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FDIC Enforcement Decisions and Orders

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{{4-1-90 p.A-1415}}
   [5133] Docket No. FDIC-87-4a (3-14-89).

   Bank's insurance terminated. Bank found to be operating in an unsound or unsafe condition because of low capital-to-asset ratio, excessive level of poor quality assets, and failure to comply with an Order of Correction.

   [.1] Terminations of Insurance—Failure to Comply with Order of Correction— Inadequate Capital
   [.2] FDIC Policy Statements—Risk-Based Capital
   FDIC's Statement of Policy on Risk-Based Capital does not replace or eliminate regulations regarding adequacy of capital, and Bank is still subject to minimum capital requirements

   [.3] Unsafe or Unsound Practices—Case-by-Case Determination—Management's Intentions
   Management's strident efforts to increase capital and a proposed imminent recapitalization are irrelevant to the risk posed to the FDIC by Bank's low capitalization.

In the Matter of
* * * BANK


(Insured State Nonmember Bank)
DECISION AND ORDER
TERMINATING FEDERAL DEPOSIT
INSURANCE

Introduction

   This proceeding seeks to terminate the insured status of * * * Bank, * * *, * * * (the "Bank" or "Respondent"), upon findings made by the Board of Directors (the "Board") of the Federal Deposit Insurance Corporation (the "FDIC") pursuant to section 8(a) of the Federal Deposit Insurance Act (the "FDI Act"), 12 U.S.C. §1818(a), that the Bank is in an unsafe or unsound condition to continue operations as an insured bank. After two examinations of the Bank by the FDIC as of July 31, 1986, and June 30, 1987, it was determined that: (1) the Bank was operating with inadequate capital and reserves and with an excessive volume of poor quality assets; (2) during this one year period the financial condition of the Bank had deteriorated; and (3) the Bank had failed to comply with the Order of Correction issued by the FDIC. For the reasons set forth below, the Board concludes that termination of insurance is warranted as found by the administrative law judge (the "ALJ") in his thorough and wellreasoned Recommended Decision which is adopted and incorporated herein.

{{4-1-90 p.A-1416}}
Procedural History

   As a result of its examination of the Bank as of July 31, 1986, the FDIC issued its Findings of Unsafe or Unsound Practices and Condition ("Findings") and Order of Correction on January 20, 1987. The Findings charged that the Bank had engaged in unsafe or unsound practices in the conduct of its business and was in an unsafe or unsound condition to continue operations as an insured bank by reason of its inadequate capital and reserves and its excessive volume of poor quality assets.
   The Order of Correction required that the Bank be restored to a safe and sound condition and take certain corrective actions in order to continue its insured status, including: (1) increase its primary capital by $4,000,000; (2) eliminate from its books, by charge-off or otherwise, 100 percent of its assets classified "Loss" and 50 percent of its assets classified "Doubtful" within 20 days of receipt of the Order of Correction; and (3) provide its shareholders a description of the Order of Correction with its next shareholder communication and with its notice or proxy statement preceding the Bank's next shareholder meeting. In accordance with section 8(a) of the FDI Act, the Bank was given 120 days to comply with the Order of Correction.
   At the expiration of the corrective period, an examination of the Bank as of June 30, 1987, revealed that the Bank had not complied with the requirements of the Order of Correction, that the Bank's capital remained significantly inadequate, and that the Bank continued to operate in an unsafe or unsound condition. Accordingly, on February 12, 1988, the FDIC issued a Notice of Intention to Terminate Insured Status and Order Setting Hearing ("Notice and Order").1 A hearing was held on September 6, 1988, at * * *, * * *. The parties filed briefs, reply briefs, and proposed findings of fact and conclusions of law. On December 23, 1988, ALJ James L. Rose issued his Recommended Decision which recommended termination of the insured status of the Bank. Exceptions to the Recommended Decision were filed by the Bank.

Discussion

   [.1] A. Statutory and Regulatory Requirements.
   It is uncontested that the FDIC has the power under section 8(a) of the FDI Act to terminate a bank's insured status upon a finding that it is in an unsafe or unsound condition. Although the high level of classified assets held by the Bank is certainly a significant factor in this matter, the principal basis upon which the FDIC seeks to terminate the Bank's insured status is the low capital-to-asset ratio. FDIC regulations provide that "any insured bank with a ratio of primary capital to total assets that is less than three percent is deemed to be operating in an unsafe or unsound condition pursuant to section 8(a) of the Federal Deposit Insurance Act," 12 C.F.R. §325.4(c).2 Subsection (c)(2) of this section provides further that a bank with a primary capital to asset ratio equal to or greater than three percent, may nonetheless be operating in an unsafe or unsound condition, and that the FDIC is not precluded from bringing an action to terminate insurance under section 8(a) of the FDI Act with regard to such a bank. The ALJ found, and the Board agrees, that the "undisputed evidence in this matter is that the Bank's capital to asset ratio in 1986 was under three percent and has continued to be under three percent to the present time."3 Recommend Decision (R.D.) at 6. Even the Bank's current management concedes that the Bank must have additional capital. Transcript (Tr.845–846) at 179, 185-6.

B. The Bank's Contentions.

   The testimony and documentary evidence demonstrate that the condition of the


1 A subsequent examination of the Bank was made by the * * * State Department of Banking ("Department") as of the close of business July 1, 1988. (FDIC Exhibit (Ex.) 1) The Department assigned the Bank a uniform rating of "5-5-4-5-5/5", and stated that "it would appear that an injection of not less than $4 million is needed to restore capital adequacy." The Department further found that, "since substantial improvement of the Bank's overall condition has yet to be achieved, this office is compelled to issue a formal order to cease and desist...."

2 Part 325 assets are defined at 12 C.F.R. §325.2(k) as the average total assets taken from the Call Report submitted by a bank, plus the allowance for loan or lease losses, minus assets classified loss, and minus intangible assets other than mortgage servicing rights.

3 The Board incorporates herein the ALJ's recommended finding of fact number 13. This finding is a chart based on information taken from the Quarterly Reports of Condition and Income (Call Reports) submitted by the Bank from December 31, 1986, through June 30, 1988. It shows, among other things, that, according to the Bank, as of December 31, 1986, its ratio of primary capital to Part 325 total assets was 2.28 percent; on June 30, 1988, the ratio was 1.89 percent.
{{4-1-90 p.A-1417}}Bank was unsafe or unsound based on its capital position and the quality of its assets, and the Bank does not seriously contest the underlying facts. Its defense and the exceptions it takes to the Recommended Decision essentially consist of four elements: (1) it is no longer in an unsafe or unsound condition; (2) its continued operation does not present a substantial risk to the insurance fund because its situation has improved since 1986 and the Board should make its determination based upon the Bank's current condition; (3) the Bank's viability should be assessed using the proposed risk based capital analysis, which would increase the Bank's capital ratio over the minimum three percent; and (4) a capital infusion of $2 million is imminent and a delay of this action will resolve the capital adequacy issue and save the Bank. The Exceptions filed by the Bank add nothing new and simply reiterate the same assertions raised throughout this proceeding. While not attacking the underlying findings made by the FDIC examiners or the * * * State examiners, Respondent disagrees with the conclusions reached by the ALJ.
   The Board finds that the ALJ's Recommended Decision is in all material respects fully supported by the law and evidence. The Bank's assertion that it is not operating in an unsafe or unsound condition simply ignores the regulatory definition contained in Part 325 as applied to its own Call Report data. The sole basis for the assertion appears to be statements regarding certain recent management and loan loss recovery improvements noted in the July, 1988, state examination report. FDIC Ex. 13. Notwithstanding these improvements, the evidence is clear that the Bank continues to operate in an unsafe or unsound condition. Therefore, the Board rejects the Bank's Exception on this issue.

   [.2] A major focus of the Bank's case-in-chief and Exceptions is its urging of the Board to view its condition "in light of the proposed `risk-based capital' structure, as proposed by the FDIC, the Office of the Comptroller of the Currency and the Federal Reserve Board, in a joint press release dated December 10, 1987." Respondent (Resp.) Exceptions at 7–8. In support of this position, it cites the testimony of the state bank examiner in response to a hypothetical question attempting to determine the Bank's capital to asset ratio if there were a risk-based capital structure. Resp. Exceptions at 8.
   This argument is not only pure speculation, as Respondent concedes (id.); it is incorrect. The Statement of Policy on Risk-Based Capital (the "Policy Statement") does not replace or eliminate the existing Part 325 primary and total capital to total asset leverage ratios. Moreover, even after the effective date of the Policy Statement, the Bank will remain subject to the section 325.4(c) three percent minimum capital requirement. Thus, even if the risk-based capital policy had been in effect during this proceeding, our analysis of the capital adequacy of the Bank and the conclusion that it is operated in an unsafe or unsound condition would not be modified.
   Furthermore, the focus of the risk-based capital framework is principally based on broad categories of credit risk. As a result, the framework does not take and is not intended to take explicit account of many other factors that can affect a bank's financial condition, such as overall interest rate exposure, liquidity, funding and market risks, the quality and level of earnings, investment or loan portfolio concentrations, the quality of loans and investments, the effectiveness of loan and investment policies, and management's overall ability to monitor and control financial and operating risks.
   A complete assessment of capital adequacy must take account of these other considerations, including, in particular, the level and severity of problem and classified assets. Thus, the risk-based capital ratio is but one element in the assessment of overall capital adequacy, and the final judgment regarding a bank's capital adequacy may differ significantly from conclusions that might be drawn solely from the absolute level of the bank's risk-based capital ratio. Banks with high or inordinate levels of risk should hold capital commensurate with the level and nature of the risks to which they are exposed. Given the numerous problems facing the Bank, the risk-based capital ratio is only the starting point of a capital adequacy analysis.
   In the instant case, capital inadequacy is not the sole basis for determining that this Bank represents a substantial risk to the insurance fund. The June 30, 1987, exami- {{4-1-90 p.A-1418}}nation report found that there had been an "extremely serious deterioration in asset quality." Problem assets totalled $9,093,000 and represented 557.5 percent of capital and reserves. Assets classified "Loss" represented 26 percent of total primary capital. In addition, more than one-fifth of the total loans were classified, for an aggregate amount of $7,689,000. The ratio of delinquent loans stood at 12 percent, which had increased from 10.3 percent and 9.3 percent at the two previous examinations. FDIC Ex. 2.
   A year later, the state bank examination found that adversely classified assets totalled $7,972,000 and represented 595 percent of capital and reserves.4 Although 29 percent of the loan classifications noted at the previous examination were charged off, paid down, or were no longer classified, existing credits not previously classified replaced much of the balance of those loans. This was noted as indicating the continued deterioration of existing credits. FDIC Ex. 13.
   The Bank is extremely highly leveraged as primary capital to adjusted average assets is less than two percent. Thus, adjusted total capital of $1,024,000 must cushion over $60 million of assets, of which $7,466,000 are classified "Substandard" and $191,500 are classified "Doubtful". Loans in both categories constitute above average risk.
   As a result of these findings, the Bank was given an overall rating of 4 by the FDIC in June, 1987, and an overall rating of 5 by the state examiners in July, 1988. The ALJ found that the Bank "is not a well managed bank in generally sound condition as is required to justify allowing the Bank to continue to operate as an insured bank with capital of less than 5.5 percent. 12 C.F.R. §325.3." R.D. at 7. The Board concurs and further finds that on the basis of the evidence before it, the Bank represents a substantial threat to the insurance fund.

   [.3] Finally, at the time of the hearing, the Bank contended that a capital infusion of $2 million is "imminent" with the purchase of $1.75 million in stock and recovery of a $250,000 note which previously had been charged off as a loss. R.D. at 4. While the stock purchase agreement and affidavit of the Bank's president are not part of this record, it is fair to say that based on Respondent's statement in its Exceptions, there has been no injection of capital to date. Respondent's Exceptions do not claim that the purchase has been consummated, but rather merely state that the Bank "has made strident efforts to increase its capital, and the Bank continues to work with third parties toward recapitalization of the Bank within the next several months." Resp. Exceptions at 9. In view of the several claims of imminent capital injections at various stages of this proceeding, the Board finds no comfort from this latest claim.
   Throughout the proceeding Respondent has made representations regarding its efforts to generate capital and has sought delays and continuances allegedly in order to accomplish this. R.D. at 5. Notwithstanding its efforts, between January 20, 1987, the date of the Order of Correction, and January 17, 1989, the date of its Exceptions, there has been no injection of capital. The Bank continues to operate at a dangerously low capital level.
   The Bank recognizes that, if its insurance is terminated it is likely to fail, and now urges the Board, as a matter of policy, to continue its insurance. Resp. Exceptions at 9. The Board believes that the continued viability of the FDIC insurance fund depends upon protecting the fund and depositors from the kind of substantial risk presented by the Bank. After more than two years, its capital to asset ratio and its asset quality have shown only minimal improvement. It remains in urgent need of a significant amount of new capital, which it has been unable to raise. It continues to operate in an unsafe or unsound condition. Termination is necessary in order to protect the insurance fund from eventual loss.

CONCLUSION

   The Board has examined the record in light of Respondent's Exceptions and finds that nothing contained therein requires any modifications to the ALJ's Recommended Decision.
   The Bank has been found to be in an unsafe and unsound condition to continue operations as an insured bank and thus presents an undue insurance risk to the FDIC. Accordingly, the Board finds that it is appropriate to issue an order terminating the insured status of the Bank and requiring


4 The findings of the State Department of Banking are not binding upon the Board. However, they may be considered as relevant evidence.
{{4-1-90 p.A-1419}}the Bank to provide notice of such termination of insured status to its depositors pursuant to section 308.30 of the FDIC Rules and Regulations, 12 C.F.R. §308.30.

ORDER TERMINATING FEDERAL
DEPOSIT INSURANCE

   IT IS HEREBY ORDERED, that the insured status of * * * Bank, * * *, * * *, is terminated effective as of the close of business sixty days from the date of this Order.
   IT IS FURTHER ORDERED, that pursuant to 12 C.F.R. §308.30, the Bank, not later than thirty days from the date of this Order, shall give notice to its depositors of the termination of its status as an insured bank. Such notice shall be mailed to each depositor at the depositor's last address of record as shown upon the books of the Bank. The Bank shall furnish the FDIC with a copy of the notice mailed, together with an affidavit executed by the person who mailed the same. The affidavit shall state that said notice has been mailed to each depositor of the Bank at the depositor's last address of record as shown upon the books of the Bank and the date thereof. Such notice shall meet the requirements of section 308.30 of the FDIC Rules of Practice and Procedures, 12 C.F.R. §308.30, as follows:

NOTICE

____, 1989
   1. The status of * * * Bank, * * *, * * *, as an insured bank under the provisions of the Federal Deposit Insurance Act, will terminate as of the close of business on the ____ day of ____, 1989.
   2. Any deposits made by you after that date, either new deposits or additions to existing deposits, will not be insured by the Federal Deposit Insurance Corporation;
   3. Insured deposits in the Bank on the ____ day of ____, 1989, will continue to be insured, as provided by the Federal Deposit Insurance Act, for two years after the close of business, provided, however, that any withdrawals after the close of business on the ____ day of ____, 1989, will reduce the insurance coverage by the amount of such withdrawals.

* * * Bank * * *, * * *

   There may be included in such notice, with the written approval of the FDIC, any additional information or advice the Bank may deem desirable.
   IT IS FURTHER ORDERED, that the Bank, not later than thirty days from the date of this Order, shall publish in not less than two issues of a local newspaper of general circulation in * * *, * * *, the said notice and shall furnish the FDIC with proof of publication of such notice in the form of a certification from the publisher and a tear sheet or clipping evidencing each such publication.
   IT IS FURTHER ORDERED, that if the Bank is closed for liquidation prior to the time of the opening for business thirty days from the date of this Order, the notices described herein shall not be given to depositors.
   The Board retains full jurisdiction over these proceedings during the interim between the date hereof and the effective termination date, as fixed above, with full power and authority to amend, modify, alter, or rescind this order of termination of the insured status of the Bank. The provisions of this Order shall remain effective and enforceable except to the extent that, and until such time as, any provision of the Order shall be modified, terminated, suspended, or set aside by the FDIC.
   By direction of the Board of Directors.
   Dated at Washington, D.C., this 14th day of March, 1989.
In the Matter of
* * * BANK

(Insured State Nonmember Bank)

RECOMMENDED DECISION

   JAMES L. ROSE, Administrative Law Judge: This is an action under 12 U.S.C. §1818(a) brought by the Federal Deposit Insurance Corporation to terminate the insured status of the * * * Bank, * * * (herein the Bank or the Respondent). Following the hearing held on September 6, 1988, at * * *, counsel for the parties filed extensive briefs, reply briefs and proposed findings of fact and conclusions of law. Upon the record as a whole,1 including my observation


1 Following the close of the hearing the Respondent filed a motion to supplement the record to include a purchase agreement which, according to the Respondent, would amount to a capital injection of $2 million, and an affidavit by (Continued)

{{4-1-90 p.A-1420}}of the witnesses, briefs and arguments of counsel, I hereby make the following:

Findings and Conclusions

I. Statement of the Case

   The Respondent is a small commercial bank operating on the outskirts of * * *. It is chartered by the State of * * * and is not a member of the Federal Reserve System, but is insured by the Federal Deposit Insurance Corporation. Accordingly, its primary regulator is the State of * * * Department of Banking, and is also regulated and examined by the FDIC.
   This matter began with the FDIC examination as of July 31, 1986, as a result of which findings an order of correction were issued on January 20, 1987. In essence, it was concluded that the Bank was operating with inadequate capital and reserves and with an excessive volume of poor quality assets. The order of correction required the Bank to increase its primary capital by at least $4 million and to eliminate all its assets which had been classified as loss and one-half of the assets classified as doubtful.
   Following expiration of the 120-day correction period; the Bank was again examined, as of June 30, 1987. As a result of this examination it was determined that the Bank had not complied with the order of correction, and on February 12, 1988, the FDIC issued a notice of intention to terminate insured status and an order setting the hearing.
   The State Department of Banking caused an examination to be made of the Bank as of the close of business July 1, 1988, the report of which is in evidence in this matter (FDIC Exhibit 13). Of significance is the transmittal letter of this report to the Bank's board of directors from the Commissioner of Banking. The Department assigned the Bank a uniform rating of "5-5-4-5-4/5." It was also stated, "Capital projections continue to be a critical area of concern, as equity will be reduced to less than $300,000 after necessary provisions to the loan loss reserve are made. Currently, it would appear that an injection of not less than $4 million is needed to restore capital adequacy." The Commissioner also noted that while the examiner found management favorable in several respects, the Bank continued to have numerous administrative weaknesses. And, "(S)ince substantial improvement of the Bank's overall condition has yet to be achieved, this office is compelled to issue a formal order to cease and desist...."
   Among other things, the State Banking Department concluded that the ratio of primary capital to Part 325 (12 C.F.R. §325) total assets was 1.96 percent. This was an increase from the June 30, 1987, FDIC examination. Then it was found that the ratio of primary capital to Part 325 total assets was 1.76 percent. The ratio of primary capital to Part 325 total assets as of July 30, 1986, was 2.43 percent.
   In short, at the examination upon which the order of correction was based it was concluded that the capital to asset ratio was sufficiently low to require the injection of $4 million in additional capital. This was not done as of the June 30, 1987, examination. Indeed, by then the primary capital to Part 325 total assets ratio had eroded somewhat. Although this ratio had increased as of the July 31, 1988, state examination, it was still only 1.96 percent.
   The Respondent contends that nearly 50 percent of its assets are in low risk government securities. If a risk base capital analysis proposed by the Comptroller of the Currency, the Federal Reserve System and the FDIC were used (see FDIC Exhibit 25), then these assets would not be considered in determining capital adequacy and, quoting from the Respondent's brief, "Under the proposed risk base capital system, Mr. * * * (the state examiner) speculated that the Bank's capital ratio would probably increase to a ratio as high as 3.8 percent, with government securities eliminated from the risk calculation." (Citation omitted.)
   Similarly, the Respondent argues that its two applications for capital forbearance should have been granted and if so, it would not be required to meet the capital levels set forth in Part 325. Suffice it that the applications were considered, and rejected, the correctness of which is not an issue here. This Bank is required to meet the capital requirements of Part 325.


1 Continued: * * *, the President of the Bank. Counsel for the FDIC objected to this motion. The motion was granted in part; however, I conclude the substance of the facts sought to be included in the record concerning the proposed infusion of $2 million to be irrelevant to any of the material issues in this case. Accordingly, the purchase agreement and affidavit are not included in the record.
{{4-1-90 p.A-1421}}
   The Respondent also contends that the state examination report highlighted that the Bank's condition has improved and that many of the Bank's lending problems were as a result of mistakes of prior management which have been corrected. In addition, the Respondent contends that a capital infusion of $2 million is "imminent" with the purchase of $1.75 million in stock and a $250,000 note which has been charged off as a loss.

II. Analysis and Concluding Findings

   The Respondent does not really contest the power of the FDIC under §1818(a) to terminate a bank's insured status upon a finding that it is in an unsafe or unsound condition.
   The Respondent's basic position is that it is no longer in an unsafe and unsound condition because its situation has improved since 1986 and, in any event, the critical determination is the Bank's condition now and not as of the 1986 or 1987 FDIC examinations.
   Further, the Respondent contends that the principal condition which the FDIC argues is unsafe and unsound is the capital inadequacy, a situation which will soon be resolved favorably upon the infusion of $2 million in capital.
   It should be noted that throughout the course of this proceeding the Respondent represented attempts to generate capital and has sought continuances of the proceeding in order to accomplish this result. Thus, at the pre-trial conference held between the undersigned and counsel in June 1988, a 90-day postponement was requested in order to pursue an avenue for capital injection. Similar requests for a continuance of the hearing date were made. To this time, however, no actual injection of capital has been made.2 Therefore the most reliable and recent information upon which a determination can be made as to the Bank's capital position is the July 31, 1988, state examination report.
   Although there are other factors involved in this matter, particularly the high level of classified assets, the principal basis upon which the FDIC seeks to terminate the Bank's insured status is the low capital-to-asset ratio.
In 12 C.F.R. §325.4(c):

    Unsafe or Unsound Condition. Any insured bank with a ratio of primary capital to total assets that is less than three percent is deemed to be operating in an unsafe or unsound condition pursuant to section (a) of the Federal Deposit Insurance Act (12 U.S.C. 1818(a)).
And in §325.4(c)(2):
    An insured bank with a ratio of primary capital to total assets that is equal to or greater than three percent may be operating in an unsafe or unsound condition. The FDIC is not precluded from bringing an action pursuant to 12 U.S.C. 1818(a) where an insured bank has a ratio of primary capital to total assets that is equal to or greater than three percent.
   The undisputed evidence in this matter is that the Bank's capital to asset ratio in 1986 was under 3 percent and has continued to be under 3 percent to the present time.
   While the Respondent argues that by accepting the proposed risk base capital approach, the ratio would be at "3.8 percent", such would not require dismissal of this action. Even accepting the risk base capital argument of the Respondent, the conclusion of the state examination is that the overall rating of this Bank is "5"—the lowest possible. The FDIC assigned a "4" in 1987. It is not, therefore, a well managed bank in generally sound condition as is required to justify allowing the Bank to continue to operate as an insured bank with capital of less than 5.5 percent. 12 C.F.R. §325.3.
   Finally, the Respondent contends that termination of insured status would effectively cause the Bank's failure. In view of the Bank's "modest improvements since the FDIC's 1987 examination and the imminent recapitalization, this Bank is worth saving." Thus, the Respondent argues that as a matter of policy and notwithstanding the inescapable conclusion that it is operat-

2 The purchase agreement the Respondent sought to include in the record does not rise to the level of an imminent infusion of capital, even if such were material. In that agreement, the purchasers' obligations are conditioned, inter alia, on (6)(d) "the granting of the purchasers' request for capital forbearance by the FDIC and the * * * Department of Banking and notice from the FDIC of its dismissal of proceedings to terminate the Bank's insurance." Even if the FDIC Board were to dismiss this action meeting one of the conditions for infusion of $2 million in capital, there would be no assurance that other conditions in this paragraph or other paragraphs of the purchase agreement would be met.
{{4-1-90 p.A-1422}}ing in an unsafe and unsound condition as set forth in Part 325, the FDIC Board ought nevertheless continue to allow the Bank its insured status.
   Inasmuch as the hoped for infusion of capital has not occurred, and is unlikely absent dismissal of this action, and since the Bank in fact has been operating at a dangerously low capital level without significant improvement during the last 2 years, the conclusion is inescapable that its continued operation as an insured bank poses a substantial risk to depositors and the insurance fund.
   Although the Respondent argues that improvements in management have been made, I note that the * * * Department of Banking nevertheless concluded that an order to cease and desist is appropriate. While such findings are not binding upon the FDIC Board, such certainly can be considered in determining the efficacy of the Respondent's argument that the report proves that the Bank's management has improved.
   Given the primary capital to Part 325 assets ratio of under 3 percent, the large volume of classified assets and the fact that these conditions have continued for more than 2 years, I conclude that the FDIC established that the Bank is in an unsafe and unsound condition. Accordingly, I conclude that the FDIC proved the predicate for terminating the Bank's insured status under §1818(a), and I will recommend to the FDIC Board that this Bank's insured status be terminated.
   Upon the foregoing findings and analysis, and the entire record in this matter, I hereby issue the following findings of fact, conclusions of law and recommended order.

FINDINGS OF FACT

   1. The Bank is a corporation organized, existing and doing business under the laws of the State of * * *, having its principal place of business in * * *. At all material times it has been an insured state nonmember bank. The Bank is not a member of the Federal Reserve System. (FDIC Ex. 4).
   2. The Bank is now and has been, at all times pertinent herein, subject to the provisions of the Act, 12 U.S.C. §1811, et seq., the Rules and Regulations of the FDIC, 12 C.F.R. Chapter III, and the laws of the State of * * *. (FDIC Ex. 4).
   3. The Bank was examined by a group of examiners from the FDIC as of the close of business July 31, 1986, and as of the close of business June 30, 1987, and Reports of Examination were prepared. (FDIC Ex. 2; TR. 30 and FDIC Ex. 7; TR. 54).
   4. As a result of the July 31, 1986, examination, the FDIC determined that the Bank was in an unsafe or unsound financial condition. (Tr. 52).
   5. The FDIC Board of Directors issued Findings of Unsafe or Unsound Practices and Condition and Order of Correction ("Findings" and "Order of Correction") against the Bank on January 20, 1987. (FDIC Ex. 4)
   6. The time period established by the Order of Correction for the Bank to be restored to a safe and sound condition was 120 days from the date of receipt by the Bank of the Order of Correction. (FDIC Ex. 4).
   7. Following expiration of the 120 day corrective period, FDIC examiners examined the Bank as of the close of business June 30, 1987, and a Report of Examination was prepared.
   8. As of the date of the June 30, 1987, examination, the FDIC determined that the Bank had failed to comply with the provisions of the Order of Correction by not having increased its primary capital by $4 million. (FDIC Ex. 7, p. 1; TR. 67 and admitted by the Bank at page 2, paragraphs 5 of its First Amended Answer).
   9. During the July 31, 1986, examination, the FDIC made the following analysis of the Bank's assets and capital:
   (a) Assets adversely classified were:

Substandard $8,423,000
Doubtful 139,000
Loss 764,000
__________
Total: $9,326,000

   (FDIC Ex. 2 p. 4; TR. 39)

   (b) Loans adversely classified were:

Substandard $7,287,000
Doubtful 139,000
Loss 760,000
__________
Total $8,186,000

   (FDIC Ex. 2 p. 4; TR. 40)

   (c) Total equity capital was $1,834,000. (FDIC Ex. 2 p. 5; TR. 43).
   (d) The Bank's total equity capital plus reserves was $2,486,000 which is the aggregate amount of loss that the Bank can absorb before its ability to honor depositor's {{4-1-90 p.A-1423}}claims becomes impaired. (FDIC Ex. 2 p. 5; TR. 45–46).
   (e) Primary capital which is total equity capital plus loan loss reserves less assets classified Loss was $1,722,000. (FDIC Ex. 2 p. 5; TR. 46–47).
   (f) Adjusted primary capital which is primary capital less 50% of assets classified Doubtful was $1,652,000. (FDIC Ex. 2 p. 5; TR. 47).
   (g) Part 325 total assets which is the average total assets taken from the Call Report submitted by the Bank plus loan loss reserve less assets classified Loss was $70,861,000. (FDIC Ex. 2 p. 5; TR. 48).
   (h) Adjusted Part 325 total assets which results from subtracting 50% of assets classified Doubtful was $70,791,000. (FDIC Ex. 2 p. 5; TR. 49).
   (i) The Bank's ratio of primary capital to Part 325 total assets was 2.43%. (FDIC Ex. 2 p. 5; TR. 49).
   (j) The Bank's ratio of adversely classified assets to total equity and reserves was 375%. (FDIC Ex. 2 p. 5; TR. 51–52).
   10. During the June 30, 1987, examination, the FDIC made the following analysis of the Bank's assets and capital:
   (a) Assets adversely classified were:

Substandard $8,486,000
Doubtful 183,000
Loss 424,000
__________
Total $9,093,000

   (FDIC Ex. 7 p. 6; TR. 56–57)

   (b) Loans adversely classified were:

Substandard $7,157,000
Doubtful 183,000
Loss 349,000
__________
Total $7,689,000

   (FDIC Ex. 7 p. 6; TR. 57)

   (c) The ratio of adversely classified loans and leases to total loans and leases was 22.22 percent.
   (d) Total equity capital was $867,000. (FDIC Ex. 7 p. 7; TR. 60).
   (e) Total equity capital plus reserves had decreased by about 30 percent since July, 1986 to $1,631,000. (FDIC Ex. 7 p. 7; TR. 61–62).
   (f) Primary capital was $1,207,000. (FDIC Ex. 7 p. 7; TR. 62).
   (g) Adjusted primary capital was $1,115,000. (FDIC Ex. 7 p. 7; TR. 62).
   (h) Part 325 total assets was $68,684,000. (FDIC Ex. 7 p. 7; TR. 63).
   (i) Adjusted Part 325 total assets was $68,592,000. (FDIC Ex. 7 p. 7; TR. 63).
   (j) The ratio of primary capital to Part 325 total assets was 1.76 percent. (FDIC Ex. 7 p. 7; TR. 64).
   (k) The Bank's ratio of adversely classified assets to total equity capital and reserves was 557.51 percent. (FDIC Ex. 7 p. 7; TR. 65).
   11. The State of * * * Department of Banking examined the Bank as of the close of business July 1, 1988. (FDIC Ex. 13; TR. 142).
   12. During the July 1, 1988, examination, the State of * * * made the following analysis of the Bank's assets and capital:
   (a) The ratio of primary capital to Part 325 total assets was 1.96 percent. (FDIC Ex. 13 p. 3).
   (b) The ratio of adversely classified items to total equity capital and reserves was 595.37 percent. (FDIC ex. 13 p. 2 TR. 103, 145).
   (c) The ratio of equity to assets was .92 percent, and, if adjusted for recommended loan loss provision, would be .39 percent. (FDIC Ex. 13 p. 3; TR. 144).
   13. The Quarterly Reports of Condition and Income (Call Reports) the Bank submitted from December 31, 1986, through June 30, 1988, show the following:

Ratio
Total Primary Capital
Date of Equity Primary To Part 325
Call Report Capital Reserves Capital Total Assets
12-31-86 $767,000 $735,000 $1,502,000 2.28%
03-31-87 $838,000 $724,000 $1,562,000 2.28%
06-30-87 $400,000 $368,000 $768,000 1.07%

{{4-1-90 p.A-1424}}

Ratio
Total Primary Capital
Date of Equity Primary To Part 325
Call Report Capital Reserves Capital Total Assets
09-30-87 $414,000 $792,000 $1,206,000 1.94%
12-31-87 $443,000 $646,000 $1,089,000 2.12%
03-31-88 $489,000 $723,000 $1,212,000 2.23%
06-30-88 $291,000 $898,000 $1,188,000 1.89%

(FDIC Ex. 14–20, 21; TR. 124)

   14. The Call Reports of the Bank submitted from December 31, 1986, through June 30, 1988, show the following with regard to earnings:

Date of Income Net Operating*
Call Report Reporting Period Income (Pre-Tax)
12/31/86 01-01-86 to 12-31-86 ($893,000)**
03-31-87 01-01-87 to 03-31-87 $70,000
06-30-87 01-01-87 to 06-30-87 ($366,000)
09-30-87 01-01-87 to 09-30-87 ($354,000)
12-31-87 01-01-87 to 12-31-87 ($323,000)
03-31-88 01-01-88 to 03-31-88 $45,000
06-30-88 01-01-88 to 06-30-88 ($139,000)


* After adjustment for loan loss reserve.

** Excludes securities gains of $235,000
(FDIC Ex. 14–20, 34; TR. 130–131)

   15. On or about June 16, 1986, the Bank requested capital forbearance (FDIC Ex. 26), which request was denied because the Bank failed to meet the definition of an oil and gas bank. (FDIC Ex. 23; TR. 160).
   16. On or about November 2, 1987, the Bank made a second request for capital forbearance (FDIC Ex. 31), which request was denied because the Bank failed to submit a viable capital plan. (FDIC Ex. 24; TR. 161–163).
   17. The Bank's earnings are insufficient to recapitalize the Bank in a timely manner (FDIC Ex. 34; TR. 130–131, 147) and are insufficient to satisfy loan loss allocations. (TR. 187).
   18. Neither FDIC nor the State of * * * has adopted a policy or regulations to evaluate a bank on the basis of risk-based capital. (TR. 161, 163).
   19. Neither FDIC nor the State of * * * analyzed the Bank on the basis of risk-based capital. (TR. 80, 151).
   20. The Bank's management changed in early 1985. (TR. 72).
   21. The Bank's current management concedes that the Bank must have additional capital. (TR. 179, 185–186).

CONCLUSIONS OF LAW

   1. The FDIC has jurisdiction over insured State nonmember banks which are subject to the provisions of the Act (12 U.S.C. §§1811–1831) and the Rules and Regulations of the FDIC (12 C.F.R. Chapter III).
   2. Whenever the Board of Directors of FDIC shall find that an insured bank has engaged or is engaging in unsafe or unsound practices in conducting the business of such bank or is in an unsafe or unsound condition to continue operations as an insured bank, the Board of Directors shall give a statement with respect to such practices for purposes of securing the correction thereof to the State authority supervising such bank with a copy to the bank, Title 12 U.S.C. §1818(a).
   3. Unless such correction shall be made within one hundred and twenty days, or such shorter period not less than twenty days fixed by the Corporation, in any case where the Board of Directors in its discretion has determined that the insurance risk of the Corporation is unduly jeopardized, or fixed by the State supervising authority, if the Board of Directors shall determine to proceed further, shall give to the Bank not {{4-1-90 p.A-1425}}less than thirty days written notice of intention to terminate the insured status of the Bank and shall fix a time and place for hearing before the Board of Directors or before a person designated by it to conduct such hearing, 12 U.S.C. §1818(a).
   4. The minimum capital requirement for a bank whose overall financial condition is fundamentally sound shall consist of a ratio of total capital to total assets of not less than 6 percent and a ratio of primary capital to total assets of not less than 5.5 percent, 12 C.F.R. §325.3(b).
   5. Any insured bank with a ratio of primary capital to total assets that is less than 3 percent is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act, 12 U.S.C. §1818(a), 12 C.F.R. §325.4(c).
   6. The following FDIC Statements of Policy are relevant to the application of the capital requirements of 12 C.F.R. Part 325:
   (a) Statement of Policy on Capital [Source: 50 Fed. Reg. 11139, March 19, 1985, effective April 18, 1985]: This statement provides in relevant part that any insured bank with a primary capital ratio of less than 3 percent must enter into and be in compliance with a written agreement with FDIC to increase its primary capital ratio to such level as FDIC deems appropriate or be subject to a termination of insurance action by the FDIC. (FDIC Ex. 22).
   (b) Capital Forbearance [dated and effective March 27, 1986]: This policy statement applies only to banks with specified concentrations in agriculture or oil and gas loans, and with primary capital ratios declining to no less than 4 percent prior to December 31, 1987. (FDIC Ex. 23).
   (c) Guidelines for Implementing a Policy of Capital Forbearance [Source: 52 Fed. Reg. 26182, July 13, 1987, effective July 7, 1987]: This policy statement requires, in part, that the bank provide a plan acceptable to the FDIC for restoring and should provide for realistic improvement in the bank's primary capital ratio. It further specifically provides that existing administrative actions against banks remain in effect —including provisions addressing capital. (FDIC Ex. 24).
   7. FDIC has considered but has not adopted a policy on risk-based capital.
   8. The examinations of July 31, 1986, June 30, 1987, and July 31, 1988, demonstrate that the Bank has insufficient capital and was, and is, in an unsafe and unsound condition within the meaning of 12 U.S.C. §1818(a).
   9. The Call Reports of the Bank demonstrate that its earnings are insufficient to recapitalize the Bank in a timely manner.
   10. Notwithstanding new management, the Bank remains in an unsafe and unsound condition.
   11. The statutory requirements of Section 8(a) have been satisfied and FDIC may issue an Order terminating the Bank's insured status pursuant to Section 8(a) of the Act.
   Upon the foregoing findings and conclusions, and the entire record in this matter, I recommend that the FDIC issue the attached Order Terminating Federal Deposit Insurance.
   Dated, Washington, D.C. December 23, 1988

In the Matter of
* * * BANK

(Insured State Nonmember Bank)

ORDER TERMINATING FEDERAL
DEPOSIT INSURANCE

   NOW, THEREFORE, In conformity with the above Findings of Fact and Conclusions of Law, and pursuant to Section 8(a) of the Federal Deposit Insurance Act:
   IT IS HEREBY ORDERED:
   FIRST, That the insured status of * * * Bank, * * * ("Bank"), be and the same hereby is terminated effective as of the close of business ____, 198__.
   SECOND, That the Bank, not later than ____, 198__, shall give notice to its depositors of the termination of its status as an insured bank, such notice to be mailed by First Class United States mail to each depositor at the depositor's last address of record as shown upon the books of the Bank, and that the Bank shall furnish the FDIC with a copy of the notice mailed, together with an affidavit executed by the person who mailed the same, which affidavit shall further state the fact that said notice had been mailed the date of the mailing thereof, and shall further state that the said notice was mailed to each depositor of the {{4-1-90 p.A-1426}}Bank at this last address as shown upon the records of the Bank as of the date the notice was mailed, and upon refusal or failure of the Bank to give such notice as specified above, the FDIC is authorized to so notify the depositors. The said notice shall be in the form as follows:

NOTICE

____, 1988
   1. The status of * * * Bank, * * *, as an insured bank under the provisions of the Federal Deposit Insurance Act, will terminate as of the close of business on the ____ day of ____, 198__.
   2. Any deposits made by you after that date, either new deposits or additions to existing deposits, will not be insured by the Federal Deposit Insurance Corporation;
   3. Insured deposits in the Bank on the ____ day of ____, 19__, will continue to be insured, as provided by the Federal Deposit Insurance Act, for two years after the close of business, provided, however, that any withdrawals after the close of business on the ____ day of ____, 198__, will reduce the insurance coverage by the amount of such withdrawals.

* * * Bank

There may be included in such notice, with the written approval of the FDIC, and additional information or advice the Bank may deem desirable.
   THIRD, That the Bank, not later than ____, 198__, shall publish in not less than two issues of a local newspaper of general circulation the said notice and shall furnish the FDIC with proof of publication of such notice in the form of a certification from the publisher and a tear sheet or clipping evidencing such publication.
   FOURTH, That the Executive Secretary of the FDIC be, and hereby is, directed to immediately send a copy of the Findings of Fact, Conclusions of Law, and this Order, by Registered Mail, Return Receipt Requested, to * * * Bank, * * *, to the Honorable * * *, Banking Commissioner for the State of * * *, and to * * *, the Counsel for the Bank participating in these proceedings.
   FIFTH, That if the Bank is closed for liquidation prior to the time of the opening for business on ____, 19__, the notices prescribed in paragraphs SECOND AND THIRD of this Order shall not be given to the depositors.
   SIXTH, That the Board of Directors of the FDIC retains full jurisdiction over these proceedings during the interim between the date hereof and the effective termination date, as fixed herein above, with full power and authority to amend, modify, alter, or rescind the order of termination or the insured status of subject Bank.
   Dated at Washington, D.C., ____, 198__.
   By direction of the Board.

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