafe or unsound banking practices, and breached their fiduciary duties; (2) as a result, the Bank has suffered and will likely continue to suffer substantial financial losses; and (3) the violations of law, unsafe or unsound practices and breaches of fiduciary duty each individually and collectively demonstrated both willful disregard for the safety or soundness of the Bank and a continuing disregard for such safety and soundness. The statutory criteria having been met by overwhelming evidence, the Board has no alternative but to order removal of the * * *.
   By direction of the Board of Directors, this 19th day of August, 1985.129

/s/ Hoyle L. Robinson
Executive Secretary

FDIC-83-252b&c,
FDIC-84-49b
FDIC-84-50e
ORDER TO CEASE AND DESIST
AND REMOVE FROM OFFICE AND
TO PROHIBIT FROM FURTHER
PARTICIPATION

   IT IS ORDERED, that the * * * Bank, * * *, its directors, officers, employees, agents, successors and assigns, and other persons participating in the conduct of the affairs of the Bank, CEASE AND DESIST from the following unsafe or unsound banking practices and violations of State laws:

       1. Engaging in hazardous lending and lax collection practices.
       2. Failing to properly charge off or eliminate all nonbankable assets (or portions thereof) from the books of the Bank.
       3. Failing to provide and maintain an adequate reserve for loan losses.
       4. Operating the Bank with equity capital that is inadequate to support the kind and quality of assets held by the Bank.
       5. Operating the Bank with insufficient liquidity in relation to the deposit structure of the Bank.
       6. Operating the Bank in violation of * * * State laws.
       7. Failing to provide adequate supervision and direction over the active officers of the Bank in order to prevent unsafe or unsound practices and violations.
       8. Operating the Bank with management whose policies and practices are detrimental to the Bank and jeopardize the safety of its deposits.
   IT IS FURTHER ORDERED, that the * * * Bank, * * *, its directors, officers, employees, agents, successors and assigns, and other persons participating in the conduct of the affairs of the Bank, take affirmative action as follows:
   1. (a) Within 90 days from the effective date of this ORDER, the Bank shall provide and continue to retain management acceptable to the Regional Director of the FDIC's * * * Regional Office (the "Regional Director").
   (b) Management acceptable to the Regional Director under paragraph 1(a) of this ORDER shall include: (1) the retention of a qualified chief executive officer (who shall not be an employee of the Bank as of September 30, 1983) who shall be given specific written authority by the Bank's board of directors for implementing lending, investment and operating policies in accordance with sound banking practices, and who shall be the senior officer in terms of overall responsibility for the daily management and operation of the Bank; and (2) the retention of a qualified senior lending officer (who shall not be an employee of the Bank as of September 30, 1983) who shall be given specific written authority by the Bank's board of directors for the direct supervision of all lending activities of the Bank conducted pursuant to and in accordance with the loan policies and procedures of the Bank adopted in accordance with the requirements of paragraph 4 of this ORDER.
   2. (a) Upon the effective date of this ORDER, the Bank shall eliminate from its books, by collection, charge-off or other proper entries, 100 percent of all assets or portions of assets classified "Loss" and 50

129 Chairman William M. Isaac took no part in the consideration of this decision by the Board of Directors.
{{4-1-90 p.A-590}}
percent of all assets or portions of assets classified "Doubtful" as of September 30, 1983 (as determined by the Board in the accompanying Decision), not previously charged-off or collected. In addition, so long as this ORDER remains in effect the Bank shall, upon the receipt of any official Report of Examination of the Bank from the FDIC, eliminate from its books, by collection, charge-off or other proper entries, 100 percent of any asset classified "Loss" and 50 percent of any asset classified "Doubtful".
   (b) Following the effective date of this ORDER, the Bank shall not extend directly or indirectly any additional credit to or for the benefit of any borrower who is obligated in any manner to the Bank on any extension of credit, or portion thereof, that has been charged-off the books of the Bank so long as such charged-off credit remains uncollected.
   (c) Upon the effective date of this ORDER, the Bank shall not extend directly or indirectly and additional credit to or for the benefit of any borrower whose indebtedness was classified, in whole or in part, "Loss" or "Doubtful" as of September 30, 1983 (as determined by the Board in the accompanying Decision), so long as such indebtedness remains so classified.
   (d) Upon the effective date of this ORDER, the Bank shall not extend directly or indirectly any additional credit to or for the benefit of any borrower whose indebtedness was classified, in whole or in part, "Substandard" as of September 30, 1983 (as determined by the Board in the accompanying Decision), or in any subsequent FDIC Report of Examination, so long as such indebtedness remains so classified. The prohibition of this paragraph 2(d) of this ORDER shall not prohibit the Bank from renewing or extending the maturity of any credit provided that all interest due at the time of such renewal or extension is collected in cash from the borrower.
   (e) The prohibition of paragraphs 2(c) and 2(d) of this ORDER shall not prohibit the Bank from renewing or extending the maturity of any credit or extending additional credit to any borrower otherwise covered by the provisions of such paragraphs if the Bank's board of directors determines that such action is in the best interests of the Bank and necessary to protect the Bank's interest in the credit already extended and such determinations are reflected in the minutes of the board of directors of the Bank; provided, however, that all interest due at the time of any such renewal or extension must be collected in cash from the borrower.
   3. (a) Within 180 days from the effective date of this ORDER, the Bank shall reduce the remaining total of all assets classified "Substandard" and "Doubtful" as of September 30, 1983 (as determined by the Board in the accompanying Decision), to not more than $16,000,000; and within 360 days from the effective date of this ORDER, such assets of the Bank shall be reduced to not more than $9,000,000. The requirements of this paragraph 3(a) of this ORDER shall not be construed as the standard for future operations of the bank. In addition to the foregoing schedule of reductions, the Bank shall eventually reduce all adversely classified assets of the Bank.
   (b) As used in paragraph 3(a) of this ORDER, the word "reduce" means (1) to collect, (2) to charge-off, or (3) to improve the quality of assets adversely classified to warrant removal of any adverse classification.
   4. (a) Within 60 days from the effective date of this ORDER, the Bank shall review its current loan practices and its written loan policies and procedures for adoption of any changes it considers necessary and appropriate and shall present its written loan policies and procedures and any amendments made thereto to the Regional Director for his review. Within 30 days of such review and after satisfactory modifications have been made to correct any deficiencies noted by the Regional Director, the written loan policies and procedures, as amended, shall be adopted by the board of directors of the Bank and fully implemented by the loan officers of the Bank.
   (b) In complying with the requirements of paragraph 4(a) of this ORDER, the Bank's written loan policies and procedures, as implemented, shall include, but not necessarily be limited to, the following:
       (1) A description of the general fields of lending in which the Bank shall engage, the types of loans and collateral considered desirable, and the types of loans and collateral considered undesirable.
       (2) An identification of the geographical trade area from which Bank loans should be generated.
    {{4-1-90 p.A-591}}
       (3) The responsibility of the board of directors in reviewing and approving loans and periodically reviewing major lines of credit.
       (4) The responsibilities and lending authority of each loan officer.
       (5) The responsibilities and lending authority of the loan committee and the composition of such committee.
       (6) The guidelines under which unsecured loans will be granted.
       (7) The guidelines for rates of interest and terms of repayment for (i) unsecured loans and (ii) secured loans.
       (8) Limitations on the amount of secured loans that will be made in relation to the market value of the collateral or security pledged, and an identification of the types of supporting documentation required by the Bank for each type of secured loan.
       (9) Standards and procedures for the acceptance of indirect paper from dealers.
       (10) The maintenance and review of complete and current credit files on each borrower.
       (11) Specific policies and procedures regarding the collection of loans including, but not limited to, the actions to be taken against borrowers who fail to make timely payments.
       (12) Specific standards regarding the renewal of loans and extensions of installment payment dates.
       (13) Specific limitations on the maximum volume to loans in relation to the total deposits and total assets of the Bank.
       (14) Specific policies and procedures governing loans to officers and directors of the Bank and their related and/or controlled interests.
       (15) Specific controls, limitations and procedures on the extension of credit through overdrafts or cash items held against deposit accounts.
       (16) Specific procedures for placing overdue loans on nonaccrual status depending on length of overdue status, including procedures that address the reversal of previous interest accruals on such loans where interest has not been collected in cash.
       (17) A prohibition against crediting to income until actually collected in cash from the borrower (a) any interest added to the unpaid balance of any loan on which interest is due, (b) interest included in a separate note accepted for uncollected interest due on any loan unless supported by additional tangible collateral which adequately and completely secures the loan, (c) interest paid by creating or increasing any overdraft in the bank, or (d) uncollected interest booked by any other means that essentially avoids recognition of overdue loans and/or artificially inflates the income of the Bank.
   5. Within 60 days from the effective date of this ORDER, the Bank shall designate an officer who shall be responsible for reviewing the initial documentation on all new loans over $10,000, and who shall be responsible for follow-up actions necessary to obtain complete supporting documentation for such loans. The designated officer shall also be responsible for reporting any deficiencies or other exceptions regarding the adequacy of such loan documentation to the Bank's board of directors or a committee thereof on a monthly basis.
   6. (a) Within 60 days of the effective date of this ORDER, the Bank shall establish and continue to maintain an adequate reserve for loan losses by charges against current operating income. In complying with the requirements of this paragraph 6 of the ORDER, the board of directors of the Bank shall review the adequacy of the Bank's reserve for loan losses prior to the end of each calendar quarter. The minutes of the board meeting at which such review is undertaken shall indicate the results of the review, the amount of any increase in the reserve recommended, if any, and the basis for determination of the amount of reserve provided.
   (b) Reports of Condition and Income required by the FDIC and filed by the Bank prior to the effective date of this ORDER and subsequent to September 30, 1983, shall reflect a provision for loan losses which is adequate in light of the condition of the Bank's loan portfolio and which, at a minimum, equals the adjustment required by paragraph 6(a) of this ORDER. If necessary to comply with this paragraph 6(b) of this ORDER, the Bank shall file amended {{4-1-90 p.A-592}} Reports of Condition and Income within 30 days from the effective date of this ORDER.
   7. (a) Within 30 days from the effective date of this ORDER, the Bank shall propose and submit a written plan for the review of the Regional Director that will provide an increase of the total equity capital and loan valuation reserves of the Bank to a level of not less than eight percent of total assets through means approved by the Regional Director.
   (b) (1) If the plan submitted by the Bank under paragraph 7(a) of this ORDER involves a public distribution of the Bank's securities (including a distribution limited to the Bank's existing shareholders), the Bank shall prepare and submit as part of the Bank's plan detailed offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Bank and the circumstances giving rise to the offering, and any other material disclosures necessary to comply with applicable federal securities laws. Prior to the implementation of the Bank's plan and, in any event, not less than twenty (20) days prior to the dissemination of such materials, the plan and any offering materials used in the sale of the securities shall be submitted to the FDIC in Washington, D.C., for review. Any changes requested to be made in the plan or materials by the FDIC shall be made prior to their public dissemination.
   (b) (2) In complying with the provisions of paragraph 7(b)(1) of this ORDER, the Bank shall provide written notice to any subscriber and/or purchaser of the Bank's stock of any planned or existing development or other change which is materially different from that reflected in any offering materials used incidental to such sales of the Bank's stock. The written notice required by this paragraph 7(b)(2) of the ORDER shall be furnished within ten (10) calendar days from the date that such material development or change was planned or occurred, whichever is earlier, and shall be furnished to every purchaser and/or subscriber of the Bank's stock who received or was tendered the information contained in the Bank's original offering materials.
   (c) If the plan submitted by the Bank under paragraph 7(a) of this ORDER involves a public distribution of the Bank's securities (including a distribution limited to the Bank's existing shareholders), the Bank's plan shall be implemented and the sale of such securities shall be completed by the Bank within 60 days after the review requirements of paragraphs 7(b)(1) and (2) of this ORDER have been completed.
   (d) If the plan submitted by the Bank under paragraph 7(a) of this ORDER does not involve a public distribution of the Bank's securities (as set forth in paragraph 7(b)(1) of this ORDER), but is limited to a private placement for which offering materials are not required and/or the collection of assets of the Bank previously charged-off or some other means approved by the Regional Director, and after the Bank has been advised by the Regional Director that no exception has been taken to such plan, the Bank shall fully implement the plan and complete the injection of equity capital required by paragraph 7(a) of this ORDER on or before December 31, 1985.
   (e) During the life of this ORDER and beginning on December 31, 1985, the Bank shall maintain equity capital and loan valuation reserves which as of June 30 and December 31 of each calendar year, shall be equal to or exceed eight percent of the Bank's average assets (adjusted for unearned income and the loan valuation reserve) for the months of June and December of that year. If such ratio is not greater than or equal to eight percent as of June 30 and December 31 of each calendar year, the Bank shall within 30 days of that date present to the Regional Director a plan for the injection of additional equity capital into the Bank to bring the ratio to eight percent. Within 60 days after the plan is reviewed and no exception is taken by the Regional Director, the Bank shall fully implement the plan and complete the injection of additional equity capital into the Bank; provided, however, that if such plan involves the sale of any securities of the Bank to the public, the Bank shall comply with the requirements of paragraphs 7(b)(1) and (2) of this ORDER and complete the sale of such securities within 60 days after the review requirements of paragraph 7(b)(1) of this ORDER have been completed.
   8. While this ORDER is in effect, the Bank shall give written notice to the FDIC at such time as five percent of the Bank's total deposits are funded by third party agents or nominees for depositors, including deposits managed by a trustee or custodian when each individual beneficial interest {{4-1-90 p.A-593}} is entitled to or asserts a right to Federal deposit insurance ("brokered deposits"). The notification should indicate how the brokered deposits are to be utilized with specific reference to credit quality of investments/loans and the effect on the Bank's funds position and asset/liability matching. The FDIC reserves the right to object to the Bank's plans for utilizing brokered deposits. So long as the level of brokered deposits equals or exceeds five percent of the Bank's total deposits, the Bank shall provide on the first Monday of each month a written report to the FDIC detailing the level, source and use of brokered deposits.
   9. (a) Within 60 days of the effective date of this ORDER, the Bank shall review its current liquidity practices and its written investment-liquidity policy for adoption of any changes it considers necessary and appropriate, and shall present its written investment-liquidity policy and any amendments made thereto to the Regional Director for his review. Within 30 days of such review and after satisfactory modifications have been made to correct any deficiencies noted by the Regional Director, the written investment-liquidity policies and procedures, as amended, shall be adopted by the board of directors of the Bank, and fully implemented by the active officers of the Bank.
   (b) In complying with the requirements of paragraph 9(a) of this ORDER, the Bank's written investment-liquidity policies and procedures, as implemented, shall include, but not necessarily be limited to, achievement of the following objectives:
       (1) A reduction of the Bank's large liability dependence ratio to not more than 20 percent by February 28, 1986.
       (2) Maintaining the volume of total loans as a percentage of total deposits at not more than 70 percent.
       (3) Maintaining a matching (in absolute terms of dollar amounts and maturities) of brokered deposits with readily marketable investment securities and/or Federal funds sold.
       (4) Maintaining the ratio of rate-sensitive assets to rate-sensitive liabilities at 30 days, 180 days, and 360 days in accordance with guidelines set forth approved in the investment-liquidity policy.
       10. Following the effective date of this ORDER, the Bank shall not pay any cash dividends without the prior written consent of the Regional Director.
       11. Within 60 days from the effective date of this ORDER, the Bank shall correct all violations of laws, rules and regulations set forth in the accompanying decision of the Board of Directors or cited in any subsequent FDIC or state report of examination. In addition, the Bank shall take all necessary steps, consistent with sound banking practices, to ensure the Bank's future compliance with all applicable laws, rules, and regulations.
       12. Sixty (60) days following the effective date of this ORDER, and every two months thereafter, unless and until each and every corrective action required by this ORDER has been accomplished, the Bank shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. Such reports may be discontinued when the corrections required by this ORDER have been accomplished and the Regional Director has released the Bank in writing from making further reports.
       IT IS FURTHER ORDERED, that Respondent * * * be, and hereby is, removed as an officer and director of * * * Bank, * * *, and prohibited from further participation in any manner in the conduct of the affairs of the Bank, and any other bank insured by the Federal Deposit Insurance Corporation;
       IT IS FURTHER ORDERED, that Respondent * * * be, and hereby is, removed as a director of the * * * Bank, * * *, and prohibited from further participation in any manner in the conduct of the affairs of the Bank, and any other bank insured by the Federal Deposit Insurance Corporation;
       IT IS FURTHER ORDERED, that Respondent * * * be, and hereby is, removed as an officer and director of the * * * Bank, * * *, and prohibited from further participation in any manner in the conduct of the affairs of the Bank, and any other bank insured by the Federal Deposit Insurance Corporation.
       The provisions of this ORDER shall become effective thirty (30) days after its issuance and shall be binding upon * * *
{{4-1-90 p.A-594}} "Bank", * * *, its directors, officers, employees, agents, successors and assigns, and other persons participating in the conduct of the affairs of the Bank, and shall remain effective and enforceable except to the extent that, and until such time as, any provision of this ORDER shall be modified, terminated, suspended, or set aside by the FDIC.
   By direction of the Board of Directors, this 19th day of August, 1985.
/s/ Hoyle L. Robinson
Executive Secretary

FDIC-83-252b&c
FDIC-84-49b; and
FDIC-84-50e

* * * For the Bank and the Individual Respondents
* * * For the Federal Deposit Insurance Corporation
BEFORE: ALLAN W. HEIFETZ, Administrative Law Judge

INITIAL DECISION

Statement of the Case

   This administrative action was instituted by the Board of Directors of The Federal Deposit Insurance Corporation ("FDIC") on August 3, 1983, when it issued a Notice of Charges and of Hearing ("First Notice") against the * * * Bank, * * * ("Bank"), pursuant to Section 8(b) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1818(b) and Part 308 of the FDIC Rules of Practice and Procedure, 12 C.F.R. § 308.1 et seq. The First Notice was based upon finding of an FDIC examination of the Bank conducted as of February 4, 1983, and charged the Bank with having engaged in unsafe or unsound banking practices and with having committed violations of law. By Order dated October 14, 1983, the matter was referred to me for hearing and the issuance of an Initial Decision.
   On November 22, 1983, the FDIC issued a second Notice of Charges and of Hearing ("Second Notice") and a Temporary Order to Cease and Desist ("Temporary Order") against the Bank pursuant to Sections 8(b) and 8(c) of the Act, respectively. The Second Notice was based upon preliminary findings of an FDIC examination of the Bank, conducted as of September 30, 1983, and stated that the FDIC had reason to believe that the Bank had engaged or was about to engage in unsafe or unsound banking practices and violations of law.
   Based upon a joint motion of the parties, I issued an Order on January 24, 1984, consolidating the actions initiated by the First and Second Notices and continuing the hearing indefinitely pending completion of the FDIC's September 30, 1983 examination of the Bank.
   Following completion of the FDIC's September 30, 1983 examination, I issued an Order on February 23, 1984, setting a prehearing conference for March 27, 1984, for the purpose of considering preliminary matters and setting a final hearing date.
   On March 12, 1984, the FDIC issued a third Notice of Charges and of Hearing ("Third Notice") against the Bank pursuant to Section 8(b) of the Act. The Third Notice was based upon findings of the September 30, 1983 FDIC examination and charged the Bank with having engaged in substantially the same unsafe or unsound banking practices and violations of law alleged in the First Notice, except that the charges contained in the Third Notice were more aggravated. On the same date, the FDIC issued a Notice of Intention to Remove from Office and to Prohibit from Participation ("Removal Notice") against Messrs. * * *, * * *, * * * and * * * ("Respondents") pursuant to Section 8(e) of the Act.1 The Removal Notice was also based upon findings of the September 30, 1983 FDIC examination, but contained some allegations based upon findings of the February 4, 1984 FDIC examination.
   On March 26, 1984, the FDIC issued an amended Notice of Charges and of Hearing ("Amended Third Notice") against the Bank and an amended Notice of Intent to Remove from Office and to Prohibit from Participation ("Amended Removal Notice") against the Bank and Respondents to correct certain technical matters.
   Following a prehearing conference held on March 27, 1984, I issued an Order on April 10, 1984 directing consolidation of all actions initiated by the First, Second, Third and Amended Third Notices, as well as the Removal and Amended Removal Notices.


1 The FDIC Board of Directors also initiated an action pursuant to Section 8(e)(4) of the Act immediately to suspend Respondents from their positions as officers and directors of the Bank, and an action pursuant to Section 8(a) of the Act to terminate the insured status of the Bank. These actions, however, are not the subject of this proceeding.
{{4-1-90 p.A-595}}Hearing of the consolidated actions, however, was limited to the allegations contained in the Second Notice, the Amended Third Notice and the Amended Removal Notice.2
   After completion of discovery, a formal hearing was held June 11—July 11, 1984, in * * *. Post-hearing briefs were timely filed on September 25, 1984 by Respondents and the Bank, and the FDIC.

Overview

   This proceeding arose as a consequence of the rapid and aggressive growth of a bank which came under the ownership and control of an experienced, reputable banker and his two sons who brought with them, as * * * exiles, their extensive knowledge of and personal contacts with the * * * business and international banking communities. As the period of accelerated growth began to coincide with a period of accelerated inflation, interest rates, currency devaluation, and business stagnation, the Bank's financial condition became threatened on two fronts. * * * customers, for a variety of economic reasons, many of which were beyond their control, had trouble keeping loans current, if not maintaining the solvency of their businesses. Domestically, several of the Bank's large customers had extensive investments in real estate projects which struggled to stay ahead of the slowing economy, and they had business dealings which came under the scrutiny of bank regulators and other law enforcement agencies for reasons other than their relationship to the Bank.
   The facts focus on two FDIC examinations which took place in 1983, one in February and one in September. In each case, the Bank was examined by trained and experienced employees of the FDIC who approached their task with an appropriate sense of professionalism and who strived to do their duty with objectivity, impartiality and consistency with established policies and objectives of the FDIC. However, several factors and facts, both internal and external to the examinations, some documented in the record and some veiled in a mist of innuendo and suspicion, affected the ability of the examiners to maintain their lack of bias despite their obvious, conscious efforts in that regard, and led to an ever increasing propensity on their part to draw any permissible adverse inference from a given set of facts. While not a proverbial scintilla of evidence was introduced to show that any action, indictment, conviction or administrative action was taken against a Bank customer, officer or employee, the examiners were aware of hints, rumors, suspicions or allegations that customers of the Bank were possibly involved in a check kiting scheme, a bank failure, money laundering, the "Mafia," and other unspecified, questionable or criminal activities; and that Bank officers were connected with some of the activities as well as others involving misapplication of funds and unspecified, questionable transactions. They were also warned, unjustifiably and incorrectly, that the room in which they were conducting their examination was monitored.
   On the other side of the coin, an air of hostility and distrust developed as bank officers reacted with shock and disbelief over the volume of assets proposed to be classified, disappointment with their inability to persuade FDIC officials to work out a remedial course of action short of formal enforcement action which included a change in management, and dismay at a second examination which they perceived as motivated by their refusal to consent to a cease and desist order and which two bank examiners of the State of * * * characterized as a "witch hunt" and a "hatchet job." Early efforts at conciliation gave way to a period of noncooperation and then a "Herculean" effort on the part of Bank Counsel to assist the Bank in shoring-up distressed loans.
   The curious aspect of distilling this cauldron of charge and countercharge is that at trial, while one would expect that representatives of the State of * * * Office of the Comptroller would support the position of the FDIC, the opposite was true. Although they have found serious deficiencies in asset quality and deterioration in the financial condition of the Bank, their conclusions differ significantly from those of the FDIC, both as to the "bottom line" of the balance sheet and as to remedy. The State of * * * has worked out a mutually satisfactory arrangement with the Bank which both agree has had a salutary effect on the financial condition and operations of the Bank.


2 On April 23, 1984, the FDIC withdrew the First Notice pursuant to an agreement of the parties.
{{4-1-90 p.A-596}}
Expert witnesses on behalf of the Bank, including a former Chairman of the FDIC, urge deference to that arrangement.
   After having given careful consideration to the testimony, documentary evidence and argument, which comprise some 14,000 pages, most of which was amassed during four weeks of hearing,3 I have concluded that deference should be given to an arrangement which has, and is working. I have also concluded that the record justifies, and the FDIC is properly entitled to the issuance of a cease and desist order which closely parallels the provisions worked out between the State of * * * and the Respondents. Finally, I have concluded that the issuance of an order of removal and of prohibition against the three individual Respondents is unwarranted. This decision begins with a description of the parties and a chronology of significant events surrounding the examinations and these proceedings; it then presents findings and conclusions regarding asset classifications, unsafe and unsound practices, and violations of law; and it concludes with a discussion of remedies followed by a recommended order.

The Parties

   1. * * * is a State Chartered Bank with deposits insured by the FDIC. The State of * * *, Office of the Comptroller, Department of Banking and Finance, Division of Banking ("State" or "State Comptroller's Office") is the chartering authority and primary regulator of the Bank. (RPFF .0)
   2. The Board of Directors of the FDIC, Washington, D.C., is an independent three-member agency of the United States Government, responsible, inter alia, for promoting and preserving public confidence in banks and for protecting the money supply through provision of bank deposit insurance coverage and periodic examinations of insured State-chartered banks which are not members of the Federal Reserve System.
   In the performance of its duties, the FDIC may, inter alia, issue cease and desist orders to a bank or banker with respect to specific violations or unsafe or unsound practices (12 U.S.C. and § 1818(b)) and suspend, remove, and prohibit from further participation bank personnel responsible for such actions. (12 U.S.C. § 1818(e))
   3. * * * Bank was first organized in 1972 and was acquired by the * * * family in May 1978. Since 1978, the Bank has been managed and controlled by Respondents * * *, * * * and * * *.4 (PFF 2.5; RPFF 0.1, 0.4)
   4. Prior to the * * *' 1978 acquisition of control, the Bank experienced little growth or success. At the end of its first six years of existence it had attracted only $7 million in deposits. In 1978, before the acquisition by present management, the Bank's aggregate operation for the period showed a net loss of $149,480. (RPFF 0.1)
   5. Approximate earnings under previous management were as follows:

Earnings
Year$000's
1972(44) Loss
1973(52)
197416
1975(46)
1976(59)
197720
Net Earnings(165)

   Under present management, earnings through 1982 were as follows:

Earnings
Year$000's
1978121
1979435
1980608
1981818
1982631
Net Earnings2,613

   Since the acquisition of the Bank in May 1978, present management has been responsible for dramatic growth in the assets of the Bank:


3 Sixteen witnesses testified at the hearing on behalf of the FDIC, and 18 witnesses testified on behalf of Respondents and the Bank. The hearing record is comprised of a hearing transcript consisting of 5,395 pages; 96 exhibits offered by the FDIC, consisting of approximately 4,300 pages; 223 exhibits offered by the Respondents and the Bank, consisting of approximately 5,400 pages; 3,225 findings of fact proposed by the FDIC, consisting of 522 pages; and responses of the Respondents and the Bank to FDIC proposed findings, along with additional proposed findings in support of certain affirmative defenses consisting of 276 pages.

4 Respondents admit both to owning more than 50 percent of the Bank's outstanding capital stock and to exercising a controlling influence over the management, policies, operations and conduct of the affairs of the Bank. (PFF 2.5) At trial, * * * testified that Respondents currently own approximately 70 percent of the Bank's outstanding shares. (Tr. 3825)
{{4-1-90 p.A-597}}

December 1978$20.5 Million
December 198036.5 Million
December 198269.1 Million
December 1983119.0 Million
(RPFF 0.3)

   6. By early 1984, the Bank's deposits totaled approximately $110 million. Pursuant to the January 25, 1984 Memorandum of Understanding with the State (MOU), the Bank has since made efforts to reduce its deposits to a level below $100 million in order to improve capital adequacy. (Tr. 3018-19)
   7. The Bank's 1983 profit of approximately $400,000 was eliminated after charging-off loss items as recommended by the State. (Tr. 3023)
   8. The Bank subsequently suffered a net earnings loss in the first quarter of 1984. This was the first quarterly loss incurred by the Bank since the first quarter of 1978 when the * * * assumed its management. The primary cause of this loss was the substantial legal expense incurred as a result of this lengthy consolidated administrative action brought by the FDIC. (RPFF 0.13; Tr. 3024; R. Ex. 441). To some extent, reduction in the loan-to-deposit ratio pursuant to the January 25, 1984 MOU resulted in a reduced opportunity to realize profits.
   9. The * * * are * * *, naturalized United States citizens. All three are career bankers with longstanding personal and business ties to the * * * community and to prominent businessmen and banking institutions in * * * and the * * *. A large number of the Bank's depositors and borrowers are * * * or members of * * * community. The Bank has helped to foster a growing * * * market in * * * and has provided substantial investment opportunities to local * * * and * * * businessmen. The Bank is * * * controlled and is designated by the Federal Government as a "minority bank." (RPFF 0.4—0.8)
   10. The Bank specializes in the financing of international commercial and domestic trade related transactions. The Bank's international lending and export financing activities are concentrated principally in * * * and are based on longstanding personal and business relationships between the Bank's executive officers and their * * * customers.5
   11. Because of its * * * orientation, the Bank's management and operating style reflects the unique cultural conditions and relationships peculiar to * * * trade and commerce. In particular, * * * banks place a premium on longstanding personal and business relationships with their customers. As compared to non- * * * depositors and borrowers, * * * are more service oriented, less sensitive to interest rates and, as borrowers, expect a one-on-one relationship with an account officer. (RPFF 0.12)
   12. * * *, age 63, is a career banker and the father of * * * and * * *. From May 1978 to February 10, 1974, * * * served as Chairman of the Bank's Board of Directors. Since February 10, 1984, he has served as Managing Director and Chief Executive Officer. * * * has been in banking for over 30 years, first in * * * and, since, 1960, in the United States. He has held numerous senior bank management positions in both * * * and the United States, including that of President and Chief Executive Officer of the Bank of * * * and Senior Executive Officer and Head of the * * * American Banking Department of * * * Banking Corporation of * * *. He received B.A. and C.P.A. degrees in * * * and has taken continuing education courses, related to banking, in the United States. (PFF 2.1; RPFF 0.4)
   13. From May 1978 to January 30, 1984, * * * served as President of the Bank and as a member of the Bank's Board of Directors. Effective January 30, 1984, * * * resigned as President of the Bank but retained his position on the Board of Directors.6 Since February 10, 1984, he has served as Chairman of the Board of Directors of the Bank. * * *, age 36, is a career banker and received B.A., M.A. and Ph.D. degrees from * * * University. (PFF 2.2; RPFF 0.4; Tr. 340-41)


5 The Bank's international lending and export financing of United States goods and services are primarily accomplished through the facilities of the Export-Import Bank of the United States ("EXIM") and the Foreign Credit Insurance Association ("FCIA"). The Bank operates an International Banking Facility ("IBF") that is supported by a core of foreign deposits, largely offset by international loans and liquid assets. (RPFF 0.5—0.6)

6 Until January 1984, * * * was in charge of the day-to-day operation of the Bank. (Tr. 3076, 3168-70, 3995) * * * present responsibilities and activities are circumscribed by a Memorandum of Understanding ("MOU") between the Bank and the State which was entered into on January 25, 1984. (See Finding of Fact No. 54)
{{4-1-90 p.A-598}}14. Since May 1978, * * * has served as Executive Vice President of the Bank. Since July 1978, he has also served as a member of the Bank's Board of Directors. * * *, age 30, is a career banker and received a B.S. degree in Business Administration from * * * International University. (PFF 2.3; RPFF 0.4) His prior banking experience was primarily in the installment and commercial loan areas. (Tr. 3820-24)
Chronology of significant events, December 1982 to May 22, 1984

   1. December 1982 —FDIC examiner * * * visited the Bank to determine the Bank's overall compliance with a June 18, 1982, MOU and to perform a general review of the Bank's overall liquidity and capital positions. (Tr.377-78) During this visit, Examiner * * * determined that the Bank was in the process of complying with the MOU. (Tr. 379) However, he also notified the Bank that the following four loan lines posed potential problems to the Bank's financial condition:

       (1) * * * and related interests;
       (2) * * * and related interests;
       (3) * * * and related interests; and
       (4) The * * * Communities Group and related interests. (Tr. 380-81)
   2. January 28, 1983 —FDIC Examiner * * * was sent to * * * Bank of * * * ("Bank") by the * * * Regional Office of the FDIC to investigate a possible check kiting scheme involving * * * and his related interests. (Tr. 2107) The * * * Regional Office had been notified by the * * * Regional Office that examiners visiting the * * * Bank of * * * ("* * * Bank") suspected the existence of a possible kite between * * * Bank and * * * Bank.
   After reviewing the loan files and determining that Mr. * * * had in fact assumed a suspicious loan obligation at * * * Bank (Tr. 2113), Mr. * * * met with Mr. * * * of * * * Bank who informed Mr. * * * that before he could make any decision regarding notification to the Federal Bureau of Investigation ("FBI") or to the bonding company, he would have to consult with * * *, Chairman and President of * * * Bank.
   At this time, Mr. * * * also prepared a report of apparent criminal activity regarding Mr. * * *'s involvement in the alleged kiting scheme. This report was forwarded to the U.S. Attorney's Office, but no evidence was introduced at trial to indicate whether any action on the report was taken or intended. (Tr. 2109)
   3. February 4, 1983 —FDIC examination of the Bank commenced with * * * as the Examiner-in-Charge (P.Ex. 9)
   4. February 23, 1983 —At a meeting, attended by Mr. * * *, Mr. * * * and Mr. * * * of * * * Bank, to discuss the allegation of a check kiting scheme involving Mr. * * *, Mr. * * * stated that he did not want to do business with anyone involved with kiting. This was interpreted by Mr. * * * to mean that Mr. * * * no longer intended to do business with Mr. * * * and his related interests. (Tr. 2111)
   By letter referring to Mr. * * *'s visit to * * * Bank which had "revealed substantial overdraft activity in various accounts of Mr. * * * and his corporate interests," (R. Ex. 447) * * * Regional Director * * * directed Mr. * * * to provide the * * * Regional Office with "current information concerning the Bank's exposure involving Mr. * * * no later than March 15, 1983." The "overdraft activity" referred to the alleged check kiting scheme. (Tr. 4304)
   5. March 2, 1983 —Mr. * * * wrote to * * * informing him that the FDIC had approved the Bank's revised Investment— Liquidity Policy submitted on February 7, 1983, pursuant to recommendations made by the FDIC on January 27, 1983. (R. Ex. 247.1) The revised policy was also approved by the State in a letter dated March 15, 1983. (R. Ex. 247.1)
   6. March 4, 1983 —* * *, Senior Vice President of * * * Bank, responded to Mr. * * *'s February 23, 1983 inquiry into Mr. * * *'s accounts. (R. Ex. 447)
   Mr. * * * informed Mr. * * * that " * * * Bank does not consider itself to be exposed as a result of any of its dealings with * * * or his corporate interests" and requested "notification from the [* * * Regional Office] of any negative information that may influence future credit decision in his behalf." (R. Ex. 447)
   7. March 30, 1983 —At a meeting with Respondents, Mr. * * * orally listed major classifications, apparent State law violations and problems with capital and liquidity as uncovered during the February 4, 1983 examination. (Tr. 484) Mr. * * * also requested additional information on the * * * and * * * lines, but he did not receive an immediate response. (Tr. 493)

{{4-1-90 p.A-599}}
   8. April 27, 1983 —A meeting was held at the Bank which was attended by the Bank's Board of Directors, the Bank's Counsel and representatives of the FDIC and the State. The meeting was called by the FDIC for the purpose of communicating to the Bank the major findings and criticisms reached during the February 4, 1983 FDIC examination. (Tr. 507) The FDIC representatives informed the Bank's Board of Directors and Counsel that it would take a "miracle" for the Bank to successfully reduce its large volume of adverse classifications. (Tr. 800-01, 936-37) During the meeting, the FDIC presented to the Bank's Board of Directors both on April 22, 1983, "management letter," which included, inter alia, a list of preliminary loan classifications (P.Ex. 10, 68) and a 14 point rehabilitative program, which required, inter alia, a minimum injection of $3.2 million in new capital to result in a 8 percent capital to assets ratio, and the appointment of both a new chief executive officer and a new senior loan officer. (P.Ex. 11, 68)
   The Bank's representatives expressed amazement at the putative astronomic increase in adverse classifications that the FDIC derived as a result of its February 4, 1983 examination, particularly in light of the results reached in the State's November 1982 examination. The Bank's representatives also expressed their concern over the content and accuracy of the April 22, 1983 management letter and advised the FDIC that the Bank would provide a detailed response within a few weeks (RPFF 396.8(a)). Bank management also advised Mr. * * * that the declining trend in income was no different from that for other institutions of similar type and nature which were affected by problems in the international trade arena. Additionally, Mr. * * * was reminded, and he acknowledged, that while the Bank's cost of funds was above average, its yield on loans was also significantly above average. (RPFF 396.14(a))
   The FDIC February 4, 1983 examination of the Bank was also completed on this date. (P.Ex. 9, p. 51)
   9. May 12, 1983 —A report of apparent criminal activity dated April 8, 1983 was transmitted by Mr. * * * to the U.S. Attorney's Office. The report did not involve the * * * or the Bank but did involve October 1982 activities of a Bank customer. * * * brought the apparent criminal activity to the attention of the FDIC examiners. (Tr. 1243)
   10. May 19, 1983 —The Bank's Comptroller, * * * visited Mr. * * * at his home. * * * had been a former assistant examiner with the FDIC prior to his employment with the Bank. * * * stated that the purpose of his visit was to discuss "certain matters which concerned him relative to his responsibilities with the bank." * * * raised questions concerning the payment of invoices by the Bank for shares of stock in * * * and for suits purchased by the * * * at * * *. * * * also claimed to have been told to "stay away" from certain accounts. Mr. * * * found * * * to be "somewhat incoherrent [sic]" and advised him to make all future contact through direct, official channels. (R. Ex. 443) * * * terminated his employment with the Bank on September 30, 1983. (Tr. 1193)
   11. May 27, 1983 —The Bank submitted its response to the FDIC's Preliminary Examination Report which has been presented to the Bank at the April 27, 1983 meeting. (P.Ex. 12) The Bank's response was received by the FDIC on May 31, 1983. (Tr. 811)
   12. June 2, 1983 —A meeting was held in * * * at the Bank's request and was attended by representatives of the FDIC, the State, and Bank's entire Board of Directors and the Bank's Counsel. (P.Ex. 13) The Bank's chief spokesperson was * * *, then a member of the Board of Directors and the * * * Manager. The purpose of the meeting, according to Mr. * * * was for the Bank to "demonstrate good faith to the FDIC that we were very serious about solving the problem and here was our proposed plan of action." (Tr. 3395) Mr. * * * informed the FDIC that the Bank was willing to adhere to 13 of the 14 points outlined in the FDIC's rehabilitative program. (Tr. 818, 3399) Consequently, although the Bank took exception to the aggregation of debts of various borrowers, the Bank offered to "adopt a Board resolution which would have addressed essentially all of the corrective items which [the FDIC would] be proposing in a Section 8(b) enforcement action, with the exception of a provision relating to acceptable management." (P.Ex. 13) The FDIC responded that nothing short {{4-1-90 p.A-600}}of formal enforcement action would be acceptable.
   13. June 8, 1983 —Mr. * * * wrote to the Bank, enclosing the February 4, 1983 Report of Examination. (P.Ex. 14) Mr. * * * gave the Bank 30 days to respond to the Report.
   14. June 11, 1983 —The FDIC;s February 4, 1983 Report of Examination was received by the Bank (Tr. 846) and the Bank sent a letter to Mr. * * * informing him that the Bank's May 27, 1983 response to the FDIC's Preliminary Examination Report (P.Ex. 12) also constituted its response to the February 4, 1983 Report. (Tr. 935)
   15. June 14, 1983 —The Bank received approximately $1,000,000 in capital through the donation of land (the Street Capital) from the City of * * *. The land had been a city street—which bisected Bank property. (Tr. 3105)
   16. June 20, 1983 —* * *, then FDIC Director of Division of Bank Supervision, and currently Director of the Savings & Loan Department, wrote to the Board of Governors of the Federal Reserve System and to the Comptroller of the Currency notifying them of an impending Section 8(b) action against the Bank. (Tr. 1181-83)
   17. August 3, 1983 —Based on the findings contained in the February 4, 1983 Report of Examination, the FDIC issued against Respondents its First Notice of Charges and of Hearing pursuant to Section 8(b) ("First Notice"), a Proposed Order to Cease and Desist ("Order") and a Proposed Consent Agreement. (P.Ex. 15) On this date, the State also issued a Confidential Emergency Cease and Desist Order. (P.Ex. 71)
   18. September 9, 1983 —A meeting was held in the Bank Counsel's * * * office, attended by Respondents, Bank Counsel and FDIC representatives. At this meeting, the parties discussed the August 3, 1983, First Notice and proposed Order and engaged in settlement negotiations, which concluded unsuccessfully on September 20, 1983. (Tr. 879-80, 3975) The major areas of disagreement voiced at the meeting and throughout the settlement negotiations were the management provision of the Proposed Order, requiring an outside chief executive officer and senior lending officer, and the format of the corrective program. Bank Counsel, * * *, expressed the view that the management provision as proposed by the FDIC was tantamount to removing the * * * from the Bank and that the Bank was amenable to an informal, legally enforceable written letter of agreement rather than a formal cease and desist order. (Tr. 880-81)
   19. September 21, 1983 —Assistant Regional Director * * * wrote a memorandum to the file indicating that as of September 12, 1983, the FDIC had taken the position that an MOU or other informal corrective program was unacceptable as a substitute for a formal cease and desist order. (Tr. 882)
   20. September 30, 1983 —The State and the FDIC began concurrent examinations of the Bank. * * * was the FDIC Examiner-in-Charge and * * * was the State Examiner-in-Charge. The State examination was designated as full-scope while the FDIC examination was designated as a special examination of limited scope. (Tr. 833, 894-95, 938)
   21. October 5, 1983 —Mr. * * * received a telephone update from Mr. * * * on the September 30, 1983 examination's progress. Mr. * * * informed Mr. * * * that (1) he had not yet spoken with senior bank officials; (2) the son-in-law of * * *, who had been appointed as a liaison between the Bank and the examiners, "[had] been very cooperative"; (3) the room in which the examiners were working might be monitored;7 and (4) Mr. * * * had said that whatever the FDIC came up with would probably to into the State Report. (P.Ex. 87)
   22. An unspecified day during the second week of October, 1983 —* * *, 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. According to Mr. * * * the FDIC examination appeared to be a "witch hunt" and a "hatchet job" and the FDIC


7 Mr. * * * testified that throughout the September 30, 1983 examination, the FDIC examiners voiced their concern that the room was "bugged." (Tr. 3416) However, at no point was the room checked for bugging devices. (Tr. 687-88, 4949-51)
   Mr. * * * concluded that in his opinion, because of such unfounded suspicions, the examiners could not be objective in making their findings. (Tr. 3418)
{{4-1-90 p.A-601}}was "not leaving any stone unturned." (Tr. 2370-71, 3413-18, 4942-48). State Examiner * * * who replaced Mr. * * * testified that "...due to the intensity that [the FDIC examiners] were using toward classifications, I questioned really their objectivity of their examination, and really arrived at the same conclusion as Mr. * * *, that they felt they were doing a hatchet job." (Tr. 3414) Furthermore, State Examiner-in-Charge * * * testified that during the September 30, 1982 examination, he heard FDIC examiners, perhaps in jest, saying, "charge-off, charge-off, charge-off ...." with reference to loan classifications. (Tr. 4952)
   23. October 19, 1983 —In a telephone update, Mr. * * * related to Mr. * * * that (1) there had been an "uproar over the examiner's request to review certain precious gems"; (2) "when examiners asked for files on the * * *, some of the material included in the files were [sic] taken out before they were handed over ...."; (3) Examiner * * * got "stalled" on credit file request, including * * *'s file; and (4) loan discussions were to begin on Tuesday, October 25, 1983, with * * *, the Bank's Counsel in attendance. (P.Ex. 88)
   24. October 24, 1983 —At an FDIC progress meeting held in the * * * Regional Office, Mr. * * * brought up the issue of "questionable activity" concerning a collateral check performed on a related interest of * * * which had in excess of $1 million in precious gems pledged against the applicable line of credit. An FBI check was requested through the Intelligence Unit in Washington. (R. Ex. 449)
   It was also decided at this meeting that a recommendation for a Temporary Order to Cease and Desist under Section 8(c) would be made "in order to prevent the deterioration in the Bank's condition." Finally, the FDIC examination was changed to one of full-scope. (Tr. 2527)
   25. November 7, 1983 —At an FDIC progress meeting held in the * * * Regional Office, Mr. * * * and Examiner * * * noted "slow progress in regard to loan discussions and acquisition of examination material needed to conduct the examination." Employees of the Bank "[had] been instructed by the * * * to direct all requests from the examiners for information through them." They "suggested that credit files [were] being purged of any notes or observations the credit official may have placed in the file as well as other pertinent information." The timing of the issuance of the Section 8(c) Order was targeted for November 28, 1983. As examples of questionable loans and activities, the examiners noted that * * * had paid off a $140,000 commercial loan at the Bank with cash and made a $50,000 cash deposit into his account. It was also mentioned that "management [was] trying to decrease the Bank's dependency upon brokered deposits." (R. Ex. 451)
   26. November 10, 1983 —Mr. * * *, wrote to * * *, Assistant Director, State Bureau of Bank Examiners, updating Mr. * * * on the progress of the State September 30, 1983 examination. Mr. * * * noted that "even before any adjustment for asset classifications, the Bank is poorly capitalized with a captal-to-asset ratio of 5.1 percent. This ratio would fall in the `4' rating zone under our existing capital guidelines." Furthermore, Mr. * * * stated, "given the anticipated examination results, the Bank's day-to-day viability will depend on liquidity more than anything else." (P.Ex. 69)
   27. November 14, 1983 —An FDIC progress meeting was held in the * * * Regional Office, attended by Mr. * * *, * * *, * * *, State Director, Division of Banking, Mr. * * *, Mr. * * *, Chief Review Examiner * * * and Review Examiner * * *. Continued slow progress with regard to loan discussions and the acquisition of materials needed to conduct the examination were reported. Mr. * * * indicated his desire to discuss the three largest loans in the Bank that week. The pending Section 8(c) temporary action, with a target date of November 28, 1983, was also discussed. (R. Ex. 450)
   After the meeting, Mr. * * * telephoned Mr. * * * and advised him that the examination was going slowly, but that it "look[ed] like the bank [was] continuing to add risk to the loan account." Mr. * * * then advised Mr. * * * that the FDIC was contemplating the issuance of a Section 8(c) Temporary Order. According to Mr. * * *, Mr. * * * confirmed the picture painted by Mr. * * * and stated that since the Bank was "possibly broke," the State {{4-1-90 p.A-602}} was "looking at removal possibilities." (P.Ex. 91)
   28. November 17, 1983 —Mr. * * * discussed the proposed Section 8(c) Temporary Order with Mr. * * *. Mr. * * * reported that in connection with loan discussions, * * * had advised him that performance on the * * * line was not related to credit quality and that "if the Bank had not cut off other related loans, Mr. * * * could have paid his loans here." With regard to another loan file, Mr. * * * informed Mr. * * * that Mr. * * *'s father was a jeweler and was "apparently attempting to sell the jewels held as collateral," although he didn't think the borrower knew that the Bank might be arranging such a sale.
   Mr. * * * subsequently spoke with Mr. * * * who indicated that "the State was assessing [its] possible use of some enforcement powers .... [and that] he was thinking in terms of prompt emergency removal of the * * *." Mr. * * * said that the State had "not firmed up their strategy," but that he felt there was a "so-so chance the Bank [would] fail perhaps by February or March 1984." According to * * *, Mr. * * * said that the State Examiners were "bending over backwards to keep some semblance of cooperation in place." (P.Ex. 92)
   29. November 18, 1983 —In a memorandum to the file, FDIC Review Examiner * * * of the Problem Bank Unit noted there is "a strong possibility that classifications will render the bank insolvent," that preparation of a Section 8(c) Temporary Order was imminent and that the "scheduling of bid package gathering and attendant preparations will be performed shortly." (R. Ex. 452)
   Mr. * * * was also advised by Mr. * * * that the Bank's overdraft report reflected a large increase in the overdraft of * * * Communities, a classified line of credit. Mr. * * * informed Mr. * * * that "the Bank had to do this to perfect a lien of the * * * property." According to Mr. * * * it was Mr. * * *'s impression that by promising to get all the loan documentation on * * * Communities together by the end of the day, * * * knew that there was some trouble with the * * * Communities line. (P.Ex. 93) After conferring with Mr. * * *, Mr. * * * indicated that he was "more convinced that removal of the * * * [was] necessary, [and that] an Emergency Temporary Cease and Desist Order [might] be necessary." Mr. * * * discussed such an Order with Mr. * * * and other State personnel and informed Mr. * * * that the State would target service of its Emergency Temporary Order for November 23, 1983. (P.Ex. 93)
   30. November 22, 1983 —The FDIC issued its Second Notice and Temporary Order against the Bank pursuant to Sections 8(b) and (c), respectively. Both were based upon preliminary findings of the September 30, 1983 FDIC examination. (P.Ex. 16, R. Ex. 11)
   Mr. * * * also telephoned Mr. * * * with an update, indicating that "not much was happening" but that he was "still having trouble getting the bank to discuss the * * * line...." (P.Ex. 94)
   Subsequent to Mr. * * *'s conversation with Mr. * * *, Mr. * * * received a telephone call from * * *, Associate Director in Charge of Enforcement and Supervision, of the FDIC's Washington Office, inquiring as to a completion date for the September 30, 1983 examination and "the feasibility of suspending and/or removing the * * * now or at least taking away their lending authority." Mr. * * * was advised that such action was not deemed necessary at that time.
   31. November 23, 1983 —Mr. * * * advised Mr. * * * that he would be "hard pressed to complete the examination by December 15" and that the examiners "[might] have to ignore some of the new loans and [would] need additional help on some of the detail of the report." Mr. * * * also noted that in discussions on the collateral covering the * * * Communities line of credit, "Attorney * * * apparently tried to lead the discussion .... [but] * * * usurped him plus * * * wouldn't let * * * say anything."
   After speaking with Mr. * * *, Mr. * * * telephoned Mr. * * *. Mr. * * * mentioned that "the * * * [were] exercising illegal control of the bank, [and that] some additional investigation was taking place concerning the * * * kite at the * * * Bank ...." Mr. * * * also advised that the State was considering a ruling that the $1 million in donated surplus capital was not considered capital since it did not have Department approval.
   After speaking with Mr. * * *, Mr. * * * again spoke with Mr. * * *. Mr. * * * informed Mr. * * * that "the upcoming {{4-1-90 p.A-603}} Board meeting really has the Bank stirred up, that the new spirit of cooperation has evaporated and that the examiners may have problems with bank records."
   Mr. * * * also spoke with Mr. * * *. Mr. * * * informed Mr. * * * that the Temporary Order had been mailed to the Bank that day.
   Mr. * * * then contacted Mr. * * *. Mr. * * * informed Mr. * * * that it was better to meet at the law firm's office on Monday, November 28, 1983 rather than at the Bank. Mr. * * * concluded that, "the nature of his cautionary remarks indicated some sort of threat."
   Bank Counsel, * * *, got on the telephone at this point and requested that Mr. * * * and other Regional Office personnel meet to discuss the * * * line of credit. Mr. * * * replied by stating, "that our examiners [have] been at the bank eight weeks and the forum for discussing loans and reviewing bank documents in connection with those loans was there."
   Mr. * * * subsequently received a telephone call from Mr. * * *. Mr. * * * said that the State "had received a proposal from the Bank's Counsel whereby all of the * * * except * * * would get out of the Bank and $2.2 million in new capital would be injected [and that] this was an apparent attempt to stay the FDIC Order and/or whatever action the State was contemplating taking." * * *, state deputy Comptroller, then got on the telephone and stated that, "if the proposal was too good to pass up the State may go with some form of consent order." Final arrangements for the November 28, 1983 meeting in * * * were also made. (P.Ex. 95)
   32. November 28, 1983 —A meeting was held at Bank Counsel's * * * office, attended by the Bank's Board of Directors and representatives of the State and FDIC. The Bank was served with the State's Emergency Temporary Order. It had already received the FDIC's Second Notice and Temporary Order earlier that day. Discussion focused on the corrective measures contained in the FDIC and State Orders as well as the preliminary findings of the on-going September 30, 1983 examinations. (P.Ex. 96) The Bank also requested specific lists of loan classifications, which were later provided by the FDIC on November 30, December 2 and December 9, 1983. (Tr. 1102, 1468, 3251-52)
   Mr. * * * also indicated that there were leaks concerning examination findings, which he attributed to examination personnel. According to Mr. * * *, Mr. * * * refused to supply specific information as to his allegations at that time, but promised to do so when such information became available. (P.Ex. 96)
   That evening, Mr. * * * and Mr. * * * held a progress meeting. Mr. * * * informed Mr. * * * that as of November 28, 1983, examiners were to request all bank records directly from * * * rather than from junior bank officers who had been acting as liaisons. This change was unacceptable to the examiners and a meeting was scheduled for the following morning "to seek assurances [of] direct, complete, and prompt access to all bank records ...." (P.Ex. 97)
   33. November 29, 1983 —A meeting of Respondents, Bank Counsel, State and FDIC representatives was held to discuss examiner access to Bank records. According to Mr. * * * "the request for direct, complete and prompt access to any and all Bank records was received with open arms on the part of the * * *, particularly President * * *." * * * also expressed his concern with the "fairness and objectivity" of the examination and his belief that the Bank was "in much better shape than currently perceived by the regulatory authorities and that they could show this condition to the satisfaction of all concerned." (P.Ex. 97)
   34. November 30, 1983 —Mr. * * * telephoned Mr. * * * to inform him that Mr. * * * had remained after the November 29th meeting, and had expressed to Mr. * * * and Mr. * * * "a more conciliatory tone acknowledging that the disciplines set forth on the temporary orders were perhaps needed in this case." (P.Ex. 97)
   35. December 2, 1983 —The State sent a letter to the Bank, informing its Board of Directors that the Bank had violated provisions of the State Emergency Temporary Order of November 28, 1983, that all further violations would be considered willful and deliberate, and that possible penalties for future violations included removal, administrative fine and personal liability. (P.Ex. 98)

{{4-1-90 p.A-604}}
   Mr. * * * received a telephoned progress report from Mr. * * * who informed Mr. * * * that the State's list of classifications thus far exceeded that of the FDIC.
   Mr. * * * also received a telephone call from the * * * Federal Reserve seeking an update on the Bank. The * * * Federal Reserve "indicated they knew the classifications to date probably equaled or exceeded capital" and "asked about the * * * line inasmuch as the Fed denied his control notice on * * * in * * * (The bank that failed earlier this year) and asked if he controlled * * * State Bank." Mr. * * * advised the * * * Federal Reserve that Mr. * * * did not control the Bank, but that he had an interest in a portion of its stock. (P.Ex. 99)
   Mr. * * * advised Respondents and Bank Counsel of possible violations of the FDIC Temporary Order. Respondents and their Counsel vocally denied these allegations and asserted that "certain State investigators in the Bank [were] merely a prelude to the FBI coming in." Mr. * * * then advised Mr. * * * of the FDIC Washington Office "that the Regional Director anticipates the State may be very reluctant to close a bank in * * * based on their past history. It may take action on our part to remove the * * * and/or to initiate Section 8(a) to accomplish the corrections needed in this institution." Mr. * * * indicated that the Washington Office would immediately forward a Section 10(c) Order to the Regional Office in the event it was needed.
   Mr. * * * then spoke with Mr. * * * who informed him that Mr. * * * described the Bank's reaction to the State's list of classifications as "stunned." State Loss classifications were nearly $4.9 million and Doubtful were approximately $1.7 million. Mr. * * * inferred that there would be a second opinion rendered on these classifications. (P.Ex. 99)
   36. December 5, 1983 —The * * * Regional Office received information from the FBI concerning * * *, a borrower at the Bank. According to the memorandum written to the file by Mr. * * *, Mr. * * *, along with * * *, appeared to have used a former Vice President of * * *, * * *, to illegally obtain funds in excess of $460,000. The funds were allegedly used to cover overdrafts by transferring funds from other customer's accounts. Mr. * * * pleaded guilty to misapplication of funds. The FBI report was silent as to any charges brought against either Mr. * * * or Mr. * * *, and the record in this case is similarly silent. (R. Ex. 453)
   The * * * Regional Office also received information from the FBI concerning * * *, Vice President of * * *, a borrower of the Bank. According to a second memorandum written by Mr. * * * to the file, Mr. * * *, "apparently" obtained $800,000 in secondary mortgage funds by making false representations to the Bank.8 The U.S. Attorney advised the * * * Regional Office that he intended to authorize prosecution in the case. (R. Ex. 454)
   In addition, a meeting was held in the * * * Regional Office to discuss the progress of the September 30, 1983 examination and compliance with the Temporary Order served on November 28, 1983. The examiners in attendance reported that on November 30, 1983, they discovered that the Bank had made additional credit extensions in the form of overdrafts to * * * and * * *. According to a memorandum written to the file by * * *, Chief Review Examiner, both these lines had been previously classified at the February 4, 1983 examination and were therefore in apparent violation of the Temporary Order. Mr. * * * reported that "banking officials, who were immediately notified, indicated that they were unaware that any violations had occurred. They further indicated that such were unintentional and probably resulted because they had not had sufficient time to place proper controls in effect which would preclude noncompliance with the Order." Mr. * * * concluded that "inasmuch as there may have been some validity in bank management's reason for the occurrence of the violations, it was decided that no action would be pursued at this time." However, Mr. * * * stressed the need for continued monitoring, and the possibility of a removal action under Section 8(e) and/or a court enforcement order if future violations occurred.
   Mr. * * * reported slow progress in his examination, but still anticipated a completion date of December 15, 1983. The preliminary findings of the examination indicated that Loss and Doubtful classifications


8 A May 1, 1983 newsclip appended to R. Ex. 454 showed that the mortgage at the Bank was $600,000 and had been satisfied.
{{4-1-90 p.A-605}}
approximated or exceeded the total capital accounts of the Bank. Consequently, Mr. * * * concluded that, "it appears likely that Section 8(a) action to terminate the insured status of the bank, and Section 8(e) action to remove the responsible bank officials will most likely be recommended by this office." (R. Ex. 455)
   37. December 6, 1983 —* * * and Mr. * * * of the State visited the Bank to make a general assessment of its condition. In a memorandum to the file, Mr. * * * stated that he concurred with Mr. * * *'s preliminary conclusion that the Bank was in an "impaired condition." Respondents had indicated to the State representatives that "sale of the institution to an individual or group capable of infusing a large amount of capital into the Bank and turning around the loan portfolio" would be a "viable option" if the State's final examination results indicated an impaired condition. The State representatives indicated that "closure was not what the Department wanted to see" and Respondents "acknowledged the need for quick action...." (P.Ex. 72)
   38. December 7, 1983 —Mr. * * * advised Mr. * * * in his daily telephone update that Mr. * * * had informed him that the purpose of a meeting between State representatives and Bank officials on December 6, 1983 was to "advise the bank to start looking for a merger or sale partner."
   Mr. * * * also advised Mr. * * * that when loan discussions started that day, the examiners were requested to leave the room so that Mr. * * * could receive a telephone call in private. Mr. * * * stated that he "overheard Attorney * * * say, `Senator, we are working on Loss and Doubtful.'" Mr. * * * also told Mr. * * * that the Bank indicated that it "is about ready to start providing evidence that the Loss classifications aren't really losses" and that there was going to be a $5 million partial payment from Swiss sources on the * * * line, but that the Bank wanted $7 million. (P.EX. 100)
   39. December 8, 1983 —Mr. * * * advised Mr. * * * in his daily telephone update that a $400,000 overdraft had occurred on December 5, 1983, but that it was a legitimate error. Mr. * * * reported that "comments received in loan discussion in the last few days from the * * * were both humorous and disturbing." Mr. * * * also indicated that "* * * may have misled examiners in discussion of the * * * loan," but that Mr. * * * was to resubmit the financial statement at issue. (P.Ex. 100)
   40. December 9, 1983 —Mr. * * * advised Mr. * * * in his daily telephone update that there was "a possible misapplication of bank funds on the part of * * * and that he had a chart drawn up to show at the meeting in the * * * Regional Office scheduled for December 12, 1983. Mr. * * * also reported that he had given the Bank another supplemental list of classifications which completed the totals. This supplemental list included an additional $2 million in Loss. According to Mr. * * *, Mr. * * * realized that the FDIC examiners viewed the title opinions provided in connection with these loan classifications as "suspect," and stated that if the FDIC wasn't going to accept them, the Bank wouldn't get them anymore.
   FDIC Counsel informed Mr. * * * that the U.S. Attorney was "staying out of the bank until the FDIC gets out as the U.S. Attorney and the FDIC wants [sic] to avoid any charge that [they are] in collusion." Possible indictments, targeted to be issued by late January 1984, were to involve "more than stock ownership as their [sic] are apparently indications of an elaborate laundrying [sic] scheme through the bank's loan account." (P.Ex. 100) Mr. * * * indicated at trial that he never saw any evidence of such a scheme. (Tr. 1258-59)
   41. December 12, 1983 —Following a meeting held in the * * * Regional Office, attended by Mr. * * *, Mr. * * * and Mr. * * *, Mr. * * * contacted Mr. * * * of the FDIC Washington Office. Mr. * * * advised Mr. * * * that there was a "possible misapplication of bank funds by * * * and that [the * * * Regional Office was] making a referral to the U.S. Attorney. Mr. * * * noted that his office would probably be turning over some material to the FBI under a Grand Jury subpoena before the week was out, as the FBI might take immediate action on the referral.
   Mr. * * * later received a telephone call from Mr. * * *. Mr. * * * stated that Respondents "spent most of the time saying the bank [wasn't] as bad as the examiners [were] finding," were "not adverse" to the suggestion of merger, and "felt they could talk the examiners out of some classifications."
{{4-1-90 p.A-606}}
Mr. * * * was advised by Mr. * * * that the FDIC hoped to get the Examination Report to the Bank by early January and "would perhaps have a Section 8(a) and 8(e) and an updated 8(b) at that time." Mr. * * * inquired as to an FDIC purchase and assumption transaction versus a payout in the event the Bank closed. (P.Ex. 101)
   42. December 13, 1983 —Mr. * * * telephoned Mr. * * * of the FDIC Washington Office informing him that the examination would close on December 16, 1983, and that the examiners would move to the * * * Regional Office to begin work on Section 8(a), (b) and (e) actions. The memorandum written by Mr. * * * to the file stated that preliminary classifications indicated that the Bank was insolvent by approximately $3 million. Loss and one-half Doubtful was $8.5 million versus capital accounts of $5.5 million. It was not clear what action the State examiners planned to take, except that they intended to continue their presence in the Bank. Consequently, Mr. * * * stated that it "seems we may need to force their hand by issuing an 8(a)." Mr. * * * also reported that "the FBI is conducting an investigation at the present time and our examiners have been called upon to cooperate." (R. Ex. 456)
   43. December 15, 1983 —In an early morning telephone call to Mr. * * *, Mr. * * * indicated that "he expected this to be show-down day as the bank presented documentation concerning all Doubtful and Loss classifications." Mr. * * * indicated that based on a preliminary review, some of the classifications might be removed or changed, if supported by documentation. Preliminary discussions on the * * * Communities line indicated that there might not be substantial loss on that line of credit. Accordingly, the Bank asserted that it had "valuable property to cover all the related debt." Mr. * * * stressed the need for documentation. Mr. * * * also advised that he had met with representatives of the U.S. Attorney's office concerning the December 12, 1983 referral of apparent criminal activity on the part of * * *. The U.S. Attorney's office advised Mr. * * * not to do any more on these transactions since it would follow up on the FDIC referral. It appeared that the U.S. Attorney's office chose to "await the departure of the FDIC examiners and State examiners before [going] to the bank with search warrants." (P.Ex. 102)
   44. December 16, 1983 —State and FDIC September 30, 1983 examinations were completed.
   Mr. * * * telephoned Mr. * * * early in the morning to inform Mr. * * * that the Bank had provided documentation resulting in a change in some classifications. It appeared that "Loss and one-half Doubtful would be about $5 million and Substandard something in the neighborhood of $22 million." Mr. * * * did not see a Loss classification on the * * * line at that point in time. Total classifications were said to represent about 42 percent of total loans. Mr. * * * also indicated that the State examiners and investigators were aware that he had gone to the U.S. Attorney's office that week. The State investigator had recognized the FBI representative who had called the Bank to set up a meeting as part of "Operation Greenback," the alleged money laundering scheme investigation. (Tr. 2647-48) Mr. * * * stated that he believed the FBI would be going into the Bank shortly.
   Mr. * * * next telephoned Mr. * * * of the State. With regard to the FBI investigation, Mr. * * * expressed concern over publicity, referring to a possible run on the Bank. Consequently, the State was drawing up papers to deal with such a potential run. Mr. * * * and Mr. * * * also discussed the Bank's capital needs and talked in terms of $7-8 million. Mr. * * * then alerted the FDIC Washington Office so that it could prepare for a possible run on the Bank.
   While later conferring with Mr. * * *, Mr. * * * "acknowledged that Mr. * * * and his associates had apparently exerted a Herculean effort in recent weeks to shoreup some of the distressed loans in the bank." Mr. * * * requested a meeting with * * * Regional Office personnel before the FDIC reached any concrete conclusions, particularly regarding the recommendation of Section 8(a) and (e) actions. Mr. * * * was noncommittal since the Examination Report had not been completed and reviewed in the Regional Office. Mr. * * * was to check back in a couple of weeks concerning his request. (P.Ex. 103)
   45. December 19, 1983 —A letter was sent to Mr. * * * by Mr. * * * providing additional information on classifications of the * * *, * * *, * * * and * * * loan lines. The letter also attempted to substantiate and document claims made on December 16, 1983 to Mr. * * * regarding im-
{{4-1-90 p.A-607}}proper examination classification of the * * * line. (Tr. 1269-79)
   46. December 22, 1983 —A memorandum to Mr. * * * from * * *, Area Director, Division of Liquidation, requested information required for preparation of a bid package in the form of a potential payment ("PPO") of the Bank. (R. Ex. 457; Tr. 2578-80)
   47 January 5, 1984 —This was the first of three meetings held to negotiate an MOU between the Bank and the State. The dual purpose of the meeting was for Bank Counsel to present a rehabilitative plan and for the State to request a review, before finalizing the results of its examination, of additional cross-collateralizations on certain lines of credit. (Tr. 3503) At the meeting, the Bank presented the State with a memorandum which reflected a willingness to infuse additional capital and to make some management changes. (Tr. 2320-22)
   48 January 9, 1984 —The second meeting was held to negotiate an MOU between the Bank and the State and to review cross-collateralizations on various classified loan lines.
   49. January 10, 1984 —Mr. * * * telephoned Mr. * * * to request a meeting with Regional Office personnel to discuss progress and plans made by the Bank which would negate the need for formal enforcement action. Mr. * * * specifically wanted to focus on his law firm's "intense involvement...to `shore-up' Loss and Doubtful assets in the last few weeks of the current examination." Mr. * * * concluded in a memorandum to the file dated January 26, 1984, that in the FDIC's view, "any meeting and/or negotiation arrangements would be unproductive unless backed by...formal enforcement actions...." (R. Ex. 461)
   50. January 11, 1984 —Mr. * * * telephoned Mr. * * * about another bank, but in response to Mr. * * *'s inquiry regarding the State's review of the * * * line, Mr. * * * indicated, according to Mr. * * *, that the State didn't "give much credence to spreading the collateral umbrella" and that the State hadn't yet made a final decision on classification of the * * * line. (P.Ex. 104)
   A memorandum was also sent on this date from * * *, Associate Director to * * *, requesting that Mr. * * * provide information, to be used in preparation of a PPO of the Bank, to Assistant Director * * *. (R. Ex. 458)
   51. January 13, 1984 —Mr. * * * responded to Mr. * * *'s December 22, 1983 request for information to be used in preparation of a PPO of the Bank. (R. Ex. 459)
   52. January 17, 1984 —Mr. * * * responded to Mr. * * *'s January 11, 1984 request for information to be used in preparation of a PPO of the Bank. Included in Mr. * * *'s response was a copy of the data supplied to Mr. * * * on January 13, 1984 by Mr. * * *. Mr. * * * concluded that "the major reason that a payout is recommended for the institution rather than a purchase and assumption transaction is the uncertainties surrounding the banking practices of the senior officers of the bank." (R. Ex. 460)
   53. January 23, 1984 —The final meeting was held to negotiate an MOU between the Bank and the State. The Bank presented the State with a list of all adversely classified loans on which there had been substantial collection. The list totalled in excess of $2 million and represented adversely classified loans on which principal payments had been made since the examination ended on December 16, 1983. This meeting resulted in an agreement that the MOU would focus on two key points, to wit, (1) a set amount of capital to be infused and (2) a reduction in * * *'s active participation in the Bank's affairs. (Tr. 2347-51, 3506-15)
   54. January 25, 1984 —The State and the Bank entered into a 16 point MOU. Pursuant to the MOU, the Bank was required to:
   (1) reduce brokered deposits to 10 percent within 45 days;
   (2) maintain a loan to deposit ratio of 70 percent, excluding loans insured through FCIA, EXIM Bank or other similar government agencies, provided total loans did not exceed 80 percent of deposits, unless the State, in writing, permitted a higher percentage;
   (3) submit monthly reports of the ratio of loans to deposits and loans to assets and a copy of the daily Statement of Condition as of the last day of each month;
   (4) reduce total deposits to $100 million or less within 90 days and maintain that {{4-1-90 p.A-608}}level until reaching a capital to deposit ratio of 6.5 percent;
   (5) restrict extension of additional credit to borrowers with loans classified Substandard in the September 30, 1983 State Examination Report unless certain conditions are met, and also restrict extension of credit and overdrafts on future lines of credit;
   (6) extend no additional credit to borrowers whose loans were classified Loss or Doubtful without prior written approval of the State;
   (7) formulate a new loan policy and documentation control mechanism within 30 days to be approved by the State and then adopted by the Bank;
   (8) increase capital by $2 million cash within 30 days and an additional $1 million within 270 days;
   (9) finalize within five days * * *'s resignation as President of the Bank and as a member of any operating committees of the Bank and his relinquishment of lending authority;
   (10) review, in six months, all existing Doubtful loans and if no principal or interest payments have been received, place such loans in non-accrual status, and initiate enforcement proceedings if not yet commenced;
   (11) submit monthly reports on all brokered deposits in excess of five percent of total deposits and all extensions of credit in excess of $250,000;
   (12) present a plan, within 30 days of the Bank's receipt of the September 30, 1983 State Report of Examination, for reduction of all cited statutory violations;
   (13) submit monthly progress reports on MOU compliance;
   (14) employ a qualified outside individual, satisfactory to the State, to act as President and Chief Operating Officer;
   (15) make no new advances, loans or other extensions of credit in violation of Federal or State law; and
   (16) comply with the MOU and thereby consider the State Cease and Desist Order dated November 28, 1983 expired as of February 26, 1984. (R. Ex. 9)
   In addition, on this date, * * *, in the name of * * *, closed on the purchase of the property known as the * * * by borrowing $1.8 million from * * *. Part of the funds acquired from * * * were used to pay off a $300,000 mortgage on the * * * property acquired by * * *. (Tr. 352-53)
   55. January 27, 1984 —A memorandum to Mr. * * * from Mr. * * * with Mr. * * *'s concurrence noted therein, summarized the results of the September 30, 1983 FDIC examination, alleged non-compliance with the November 28, 1983 State and FDIC Orders and recommended a Section 8(e) removal action against the Respondents. (P.Ex. 105)
   56. January 31, 1984 —Mr. * * * informed the Bank and other interested parties that the State did not take exception to the swap of the Bank premises for the * * * property. However, Mr. * * * noted that this approval was "subject to a final appraisal of the [* * *] property indicating a fair market value of not less than $4,750,000." (P.Ex. 109)
   57. February 3, 1984 —A meeting was held between State and FDIC representatives in * * *. The purpose of the meeting was for the State to explain its reasons for entering into an MOU. (Tr. 3517) The FDIC voiced its disagreement with the State's use of an MOU rather than a formal action and left the State with the impression that it was contemplating a removal action. (Tr. 3517-19)
   58. February 8, 1984 —A report of apparent criminal activity was transmitted by Mr. * * * to the U.S. Attorney's office. The report involved transactions allegedly engaged in by * * * and another Bank officer during January 1984. (Tr. 1246-47)
   59. February 10, 1984 —The FDIC September 30, 1984 Report of Examination was forwarded to the Bank with an attached letter of explanation from Mr. * * *. Mr. * * * advised the Bank that he would recommend to the FDIC Washington Office that the Bank be retained on the formal problem bank list and that formal action be taken under Sections 8(a), (b) and (c). A response to this letter was due within 30 days. (P.Ex. 106)
   A confidential memorandum to DBS files from Mr. * * * stated that "Bank management has been entirely uncooperative as evidenced by their refusal to stipulate to the Section 8(b) Notice and corrective program" and that the three * * * "are collectively responsible for the serious condition of the bank." Mr. * * * also stated that "the State Authority, without, consultation with this office, unilaterally entered into an {{4-1-90 p.A-609}}informal Memorandum of Understanding with the bank, apparently based upon their September 30, 1983 findings. The results of a February 3, 1984 meeting with State officials to discuss the potential ramifications of the divergent corrective programs is recorded in a February 3, 1984 memorandum to the files." (R. Ex. 462)
   Also on this date, the Bank's Board of Directors held a meeting at which it adopted resolutions authorizing the swap of the Bank's premises for the * * * property. (Appendix to P.Ex. 10)
   60. February 21, 1984 —The swap of the Bank premises and the * * * property received final approval of the State following one month of appraisal exchanges and review. (Tr. 3617-19)
   A $3 million wire transfer also came into the Bank from * * *, * * *. (Tr. 2675)
   61. February 24, 1984 —Mr. * * * spoke with Assistant Regional Director * * *, his counterpart in the * * * Regional Office, to request that Mr. * * * make an inquiry into whether * * *'s assets were being used to cover an overdraft in the Bank. Mr. * * * also brought up the Bank's problems with the * * * line, and indicated to Mr. * * * that he was aware that Mr. * * * was involved as a principal figure in the failure of * * * in * * *. (Tr. 2674-80)
   Mr. * * * was aware of * * *'s failure, which had occurred on December 30, 1983, based on information he had been provided with after making an inquiry to the FDIC's Liquidation Division concerning Mr. * * *. Mr. * * * had also received memoranda from the * * * Regional Office in early January 1984 concerning * * *'s connection with other banks in the * * * region. (Tr. 2682)
   62. February 26, 1984 —Mr. * * * telephoned * * *, Director of Examinations, * * * Savings and Loan Department, and advised Mr. * * * that * * * Savings and Loan of * * *, * * * ("* * *"), a bank under Mr. * * *'s jurisdiction, had wired on February 16, 1984 nearly $3 million to * * *, "a five graded bank (The Worst)." (R. Ex. 445) Mr. * * * requested that Mr. * * * determine what the disbursement was for. Mr. * * * referred to the Bank as a "Mafia bank," mentioned that the FDIC was contemplating removal of its insurance, and stated that it was about to be closed.9 (R.EX. 445, Tr. 4062-65, 4073-76)
   In response to Mr. * * *'s call, on February 27, 1984, Mr. * * * made preparations to send Examiner * * * to * * * on February 27, 1984 in order to inquire into the $3 million transaction involving the Bank and any other loans in * * *. (Tr. 4066)
   Mr. * * * also telephoned * * *, President and Managing Officer of * * * to inform him that he was sending Mr. * * * in to check on a $3 million disbursement to the Bank. Mr. * * * was very excited and wanted to know "why the hell [* * *] was making a loan like [he] had made in * * *." Mr. * * * informed Mr. * * * that the loan committee felt that it was a good loan. Mr. * * * replied that it was not a good loan and should not have been made. Mr. * * * and Mr. * * * had known each other for over 20 years and held each in high regard, but Mr. * * * had never seen Mr. * * * so extremely upset and excited. (Tr. 4085-86, 4166, 4181)
   Mr. * * * also telephoned Mr. * * * to give Mr. * * * a rundown of the problem. During subsequent conversations with Mr. * * *, Mr. * * * referred to the Bank as a "Mafia-type" operation.10

9 R. Ex. 445 is a February 25, 1984 memorandum prepared by Mr. * * * regarding the events of February 26-28, 1984. The side margin comments are those of * * *, Director of Supervision, * * * Savings and Loan Department. (Tr. 4094) Changes in the body of the memorandum were made by Mr. * * * after consultation with Mr. * * * (Tr. 4100).
   The phrase "...* * * said it was a `Mafia bank that was about to be closed'" was changed to `...* * * said it was a Mafia bank that was a five graded bank (The Worst)." I find that both phrases accurately describe the sentiments expressed by Mr. * * *.
   Mr. * * * also advised Mr. * * * to change the sentence "further intrigue is that (according to * * *), * * * busted the * * * in * * *" to "...* * *, a friend of * * * who busted the * * * in * * *, * * *...." (Tr. 4097-98) Mr. * * * stated that if the memorandum hadn't been corrected and it was * * * instead of * * * who had been responsible for busting * * * Bank, he would have had greater cause for concern. (Tr. 4155)
   Mr. * * * did not discuss the meaning of the term "Mafia" with Mr. * * *. However, Mr. * * * admitted that it caught his attention and was interpreted by him "to express concern about something going on that is out of the ordinary or irregular." (Tr. 4081-82, 4089-91)

10 Mr. * * * saw the term "Mafia," used with reference to the Bank, for the first time when he received a copy of Mr. * * *'s February 28, 1984 memorandum. (R. Ex. 445) Mr. * * * stated that the term "has a way of sticking out," that (Continued)

{{4-1-90 p.A-610}}
   63. February 27, 1984 —Mr. * * * went to * * * to investigate the $3 million loan to the Bank and other loans made by * * * to * * * borrowers. Based on Mr. * * * findings, Mr. * * * advised Mr. * * * that the $3 million disbursement was a loan to * * * as an individual and that the loan file indicated that security for the short-term, 6-month loan consisted of a property in * * * and a property in the * * *. Mr. * * * considered the loan to * * * to be "abnormally and hurriedly closed without the required documentation at a rate of 1 ½ percent over prime—floor of 13 percent, which is not any great return on a loan of this kind" and was therefore "unsafe and unsound." (R. Ex. 445) Mr. * * * had also informed Mr. * * * that a $2.3 million loan had been made to Mr. * * *. (Tr. 4068, 4077-78)
   Mr. * * * also had a second conversation with Mr. * * * during which he was critical of the lack of documentation in * * *'s loan file and specifically referred to the * * * as "bad people who should not have been lent money." Mr. * * * also told Mr. * * * that the source of his information was the FDIC. (Tr. 4171-74)
   Mr. * * * "urgently suggest[ed that the State of * * *] stop this lending pattern before irreparable damages occurs [sic] at * * *" and that it put Mr. * * * "on notice" of this "concern." (R. Ex. 445) Consequently, * * *'s and the State of * * * entered into preliminary discussions leading to a supervisory agreement which would restrict further loans by * * * in * * *. (Tr. 4174) However, Mr. * * * pointed out that * * * had entered into a legally valid and enforceable commitment with Mr. * * * and, therefore, it was agreed that * * * should continue to go through with that loan (Tr. 4175-76) Mr. * * * stated that, in 20 years of banking and because of the loan to * * *, "this [was] the hardest I ever had regulatory agencies come down on me." (Tr. 4179)
   A meeting was also held on this same day in * * * among FDIC and State representatives, the * * * and Bank Counsel.
   Mr. * * * opened the meeting by saying that the FDIC was not there to discuss loan classifications. (Tr. 2338) Mr. * * * stated that he had already made his recommendations to the Washington Office and that they were not going to be changed. (Tr. 2653)
   64. February 29, 1984 —* * * made an infusion of capital by purchasing 200,000 shares of Bank stock for $2 million. (Tr. 252-54) The funds were from Mr. * * *'s loan. (Tr. 256)
   65. March 6, 1984 —At a meeting held in * * *, attended by representatives of * * * Savings and Loan Department and * * *, Mr. * * * requested that * * *'s Board of Directors execute a supervisory agreement dated March 2, 1984. (R. Ex. 446) The agreement required that * * * "no longer fund loans in * * * unless for the granting or purchasing of single-family dwelling loans (1 to 4 dwelling units)." Mr. * * * presented the agreement to the Board of Directors and approximately one month later, the agreement was signed and referred to the Savings and Loan Department's * * * office.
   66. An unspecified day during the first week of March, 1984 - At a meeting held in Washington and attended by State and FDIC officials, the * * * and Bank Counsel, the State attempted again to explain its MOU to the FDIC and requested that the Washington Office override the * * * Region and give the MOU a chance to work. The State assured the FDIC that if, after giving the MOU a chance to work, the Bank's condition didn't improve, then it would be willing to take appropriate action to close the Bank. The Washington Office chose to follow the * * * Regional Office's decision not to follow the course of action recommended by the State. (Tr. 3562-64)
   67. March 12, 1984 —The FDIC issued a Third Notice against the Bank under Section 8(b). This Notice was based upon findings of the September 30, 1983 FDIC examination, and charged the Bank with having engaged in substantially the same unsafe or unsound banking practices and violations of law alleged in the First Notice. However, the charges contained in this latest Notice were substantially more aggravated. On the same date, the FDIC issue its Removal Notice against the three * * * under Section 8(e). The Removal Notice was also based upon findings of the September 30, 1983 FDIC examination, but some allegations were also based upon findings of the February 4, 1983 FDIC examination.


10 Continued: it caused him "concern," and that to him, it "refers to organized crime." (Tr. 4142, 4148) Mr. * * * also stated that "I would have to say when I first read it, I understood it to mean [the Bank] was owned by the Mafia." (Tr. 4148)
{{4-1-90 p.A-611}}
   68. March 15, 1984 —The * * * were served by the FDIC with an Immediate Order of Suspension from Office and Prohibition from Further Participation ("Immediate Suspension Order") dated March 12, 1984. (R. Ex. 12)
   69. March 16, 1984 —A report of apparent criminal activity against the Bank as a corporate entity was referred by the FDIC to the U.S. Attorney's office. (Tr. 1243)
   Respondents sought a Temporary Restraining Order ("TRO") to challenge the March 12, 1984 FDIC Immediate Suspension Order in United States District Court, before Judge Edward Davis. Once news of the impending TRO hearing became public on Friday, March 16, 1984, media coverage followed and extended through the weekend preceding the start of the Monday TRO hearing. (Tr. 4224-25)
   70. March 17–19, 1984 —Media publicity involving the TRO hearing resulted in both customer inquiry as to whether the Bank was closing and actual withdrawal of deposits. Although it is clear that Respondents played no part in arranging for the presence of a * * * reporter on March 19, 1984, the first day of the hearing at the Bank's office (Tr. 3331-33), no evidence was submitted to support a finding that either the FDIC or the U.S. Attorney's office took any affirmative steps to solicit the reporter's coverage.
   A "run" on the Bank, amounting to at least $10 million, started on Monday, March 19, 1984, and continued through May, 1984. (Tr. 3329-30). State Examiner * * * testified that he personally monitored the Bank for three successive days immediately after the "media attention" began and, as a result, concluded that "quite obviously media attention has had some effect in closing over a million dollars of accounts in three days...." since people came into the Bank making comments like "when are they going to close; why are they going to close." (Tr. 3466) Mr. * * * testified also that what could be characterized as a "silent run" accounted for a drain of deposits totally $16 million. (Tr. 3465)
   * * *, through Mr. * * *, directed Examiner to begin tentative preparation of a bid package on the Bank for possible liquidation, sale or merger. (Tr. 2613, 3805-09, 4222-28)
   71. March 20, 1984 —A TRO against the FDIC's Immediate Suspension Order was entered by Judge Davis. (R. Ex. 433)
   Notwithstanding a more than 15-year banking relationship with * * *, Mr. * * * a * * * borrower at the Bank, withdrew more than $1 million after being informed of the Bank's adverse publicity. (Tr. 3028)
   72. March 22, 1984 —Mr. * * * received final and expanded instructions from Mr. * * * to assemble bid package information. (Tr. 3805-09, 4209)
   73. March 26—28, 1984 —Mr. * * * compiled final bid package information and forwarded it to the FDIC * * * and Washington Offices. (Tr. 4209)
   The FDIC issued an Amended Third Notice and an Amended Removal Notice against the Bank and Respondents to correct certain technical matters.
   74. May 16, 1984 —At Mr. * * *'s instruction, Mr. * * * inquired into * * * Bank's ("* * *") loan relationship with Mr. * * * and * * *. * * * was on of the Bank's correspondents and had established a banking relationship, based on a revolving credit line, with Mr. * * * and * * * after having been introduced to Mr. * * * by * * *. (Tr. 2092–2105, 2117-20, 3887-92)
   Mr. * * * notified Mr. * * * of a $1 million wire transfer from * * * to * * *'s * * * account.
   Upon checking with * * * Officer * * * and Vice President * * *, Mr. * * * was advised that the $1 million wire transfer into * * *'s * * * account had resulted both in transfers out of * * * and payoffs of * * * loans at * * *. One of the wires out of * * * was to the Bank, Mr. * * * informed Mr. * * * that the FDIC was conducting an examination of the Bank which would result in adverse classifications and also stated that "[if I were you], I would review the financial information..." and "you have to use your own judgment if you are going to make loans to them." (Tr. 2097)
   75. May 18, 1984 —The State began a limited scope examination of the Bank to determine compliance with and effectiveness of the State January 25, 1984 MOU and to facilitate the offering of testimony in this proceeding by State representatives. (R.Ex. 441; Tr. 3534).
{{4-1-90 p.A-612}}
   A meeting was held in the * * * Regional Office between * * *, FDIC * * * Regional Attorney, and * * * Counsel for * * *, regarding a May 31, 1984 Bankruptcy Confirmation Hearing concerning * * * at * * *.
   * * * planned to contest the reorganization plan in Bankruptcy Court and this meeting was held to assist Mr. * * * in limiting the scope of his contemplated subpoenas of FDIC material. Prior to the meeting, Mr. * * * was not asked for, nor did he submit to the FDIC a written request for records specifying his reasons for the request, as required under FDIC Rules and Regulations, Section 309.6(c)(6).11 (Tr. 3766)
   76. May 21 – 22, 1984 - Mr. * * * made an inquiry into activity in the * * * account and was informed by * * * that it had cancelled the * * * $1 million credit line and asked Mr. * * * to take his banking business elsewhere. (Tr. 2099, 3889)
   Mr. * * * indicated at the meeting that he had obtained a copy of the FDIC's September 30, 1983 Report of Examination from a clerk of the U.S. District Court after the confidential March 1984 TRO hearing. Mr. * * * informed Mr. * * * that he needed to determine which parts of the * * * Report were pertinent to the upcoming Bankruptcy Hearing, and he made particular reference to the * * * loan lines, which included * * * at * * *. Mr. * * * also showed Mr. * * * a November 22, 1983 standby letter of credit that the Bank was purporting to issue in favor of * * * at * * * and asked how FDIC examiners would handle it. Mr. * * * joined the meeting at this point in order to comment specifically on how examiners handle such contingent liabilities. Mr. * * * asserted that his chief concerns were whether the Bank's financial weakness as established in the FDIC * * * Report would impede its ability to fund the letter of credit and whether the letter of credit violated the November 28, 1983 Temporary Order.
   Mr. * * * received a subpoena from Mr. * * * the following week requiring, inter alia, production of the entire September Report and the November 28, 1983 Temporary Order. Mr. * * * advised Mr. * * * that he would supply only a narrative summary of the four * * * loan lines, the November 28, 1983 Temporary Order and a nine line synopsis of some other * * * lines. Bankruptcy Court Judge Joseph A. Garsen ruled the documents inadmissible and District Court Judge Davis ordered Mr. * * * to return all records mistakenly obtained from the Court Clerk. The records are currently under seal in the bankruptcy proceeding. (Tr. 3737-43)
   With regard to his handling of Mr. * * *'s request for confidential information, Mr. * * * admitted:
   (1) that he failed at the very outset to obtain an agreement from Mr. * * *, either orally or in writing, requiring Mr. * * * to protect the confidentiality of the matters being discussed relating to the Bank (Tr. 3764);
   (2) that Mr. * * * could have bluffed Mr. * * * into divulging information by making Mr. * * * believe that he knew more about the contents of the FDIC September Report than in fact he knew. (Tr. 3767);
   (3) that he did not have written authority nor did he provide Mr. * * * with written authority to make disclosures of confidential information to Mr. * * *12 (Tr. 3772); and
   (4) that the FDIC Rules and Regulations at Section 309.6(c)(6) did not cover the disclosures either he or Mr. * * * made

11 FDIC Rules and Regulations, Section 309.6(c)(6) provides:
Reports of examination and other exempt records- disclosure to third parties. Except as otherwise provided in § 309.6(c)(1) through 309.6(c)(5), the Director of the Corporation's Division of Bank Supervision, or anyone designated by him in writing, may disclose copies of any report of examination of a bank or data center or other exempt records to any third party where requested to do so in writing - Any such written request shall: (i) specify the record or records to which access is requested; and (ii) give the reasons for the request. Any Corporation employee authorized to disclose exempt Corporation records to third parties may disclose the records only upon determining that good cause exists for the disclosure. Either prior to or at the time of any disclosure, the Corporation employee shall impose such terms and conditions as he deems necessary to protect the confidential nature of the record, the financial integrity of any bank to which the record relates, and the legitimate privacy interests of any individual named in such records.

12 I find credible and reasonable Mr. * * *'s testimony that, based on Mr. * * *'s status as an FDIC attorney, he perceived he had been granted implicit authority permitting his disclosure of otherwise confidential information concerning the Bank to Mr. * * *. (Tr. 1435, 1450–1451) Any confusion Mr. * * * may have had as to his authority to make such disclosure is understandable in light of Attorney * * *'s testimony, first, that he was not authorized to grant FDIC examiners the right to disclose information (Tr. 3773), and then, later, that "I am not sure about that." (Tr. 3773-75)
{{4-1-90 p.A-613}}during the meeting with Mr. * * * (Tr. 3772) and that he had no authority to allow such disclosures in light of Title 18 U.S.C., Sections 1905 and 1906. (Tr. 3773)

Asset Classification

   The September 30, 1983 examination of the Bank was conducted in accordance with the policies and examination objectives set forth in the Manual of Examination Policies ("Manual") developed by the Division of Bank Supervision of the FDIC. (R. Ex. 1) The Manual does not, and was not intended to have the binding effect of law since it has not been published for notice and comment pursuant to the provisions of the Administrative Procedure Act (5 U.S.C. § 553). However, the Manual is admissible evidence of just what it is intended to be, that is, a compendium of policy guidelines to be used as an aid in the performance of the examination function, consistent with the development and exercise of good judgment and common sense on the part of the examiner. To that end, as explained in the Manual's forward, "considerable flexibility is available to tailor examination procedures and methods to the particular requirements and circumstances of the bank being examined."
   The Manual does not narrowly limit administrative discretion. To the contrary, it encourages the free exercise of examiner discretion in applying knowledge, skills and abilities to particular factual situations and circumstances. The Manual, then, is a non-binding statement of policies which is not required to be published for notice and comment since it is "...not determinative of issues or rights addressed...[and does not] foreclose alternative courses of action or conclusively affect rights of private parties." Batterton v. Marshall, 648 F.2d 694 (D.C. Cir. 1980). See also, Guardian Federal Savings and Loan v. FSLIC, 589 F.2d 658 (D.C. Cir. 1978); and Jean v. Nelson 711 F.2d 1455 (11th Cir. 1983).
   While the Manual accords the examiners the use of discretion to come to their evaluation of the bank's lending policies and its loan portfolio, and while the expertise of these experienced examiners is entitled to the weight ordinarily given to the testimony of any other "expert" witness, 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 analyses, opinions and conclusions. Moreover, in a proceeding such as this, it is not enough that the examiners may have performed well enough to enable the FDIC to exercise its oversight responsibilities. While any reasonably conducted examination may serve a key role in the supervisory process in that it (1) maintains confidence in the integrity of the banking system and the individual bank; (2) protects the financial integrity of the deposit insurance fund; and (3) provides a basis for an analysis of the nature, relative seriousness and ultimate causes of a bank's problems, an examination report which stands as the foundation of litigation to determine and enforce compliance, must be held to more exacting standards.
   Here, the burden of proof is on the agency to show by a preponderance of evidence that the examiner's conclusions should be upheld as being reasonable, logical and persuasive.
   Loan classification is as much art as it is science. The examiners, as well as several other expert witnesses, all agree that the process is one which is highly subjective and that any one loan may not necessarily be accorded the same classification by two different examiners. As Professor * * * of the University of * * * concluded in his unrebutted testimony, "the case for the accuracy of bank examination classifications cannot be made." (Tr. 4432)13 The point is dramatically illustrated by the difference in conclusions reached as to loans by the State of * * *, on the one hand, and the FDIC, on the other (State loss classification was


13 Although research on examination techniques for determining the status and collectibility of loans is not extensive, Professor * * * reached the "tentative conclusion" that exam classifications are not accurate indicators for determining the ultimate collectibility of loans. According to Professor * * *, "if you take a group of banks, a sample of banks, and go through the loans that examiners classified as substandard or doubtful, and track them through their life, the interesting statistical conclusion is that in over 70 percent of the cases, those loans are fully paid off." Of the remaining 29 percent, some are partially recovered or awaiting final disposition. (Tr. 4432)
   Professor * * * pointed out that one study demonstrated that the FDIC's * * * region classified roughly three times the amount of loans classified by the * * * region as substandard (Tr. 4433). While it is possible that the * * * region "just has an awful lot of bad loans," Professor * * * felt "a little bit of uncertainty of whether we're using the same yardstick in all places." (Tr. 4434)
{{4-1-90 p.A-614}}$3.37 million less than that of the FDIC; its doubtful classification was $1.4 million more). That is not to say that the examiners' work product should not be given any deference. Indeed, in many cases the conclusions of the FDIC examiners have been admitted or upheld in their entirety, and, in all cases, they have been given complete consideration. Their conclusions, however, have not been presumed to constitute a prima facie case for upholding any classification. Rather, the rationale for each conclusion has been examined in light of cross-examination, contradictory testimony and documentation, and, as discussed below, factors and circumstances which may have affected the subjective judgment of the examiners. 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. That examiners jokingly refer to the classification summary page of the examination report as the "Ouija Board" (Tr. 692-96, 756) only points to the understandable desire for telepathic inspiration to settle close questions. But in the litigation arena, analysis and rationale have no substitute.
   Having closely observed the demeanor of the examiners as they testified, I readily conclude that they all devoted their best efforts to conduct themselves with the highest intentions of fairness, impartiality and thoroughness. They 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. However, having stated that, I also 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 "Ouija Board." While the effect may be subtle and unintentional (Tr. 4324) or candidly admitted (Tr. 688, 2109, 2117), the effect is real and is most crucial when the decision on classification is the most difficult. As detailed in the chronology of events, the following incidents of reported "apparent criminal irregularity," questionable practices and bugging of the examiners' workplace, none of which have apparently resulted in any criminal charges being brought; reported non-cooperation of Bank officials; and early predictions of insolvency, all have had some affects on the absolute impartiality of even the best intentioned examiners:
       1. As early as January and February 1983, an investigation began into a possible check kiting scheme involving a borrower with large loans which were later classified and who also had an indirect investment in Bank stock;
       2. In April 1983, Bank officials were told it would take a "miracle" to reduce the large volume of adverse classifications;
       3. In May 1983, a Bank employee, formerly with the FDIC, raised a question as to the propriety of the payment by the Bank of certain invoices14;
       4. In June 1983, the Bank was told that nothing short of formal enforcement action would resolve the findings of the February 1983 examination;
       5. In September 1983, the Bank refused to sign a consent agreement, and that refusal was taken to evidence noncooperation;
       6. In October 1983, the Bank employee who was formerly with the FDIC told examiners that their room might be monitored15; two State examiners described the examination as a "hatchet job" and a "witch hunt"; files were alleged to have been purged16; an FBI investigation was requested regarding gems which had been offered as collateral; and the condition of the Bank was determined to warrant the preparation of a Temporary Cease and Desist Order;
       7. In November 1983, a loan payoff and a deposit in cash by * * * were questioned17; the strong possibility of insolvency was noted; preparation for a bid package was called for; a temporary cease and desist order was issued on Tuesday of the week discussions on the three larg-

14 No evidence on this matter was offered at trial.

15 Based on his demeanor and testimony, I find witness not to be credible. His suspicion that the examiners' workplace might be bugged was based solely upon his recollection that six or eight months prior to the examination "a gentleman came in and checked all the phones in the Bank." (Tr. 4853) I suspect that * * * had his own reasons for making trouble for the Bank prior to his departure. (Tr. 3830-37, 3946-55)

16 There was no proof that any files were purged prior to turning them over to the examiners.

17 At trial, no issue was made of any cash payoff and deposit which may or may not have been made.
{{4-1-90 p.A-615}}
    est loans were scheduled; and the first list of specific loan classifications was provided to the Bank; and
       8. In December 1983, removal and termination of insurance were suggested as the prerequisites for corrective action; two FBI reports were received regarding three borrowers18; a note indicated that * * * possibly misled examiners about loans19; a note indicated a possible misapplication of funds by * * * and a Grand Jury investigation20; title opinions in Bank files were referred to as "suspect"; the FBI was expected to move in after examiners left to conduct an investigation into an elaborate laundering scheme21; Loss and Doubtful classifications were estimated to exceed capital by as much as $3 million; and Washington was told to prepare for a possible run on the Bank.
The existence of these events, which evidence a highly charged atmosphere of charges and countercharges, does not warrant any disregard for the diligence and work product of the examiners; rather, it calls only for that higher degree of scrutiny which is necessary to assure that each classification may be justified solely on the basis of reliable and probative evidence.
   Another factor reflecting on the accuracy of classification is the issue of "* * * banking." As the Manual notes:
       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 economics and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. (P. Ex. 2/1)
There is no serious dispute that the Bank is * * * controlled, does extensive business in Latin America and has a substantial number of Latin and Latin based customers.22 The evidence demonstrates that among the characteristics of * * * banking are (1) a customer desire for confidentiality of identity or a reluctance to reveal all personal assets on a financial statement (Tr. 749-51, 765-67); (2) a bank-customer relationship which is personal and "goes much beyond the paper that is presented and the note that is signed"; and (3) a concern for family name and reputation which is a significant factor in considering credit worthiness (Tr. 4556-58). As to loans from and to those who form the * * * exile community, one member of that community noted, "They were just made...they had an extra measure which was based on trust and knowledge and of going through the same life experience that they had gone through." (Tr. 2951-52)
   Of course, the fact that a bank is * * * does not mean that it is exempt or excused from its duty to conduct its affairs according to safe and sound banking principles and regulations. What is required by the Manual is consideration of, and sensitivity to those characteristics of Latin or Hispanic banks which differ from those of other banks, yet which do not impair safety and soundness. The State of * * * agrees that such sensitivity should be exercised by their examiners (Tr. 2306). In reading various loan write-ups, it was not at all clear that FDIC examiners gave consideration to those characteristics as they scheduled documentation deficiencies, in spite of the following comment in the September Report:
       Chairman * * * indicated during the examination that loan officers are aware of the need for accurate and current financial statements, but stated that many borrowers who now reside or who formerly resided in * * * and * * * are not accustomed to providing complete statements. Obviously the education of these borrowers in the needs of United States banking practices must be continued. (P. Ex. 17/8)
There is no indication in the body of the Report, however, as to whether any such consideration and sensitivity were given when the Bank was charged with 43 instances of failing to properly document loans (PFF 232.0-232.43). Nor is there any

18 No evidence was introduced as to any wrongdoing or finding of wrongdoing on the part of the three borrowers.

19 No evidence was introduced to indicate that examiners were misled.

20 No evidence was introduced to indicate any misapplication of funds; as a matter of fact, FDIC counsel have stated that no issue of personal dishonesty is alleged in this case as to any of the * * *.

21 No evidence of any laundering scheme was introduced at trial.

22 At the unopposed request of Respondents, I take official notice of an article in the September 1984 issue of Hispanic Business indicating that the Federal Reserve's statistical section listed the Bank as the fifth largest Hispanic- owned bank in the United States as of December 31, 1982.
{{4-1-90 p.A-616}}recognition or credibility seemingly given, or reason for the lack thereof, to the representations of the * * * as to the borrowers' ability and willingness to repay their loans or to the accuracy of their financial statements and the value of their collateral, especially in light of economic conditions in South and Central American countries in 1982 and 1983 as reflected by monetary controls, raging inflation and currency devaluations, which obviously caused cash flow problems among many of the Bank's Latin customers. Confronted with such circumstances, the Manual would seem to urge, if not direct the examiner to exercise his sound discretion to show some degree of forbearance in reviewing such loans. Certainly, in exercising that discretion, he may still schedule the credit, but he must provide some rationale if he is not to be arbitrary.
   The Manual describes loan classifications as "expressions of different degrees of a common factor, risk of nonpayment." (P. Ex. 2/12) The "Substandard" classification is defined to apply only when a loan is "inadequately protected by the sound worth and paying capacity of the obligor," on the one hand, "or of the collateral pledged," on the other, or a combination of both. Because a Substandard loan is "characterized by the distinct possibility that the bank will sustain some loss," it makes no sense to classify a loan as Substandard when it is so amply collateralized as to protect against all loss, merely because the borrower suffers a deterioration in his earnings or liquidity. The Manual recognizes that while the primary measure of risk may be the ability and willingness of the borrower to perform as agreed, "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." (P. Ex. 2/11) Consistent with this provision, the FDIC's expert witness, * * *, an FDIC examination specialist, conceded that it would be difficult for him to classify a loan as Substandard if it had a collateral value which was double the loan amount (Tr. 4819), or one which was very strong at origination and, at the time of examination had remained sufficiently strong, notwithstanding substantial deterioration (Tr. 4822). Accordingly, I have not upheld classifications which were inconsistent with these principles unless a rationale was given to depart from them. With respect to determining the adequacy of collateral, I have not rejected any MAI appraisals of real estate in the Bank's loan files merely on the basis of an examiner's opinion (See, e.g., Tr. 1305), since none of the examiners is qualified as a real estate appraiser.
   While one may find appealing Respondent's argument that the FDIC should follow the lead of the Comptroller of the Currency and "avoid classifying an entire credit Doubtful when collection of a specific portion appears highly probable" (Tr. 4581), I am constrained to follow as a reasonable exercise of discretion the policy of the FDIC to apply the Doubtful classification if collection or liquidation in full is highly questionable and improbable (P. Ex. 2/13).
   I have parted company with the examiners on the classification as Loss of all interest earned but not collected ("IENC") on loans not classified Loss themselves. The examiners have taken the position that they have the ultimate discretion to classify interest as Loss, even if the loan itself is unclassified and even if, under FDIC standards, the accrual of interest is proper. This is based on the theory that it is possible for principal to be collected while interest may not, or that it is possible that principal might be collected "down the road" and that interest should not be building up in the current period. (Tr. 1170-72, 1483-84, 2575-76, 2724-25) According to Mr. * * *, this is use of the Loss classification to adjust income (Tr. 4778-82). However, the FDIC's own standards on nonaccrual of interest, the Call Report standards, were not applied by the examiners and, were a loan to meet those standards whereby interest might permissibly be accrued, then, according to Mr. * * *, IENC should not be classified as Loss. (Tr. 4805-06) The Call Report standards are consistent with the Manual's treatment of classification as degrees of risk of nonpayment, not a method of adjustment to current income, in and of itself.
   Another FDIC expert witness and a bank holding company chief executive officer, * * *, testified that when the ultimate collection of the loan is not in doubt, he would classify IENC the same as the loan. FDIC witness * * * was instructed at the FDIC examiner school that the normal procedure for classification of IENC is to follow the classification of the underlying loan. (Tr. 4960) The State of * * * did it that way (Tr. 3431-32), and Respondent's expert es- {{4-1-90 p.A-617}}tablished that under the accrual method of accounting and its "matching" concepts, the most accurate and fair way to report IENC is to match the IENC classification with that of the underlying loan (Tr. 4598–4601).
   Consistent with these principles, and as set forth in Table II, I have found that there is no evidence of record to justify the classification of IENC where the underlying loan does not warrant classification and I have not classified any IENC which was actually paid during the course of the examination. All other IENC has been classified according to the underlying loan classification in the absence of any evidence justifying a more severe classification.
   Consistent with the preceding discussion, Table I, which follows, presents my conclusions as to the most severe classification which may be justified for the listed loans based on the evidence of record and in accordance with the principle that the burden of proof with respect to justifying a classification is on the FDIC. In accordance with the agreement of the parties, reached on the basis of the sheer volume of this record (some 14,000 pages) and the desire for an expeditious decision, detailed subsidiary findings of fact as to each loan have not been made. Rather, as to those classifications admitted by Respondents and those upheld as proposed by the FDIC, resort may be had to the Proposed Findings of Fact of Proponent (FDIC) which are numbered beginning with the number shown in the column to the left of the named loan. As to all other classifications, resort may be had to the Footnotes to Classification Conclusions, which immediately follow the table. The Footnotes contain narrative comments as well as references to the Proposed Findings of Fact of Proponent (PFF), to the Response to the Proposed Findings of Fact of Proponent (RPFF), to the exhibits (P. Ex. ____, or R. Ex. ____,), or to the transcript (Tr. ____), which are principally relied upon to reach the classification conclusion.23 By that agreement, those Findings of Fact and Responses to which reference has been made in the Footnotes are adopted and incorporated by reference into this decision as if they had been written out in full.24
   Having given full consideration to all evidence relating to the loan files up to and including December 16, 1983, the last day of the September 30 examination period, and as displayed in Table I, I conclude that justification has been shown to classify loans amounting to $15,926,300 as Substandard, $435,000 as Doubtful and $1,377,400 as Loss; and assets amounting to $16,700,600 as Substandard, $435,000 as Doubtful and $1,478,700 as Loss.

Unsafe or Unsound Banking Practices

   As one predicate for the issuance of a cease and desist order, the FDIC alleges that the Bank has engaged in five categories of unsafe or unsound banking practices. Although the term "unsafe or unsound banking practice" is undefined by statute, it


23 A multipage exhibit is referred to first by its number, followed by a / and the page number of the exhibit, e.g., P. Ex. 17/246.

24 Proponent argues, at Footnote 2 of its Brief, that Respondents, in their responses to proposed findings of fact, have failed to comply with the requirements of the prehearing conference order, as well as with Rule 36 of the Federal Rules of Civil Procedure, calling for specific admissions or denials, giving nonconclusory and nonargumentative reasons upon which any denial is based. By letter dated October 3, 1984, Respondents argue that the issue is untimely raised, that it has therefore been waived, that Rule 36 does not apply, and that, in any event, the responses to proposed findings of fact meet the requirements of the prehearing conference order. By rejoinder dated October 5, 1984, Proponent argues that "the only reason our position was not raised formally prior to the hearing was because of the expedited nature of the proceeding and the lack of sufficient opportunity to properly research the matter." This is basically the same argument raised by Respondents to urge that, assuming any defective responses, they were unintentional and, in view of time constraints, Proponent could have alleged prejudice and asked for amended responses.
   I believe that counsel for both sides should be commended for doing an outstanding job of trying a lengthy case involving a myriad of complex issues under severe time constraints. Under such circumstances, certain errors and omissions are to be expected and have occurred on both sides. However, in view of the professional competence and decorum displayed, sanctions are not warranted on this issue or any other which has, or could be raised by either side.
   To take all of the so-called "A2" findings Proponent urges be considered as admitted would not give full consideration to the testimony and exhibits received at trial, to the sponsorship of those responses as set forth on page 2 of the Appendix to Respondents' Post-trial Brief pursuant to the stipulation of the parties, or to the Proponent's Response to Respondents' New Findings. On the other hand, it would not be appropriate to accept argumentative or unsupported assertions of counsel as evidence. Accordingly, I have considered only those assertions of counsel which have been sponsored, are factual, are corroborated by other evidence, or are admitted (with or without confirmation) by the other side.
{{4-1-90 p.A-618}}is well recognized in banking parlance and its interpretation by bank regulators has been recognized by the courts. The following quotation, from a memorandum authored by the then Chairman of the Federal Home Loan Bank Board, John E. Horne, and which received Congressional approval during hearings on amending Section 8 of the Act, may be considered archetypical:
       Generally speaking, an "unsafe or unsound practice" embraces any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.25
Accord, First National Bank of Eden v. Department of the Treasury, 568 F.2d 610 (8th Cir. 1978); and First National Bank of LaMarque v. Smith, 610 F.2d 1258 (5th Cir. 1980). And in Independent Bankers Association v. Heimann, 613 F.2d 1164, 1169 (D.C. Cir. 1979), the Court held that the regulator's "discretionary authority to define and eliminate `unsafe and unsound' conduct is to be liberally construed."
   Findings and conclusions as to the five categories of alleged unsafe and unsound banking practices follow:

   I. Hazardous lending and lax collection
practices

   At the outset I should note that the allegations of hazardous lending and lax collection practices consist of simple, straightforward declarations that the Bank engaged in a particular practice on a specified number of occasions. Aside from a reference to the particular page of the September Report, there are no subsidiary findings proposed, nor is there an abundance of testimony26 or argument on brief to indicate how any alleged practice, which if continued, would result in abnormal risk or loss or damage to an institution, its shareholders, or the agency administering the insurance fund.
   Respondents admit, as alleged, that as of September 30, 1983, Bank loans totaling almost $12 million were overdue for 30 days or more, including loans totaling $4,298,000 that were overdue for six months or more (PFF 13.1). The fact that over 18 percent of total loans were overdue is, of itself, disturbing. However, having examined the individual loan files, I further conclude that the proportion of overdue loans for which untimely collection is a result of Bank inaction or inattention is so great as to constitute an unsound practice.
   Respondents deny allegations relating to the 99 loans and nine separate practices which are displayed by matrix in Table III which follows. Each loan is listed by the name of the borrower and a citation to each of Proponent's Proposed Findings of Fact which alleges a hazardous lending or lax collection practice. Since the allegations, for the most part, appear to be based on the underlying classification of the examiner, I have noted in the next set of columns the classification conclusion which I have come to and which is taken from Table I and the accompanying footnotes to that table. 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. In most cases where the allegation is not upheld, the reference in the far right column is to the particular footnote to Table I which is relied upon to support the decision not to uphold the allegation. In other cases where the allegation is not upheld.

    234.0 - renewing loans without collecting interest due thereon, but adding such interest to the balance of renewed loans; 12 instances alleged, 10 upheld;
    235.0 - extending credit by paying overdrafts to provide funds for the payment of interest due on loans; 15 instances alleged, nine upheld;
    236.0 - accruing interest income on loans notwithstanding the overdue status of such loans and the doubtful collection of interest on such loans; seven instances alleged, two upheld; and
    237.0 - 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.

25 Financial Institution Supervisory Act of 1966: Hearings on S.3158 Before the House Committee on Banking and Currency, 89th Cong., 2d Sess., at 49–50 (1966).

26 I am not unmindful of Tr. 1010-17.
{{4-1-90 p.A-619}}

TABLE III

   S = Substandard
   D = Doubtful
   L = Loss

FDIC Findings
ALLEGED HAZARDOUS CLASSIFICATION FDIC PROPOSED Not Upheld
LENDING AND LAX CONCLUSION FINDINGS UPHELD (See Footnote
COLLECTION PRACTICES (From Table I) to Table I

NONE S D L 10.0 11.0 12.0 232.0 233.0 234.0 235.0 236.0 237.0 or other ref.)
10.1, 11.1, 234.1, 235.1, 236.1 X X X (1)
232.1, 234.2 X X X
10.2, 232.2 X X X
10.3, 11.2, 12.1, 232.3, 237.1 X X X X X
232.4 X R. Ex. 21.6
10.4, 11.3, 12.2, 237.2 X (7)
10.5, 11.4, 235.2, 237.3 X X (8)
10.6, 11.5, 12.3 X (9)
10.7, 12.4, 237.4 X X X X (10)
10.8 X X
232.5 X X
232.6 X X
10.9, 237.5 X (12)
10.10, 232.9, 233.1 X (13)
10.11, 232.10 X X (14)
10.12, 11.6 X X (15)
10.13, 233.2 X (16)
10.14, 232.7 X (17);
R. Ex. 37.6
10.15, 11.7, 232.11 X X (18)
in Trust For 10.16, 11.8 X X (19)
10.18, 237.6 X X RPFF 40.6
10.17 X (20)
10.19 X (21)
10.20, 232.8 X X X
10.21 X X
10.22, 11.9 X X X
10.23, 12.5, 232.12 X (22)
10.24 X (23)
10.25 X (24)
10.26 X X
11.10, 232.13, 237.7 X X X X
236.2 X X X
12.6 X X
237.10 X RPFF 54.5
10.27, 12.7, 232.14, 234.3, 235.3, 237.8 X X X X (28)
10.28, 12.8, 232.15 X X R. Ex. 56.2;
Tr. 4017-19
10.29, 12.9, 232.16 X X X (29)
10.30, 12.10, 232.17, 234.4, 235.4, 237.11 X (30)

{{4-1-90 p.A-620}}

FDIC Findings
ALLEGED HAZARDOUS CLASSIFICATION FDIC PROPOSED Not Upheld
LENDING AND LAX CONCLUSION FINDINGS UPHELD (See Footnote
COLLECTION PRACTICES (From Table I) to Table I

NONE S D L 10.0 11.0 12.0 232.0 233.0 234.0 235.0 236.0 237.0 or other ref.)
10.31, 11.11, 232.18, 234.5, 236.3, 237.9 X X X X X X
10.32, 11.12, 232.19, 235.5, 236.4 X X (31)
10.33, 232.20, 235.6, 237.12 X X X X (33)
10.34, 11.13, 235.7 X X Tr. 4615-19
11.14, 232.21, 233.3 X X X X
11.15, 232.22, 236.5 X X X
11.16 X X
10.35, 11.17, 12.11, 234.7 X X (36)
10.36, 11.18, 232.23 X X X X
10.37, 232.24, 234.8 X X X X
10.38, 232.25 X X X
10.39, 232.26 X X X
10.40, 12.12 X (39)
10.41, 232.27 X X (40)
10.42 X (41)
10.43, 11.19, 12.13, 232.28, 234.9, 235.8, 236.6, X X X X X X X X X X
237.13
10.44, 232.29, 237.14 X X X
10.45, 12.14 X X X
10.46, 232.30, 234.10, 235.9 X X X X
10.47 X X
10.48, 233.4 X X RPFF 85.8
10.49 X X
10.50 X X
10.51, 11.20, 233.5 X X X X
10.52, 232.31 X X (44);
PFF 89.2
10.57, 232.32, 233.8 X X X RPFF 4
11.21 X X X
10.58, 232.33 X X X
10.59, 235.10, 237.17 X X (47)
10.60, 11.22 X X
10.61, 12.15 X X (48)
10.62, 233.6 X X X
10.63, 11.23 X (49)
10.64, 232.34 X X (50)
10.53, 233.7 X X
10.54, 237.18 X X (51)
10.55, 12.16, 232.35, 237.19 X X X X (52)
10.56 X X
232.36 X X
10.65 X X
234.11 X X
10.66, 2324.6, 237.15 X X X X
10.67, 11.24, 235.11, 236.7, 237.16 X X X X X

{{4-1-90 p.A-621}}

FDIC Findings
ALLEGED HAZARDOUS CLASSIFICATION FDIC PROPOSED Not Upheld
LENDING AND LAX CONCLUSION FINDINGS UPHELD (See Footnote
COLLECTION PRACTICES (From Table I) to Table I

NONE S D L 10.0 11.0 12.0 232.0 233.0 234.0 235.0 236.0 237.0 or other ref.)
232.37 X X

   II. Failure to properly charge off or elimi-
nate non-bankable assets

   These allegations are, of course, grounded on the FDIC's classification of assets as Loss or Doubtful. The Bank does not dispute that it has an obligation to charge off all Loss classifications and, if established that it is under such an obligation, to charge off one-half of Doubtful. The Bank further argues that it has charged off all items required by the MOU with the State and that it will comply with the ultimate charge off figure reached in these proceedings. (RPFF 394.1) Of the 23 instances where the Bank is alleged to have failed to charge off or eliminate assets from its books, 10 had been charged off during the examination (RPFF 226.0), and four others concerned Loss classifications which were not upheld.
   Based on the findings in Table I, I conclude that the Bank was under an obligation to charge off $1,478,700 in assets classified Loss and $217,500 in assets classified Doubtful.

   III. Failure to provide and maintain an
adequate reserve for loan losses

   There is no dispute that the loan loss reserve of the Bank as of September 30, 1983 was only $400,000. Its sufficiency to cover all of Loss and one-half Doubtful, of course, rests on a determination of those classifications. Consistent with the findings in Table I, I conclude that the loan loss reserve was insufficient by $1,194,900 to cover all loans classified Loss and one-half of those classified Doubtful.
   Although it is true that there was also no provision in the Bank's reserve for loan losses for any loans classified Substandard, there is no FDIC, State or any other regulatory policy requiring such a provision, nor is there any regulatory requirement that any portion of Substandard loans be charged off against current income. Moreover, there is no reliable or probative evidence of record upon which one could predict, with any degree of certainty, any amount of loss which would be sustained with respect to loans classified Substandard. While it might be prudent to add to reserves an amount equal to one percent of nonclassified loans (Tr. 4593), which in this case would amount to $481,653, there has been no showing on this record that failing to include in loan loss reserve this amount or an amount equal to 10 to 15 percent of Substandard loans would amount to "an abnormal risk" to the Bank, its customers or the FDIC. Although the September examination showed that the Bank continued to compare favorably with its peer group with respect to the ratio of its reserve to total loans, it is obvious that, due to the volume of classified loans, the loan loss reserve was clearly inadequate. Notwithstanding the contest with the FDIC over classifications, it is clear from this record that attention needs to be paid on a continuing basis to the size of the reserve as it relates to the condition of the Bank's portfolio. There is an obvious need for the Bank to develop guidelines to determine the adequacy of the reserve on a quarterly basis and to be able to document its reasons for selecting the reserve level so that it may comply with Call Report Instructions.

   IV. Failure to provide and maintain an
adequate level of capital protection.

   Again, this allegation rests on the assumption that the conclusions of the September Report will be upheld and that it is correct to find (1) that adjusted equity capital and reserves of the Bank amounted only to $161,000 or .17 percent of adjusted total assets, and (2) that the Bank had adversely classified assets totaling $32,246,000, which equaled 581.1 percent of the Bank's total equity capital and reserves. The argument advanced is that these ratios indicate an inadequate and therefore unsound level of capital protection which exposes shareholders and depositors to extreme risk of loss. Finally, Proponent argues that total dissipation of capital and reserve was avoided "only by the injection of $2 million of capital in January of 1984."
   As can readily be seen from Table IV, Analysis of Financial Condition, on page 78, I have concluded that the results of the {{4-1-90 p.A-622}}examination justify a finding that as of September 30, 1983, total adjusted equity capital and reserves of the Bank amounted to $3,852,800 or 3.87 percent of adjusted total assets. That conclusion was based on a finding that the Bank had adversely classified assets totaling $18,614,300, which equaled 335.45 percent of total equity capital and reserves.
   The numbers are relatively easy to determine. The answer to the question of what constitutes adequate capital is as elusive as the Holy Grail. In discussing the prolonged debate over the subject among regulatory authorities, bankers, industry analysts and others, the Manual notes:

       ...One major consensus has emerged from this extensive discourse; it is that no single capital adequacy ratio or even set of ratios can be considered to provide a uniform standard that can be universally applied to all banks in all situations. This is the case for the simple but important reason that banks are too dissimilar in asset quality and distribution, management competency, liability composition, local operating environment, and in many other respects, to permit use of standards based on one or a few criteria only. Therefore, if any generalization on the subject may be made at all, it is that capital of any given bank should be sufficient to support the volume, type and character of the business presently conducted, provide for the possibilities of loss inherent therein, and permit the bank to continue to meet the reasonable credit requirements of the area served. (Section G, p.1.)
   Respondents' expert, Professor * * *, agrees that there is no universally agreed upon formula for determining what is an adequate amount of capital, and he gave examples of banks (most regional, but some made up of smaller banks) generally recognized to have been well-managed, with capital ratios of an average 4.3 percent, well below the FDIC's minimum standards of 5 to 6 percent for well-managed banks (Tr. 4436-39).
   The difficulty in ascertaining capital adequacy in this case is that the examination report and the testimony offered by experts for the Proponent speak only to the numbers and ratios. The other concerns, noted in the above quotation from the Manual, are not addressed. Therefore, looking at the numbers and ratios alone, my conclusion as to capital adequacy is that, as of September 30, 1983, it may have been inadequate. This conundrum is resolved, however, if we stretch slightly beyond the close of the examination, to February of 1984. The injection of $2 million in capital during that month,27 brings adjusted equity capital and reserves to $5,852,800 or 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. And if one considers that an additional $1 million was to have been infused by October 25, 1984 (in accordance with the MOU), the figures would rise to approximately $6,852,800 and 6.88 percent.

   V. Failure to maintain adequate liquidity

   It is not disputed that, as of September 30, 1983, the Bank was dependent upon potentially volatile deposit liabilities to fund loans and other assets of the Bank. At that time it had short term, rate sensitive certificates of deposit of $100,000 or more equaling more than 61 percent of the Bank's total deposits, which resulted in a liability dependency ratio of 54.8 percent. While the conclusion may be warranted that this is "unsatisfactory" (Tr. 1031-33), it does not warrant a finding of an unsafe or unsound practice since this "snapshop" taken as of September 30, 1983, does not place the picture in proper perspective.


27 There was considerable testimony and documentary evidence introduced on the issue of this $2 million of infused capital. The issue arose over the net effect of a land swap of the Bank premises for a property known as the "* * *" which is located in an exclusive section of * * * where a number of international banks have established offices. The FDIC interposed the * * * issue as rebuttal to the Bank's affirmative defense that it had infused $2 million in cash into the Bank's capital accounts. Since an appraisal of the * * *, obtained by the FDIC, claimed a value only of $1.6 million, the argument was advanced that the net affect of the swap was a loss to the Bank since it swapped property worth $2.5 million. However, that appraisal, which was based on assumptions regarding zoning restrictions, which I conclude are unwarranted, was $3.195 million less than the appraisal which was obtained by the Bank. Footnote 14 to Proponent's Brief renders any further discussion of this issue unnecessary in that it concedes that the $2 million was infused into the capital accounts of the Bank. That footnote concludes that "additional evidence is needed and that until such information is obtained, a final conclusion cannot be drawn relevant to this proceeding regarding the financial impact of the property exchange..." (emphasis in the original). This conclusion is consistent with mine that the * * * appraisal of $4.795 million (P. Ex. 109) has not been shown to be unreasonable.
{{4-1-90 p.A-623}}
   As noted in the Chronology, at paragraph 5, in March 1983, the FDIC approved the Bank's revised Investment-Liquidity Policy which had been submitted pursuant to FDIC recommendations. That policy was also approved by the State that same month. The following figures, which I adopted from RPFF 247.1-4, show a dramatic improvement in this area:

Large Deposits ($000's) Volatile Liability
% of Total Amount Dependence Ratio
December 31, 1982 74% $43,292 71.55%
September 30, 1983 61% 55,865 54.80%
December 31, 1983 48% 52,909 35.25%
April 30, 1984 38% 35,687 31.64%
9-30-83 3-31-83
ASSETS ($000's): ($000's)
Maturing within one year $70,530 $74,799
Maturing over one year 13,951 16,652
_______ _______
$84,481 $91,451
_______ _______
LIABILITIES
Maturing within one year $56,683 $62,736
Maturing over one year 2,137 8,987
_______ _______
$58,820 $71,723
_______ _______

Violations of Law

   Under Section 8(b) of the Act, Congress empowered the FDIC to initiate an action for the issuance of a cease and desist order for a violation of "a law, rule, or regulation." The Statute does not limit that authority to violations of State law, and the FDIC has interpreted the cited section to include violations of applicable State law. No contrary interpretation has been cited by Respondents.
   On brief, Proponent alleges five categories of violations of * * * State law, which are discussed below, seriatim. Since all five categories of violations are civil in nature, I have examined the evidence and come to conclusions by determining whether the FDIC has met its burden of proving, by a preponderance of the evidence, that a State law has been violated. Where it has met its initial burden of coming forward with evidence upon which I could conclude that there was a violation, whether adduced directly or by permissible inference or presumption, I have considered that the burden then shifted to Respondents to counter that evidence and, if countered, to again put the onus on Proponent to offer rebuttal.

   I. Loans of the Bank in excess of the legal
lending limit

   The applicable law is Section 658.48 of the Statutes which provides, in pertinent part:
   (2) Loans to other persons.—
   (a) No bank shall lend to any person [not an officer or director of the bank] any amount which would exceed the following limitations:

       1. Ten percent of the capital accounts of the lending bank for loans and lines of credit which are unsecured and 25 percent of the capital accounts for loans and lines of credit, all components of which are amply and entirely secured; and
       2. When outstanding loans consist of both secured and unsecured portions, the secured and unsecured portions of the loans together may not exceed 25 percent of the capital accounts of the lending bank, and the unsecured portion of the loan may not exceed 10 percent of the capital accounts of the lending bank.
{{4-1-90 p.A-624}}
   (3) Computing total liabilities.—In computing the total liabilities of any person, partnership, or corporation subject to the limitations provided in this section, there shall be included all loans endorsed or guaranteed as to repayment and all loans to any person, partnership, or corporation if such person, partnership, or corporation, directly or indirectly or acting through or in concert with one or more persons, partnerships, or corporations:
       (a) Owns, controls, or has the power to vote 25 percent or more of any class of voting securities of the borrower;
       (b) Controls in any manner the election of a majority of the directors of the borrower; or
       (c) Has the power to exercise a controlling influence over the management or policies of such borrower.
   (5) Applicability of loan limitation.—The loan limitations otherwise provided in this section shall not apply to:
       (a) Loans which are fully secured by assignment of a savings account or certificate of deposit of the lending bank.
   Preliminarily, I should note two matters. First, I have concluded that for lending limitation purposes, the Street Capital (see par. 15 of the Chronology) should be included, as of June 14, 1983, in the computation of the Bank's capital accounts. The August 31, 1983 memorandum and related documents which booked the Street Capital as of June 14 provided all the necessary documentation to justify its booking as of that date (R. Exs. 250.3 and 419). The testimony of Messrs. * * * (Tr. 2334-35, 2407-09) and * * * (Tr. 4560-62) confirm that the retroactive booking was consistent with proper accounting principles and * * * law. Second, although my conclusions will speak for themselves, there is an unexplained inconsistency between Proponent's Brief, at p. 30, which alleges 37 violations of the State lending limitations, on the one hand, and, on the other, the first page of the September Report, at line 32 (P. Ex. 17/1), which alleges only 25 violations involving four different laws, and that in contrast to the column indicating that in February 1983, 52 violations of eight State laws occurred. That same page of the Brief alleges that there is evidence of at least 38 violations of the * * * State lending limitations discovered during the February 4, 1983 examination. The State Report of May 1984 noted a continuing improvement, listing three overlines, five loans needing board approval and two loans needing to be charged off. (R. Ex. 441)
   Seven of the alleged violations listed in the Report involve * * * and interests which are attributed to his ownership and/or control. (PFF 248.1 - 254.2).
   In a 1981 10-K Report of * * * Corporation ("* * *"), the following appears on page 60 under the heading, Changes in Control:
       By reason of their stock holdings and positions with the Company, * * *, Chairman of the Board of Directors, and * * *, Vice Chairman of the Board of Directors, may each be deemed to be a control person of the Company. (P. Ex. 53/136).
   Page 48 of that same 10-K states, in pertinent part:
       During 1982, * * * ("* * *") a corporation wholly-owned by Mr. * * * and Mr. * * *, loaned $945,000 directly to the Company to be used by the Company to pay expenses and debts when due.
       Mr. * * *, certain corporations owned or controlled by him, Mr. * * * and * * * (the "inside Lenders") have borrowed from banks...most of the funds they have advanced to or on behalf of the Company...(P. Ex. 53/124).
The 10-K was signed by * * * in his capacities as Vice Chairman of the Board of Directors, Chairman of the Executive Committee of the Board of Directors and Chief Executive Officer (P. Ex. 53/139).
   It is obvious that an examiner, in the reasonable discharge of his duties, cannot keep informed on a day-to-day basis, of every shift in ownership or control of various entities for the purpose of determining which loan lines may be aggregated for lending limitation purposes. That is especially true when the information is spread throughout numerous geographical locations and not under the control of the bank being examined. Under such circumstances, and where sufficient indicia of ownership and control are present, the examiner should be entitled to infer ownership and control, thus shifting the burden to the Bank to come forward with evidence to show why that inference is impermissible or that ownership or control does not, in fact, exist.
{{4-1-90 p.A-625}}
   Here, the issue of control is so similar in nature for SEC purposes as it is for State banking purposes that it is reasonable to conclude that * * * controls and by virtue of its ownership as detailed in the 10-K, that he also controls * * * and * * *. Mr. * * *'s relationship with * * *, the history of his involvement with it and the offices he holds with * * *, taken together, warrant that conclusion.
   It may be somewhat disingenuous to suggest that the statement that Mr. * * * "may ...be deemed" to control * * * means only that it is possible that he does. In common legal parlance "may" is read to mean "shall" or "must." It does not rebut Proponent's prima facie showing of control to point out the absence of any mention of any ownership on an unaudited, out of date financial statement. Clearly, the burden on Respondents is greater.
   With regard to * * *, the fact that Mr. * * * signed two documents as president of * * * does not, standing alone, demonstrate sufficient indicia of ownership or control, to warrant any inference that he does, in fact, own or control * * *. As to * * *, however, the statement in the 10-K, coupled with the interlocking business relationships of * * *, * * *, * * * and * * *, give sufficient indicia of control to shift the burden of persuasion.
   Accordingly, I conclude that five violations were shown by the overlines which occurred on February 10, 1983; March 25, 1983; July 29, 1983; September 13, 1983; and September 30, 1983, when the liabilities of * * * were aggregated with those of * * *, * * *, * * * and * * *.
   Four alleged overline violations were based on aggregating liabilities of * * *, * * * and * * * (PFF 255.1 - 258.2). However, on the basis of the Responses to those Proposed Findings of Fact, I conclude that no violations were proved since (1) the examiners included loans secured by savings accounts or certificates of deposits (* * * § 658.48(5)), and (2) the * * * guarantee was orally modified to exclude the $350,000 loan to * * *, consistent with State law which provides that while the guarantee must be in writing, written evidence of its termination or modification need not. See, e.g., Fidelity and Deposit Company of Md. v. Tom Murphy Construction 674 F.2d 880, 884-86 (11th Cir. 1982).
   Three alleged overline violations concerned * * * (PFF 259.1 - 261.2). However, I conclude that none was proved since there is no evidence that any guarantee of * * *'s debts by Mr. * * * was in effect at the time the $195,000 loan was made to * * *. No guarantee was offered in evidence although it is clear that, at some unspecified time on or prior to August 8, 1983, a guarantee, which purportedly had been in existence, was released.
   I conclude that no violation occurred as alleged in PFF 262.1 —262.2 since the obligations of * * * as Trustee are separate and not aggregable with those of his as an individual (Tr. 2488-89).
   The mere fact that an individual is an officer of a company and owns demonstrably less than 25 percent of that company is not sufficient evidence to allow for debt aggregation under * * * § 658.48(3). Consistent with RPFF 263.7, I conclude that no violation was shown since control by Mr. * * * of * * * was not proved and the advance in the name of * * * was improperly aggregated.
   I find no violations of lending limits with respect to * * * because the drafts were secured and, therefore, the totals were within the lending limits (RPFF 264.5-.6; 265.1-.2).
   The "two tiered aggregation theory," whereby violations were alleged as a result of * * *'s guarantee of the debts of * * * which, in turn, guaranteed the debts of * * * and * * * is a perfectly reasonable view of the * * * Statute (§ 658.48(3)), since the guarantees extend to all debts, direct or indirect, and it is clear that the Bank would have recourse back through the chain of guarantors should any debtor default. As noted above, under * * * law, a guarantee may be modified rather easily and it is not unreasonable to expect banks to document any such modification. The record does not warrant a finding that any such modification was made at the time of the violation. I conclude, therefore, that three violations were shown (PFF 266–268).
   * * * guaranteed the direct and indirect liabilities of * * * and, as admitted, it is therefore proper to aggregate their liabilities and to find a State law violation as of * * * 1983, as alleged (RPFF 273.2). However, four other allegations are not proved since Mr. * * * owns only 23 percent of * * * {{4-1-90 p.A-626}}and * * * and 23 percent of * * * (PFF 269.2; RPFF 269.5). The additional fact that he is also an officer and director does not permit any inference of control. One could as easily infer that he is a minority shareholder who holds office at the sufferance of the majority.
   On the basis of the two tiered aggregation theory, I conclude that two violations involving the * * * and their related interests, were proved as alleged in PFF 274.1 -275.3.
   No finding of either violation is upheld regarding * * * because the debt was secured and the guarantee of the debt of * * * of * * * had been discharged. (RPFF 276.3-.8).
   In summary, I conclude that 11 of the 37 violations alleged to have occurred during the September examination have been proved.
   Proposed Findings of Fact 319 through 349 allege violations of State lending limitations listed in the February 4, 1983 examination.
   The Bank's files contained a financial statement for * * * dated October 31, 1981, which shows stockholder equity of only $148,000. The files also contained a personal financial statement of * * *, dated December 31, 1981, which shows an equity interest in * * * of $250,000 (P. Ex. 20).
   However, the examiners were also aware from their investigation of other credit files that a personal financial statement of * * *, dated November 16, 1983, asserted stockholder equity in * * * in the amount of $148,000, the same amount shown as total equity on the financial statement of * * * (P. Ex. 22/22). Under those circumstances it was not shown directly, nor could one reasonably infer what percentage of ownership Mr. * * * might have had in * * * as of July 23, 1982. Consequently, I conclude that none of the violations has been shown to have occurred as alleged in PFF 319–321.
   Three other violations were proved as alleged in Proposed Findings of Fact 322 –324. As discussed previously, in the absence of evidence to the contrary, the examiners reasonably found * * * to control * * * and * * * and, therefore, properly aggregated their loans.
   Two violations were proved as alleged concerning * * *, * * * and * * * (PFF 325 and 326). These debts were properly aggregated since it is admitted that Mr. * * * guaranteed the obligations of * * * and the evidence shows that, as late as April 19, 1982, Mr. * * * owned 6,000 of the 9,000 issued shares of * * * (P. Ex. 22/32). No evidence of ownership changes at the time of the violations was introduced (sic).
   The alleged violations relating to * * * (PFF 327 – 329) were not proved. Merely because he is a stockholder of * * * does not demonstrate that he is personally liable for any debts guaranteed by that corporate entity. Neither does paying a bill on behalf of * * * demonstrate ownership or control over that company.
   As to the five violations alleged in PFF 330 – 334, none is found to have occurred since the $800,000 debt of * * * was not shown to be properly aggregated. The evidence demonstrated only that * * * was an officer of the company with authority to borrow on its behalf.
   Since there was no delivery of the certificate of deposit, the two alleged violations relating to * * * were not proved. (RPFF 335.1-.4; 336).
   The alleged violation as of * * * 1983, regarding * * *, was not proved since the guarantees of * * * and * * * were dated April 6, 1983. (P. Ex. 26).
   Two violations regarding * * * were not shown because the examiners should not have aggregated the $150,000 loan to him as Trustee. (RPFF 338.4, 339.2). One violation was proved, however, since the $200,000 overdraft was guaranteed by him and was not secured by a certificate of deposit. The Bank's misunderstanding of * * * law is not an excuse. (PFF 340.2-.3).
   One violation attributed to Mr. * * * and interest was not proved because the guarantee of * * * was not operative (PRFF 341.3-.4); the other was admitted (RPFF 342.2).
   Because the loans to * * * and * * * were secured, no violation was proved (RPFF 343.1 and 344.4).
   The violation regarding * * * and * * * was admitted (RPFF 345.1-.8).
   Four violations were proved regarding the * * * interests because of the two-tiered guarantees (PFF 346.1 – 349.2).
   In summary, I conclude that 12 of the 31 violations alleged in the February Report were proved at trial.
{{4-1-90 p.A-627}}

       II. Loans to Bank officers without ap-
    proval of the board of directors of the
    Bank

   The overdrafts alleged to violate * * * law occurred in August and September 1983 and ranged from $3 to $1697.28 The three violations are alleged to have resulted from lack of preapproval by the Board of Directors of the Bank. The evidence shows that these were * * * Accounts, approved by the Board of Directors and which required repayment of principal and interest (R. Ex. 278.5). Debit memos on the accounts indicate interest payments and therefore, the violations were not proved.

       III. Loans of the Bank secured by ju-
    nior mortgages in excess of the legal limit
    of the Bank

   This allegation of a single violation concerns a loan of $620,000 made to * * * on March 7, 1983, and secured by a second lien on real property. According to the Statute, such a loan is not to exceed 10 percent of the capital accounts of the bank (* * * § 658.48(4)(d)4). On March 7, 1983, 10 percent of the capital accounts of the Bank equaled $404,000. Of the $216,000 which appeared to exceed the limit, $26,000 cannot be included since it was secured by a certificate of deposit (* * * § 658.48(5)(a)), and as of March 14, 1983, $189,000 was also secured by the assignment of a certificate of deposit. (R. Ex. 255.1) This hypertechnical violation, which after the seventh day exceeded the loan limit by only $1,000 and which the State did not take seriously (Tr. 2331-32), could have been remedied in an ironic fashion. If the Bank had loaned the money on an unsecured basis, there would have been no violation of the lending limit. It is only because the Bank improved its position that the violation occurred at all De minimis non curat lex.

       IV. Assets booked and carried by the
    Bank in excess of the legal limit

   As of the close of the examination, no violations were shown to exist. The estimated shortage of $27,000 for the five repossessions/loans was adjusted during the examination in accordance with Bank practice (RPFF 282.2). The examination report noted that the $21,000 in installment loan deficiency balances of six loans was approved for charge off during the examination (P. Ex. 17/254). They were charged off in accordance with the normal practice of the Bank (RPFF 282.3).

       V. Loans carried as assets on the books
    of the Bank required to be charged off

   No violation of * * * § 658.52 was shown with regard to loans to * * * and * * *, since no consideration was given to the exception in the statute which provides that past due paper may continue to be carried on the books to the extent of the reasonable value of the collateral and, if it is in the process of collection, at its reasonable value as determined by the board of directors. (RPFF.350.6-.8; 351.7; R. Ex. 350.7; Tr. 2034-29)
   The following is a list of admitted statutory bad debts by Proposed Finding number, amount, and designation as an American Express Account (AE) or * * *); all have been either charged off or paid up by the borrowers:

PFF 353- $2,000 (AE)
PFF 354- 622 (AE)
PFF 355- 1,131 (AE)
PFF 356- 1,799 (AE)
PFF 357- 1,562 (AE)
PFF 358- $3,574 (AE)
PFF 359- 2,062 (AE)
PFF 360- 2,451 (SA)
PFF 361- 2,312 (SA)
PFF 362- 124 (SA)

       VI. Failure of the Bank to maintain
    minimum liquidity reserves

   The Bank admits that due to large, unexpected deposit withdrawals in December 1982, it experienced temporary liquidity reserve deficiencies for a period of eleven days. During that time the Bank did not

28 Because the * * * legislature has recognized the rather petty nature of violations of this sort, the statute has been amended effective October 1, 1984 to permit loans to officers or directors without approval being required by the bank's Board of Directors where the amount of the loan does not exceed $25,000. * * * laws of 1984, Chapter 84-216, § 30 (effective October 1, 1984) provides: "no loan in excess of $25,000 shall be made to an executive officer or director unless previously approved by the board of directors"; replacing the prior version of the statute which stated that "no such loan shall be made in any amount unless previously approved by the board of directors"). See, Otero Savings and Loan Association v. Federal Home Loan Bank Board, 665 F.2d 279, 289 (10th Cir. 1981) (federal financial institutions' statutory authorization for orders to cease and desist "do not grant power to restrict presently lawful conduct in attempting to readjust competitive conditions claimed to have been disturbed by past conduct. Such power to adjust for competitive effects of past conduct by a penalty box remedy is not contemplated by the statute").
{{4-1-90 p.A-628}}have to borrow Federal funds from correspondents, or otherwise from the Federal Reserve Bank or other sources to meet its actual liquidity needs. (RPFF 363.1 - 370.2; Tr. 2045). The following is a list of violations alleged by Proposed Finding number, date and amount of deficiency:

PFF 363.2 December 9, 1982 - $1,283,008
PFF 364.2 December 10, 1982 - 1,184,385
PFF 365.2 December 13, 1982 - 1,506,599
PFF 366.2 December 14, 1982 - 2,168,183
PFF 367.2 December 15, 1982 - 2,579,681
PFF 368.2 December 16, 1982 - 2,685,832
PFF 369.2 December 17, 1982 - 946,120
PFF 370.2 December 20, 1982 - 259,292

       VII. Sale of Federal funds in excess of
    the legal limit

   Two instances are alleged of one or two days' duration (PFF 374.1 – 375.2). The limit was $4,040,000 but the Bank sold $4,250,000. The evidence does not support the Bank's contention that the purchasing (borrowing) banks were acting as agents rather than as principals (Tr. 1767-68), therefore a minor violation was proved.

       VIII. Deposit of the Bank in a savings
    and loan association in excess of legal
    limit

   The Bank admits a violation as of January 28, 1983 and February 4, 1983. It took steps to reduce the total investment by attrition over the next few months.

Remedies

   A. Cease and Desist Order

   The purpose of formal corrective action in the form of a Cease and Desist Order is not to punish for past practices, but rather to insure that in the future the public will be protected, and that the public interest in the issuance of such an order requires that there be some reasonable expectation that the violations will not be repeated. While the Bank's financial condition has significantly improved since completion of the September 30, 1983 FDIC examination, there still remains a disturbingly large volume of classified assets which, in and of itself, warrants imposition of formal corrective action by the FDIC. Furthermore, while these improvements are noteworthy and commendable, they are nonetheless recent and thereby run the risk of being short-lived in the absence of strong regulatory oversight and enforcement mechanisms. Only through imposition of a formal Cease and Desist Order can the FDIC assure itself and the public interest it serves that the Bank will maintain a steady course on the road to long-term financial recovery, stability and growth.
   Table IV is a comparative analysis of the financial condition of the Bank. It lists the conclusions of the State and the FDIC as of September 30, 1983; my conclusions as to the condition of the Bank as of that date, which are based on what classifications could be justified by the FDIC; and the conclusions of the State as of their May 18, 1984 examination.
   As my conclusion show, over $18.6 million in assets were classified. Those classified assets were 335 percent of capital and reserves. At the time of examination, a little under one-third of the capital and reserves was needed to offset charge offs for assets classified Loss and one-half of those classified Doubtful, and the reserve for loan losses was short by $1.2 million to cover loans similarly classified. Equity capital and reserves equaled 3.87 percent of adjusted total assets. As I concluded at p. 67, large deposits were 61 percent of total deposits and the volatile liability dependence ratio approached 55 percent.
   In the first six years of the Bank's history it managed to accumulate assets of only seven million dollars. In only five years under the control of the * * *, it grew to over $100 million. As the Bank aggressively sought and attracted depositors, primarily in the * * * communities, it was faced with the need to make loans just as aggressively. For the most part, the Bank relied on the reputation of its owners and their extensive contacts in the * * * business community to find borrowers. However, in counterpoint to this aggressive growth strategy and success arose the irresistible force of eco- {{4-1-90 p.A-629}}nomic conditions, fueled by an unforseeable oil shortage crisis and resulting in rapidly accelerating interest rates and inflation and rapidly declining economies in South and Central American countries. Obviously, the financial condition of the Bank had to give.

TABLE IV

ANALYSIS OF FINANCIAL CONDITION

Conclusion of
State as of FDIC as of ALJ as of State as of
-83 -83 -83 -84
Adversely Classified Assets
Substandard 26,349,999 26,215,000 16,700,600 31,998,000
Doubtful 2,694,000 1,286,000 435,000 1,074,000
Loss 1,395,000 4,745,000 1,478,700 303,000
Total 30,438,000 32,246,000 18,614,300 33,375,000
Loss + ½ Doubtful 2,742,000 5,388,000 1,696,200 840,000
Substandard + ½ Doubtful 27,696,000 27,158,000 16,918,100 32,535,000
Adversely Classified Loans
Substandard 26,092,000 25,822,000 15,926,300 28,940,000
Doubtful 2,694,000 1,285,000 435,000 1,048,000
Loss 1,265,000 3,710,000 1,377,400 232,000
Total 30,051,000 30,817,000 17,738,700 30,220,000
Loss + ½ Doubtful 2,612,000 4,352,500 1,594,900 756,000
Total Equity Capital & Re-
serves 5,549,000 5,549,000 5,549,000 6,838,000
Assets Classified Loss + ½
Doubtful 2,742,000 5,388,000 1,696,200 840,000
__________ __________ __________ __________
Adjusted Equity Capital &
Reserves 2,807,000 161,000 3,852,800 5,998,000
Total Assets 100,835,000 100,835,000 100,835,000 99,719,000
Reserve for Loan Losses 400,000 400,000 400,000 1,582,000
Assets Classified Loss + ½
Doubtful 2,742,000 5,388,000 1,696,200 840,000
__________ __________ __________ __________
Adjusted Total Assets 98,493,000 95,847,000 99,538,800 100,461,000
Total Deposits 91,281,000 91,281,000 91,281,000 91,886,000
Total Loans 65,904,000 65,904,000 65,904,000 67,226,000
Ratios:
Total Classified
Loans/Total Capital & Re-
serves 541.56% 555.36% 319,67% 441.94%
Total Classified As-
sets/Total Capital & Re-
serves 548.53% 581.11% 335.45% 488.08%

{{4-1-90 p.A-630}}

TABLE IV

ANALYSIS OF FINANCIAL CONDITION

Conclusion of
State as of FDIC as of ALJ as of State as of
-83 -83 -83 -84
Adj. Equity Capital & Re-
serves/Adj. Total Assets 2.85% 0.17% 3.87% 5.97%
Assets Classified Loss + ½
Doubtful/Total Equity Ca-
pital and Reserves 49.41% 97.10% 30.57% 12.28%
Shortage of Reserve for
Loan Losses Against All
Loans Classified Loss +
½ Doubtful 2,212,000 3,952,500 1,194,900 (826,000)
Shortage of Adj. Equity Ca-
pital & Reserves Against
All Assets Classified
Substandard + ½
Doubtful 24,889,000 26,697,000 13,065,300 26,537,000

   While that condition had to bend substantially, it did not break. That is because, for the most part, even the loans classified Substandard were collateralized to the extent that the Bank should suffer no eventual loss. Of the 18 instances alleged to have constituted extensions of credit without adequate security or collateral, only seven were upheld. The problem is one of cash flow and timely collection of loans. I found 42 instances of extensions without regard to the borrower's ability to make repayment (although the collateral may have been more than enough to cover the principal and interest). As of September 30, 1983, Bank loans totaling almost $12 million were overdue for 30 days or more, including more than $4 million which were overdue for six months or more.
   While I have found the condition of the Bank to be significantly better than as alleged in the FDIC September Report, I agree that, even on the basis of the condition as I have found it to have been at that time, remedial measures were, and are warranted. The Bank, however, was not brought "to the brink of insolvency" any more than it will take a "miracle" to reduce the volume of adverse classifications as contended by the FDIC. A glance at Table IV will show that in eight months, according to the State, assets classified Loss and one-half of those classified Doubtful have been halved from the amount I found to exist in September 1983. The capital ratio has improved to just under six percent and the loan loss reserve exceeds the total of loans classified Loss and one-half those classified Doubtful by $826,000. No miracle there, just the acronym, MOU.
   In circumscribing the function and format of an FDIC Cease and Desist Order it is of critical importance to note that the dual banking system in which the FDIC operates recognizes that the State authority is the Bank's prime regulator and, as such, deference should be payed to its remedial prescriptions. That such deference is not the equivalent of an abdication of the FDIC's regulatory responsibilities is clearly stated in the FDIC's own Manual, Section V, p. 1:

       Exceptions to the above policy concerning banks rated `4' or `5' [which requires some formal action by the FDIC] should be considered only when the condition of the bank clearly reflects significant improvement resulting from an effective corrective program or where individual circumstances strongly mitigate the appropriateness or feasibility of this supervisory tool. For example, the State authority might preempt the need for FDIC action...."
   * * *, former Chairman of the FDIC, is of the opinion that when the prime regulator believes that the bank has improved and stabilized, the FDIC "should join with the prime regulator in the remedy, but if they {{4-1-90 p.A-631}}can't do that, I think that they should at least give the State's remedy a chance to work." (Tr. 4355-56)
   The corrective action set forth by the State in its January 25, 1984 MOU has, without doubt, resulted in substantial stabilization and improvement in the Bank's condition. Capital adequacy has improved, asset classifications have been or are in the process of being charged off, classified loans have been or are in the process of being collected, violations of State law have been corrected and reduced significantly, reserves have increased, the volatile liability dependency ratio has been reduced, brokered deposits have been reduced, and an outside Chief Operating Officer has been appointed. Mr. * * * agreed with Messrs. * * * of the State that the Bank has substantially complied with the MOU and, as a result, its condition has both stabilized and improved as evidenced by the State May 18, 1984 Report of Examination. (Tr. 2367-69, 3430, 3435-37, 3558-59)29 While the State's May 18, 1984 examination was limited in scope, it clearly demonstrated substantial trends of improved financial condition which stand unrebutted on this record.
   While the provisions of the MOU are not as broad nor comprehensive as those sought by Proponent, they are not inconsistent with the relief sought by the FDIC. Because the Bank's condition has improved as a result of its substantial compliance with the MOU, it is reasonable to defer to those provisions because they accomplish the intended ends of those similar provisions suggested by the FDIC and they do so without subjecting the Bank to having to satisfy two dissimilar standards of conduct or two possibly different, or even conflicting, evaluations of compliance.
   Although I conclude that the FDIC should give deference to the terms of the MOU, by no means do I conclude that the FDIC should not be without a cease and desist order against Respondents. The FDIC should not have its hands tied should noncompliance ever become a problem. Under those circumstances, it should not have to bring another action to obtain a cease and desist order, it should need only to take action to enforce one, albeit similar in nature to the State MOU. By deferring to the terms outlined in the MOU, the FDIC holds out the carrot with which Respondents have indicated they can live, while it also holds the stick of a cease and desist order which it rightly insists it needs to protect its interests.
   While Proponent has argued for the imposition of several provisions beyond those addressed by the MOU, I conclude that only one is justified, therefore, the order which follows proposes the additional provision as well as those which would parallel the MOU. The additional provision is one to provide for maintenance of an adequate reserve for loan losses. The MOU does not address that problem, but the evidence warrants a finding that the Bank's customary policy for calculating loan loss reserve does not take into consideration the condition of the loan portfolio; rather it would appear to look only to a percentage of total loans. Since I find that an inadequate reserve for loan loss is an unsafe and unsound practice, I conclude that such a provision in a cease and desist order is necessary.
   I have not recommended the infusion of additional capital for two reasons. First, by terms of the MOU, $3 million of additional capital will have been infused by the time this initial decision is issued. Adding the $1 million due in October 1984 to the capital figure reached by the State as of May 18, 1984, results in an expected capital to asset ratio of approximately 6.97 percent, well over the minimum the FDIC sets for wellmanaged banks. Second, there is no evidence of record which would justify the requested level of eight percent, or, for that matter, any amount in excess of that agreed to in the MOU. (Manual, § G/5; Tr. 4436).

29 Mr. * * *'s insights regarding Bank compliance with individual provisions of the State MOU are particularly instructive on the Bank's improved financial condition. Mr. * * * was struck by the harshness of the State MOU's requirement that the "man running the bank [* * *] resign...it's a pretty drastic remedy right there." (Tr. 4338) He was favorably impressed with the requirement of the injection of a "considerable amount of new capital for a bank this size." (Tr. 4338) He felt that the MOU's reporting requirements were burdensome but significant. (Tr. 4339) Mr. * * * believed it was particularly positive that the Bank's brokered deposits have been significantly reduced because, as he put it, "I...live in fear of brokered deposits." (Tr. 4339) Mr. * * * pointed out that according to the February 1983 FDIC Report, the Bank had relied heavily on brokered deposits, maintaining amounts in excess of 27 percent and, perhaps, as high as 30 percent. (Tr. 4339) He noted that the State's MOU required a reduction below five percent, and that the May 18, 1984 State Report indicated that the present level of brokered deposits was actually below three percent. (Tr. 4340)
{{4-1-90 p.A-632}}
   I also do not recommend a provision for reducing violations of law and adverse classifications according to a rigid timetable. To do so ignores practical considerations relating to the enforceability of time constraints, even should the Bank wish to comply, and it eliminates the flexibility to accomplish the same end which is afforded by the MOU. There is no evidence which even speaks to the propriety or feasibility of the proposed time limits.

   B. Removal

   The statutory grounds for removal of an officer or director from an insured bank require a tripartite showing. Essentially, and as pertinent to this case, 12 U.S.C. § 1818(e)(1) provides that the FDIC may remove an officer or director who:

       1. a. has committed any violation of law, rule or regulation or a cease and desist order which has become final;30 or
       b. has engaged or participated in any unsafe or unsound practice; or
       c. has breached his fiduciary duty, and
   2. the FDIC determines that the bank has suffered or will probably suffer substantial financial loss by reason of such violation or practice or breach of fiduciary duty, and
   3. the FDIC determines that such violation or practice or breach of fiduciary duty is one involving personal dishonesty or one which demonstrates a willful or continuing disregard for the safety or soundness of the bank.
   Once those grounds have been established, the FDIC, in the exercise of its discretion, "may issue such orders of... removal...or prohibition .. as it may deem appropriate." 12 U.S.C. § 1818(e)(5). The exercise of that discretion is a heavy responsibility since, for the banker, an action of removal and prohibition is the equivalent of commercial capital punishment. The United States Senate observed that "the power to suspend or remove an officer or director of a bank...is an extraordinary power, which can do great harm to the individual affected...it must be strictly limited and carefully guarded." 112 Cong. Rec. 20083 (1966).
   So grave was Congress' concern over the exercise of the removal power that it provided that no single person should be invested with that power. In reporting to the full Senate on a recommendation that the Federal Reserve Board, and not the Comptroller of the Currency, should be designated with removal power over national bank officials, the Senate Committee on Banking and Currency stated:
       The duty and responsibility of suspending or removing bank officials is a quasi-judicial function of the highest delicacy, requiring the most careful balancing of the interests of the institutions and officials involved, on the one hand, and the interest of the depositors, savers, borrowers, and the Government and the public generally on the other hand. To permit suspensions and removals without thorough consideration would be unfair to the institutions and officers involved. Any procedure which would permit this would have a harmful effect on the banking system itself and on depositors, borrowers and the public. S.Rep. No. 1432, 89th Cong. 2 Sess., page 3, (1966), U.S. Code Cong. § Admin. News 1966, p. 3540.

   1. Conduct alleged as grounds for removal

   a. Considering the first element required to be shown under the Statute, it is apparent that the major allegation against the individual Respondents is that they were responsible for the bulk of adversely classified loans. There was no dispute as to their involvement with these loans, although they did, of course, dispute the classifications. Using my conclusions as to classifications, proposed findings of Proponent 314 – 318 may be restated as follows:
   (1) Of 107 loans adversely classified and totaling $17,738,700, 68 loans (63.5 percent) amounting to 87.7 percent of the total dollar amount adversely classified were originated by the * * *.
   (2) * * * originated 20 loans, amounting to one-third of the dollar volume classified. Nineteen of the loans were classified Substandard, one was Doubtful ($250,000) and none was Loss.
   (3) * * * originated 14 loans, amounting to just under one-quarter of the dollar volume of classified loans. Of those, 11 were classified Substandard, none was Doubtful, two were Loss and one was split between


30 If the words "which has become final" are to have any meaning, the Statute must be construed as excluding from these grounds violation of a cease and desist order which has not become final. Accordingly, I have excluded any evidence of alleged violations of the FDIC Temporary Order as grounds for removal.
{{4-1-90 p.A-633}}Substandard and Loss. The dollar volume of Loss was $287,000.
   (4) * * * originated 28 loans, amounting to just under one-quarter of the dollar volume of classified loans. Of those, 21 were classified Substandard, none was Doubtful, five were Loss and two were split between Substandard and Loss. The dollar volume of Loss was $768,000.
   (5) All three * * * shared responsibility for the origination of five loans, all classified Substandard, which amounted to 5.2 percent of the total volume of classified loans.
   b. As the discussion on unsafe and unsound practices reveals, the only substantial allegation involved lending and collection practices. By referring to Table III and PFF 314 – 318, the following may be concluded as to responsibility:
   (1) Of the 76 loan lines criticized, 65 were originated by the * * *.
   (2) * * * originated 18 which contained 34 criticisms, nine of which related to the ability of the borrower to repay and nine related to documentary deficiencies.
   (3) * * * originated nine which contained 18 criticisms, six of which related to the ability of the borrower to repay, four related to enforcement of repayment, and four related to documentary deficiencies.
   (4) * * * originated 27 which contained 47 criticisms, 16 of which related to the ability of the borrower to repay, 10 related to documentary deficiencies, and eight related to enforcement of repayment.
   (5) All three * * * shared responsibility for originating 11 loans which contained 19 criticisms, nine of which related to documentary deficiencies, three related to the ability of the borrower to repay, and three related to overdrafts extended without collection of principal and interest.
   Of the State law violations alleged, the only substantial violations proved were the 11 overlines cited in the September Report and 12 overlines in the February Report. The overlines had been reduced to three according to the May 1984 Report of the State.
   c. Proponent also argues that Respondents breached their fiduciary duty as officers and directors in that they failed to heed supervisory notices and warnings of mismanagement. Since the sum and substance of this argument amounts to one that Respondents demonstrated a continuing disregard for the safety or soundness of the Bank, it will be treated below in the discussion of the third prong of the Statutory standard. Suffice it to say here that I conclude that no such breach occurred.
   Proponent has met the burden of proof under subsections (a) and (b) of the first part of the removal section. The next question is whether the Bank "has suffered or will probably suffer substantial financial loss" as a proximate cause of Respondents' actions.

   2. Alleged financial loss to the Bank

   On brief, Proponent argues that the Bank sustained net loan losses in excess of $1.5 million between January 1982 and March 1984. That is not an insubstantial amount of financial loss. But that fact alone says nothing about causation, and neither does the Brief nor the proof. One could find, on the basis of the record, that of the $1.6 million which comprises all loans adversely classified Loss and one-half of those classified Doubtful (according to my conclusions), * * * originated one loan which consisted of 7.8 percent of that figure, * * * originated three loans which consist of 18 percent of that figure, and * * * originated seven loans which consist of 48 percent of that figure. But one cannot conclude with respect to any of those loans that any loss was, or will be incurred solely because the loan was not good when made. The record does show that many of the problem loans have evidenced poor performance due to factors beyond the control of the * * * and for which the * * * cannot properly and fairly be held accountable (See, e.g., Tr. 3025-26). In fact, one of the FDIC examiners conceded that the significant decline in the economic structure of * * * countries, which was characterized by monetary controls, raging inflation and currency devaluation, contributed in large part to the significant increase in classified loans (Tr. 550-51). I also note that the loan loss reserve, as determined in the State May 1984 Report of Examination, is now of a magnitude sufficient to absorb such losses.
   In exercising the awesome power of removal and prohibition, one cannot dispense with the essential ingredient of causation, nor can a Respondent's guilt be determined merely by association. Is * * * to be re- {{4-1-90 p.A-634}}moved on the basis that he originated only one loan in the amount of $250,000 which was classified Doubtful? As noted below, this is not the usual type of removal proceeding which is based on an allegation of personal dishonesty or criminal conduct and is an easier case to prove. However, the standard of proof should not be eased in a case of this type, where matters of proof are surely more difficult, but where there is no allegation of personal financial gain or of a crime involving moral turpitude.
   Proponent also argues that based on the volume and quality of the Bank's loans and assets, the Bank will incur substantial future financial losses in the magnitude of $5 to 6 million. Categorically, there is no reliable or probative evidence in this record which would justify that assertion. It is true that a handful of present or former examiners came to the conclusion that the Bank would eventually suffer a loss of anywhere from 10 to 25 percent of its assets classified Substandard. However, the basis of that testimony is less than the type of competent economic testimony upon which the financial and commercial fate of these Respondents should turn. The loss prediction "experience" of these witnesses takes into consideration none of the variables which may or may not apply to this Bank or any other bank which is encompassed in their universe of observations. No multiple regression analysis was performed to test their hypothesis, to see with any degree of confidence that their prediction of loss for this particular bank is probable, or to demonstrate that their past experiences were more than mere random observations of similar results obtained by diverse causes. The only study referred to by one of the witnesses as "conclusive" involved the ex post facto analysis of examiners' reports of banks which had closed. (Tr. 2777). This bank certainly has not failed, although from reading the Report, one would have expected its demise months ago.
   I cannot conclude, on the basis of the record and the evidentiary deficiency noted above, that the Bank "will probably suffer substantial financial loss." Even if I were able to come to the conclusion that it would suffer such loss, the absence of proof as to causation would not permit me to conclude that such loss would be caused, in whole or in part, by the actions of the * * * or, if so, whether it would result "by reason of such violation, practice or breach."
   Furthermore, of the proven allegations of hazardous lending and lax collection practices, the three major categories included a total of only five loans classified Loss and two which were split between Substandard and Loss. None was classified Doubtful. The dollar amount classified Loss was $752,000, or 1.14 percent of total loans, which is now covered by the loan loss reserve. None of these loans was originated by * * *; one was originated by * * *. Causation is not argued as to any, nor is the issue of substantiality.
   Finally, although overlines have been proved, there is no argument that they have resulted in, or that they will probably result in substantial loss by reason of their creation. Proponent has not met the burden of proof under the second part of the removal section.

   3. Alleged continuing disregard for safety
or soundness

   Even assuming Proponent were able to demonstrate substantial financial loss, the case for removal has not been made.
   The final burden on Proponent is to prove personal dishonesty or willful or continuing disregard for the safety or soundness of the Bank. No evidence has been introduced upon which a finding could be made, and no argument or allegation is offered that involves personal dishonesty on the part of any Respondent. Neither is there evidence upon which I could find, nor is there any argument urging I find willful disregard for the safety or soundness of the Bank.31 The only question is whether any Respondent has engaged in conduct which demonstrates "continuing disregard" for the safety or soundness of the Bank.
   Arguing by analogy to cases determining liability under Section 10(b) of the Securities and Exchange Act of 1934 (15 U.S.C. § 78j(b)), Proponent argues that "continuing disregard" requires a degree of knowledge of wrongdoing which is less than that needed to prove "willfulness" but is more than that which would merely prove negligent conduct. The suggested standard is


31 Lest there be any question as to the significance of the oblique reference in Proponent's footnote 25 to the evidence concerning the real estate swap of the Bank's premises, I note here that I have relied on Proponent's footnote 14 which concedes that the evidence will not support a finding in this proceeding that there was any willful disregard, or that any other conclusion pertaining to that swap could be made. I concur with that concession.
{{4-1-90 p.A-635}}that of "recklessness" as articulated by the Court in Rolf v. Blyth, Eastman Dillon & Company, Inc., 570 F.2d 38 (2d Cir.), cert. denied, 439 U.S. 1039 (1978).
   A recent case which did arise under Section 1818(e)(1) appears to agree that the Rolf standard of recklessness would be applicable in this type of removal case. The Court agreed that some sort of scienter was intended by the Statute since the word "disregard" suggests voluntary inattention. Brickner et al. v. FDIC, No. 84-5142, slip op. at 8 (8th Cir. Aug. 29, 1984).
   In order to place Respondents within this standard, Proponent argues that they were warned on five separate occasions over a period of ten months that unsafe or unsound banking practices and violations of law were being committed and that, as a result, the financial condition of the Bank was deteriorating. The argument follows that Respondents, nevertheless, continued to engage essentially in the same lending activities and practices. That argument might be persuasive if the record demonstrated only those simple facts. However, the record is to the contrary in two significant aspects. First, Respondents vigorously contested the allegations of the examiners and, second, they undertook to resolve those differences and the concerns of the FDIC on numerous occasions throughout a period in excess of the ten months adverted to by the FDIC.
   If the words "removal order" are substituted for "cease and desist order" in the following quote, the observation of the Court in Stokely - Van Camp, Inc. v. Federal Trade Commission, 246, F.2d 458, 465 (9th Cir. 1957) becomes quite poignant:
       ...no criticism is to be made against respondents...for vigorously defending the position they had taken, which, of course, they had a right to do. It does not follow, however, that one who defends charges before the Commission is, on that account, to be subjected in the future to a cease and desist order because his defense there proves unsuccessful. That would be a policy abhorrent to our sense of justice.
Here, the case is even stronger since the defense has had its measure of success.
   The record shows that the initial indication by any FDIC employee that the Bank was on a course perceived by the FDIC to be unsafe or unsound was in late December 1982. At that time examiner * * * expressed limited concerns about four loan lines but "left it with the management to take whatever action they deemed necessary." (Tr. 381). He also determined that the Bank was in the process of complying with a previous memorandum of understanding.
   The April 27, 1983 meeting at the Bank was the first significant communication to Respondents that the FDIC believed the Bank to have severe problems with its loan portfolio. The * * * disputed the findings of the FDIC. The response of the FDIC consisted of (1) a comment that it would take a "miracle" to successfully reduce the volume of adverse classifications and (2) the presentation of a 14 point rehabilitative program which included the appointment of a new chief executive officer and a new senior loan officer. No discussion of loan classifications was permitted.
   One month later, the * * * forwarded to Regional Director * * * a detailed, comprehensive response to the preliminary loan classifications. Shortly thereafter, the Bank requested a meeting in * * * to further allay concerns of the FDIC and to discuss a corrective program. At this meeting, which was held on June 2, 1983, the Bank indicated its willingness to adhere to 13 of the 14 points in the rehabilitation program presented by the FDIC. As Bank Director * * * testified:
       ...as a matter of fact, our approach for the report was that — basically, whatever the FDIC wants us to do to come into compliance, even though the * * * felt some technicalities, we didn't have to do it — my approach was let's not get into an argument with technicalities, even if we don't want to do it. My approach was let's bite the bullet and do it, anyway. The only way we objected to biting the bullet, was changing the management of the Bank. Everything else we basically agreed to, even over the objection of the banking experts in the Bank,...who felt they could win on appeal. [However, the FDIC would not give the Bank any] answers, no response, other than `we want to change the management of the bank and we have got the report' (Tr. 3405-07).
{{4-1-90 p.A-636}}
   The Bank did not receive the voluminous February Examination Report until June 11, 1983. On August 3, 1983, the FDIC issued its Notice of Charges, Proposed Order to Cease and Desist and Proposed Consent Agreement.
   Another meeting was held in * * * on September 9, 1983 among the Bank, its Counsel and FDIC officials in order to work out a settlement. Those negotiations continued through September 20, 1983 when they broke down. Within 10 days the examiners were back in the Bank.
   As the chronology illustrates, the next two months were not harmonious. The State examiner-in-charge was ready to find whatever the FDIC found. Other members of his team believed the FDIC examiners were overzealous. The FDIC examiners thought they were being stalled by Bank officers and the * * * were frustrated by what they perceived to be a reluctance to compromise and a lack of fairness and objectivity on the part of FDIC officials.
   Although Proponent concedes (Brief p. 41) that Respondents "with the intensive assistance of counsel and others, initiated corrective actions" in mid-December, that did not deter the FDIC from continuing to consider action to remove the * * *. Since the actual Removal Notice was not issued until March 1984, it is appropriate to review the actions of Respondents up until that time to assess their overall attitude during the examination process.
   Following the culmination of the concurrent examinations of the FDIC and the State of * * *, the Bank entered into the MOU with the State on January 25, 1984. Notwithstanding his resignation from day-to-day management and operation of the Bank, * * * infused $2 million of capital into the Bank on February 29, 1984, to satisfy one of the terms of the MOU.
   While the MOU was in place and working, Respondents requested yet another meeting in * * * at the end of February 1984 to resolve the pending charges. Again failing to reach agreement, Respondents traveled to Washington, requesting FDIC officials then to override the * * * Regional Office and give the MOU a chance to work. That request was rejected notwithstanding the State's offer to close the Bank if the MOU did not work and the Bank's condition did not improve. Instead, the FDIC issued its Temporary Suspension Order on March 12, 1984. This litigation ensued.
   Under the circumstances presented in this case, it is clear that none of the * * * has been shown to demonstrate a continuing disregard for the safety or soundness of the Bank. Even prior to the receipt on June 11, 1983 of the final version of the February Report of Examination, Respondents had vigorously contested the preliminary loan classifications, yet agreed to all but one provision of the proposed rehabilitation program. This action certainly does not indicate any voluntary inattention to the problems noted in the February examination, nor does it evidence a reckless attitude towards the financial condition of the Bank. The * * * and the Bank were willing to do whatever the FDIC wanted them to do to come into compliance, except one thing. They would not accede to a change in management, a change which is categorized by some as a "back-door removal." Director * * *'s statement on behalf of the Bank's Board of Directors supports the conclusion that the attitude and actions of the Board and the * * *, rather than showing any breach of fiduciary duty, shows to the contrary every consideration of that duty in that they proposed to do what they believed was in the best interests of the Bank, including a determination not to make a change in management which might affect the confidence of depositors or borrowers.
   Other than charging the * * * merely with knowledge of the FDIC's findings as to the condition of the Bank, findings which they disputed, the only allegation of affirmative conduct alleged to be reckless is the extension of credits to borrowers whose loans were already adversely classified. However, not all of those classifications have been upheld and, even as to those which have, the fact that an additional extension has been made is not, ipso facto, proof of recklessness. An extension of credit for working capital, for a piece of equipment or a bridge pending receipt of governmental or other funds may actually prevent a possible loss for the Bank or a deterioration of the quality of the classified loan. (See, e.g., Tr. 3088). The evidence in this record does not demonstrate a consideration by the examiners of the reason for any additional extension and, therefore, no finding of recklessness can be made as to any such extension.
{{4-1-90 p.A-637}}
   The record also shows that State law violations decreased from the February Report to the September Report. Page one of the September Report notes that in the February Report, 52 violations of eight laws were noted. In September, the number of violations noted had been reduced to 25, involving four State laws. And as my conclusions as to overlines show, the number has been reduced, albeit not considerably. However, a considerable reduction is noted as of the May 1984 State Examination. If anything, the evidence indicates positive results rather than indifference to criticism.
   Taking the evidence as a whole, I conclude that not only is there no proof of continuing disregard on the part of the * * * as a group, but also, that there has been no evidence to indicate continuing disregard on the part of any individual * * *.
   4. The discretion to order removal
   Even is one were to conclude that grounds for removal had been shown, as the legislative history shows, before an order of removal may be entered, consideration must be given to the balancing of the interests of the Bank, its officials, its customers, the Government, and the public in general. I conclude that such balancing dictates that the * * * not be removed.
   * * *, Assistant Director of the * * * State Bureau of Bank Examiners, testified that "the * * * are the Bank" (Tr. 2373), and that "there is no question" that * * * and * * * would have a much better opportunity collecting adversely classified loans than anyone else (Tr. 2374). * * *, * * * State Director, Division of Banking, testified that * * * should not be removed from banking because by remaining, "the appearance within the community would be that he was still part of the Bank and [therefore] could facilitate the collection of the classified loans [and] the infusion of capital." (Tr. 3511) With regard to * * * and * * *, he testified that "they were a vital part of the institution, and had not caused the problems at the institution. We felt they were capable management . . ." (Tr. 3516).
   Former FDIC Chairman * * *, in offering his reasons why he would not have voted for the removal of any of the testified, "One of these men has been in banking for 35 years [* * *]. And it just doesn't make sense to me, that you should punish every banker who has a losing year by kicking him out of banking. . .based on these facts, I couldn't see that it's necessarily dictated by the law, that people forfeit their jobs when they lose money." (Tr. 4387) He also stated that he would give great deference to the State of * * * which chose not to remove the * * * from banking and that he would also strongly consider the * * * relationship between management and its customers on the removal issue (Tr. 4388, 4396).
   Professor * * *, an expert in the field of bank management and banking markets concluded of the * * * that "these people are good managers." (Tr. 4435) Noting that the Bank is recovering from a one-year period in which its equity capital declined, he opined that looking at the picture as a whole, the * * * have exhibited "an impressive performance." (Tr. 4435).
   * * *, Senior Vice President of the Bank of * * * testified that the * * * are dedicated bankers, professionals and very respected in the community (Tr. 4413). * * *, Chairman of the * * * County School Board and President of Savings and Loan, testified that * * * enjoys an excellent reputation in the community and that his morals, integrity and character are highly regarded. (Tr. 2142). * * *, President of * * * Savings and Loan Association in * * *, * * *, stated that after doing extensive checking, he found that * * * and his family enjoyed good reputations as bankers and that * * * had a good credit history and reputation as a borrower (Tr. 4187, 4190-91). * * * and * * *, customers and borrowers of the Bank, both testified to the * * * excellent reputation in the community. Mr. * * * stated that it the * * * were removed from the Bank, he would withdraw all of his accounts at the Bank (Tr. 4524).
   * * *, the examiner-in-charge of the February FDIC examination, testified that his personal opinion of * * * was that his extensive background in international banking is a positive one and that he should "be allowed to operate the international portions of the Bank" and "to stay in banking." (Tr. 670, 675, 682). He also did not recommend removal as to * * * or * * * (Tr. 682).
   * * *, expert witness for the FDIC, said of * * * and * * * that he would not necessarily remove them from banking, but rath-
{{4-1-90 p.A-638}}er would "be willing to work with it for a while" (Tr. 2874).
   If State officials, a former FDIC Chairman, expert witnesses for both Respondents and the FDIC, and members of the banking community and the general public all agree that removal is not in the best interests of the Bank, its customers and its borrowers, then what reason is there to press for their removal? Taking that action may cause a run on the bank and its consequent failure since the reputation of the * * * is largely responsible for its growth and the loyalty of its depositors (Tr. 3224). As for the * * *, in addition to humiliation and degradation in their community and their profession, they would stand to lose upwards of $8 million in assets (Tr. 3074, 3942). The answer to the question posed does not lie in the record. In the face of evidence which indicates the probability of adverse consequences to the Bank, to its customers and borrowers, and ultimately to the insurance fund of the FDIC should the * * * be removed, there is a conspicuous absence of evidence which would point to benefits to those interests should the * * * be removed.
   Respondents have suggested an answer to the question why their removal is being sought, in their affirmative defense alleging bad faith and interference on the part of the FDIC, which they allege contributed negatively to the financial condition of the Bank. I do not find that to be a valid defense to the action of removal itself because, contrary to Respondents' contention, the classic elements of an estoppel, including reliance upon the action of the party to be estopped, have not been alleged nor proved in this case. Nor do I believe such a defense would be valid when the tripartite statutory standard had been met by evidence untainted by the conduct alleged to support the estoppel. However. I do find that such allegations are valid in considering the discretionary authority of the FDIC exercising that "quasi-judicial function of the highest delicacy, requiring the most careful balancing of the interests," S.Rep. NO. 1432, Supra, to determine whether or not to issue an order of removal.
   At this point it becomes crucial to distinguish certain functions of the FDIC as a regulatory agency. Its adjudicatory function requires it to determine facts and, on the basis of those facts, to issue appropriate order of relief. Its prosecutorial function is, by dint of the Administrative Procedure Act, wholly separate and apart. The FDIC, as adjudicator, is the ultimate finder of fact; the prosecution staff is merely a party upon whom the burden of proof lies. The allegations of bad faith and interference do not reach the FDIC as adjudicator; they question the motivation for prosecution of the removal action to suggest an absence of foundation for it.
   The evidence strongly suggests that removal of the * * * has been sought, not upon a consideration of the delicate balance of the interests, as prescribed by Congress, but, rather because they, like the respondents in Stokely - Van Camp, Inc., Supra, vigorously defended their position that they would not accede to a change in management nor consent to the proposed cease and desist order. As the * * * Regional Director's memorandum of February 10, 1984 states, "Bank management has been entirely uncooperative as evidenced by their refusal to stipulate to the Section 8(b) Notice and corrective program." (R. Ex. 462). This memorandum made no mention of the June 2, 1983 meeting in * * * during which the Board of Directors of the Bank, in a presentation by Director * * *, offered to implement 13 of the 14 corrective actions prescribed by FDIC officials.
   The mind set at the Regional level was evidenced by the shocking events which took place in * * *. As detailed in the chronology, after conversing with his counterpart in * * *, the Assistant Regional Director of the FDIC in * * * called a Savings and Loan Department official and referred to * * * as a "Mafia" or "Mafia-type" bank! The effect of this egregious lack of discretion was predictable. For his business involvement with the Bank and the * * *, the President of * * *'s Savings and Loan said of * * * Savings and Loan Department officials, "In 20 years, this is the hardest I ever had regulatory agencies come down on me." (Tr. 4179).
   While I do not suggest that FDIC officials should not share information with other regulatory or law enforcement agencies, it is apparent to me that appropriate guidelines for the dissemination of such information either have not been developed or have not been observed. This deficiency, along with a "sentence first, trial later" attitude is responsible for the outrageous result in * * * as well as two other troubling incidents.
{{4-1-90 p.A-639}}
   The first involves a breach of the confidentiality of examination information. Simply stated, an attorney for a competing creditor of the Bank in a bankruptcy proceeding was able to walk into the Regional Office of the FDIC and, without having to execute any pledge of secrecy or confidentiality, to obtain access to confidential information on the competitor, compiled during the September examination. In what can most generously be characterized as a naive explanation, Attorney * * * had hoped that by opening up the files he could persuade the attorney for the competing creditor to narrow the scope of any information he might wish to subpoena in the future! Not surprisingly, Respondents took no comfort from the shutting of the barn door.
   The other incident put an examiner between the proverbial rock and a hard place. In trying to walk the fine line of nondisclosure while investigating the activity of a borrower at other banks, Examiner * * * warned officials of * * * with respect to * * * and * * * that "I would review the financial information . . ." and "use your own judgment if you are going to make loans to them" (Tr. 2007). Mr. * * * had been introduced to * * * by * * * with the result that * * * granted * * * a $1 million line of credit. * * * had repaid * * * their first draw of approximately $500,000 earlier than required. Almost immediately after the examiner's visit, * * * cancelled the $1 million line of credit, thereby depriving * * * of the funds they had expected to use to pay off interest due * * *. According to * * *, at least $800,000 of line at * * * was to be used to pay off interest at the Bank and, if that interest were paid off, the Bank would not have the loan delinquency ratio it had at the time of the examination. (Tr. 3888-91).32
   As I have noted previously, and I repeat here for emphasis, my observation of the demeanor of the FDIC employees who testified in this proceeding leads me to conclude that they were honest and forthright in their testimony and in their conduct of the examinations of the Bank. However, I am left with the impression, after hearing the totality of evidence presented at trial, that pieces are missing from this complex puzzle which might shed light on the motivation to so zealously seek the removal of the * * *. Query, what facts came to prompt the filing of an Order of Immediate Suspension on March 12, 1984, almost two months after the State and the Bank entered into the salutary MOU, and only some two weeks prior to the pre-trial conference scheduled in these proceedings? The MOU was working, but the publicity surrounding the ensuing hearing on the Temporary Restraining Order, sought to prevent the immediate suspension of the * * *, caused a run on the Bank of some $10 million (Tr. 3329).
   One answer to that question was suggested by * * *, Director of the State of * * * Division of Banking, who thought that the Bank was to be used as an example which would not cost much:
       I think they needed a bank in which to take strong action, and they probably went out on a limb - my personal opinion is that they made representations to Washington that this would be a good case, yet the examination did not support the facts in December and in February. Now, my personal opinion is that * * * Regional Office had gone so far out on a limb with this particular institution, they couldn't back up (Tr. 3522-23).
   I certainly hope that assessment is wrong. But in the absence of evidence tending to show that the balancing of interests should tilt against the * * * Mr. * * * analysis nurtures those seeds of doubt which have been cast upon this record and reinforces my conclusion that removal of the record and reinforces my conclusion that removal of the * * * would not be of benefit to the interests of the Bank and the * * *, on the one hand, and the interests of the depositors, savers, borrowers, the Government and the general public, on the other hand.
   Accordingly, having found and concluded that Respondents have engaged in certain unsafe and unsound banking practices, that

32 Respondents also argue that action on the part of FDIC officials caused * * * Savings and Loan to renege on an agreement to participate in a number of real estate loans in the amount of $2.5 million (Tr. 3867). Although the timing of a phone call from the President of * * * to * * * regarding a regulatory examination of those files was close to that of the decision of * * * not to agree to participation, more concrete evidence of a nexus between the two is not in the record and, since there is also a question as to the adequacy of the documentation in the loan files, I cannot conclude that any action on the part of the FDIC influenced the final decision of * * *.
{{4-1-90 P.A-640}}an order to cease and desist from certain practices should issue, but that an order of removal and prohibition is not warranted, I propose that the Board of Directors of the Federal Deposit Insurance Corporation issue the following:
ORDER
   ORDERED, that the * * *, * * *, its directors, officers, employees, agents, successors and assigns, and other persons participating in the conduct of the affairs of the bank, CEASE AND DESIST from the following unsafe or unsound banking practices and violations of State laws:
   1. Engaging in hazardous lending and lax collection practices;
   2. Failing to properly charge off or eliminate all nonbankable assets (or portions thereof) from the books of the Bank;
   3. Failing to provide and maintain an adequate reserve for loan losses;
   4. Operating the Bank with equity capital that is inadequate to support the kind and quality of assets held by the Bank; and
   5. Operating the Bank in violation of * * * State Laws.
   FURTHER ORDERED, that the * * *, * * *, its directors, officers, employees, agents, successors and assigns, and other persons participating in the conduct of the affairs of the Bank take affirmative action as follows:
   1. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to maintain a level of brokered deposits no greater than 10 percent of total deposits.
   2. Continue, until otherwise notified by the State in writing, and as set forth in the State's * * * 1984 MOU, to maintain a loan to deposit ratio of 70 percent, excluding loans insured through FCIA, EXIM Bank or other government agencies or programs of a similar nature (e.g., S.B.A.), provided that the total of all loans shall not exceed 80 percent of deposits unless the State shall, in writing, permit a higher percentage.
   3. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to report to the State on the 15th day of each month regarding the ratio of the Bank's total loans to total deposits, as well as the ratio of total loans to total assets. A copy of the Bank's daily Statement of Condition as of the last day of each month shall also be provided within seven days of the date thereof. A copy of all such reports filed with the State shall be forwarded to the FDIC.
   4. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to maintain a level of total deposits of $100 million or less. This limit shall not be exceeded without prior written approval from the State or the attainment of a capital to deposit ratio of 6.5 percent. To exceed this limit thereafter, the Bank must continue to maintain a 6.5 percent capital to deposit ratio. The Bank shall also continue to file a monthly report with the State setting forth its total capital to deposit ratio. A copy of this report shall be forwarded to the FDIC.
   5. (i) Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to grant no additional extensions of credit to any borrowers whose loans were classified Substandard by the State as of September 30, 1983, unless all interest then due from any such borrower has been paid (but not paid by any overdraft or a further extension of credit by the Bank) and unless there has been obtained additional tangible collateral or a new independent guarantee of repayment, and
   (ii) Notwithstanding the above, the Bank shall not, without approval of a majority of the full Board of Directors, extend any such credit in excess of $250,000 to borrowers. Furthermore, in no event shall the Bank permit overdrafts in any account in excess of $5,000 or allow overdrafts to any one borrower in excess of $20,000. (These amounts shall be calculated in accordance with Section 658.48(3), * * * Statutes.)
   6. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to extend no credit to borrowers whose loans are classified Loss or Doubtful without prior written approval of the State.
   7. Continue until otherwise notified by the State in writing, and as as set forth in the State's January 25, 1984 MOU, to insure that the revised loan policy incorporating control mechanisms to improve documentation and performance of future loans is fully implemented.
   8. (i) Within 60 days of the effective date of this ORDER, the Bank shall establish
{{3-31-92 p.A-641}}and continue to maintain an adequate reserve for loan losses by charges against current operating income. In complying with the requirements of this paragraph 8 of the ORDER, the Board of Directors of the Bank shall review the adequacy of the Bank's reserve for loan losses prior to the end of each calendar quarter. The minutes of the board meeting at which such review is undertaken shall indicate the results of the review, the amount of any increase in the reserve recommended, if any, and the basis for determination of the amount of reserve provided.
       (ii) Reports of Condition and Income requested by the FDIC and filed by the Bank prior to the effective date of this ORDER and subsequent to September 30, 1983, shall reflect a provision for loan losses which is adequate in light of the condition of the Bank's loan portfolio and which, at a minimum, equals the adjustment required by paragraph 8 (i) of this ORDER. If necessary to comply with this paragraph 8(ii) of this ORDER, the Bank shall file amended Reports of Condition and Income within 30 days from the effective date of this ORDER.
   9. Until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, the Bank shall:
       (i) be prohibited from reinstating * * * as President of the Bank;
       (ii) be prohibited from reinstating * * * as a member of any and all operating committees of the Bank;
       (iii) be prohibited from reinstating * * * lending authority;
       (iv) be prohibited from amending its By-Laws to alter the fact that the Chairman of the Board is not the Chief Executive Officer of the Bank;
       (v) be prohibited from altering the status of the Chairman of the Board as a co-equal of any other Director, with no power greater than any other Director;
       (vi) permit * * * to remain a member of the Board of Directors and Chief Executive Officer of the Bank; and
       (vii) be prohibited from removing the outside individual employed in accordance with Paragraph 14 of this Order as President and Chief Operating Officer of the Bank.
   10. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1994 MOU, to actively pursue unresolved legal enforcement proceedings regarding loans placed on nonaccrual status pursuant to Item No. 10 of the State MOU.
   11. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to file a report with the State on the 15th day of each month, as to the preceding month, setting forth all brokered deposits in excess of 5 percent of total deposits and all extensions of credit in excess of $250,000. A copy of this report shall be forwarded to the FDIC.
   12. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to implement the plan for scheduled reduction of all statutory violations cited in the September 30, 1983 State Report issued pursuant to Item No. 12 of the State MOU.
   13. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to file a progress report with the State on the last day of each month detailing steps taken to comply with the various provisions of the January 25, 1984 MOU and this Order. A copy of this report shall be forwarded to the FDIC.
   14. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to employ a qualified outside individual satisfactory to the State as President and Chief Operating Officer of the Bank. The State shall be given prior notice of the termination of such officer. The Bank shall also continue not to employ any new senior officers at or above the level of the Vice President or add any new members of the Board of Directors without prior written approval of the State.
   15. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, not to make any advance, loan or other extension of credit that is in violation of Federal or State law.
   16. Continue, until otherwise notified by the State in writing, and as set forth in the State's January 25, 1984 MOU, to make all efforts to resolve amicably with the State and FDIC all issues of compliance with banking laws and regulations, and to cooperate with the FDIC and State in all efforts ami- {{3-31-92 p.A-642}}cably to resolve related issues as they may arise.
   FURTHER ORDERED, that the Amended notice of Intention to Remove from Office and to Prohibit from Further Participation, in Docket No. FDIC-84-50e, is dismissed.
/s/ Alan W. Heifetz
Administrative Law Judge
U.S. Department of Housing and Urban Development
451 7th Street, S.W., #2156
Washington, D.C. 20410
Dated: November 20, 1984

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