Each depositor insured to at least $250,000 per insured bank



Home > Regulation & Examinations > Bank Examinations > FDIC Enforcement Decisions and Orders




FDIC Enforcement Decisions and Orders

ED&O Home | Search Form | Text Search | ED&O Help


{{3-31-91 p.A-1567}}


   [5156] In the Matter of Boundary Waters State Bank, Ely, Minnesota, Docket No. FDIC 88-285a(11-5-90).

   Bank's insurance terminated. Bank found to be operating in an unsafe or unsound condition because of inadequate capital, excessive volume of poor quality assets, and inadequate management. (This order was terminated by order of the FDIC dated 1-7-91; see15,213.)
   [.1] Termination of Insurance — Inadequate Capital
   FDIC's power to terminate insurance when Bank's capital to asset ratio is less than 3 percent is discretionary. Termination is appropriate when Bank is operating in an unsafe or unsound condition.
   [.2] Termination of Insurance — Defenses — Arbitrary and Capricious Conduct by FDIC
   FDIC's earlier rejection of an application for change in control of Bank does not estop FDIC from terminating Bank's insurance.
   [.3] Termination of Insurance — Standard of Review
   In a proceeding to terminate insurance, FDIC need prove only that Bank is unsafe or unsound.
   [.4] Management — Conduct of Prior Management
   Even when Bank's problems began under prior management, problems may be attributed to current management where current management has controlled Bank for one year and Bank's overall condition has not improved.
   [.5] Termination of Insurance — Costs of Termination

   In a proceeding to terminate insurance, FDIC is not required to consider the costs of termination or the risk to the insurance fund posed by Bank's continued operation.
In the Matter of

BOUNDARY WATERS STATE BANK
ELY, MINNESOTA
(Insured State Nonmember Bank)
DECISION AND ORDER
TERMINATING FEDERAL
DEPOSIT INSURANCE

INTRODUCTION

   This proceeding seeks to terminate the insured status of Boundary Waters State Bank, Ely, Minnesota (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 an examination of the Bank by the State of Minnesota (the "State") as of September 1989 (the report of which is not in evidence), an examination by the FDIC as of March 3, 1989, and a visitation by the State as of January 29, 1990, the FDIC concluded that (1) the Bank is operating with inadequate capital and reserves; (2) the Bank is operating with an excessive volume of poor quality assets; and (3) the Bank is operating with management whose policies and practices are detrimental to the Bank and jeopardize the safety of its deposits.
   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 Recommended Decision, which is adopted and incorporated herein.

PROCEDURAL HISTORY

   The FDIC initiated this action on December 23, 1988, by issuing to the Commissioner of Commerce for the State of Minnesota ("Commissioner") and to the Bank, notice of the FDIC's determinations of the Bank's unsafe or unsound condition and practice in the form of the Findings of Violations of Cease-and-Desist Order and of Unsafe or Unsound Practices and Condition and Order of Correction.
   The FDIC's examination of the Bank as of March 3, 1989, revealed that the Bank's condition and practices remained unsafe or unsound. As a result of these findings, on October 31, 1989, the FDIC issued a Notice of Intention to Terminate Insured Status. Findings of Violation of Order and/or Unsafe

{{3-31-91 p.A-1568}}or Unsound Practices and/or Condition, and Order Setting Hearing ("Notice"). The Bank and the Commissioner were served with the Notice on or about November 17, 1989. The Bank filed its Answer on December 6, 1989.
   A hearing was held on April 9 and 11, 1990, in Minneapolis, Minnesota, before Administrative Law Judge James L. Rose. At the hearing, the ALJ permitted the Bank to amend its Answer to allege as an affirmative defense arbitrary and capricious conduct by the FDIC based upon the FDIC's denial of an application for a change in control of the Bank, in the case captioned In the Matter of Boundary Waters State Bank, Ely, Minnesota, FDIC Docket No. FDIC-89-161j. As part of his ruling, the ALJ held that the transcript and his Recommended Decision in that case would be part of the record in this matter.1 The parties filed briefs, reply briefs, and proposed findings of fact and conclusions of law.2 On July 26, 1990, the ALJ issued his Recommended Decision which recommended termination of the insured status of the Bank. No Exceptions to the Recommended Decision were filed by either party. Accordingly, both parties have waived objection to the Recommended Decision. 12 C.F.R. § 308.41(d).

DISCUSSION

   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. The central issue is, of course, whether the Bank was in such condition. 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).3 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.

   [.1] Although the Respondent devotes a considerable portion of its submissions to the assertion that the FDIC need not terminate the insurance of a bank with less than three percent primary capital and that the above cited regulation creates only a rebuttable, rather than conclusive, presumption, this argument is essentially irrelevant in the circumstances of this case. While there may be a case in which the FDIC might exercise its discretion to refrain from terminating the insurance of a bank with less than three percent primary capital, this is not such a case. The record herein so strongly supports the conclusion that this Bank was and is operating in an unsafe and unsound condition, that the distinction between a rebuttable and a conclusory presumption is meaningless. Assuming the presumption were rebuttable, no evidence presented by the Respondent even approaches the threshold necessary to rebut the presumption. The ALJ found, and the Board concurs with the finding, that "there is nothing in this record which would suggest that the Bank's capital to asset ratio of less than 3 percent does not imply an unsafe and unsound condition...Not only does the March 3, 1989 examination demonstrate that the Bank was in an unsafe and unsound condition, its own Call Reports confirm this. And the state visitation of January 1990 shows that the condition has not changed." R.D. at 7.
   B. The FDIC's Assertions
   The low capital-to-asset ratio and the high level of classified assets held by the Bank are the principal bases upon which the FDIC seeks to terminate the Bank's insured status.4 The underlying statistics of the case


1 The ALJ also permitted the FDIC to withdraw allegations in the Notice regarding violations of the Cease-and-Desist Order against the Bank, reserving such allegations without prejudice for a related enforcement matter.

2 Citations in this Decision shall be as follows:
   Recommended Decision — "R.D. at ____."
   Transcript — "Tr. at ____."
   Exhibits — "FDIC Ex. ____" or "Resp Ex. ____."

3 "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.

4 The FDIC further asserts that the bank's condition was unsafe or unsound by reason of its poor management and poor earnings and liquidity. The ALJ so found, and the Board concurs. R.D. at 7.
{{2-28-91 p.A-1569}}are not contested by the Bank. R.D. at 3. At the March 3, 1989, examination it was found that, of $13,092,000 in total assets, the Bank had $2,716,000 in adversely classified loans. The Bank's ratio of primary capital to Part 325 total assets was 1.36 percent. FDIC Ex. 3a, p. 11. This was down from 3.1 percent as of June 24, 1988; 4.70 percent as of the State examination of September 25, 1987; and 6.8 percent as of January 23, 1987. It was also found that the Bank's adjusted primary capital to adjusted Part 325 total assets was negative 0.36 percent and that the ratio of adversely classified loans to total equity capital and reserves was 532.80 percent. The examiner found that the Bank's liquidity ratio was a low 16.9 percent. He gave the Bank a composite rating of 5, the worst possible rating indicating severe problems threatening the viability of the Bank. R.D. at 2. In its brief, the Bank concedes that its equity capital including reserves has been and is now less than 3 percent of its Part 325 total assets. R.D. at 3.
   As of the March 3, 1989 examination, capital and loan loss reserves were significantly inadequate. FDIC Ex. 3a, p. 11. The dollar amount of loans in the Bank adversely classified "Loss" and half of those adversely classified "Doubtful" as of March 3, 1989, consisting of $248,000 and $228,000, respectively, totalled $476,000 and well exceeded the Bank's loan loss reserves of $383,000. FDIC Ex. 3a, p. 11, 14d; Tr. at 63. The record indicates that 22.82 percent of the Bank's assets were adversely classified, and such adversely classified assets were 532 percent of the Bank's total equity capital and reserves.5 Tr. at 79–82, 133; FDIC Ex. 3a, p. 11. The largest portion of the Bank's assets, its loans, were of a very poor quality. The record indicates that 27.82 percent of the loans were adversely classified, and that 18.68 percent of the Bank's loans were overdue. Tr. at 78, 80–82; FDIC Ex. 3a, p. 10.
   The Board adopts the findings of the ALJ that "all of the evidence of record concerning the Bank's capital, asset quality, liquidity, and management show that it is and has been operating in an unsafe and unsound condition and therefore is a potential threat to the insurance fund." R.D. at 7. The Board further adopts the ALJ's finding that, "as of the date of the hearing the Bank continued to operate with inadequate capital, even for a well managed bank without substantial loan problems. Respondents evidence fails to show that it is well managed or without severe problems." R.D. at 8.
   C. The Bank's Defenses

   [.2] The ALJ permitted the Respondent to amend its Answer prior to the hearing to assert as an affirmative defense that this Board's failure to approve an application for a change in control of the Bank, which allegedly would have infused capital sufficient to satisfy the FDIC's requirements, was arbitrary and capricious, and, accordingly, that the FDIC is estopped by its conduct from terminating the Bank's insured status based upon capital insufficiency.
   Although this is Respondent's principal defense, it was appropriately summarily rejected by the ALJ. The Board similarly rejects this defense, as it is totally without merit. After a complete administrative hearing in which the representative of the proposed new control group had a full opportunity to present his case, and after a full review of the record, this Board disapproved the application for change in control. The Board concluded that the proposed president and chief executive officer and proposed acquiring party lacked both the competence and integrity to justify approval of the application. Additionally, the Board concluded that the terms of the application placed unacceptable conditions on the FDIC's exercise of its regulatory authority. See FDIC-89-161j. The suggestion that the Board's analysis and conclusions are arbitrary and capricious will not withstand even a glance at the Board's Decision in that case. The statutory time period for appeal of that decision has expired, and no appeal has been filed.6


5 The FDIC's adverse classifications of Bank assets as of March 3, 1989, are unchallenged by the Bank.

6 Although the Board need not, and does not, decide this case on this issue, FDIC Enforcement Counsel correctly asserts in his brief that Respondent's estoppel defense could not prevail. First, estoppel is not ordinarily available as a defense against action by an agency of the Federal government. Second, the Bank cannot raise estoppel as a defense where the alleged estoppel arises out of a matter or transaction to which the Bank was not a party. Finally, a party claiming an estoppel cannot do so without at least pleading (and, presumably, later proving) that the traditional elements of an estoppel are present. Respondent has not even done this.
{{2-28-91 p.A-1570}}

   [.3] Respondent asserts that the Bank "is not in such an unsafe or unsound condition" that deposit insurance must be terminated (emphasis added). Of course, this is an attempt by the Bank to create a new standard, not found in either the FDI Act or the FDIC regulations. The FDIC need not prove by a preponderance of the evidence that the Bank is "so" unsafe or unsound as to require termination of insurance; it must prove only that the Bank is unsafe or unsound. This it has done.

   [.4] The Respondent argues that its condition was the result of actions by previous management, and that current management has improved conditions such that the Bank is and will be profitable according to its budget statement. The record does not support this assertion. While in 1989 there had been some improvement in the amount of losses over the losses experienced in 1988 and 1987, Respondent's own Reports of Condition and Income for 1989 show that the Bank had a net operating loss of $259,000 for the year. Moreover, the Bank's income statement for the first two months of 1990 reports an accumulated loss of $15,126.89. As noted by the ALJ, "while this may be a better figure than that in the budget, it is nevertheless negative." R.D. at 3.

   To show improvement both in management of the Bank and in its condition, much is made by the Bank of its restructuring of credit lines. However, State Bank Examiner Curtis Thoreson testified that the quality of the Bank's loan portfolio was still unsatisfactory, both as of September 8, 1989, and as of January 29, 1990. Tr. at 168–169. Examiner Thoreson noted that while some loans were "restructured," the fundamental problem of the borrowers' inability to repay the debt had not been improved in the least. Tr. at 169, 172. The evidence shows that the restructuring that was done consisted primarily of extending the payment terms for loans so that they would not be overdue. The Bank's records do not contain updated financial statements or other documentation indicating any likelihood that borrowers could make payments when the extended terms expire. Tr. at 169-70.
   In addition, the Board notes that, although the Bank's problems began under prior management, the continuing (and in some areas, increasing) problems of the Bank are attributable to current management, which had been in control for over a year at the time of the March 3, 1989, examination. For example, current management failed to adequately reduce the percentage of classified assets and to maintain adequate loan loss reserves and capital, and to adequately monitor the Bank's liquidity position. Tr. at 88–90, 95; FDIC Ex. 3a, pp. 3, 13. The Board adopts the ALJ's finding that "the Bank remains in a precarious position...[and] management has not improved the overall condition of the Bank." R.D. at 7.

   [.5] Finally, Respondent contends that the FDIC's costs in terminating the Bank's insured status would be far greater than the alleged risk the Bank poses to the insurance fund, and that for policy reasons the Board should not terminate the Bank's insurance. Section 8(a)(2) of the FDI Act provides for involuntary termination of insurance if the Board determines that one of three conditions is present.7 Nothing in the statutory language or legislative history suggests that consideration of the potential cost of liquidation compared with the financial risk posed by continued operation was intended by Congress to be an aspect of the administrative determination required under section 8(a)(2). In this case, the Board need only find that the Bank is operating in an unsafe or unsound condition. Such finding does not include any consideration of the cost of liquidation. See FDIC-89-24a.
   Recognizing that if its insurance is terminated it is likely to fail, the Bank now urges the Board, as a matter of policy, to continue its insurance. 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 barely improved. 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. Therefore, the Board finds that termination of insured status is necessary


7 Those conditions are as follows: (1) the institution or its directors "have engaged or are engaging in unsafe and unsound practices"; (2) the institution is "in an unsafe and unsound condition to continue operations as an insured institution"; or (3) the institution or its directors have violated a law, regulation, or order, a condition imposed by the FDIC in writing or an agreement entered into with the FDIC.
{{5-31-92 p.A-1571}}to protect the insurance fund from eventual loss.

CONCLUSION

   The Board fully examined the record and finds that nothing contained therein requires modification to the ALJ's Recommended Decision.
   The Bank has been found to be in an unsafe or 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 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 Boundary Waters State Bank, Ely, Minnesota, 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. § 308.62, 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 308.62 of the FDIC Rules of Practice and Procedures, 12 C.F.R. § 308.62, as follows:

NOTICE

____, 1990
   1. The status of The Boundary Waters State Bank, Ely, Minnesota, 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 ____, 1991.
   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 ____, 1991, 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 ____, 1991, will reduce the insurance coverage by the amount of such withdrawals.
   The Boundary Waters State Bank Ely, Minnesota
   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 no fewer than two issues of a local newspaper of general circulation in Ely, Minnesota, 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 5th day of November, 1990.
{{5-31-92 p.A-1572}}

RECOMMENDED DECISION

In the Matter of
Boundary Waters State Bank
Ely, Minnesota
(Insured State Nonmember Bank)

James L. Rose, Administrative Law
Judge:

   This matter was tried before me at Minneapolis, Minnesota, on April 9, 10, and 11, 1990, upon a notice by the FDIC to terminate the Federal Deposit Insurance of Boundary Waters State Bank (herein the Bank) pursuant to 12 U.S.C. § 1818(a).
   Upon the entire record in this matter, including briefs and arguments of counsel, I hereby make the following findings of fact, conclusions of law, and recommended decision:

I. Statement of Facts

   The Bank is a small commercial bank in northern Minnesota which has been the subject of regulatory concern of the FDIC and the State of Minnesota for some years. Among other things, the Bank currently is subject to a consent cease-and-desist order of the FDIC, violation of which was alleged to be a cause for termination of the Bank's insurance. This allegation was withdrawn at the outset of the hearing.
   The FDIC's principal basis for seeking termination of the Bank's insurance is the inadequacy of its capital along with the poor quality of its loan portfolio as set forth in the report of examination as of March 3, 1989.
   At that examination it was found that of $13,092,000 in total assets, the Bank had $2,716,000 in classified loans (substandard, doubtful, or loss). The Bank's primary capital to total assets (as defined in Part 325 of Title 12 of the Code of Federal Regulations, the FDIC Rules and Regulations relating to capital maintenance) was 1.36 percent down from 3.1 percent as of June 24, 1988; 4.70 percent as of the state examination September 25, 1987; and, 6.8 percent as of January 23, 1987.
   It was also found that the Bank's adjusted primary capital to adjusted Part 325 total assets was minus 0.36 percent and that adversely classified items to total equity capital and reserves was 532.80 percent.
   The examiner further found that the Bank's liquidity ratio was a low 16.9 percent. He gave the Bank a composite rating of 5, the worst possible rating indicating severe problems threatening the viability of the Bank.
   The Bank was examined in September 1989 by the state agency (the report of which is not in evidence) which was followed by a visitation on January 29, 1990. As of this visitation, the state examiner reported "(t)he quality of the loan portfolio appears to be about the same as at the September examination. Since then management has restructured some of the larger credits...With these credits as well as many of the other classified lines the primary problem remains the questionable abilities of the borrowers to service the debt." (FDIC Ex. 7.) He concluded that it appeared that management was making some effort to improve the problem lines of credit but that progress has been limited.
   He further found that as of January 26, 1990, the ratio of equity capital including the loan loss reserve to total assets was 2.12 percent, which was a slight improvement over the 1.96 percent as of the September examination. He stated, however, that the improvement could be attributed to the $1 million decrease in assets during that period. This examination also noted that the Bank's earnings in 1989 were a minus $259,000, and that for January earnings were $5,466 (a figure which differs somewhat from the $3,883 set forth in Respondent's Exhibit 32, the Bank's income statement for January and February).
   As indicated, the principal basis upon which the FDIC seeks to terminate the Bank's insurance is inadequacy of its capital and the high volume of classified loans. None of these figures are contested by the Bank.
   Indeed, on brief, the Bank agrees that its equity capital including reserves has been and is now less than 3 percent of its Part 325 total assets. However, the Respondent maintains that its condition was the result of actions by previous management, and that current management has turned the matter around such that the Bank is and will be profitable according to its budget statement. For instance, the 1989 loss of $259,000 was an improvement over the losses in 1987 ($306,000) and 1988 ($533,000). However, the Respondent's income statement for the first 2 months of 1990 shows an accumulated loss of $15,126.89. While this may be a better figure

{{2-28-91 p.A-1573}}than that in the budget, it is nevertheless negative.
   Secondly, the Respondent contends that its capital would be sufficient had the FDIC approved an application for change in control. The Respondent argues that denial of the application was arbitrary and capricious on the part of the FDIC. Accordingly, the agency is estopped from using inadequate capital as a reason to terminate its insurance.
   Finally, the Respondent contends that the FDIC is not required to conclude that the Bank is in an unsafe or unsound condition even with capital of less than 3 percent of assets, nor is it required to terminate the Bank's insurance even if it has inadequate capital. The Respondent argues that the Bank's problem with loans has been turned around and it is on its way to becoming a sound institution. Therefore it would be more harmful to the insurance fund to terminate the Bank's insurance, which would necessarily result in the Bank's failure, than it would be to allow the Bank to continue to operate as an insured bank.

II. Analysis and Concluding Findings

   A. The Bank's Unsafe and Unsound Practices and Conditions
   As amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989, 12 U.S.C. § 1818(a) provides that after notice and an administrative hearing, the Board of Directors of the Federal Deposit Insurance Corporation may terminate the insurance of a depository institution upon finding of "any unsafe or unsound practice or condition or any violation specified in such notice."
   12 C.F.R. § 325.4 states:

       (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 8(a) of the Federal Deposit Insurance Act (12 U.S.C. 1818(a)).
   The Bank here has been in a distressed condition for a number of years; however, it is principally upon the findings of the March 3, 1989, examination that the FDIC has administratively concluded that it is in an unsafe and unsound condition and has committed unsafe and unsound banking practices requiring the termination of its insurance. While a number of facts are set forth in the examination report pointing to the existence of unsafe and unsound banking practices and conditions, the principal basis upon which the FDIC seeks to terminate the insurance here is the fact that the Bank's capital is and has been less than 3 percent of assets and that it has a high volume of classified loans.
   Indisputedly as of March 3, 1989, the Bank's capital to asset ratio was under 3 percent and has continued to be under 3 percent to the present time. The Respondent seems to argue that a capital to asset ratio of 3 percent is the base line and makes a semantic argument that use of the word "deemed" in the regulation suggests that the FDIC might reasonably conclude that a bank whose capital to asset ratio is less than 3 percent is not operating in an unsafe and unsound condition. I reject this argument and conclude that the section 325.4(c) means that if a bank's capital to asset ratio is less than 3 percent it is presumed to be in an unsafe and unsound condition.
   First, the base line capital ratio is 5.5 percent, not 3 percent. Section 325.3(b) states:
       Calculation of minimum capital requirement. The minimum capital requirement for a bank (or an insured bank making an application to the FDIC) 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.
   On somewhat similar facts as here, the Board held:
       The evidence shows that the Bank's adjusted capital was an inadequate 3.56% of adjusted assets (Findings 17–18) while the minimum required capital for a bank which—unlike this Bank—has no significant loan or other problems is 5.5% primary capital and 6.0% total capital. 12 CFR 325.3(b). Further, a bank with the asset quality, and other problems found here needs far more than that minimum level of capital. 2 P-H FDIC Enf. Dec. ¶5092 (1987) at 7143.
   Other sections of this Part state that the mere fact of a capital to asset ratio exceeding 3 percent does not preclude a finding that a bank is in an unsafe and unsound

{{2-28-91 p.A-1574}}condition. Whether a bank's condition would be considered unsafe and unsound with a greater than 3 percent capital to asset ratio would depend on other factors, including quality of the loan portfolio, management and liquidity. Clearly, section 325.4(c) sets the minimum below which a bank's capital cannot drop without it being found in an unsafe and unsound condition regardless of other considerations. (There are circumstances set forth in the regulations, not applicable here, in which a bank operating with less than 3 percent capital to asset ratio may nevertheless not be subjected to having its insurance terminated.)
   Equity capital is, in effect, a bank's net worth—the remainder of assets minus liabilities. One of the principal objects of capital is to provide a cushion to service liabilities in the event that assets lose their value, such as a loan becoming uncollectable. Therefore, the amount of capital and reserves reasonably needed for a bank to remain viable is to a large extent a function of its loan portfolio quality.
   As of March 1989, the Bank had classified assets in the amount of $2,989,000. Its total equity capital of $178,000 plus loan loss reserves of $383,000 provided $561,000 to cushion against classified assets of $2,989,000. The Bank had about $1 of capital and reserves for each $5.33 of classified assets. Thus, if less than 20 percent of the classified assets became uncollectable the Bank would be insolvent. Such clearly shows that the Bank's capital was inadequate, in addition to being presumptively an unsafe and unsound condition in that it was less than 3 percent of total assets.
   While the testimony seems to suggest that the recent bank management has made some strides toward improving its loan portfolio, as of the most recent examination of record, the state visitation in January 1990, the loan portfolio includes too high a percentage of classifieds to consider it without problems.
   In case FDIC-87-4a decided on March 14, 1989, the Board said,

       A complete assessment of capital adequacy must take account of these other considerations (overall interest rate exposure, liquidity, funding and market risks, earnings, and management) including, in particular, the level and severity of problem and classified assets. Slip op. 7.
   The same may be said for management. New management has worked to rectify the situation and has made some progress. The recent earnings, though negative, are not as bad as 1987 or 1988. Nevertheless, the credible evidence shows that the Bank remains in a precarious position, with a recent CAMEL rating of 5. Thus, management has not improved the overall condition of the Bank.
   Kermit Kirchhoff is a Review Examiner for the FDIC, whose duties involve reviewing examination and other reports in order to determine the condition of banks. Among others, he reviewed the Bank's 1989 quarterly call reports. Kirchhoff testified that the December 31, 1989, call report (FDIC Ex. 5d) showed that the Bank's capital was inadequate, being about 2 percent of assets. Total equity capital was negative $148,000, with reserves of $419,000 and assets of $13,811,000. In addition, Kirchhoff concluded that the loan loss reserve of $419,000 was inadequate considering the quality of the loan portfolio.
   Kirchhoff's analysis of the call report, and his conclusion concerning the adequacy of the reserve is entitled to great deference since it constitutes a predictive judgment concerning the condition of the Bank. Sunshine State Bank v. FDIC, 783 F.2d 1580 (11th Cir. 1986).
   Not only does the March 3, 1989, examination demonstrate that the Bank was in an unsafe and unsound condition, its own call reports through 1989 confirm this. And the state visitation of January 1990 shows that the condition has not changed.
   In short, there is nothing in this record which would suggest that the Bank's capital to asset ratio of less than 3 percent does not imply an unsafe and unsound condition. To the contrary, all of the evidence of record concerning the Bank's capital, asset quality, liquidity, and management show that it is and has been operating in an unsafe and unsound condition and therefore it is a potential detriment to the insurance fund.
   As of the hearing, the Bank continued to operate with inadequate capital even for a well managed bank without substantial loan problems. The Respondent's evidence does not show it is well managed or without severe problems.
   Counsel for the FDIC argues that the Bank's current condition is irrelevant—that of concern is its condition as of March 3,
{{2-28-91 p.A-1575}}1989, or at the very latest, the date of the Notice. Counsel's contention may be an accurate view of the FDIC's statutory authority, e.g. 1 P-H Enf. Dec. ¶5007 (1987). However, termination of insurance is unlike other enforcement actions where the aim is remedy of past violations of the statutes and regulations. Here the aim is to protect the insurance fund and the Board has the discretion to terminate or not to terminate a bank's insurance. It therefore follows that the most recent available facts ought to be considered. For instance, had this Bank's capital and other conditions significantly improved since March 1989, termination might not be in the best interests of public policy. But such is not the case. The Bank's capital continues to be less than 3 percent of assets and its classified loans continue to be high.
   On these facts, I recommend that the FDIC terminate the Bank's status as an insured institution.

B. Respondent's Defenses

   The Respondent's principal defense concerns the rejected application for change in control, contending that the proponents would have infused sufficient funds to bring the capital-to-assets ratio to an acceptable level. Since, according to the Respondent, the FDIC rejected the application capriciously, it is estopped from terminating the Bank's insured status based upon capital insufficiency.
   This argument deals in speculation, whereas the issue of whether or not to terminate the Bank's insurance must be based on facts. In any event, without deciding whether the proposed infusion of capital would have rectified the Bank's unsafe and unsound condition, suffice it that following an administrative hearing in case FDIC-89-161j, it was concluded that the application for change in control was appropriately disapproved. In brief, it was concluded that Paul E. Oberstar and Gary Ellefson lacked the competence and integrity to justify approval of an application for change in control with Oberstar as an acquiring party and Ellefson as proposed president and chief executive officer. It was also concluded that the application proposed unacceptable conditions on the FDIC's exercise of its regulatory authority.
   Since I reject the Respondent's argument that the FDIC's disapproval of the application for the change in control was capricious, I reject the Respondent's argument that the FDIC is somehow estopped from proceeding with a termination of insurance action based upon the Bank's insufficient capital.
   Finally, the Respondent argues that notwithstanding its capital is and has been less than 3 percent of its assets, the FDIC should not terminate its insurance because the Bank is a viable institution. The Respondent contends that to terminate the insurance would be more detrimental to the insurance fund than allowing the Bank to continue to operate.
   Given the permissive language of section 1818(a), there appears little doubt that the FDIC has the discretion not to terminate the insurance of a bank notwithstanding that it is operating in an unsafe and unsound condition. There may be situations in which the Board could reasonably conclude that the insurance fund would be better served by not terminating the insurance of a bank in an unsafe and unsound condition.
   However, the Respondent presented insufficient facts to persuade me that this is such a case. This Bank has been operating with a low level of capital and a high level of classified loans for several years. Its management has been incapable of resolving these problems with any significant degree of success. While the Bank continues to exist, its own records show that such is precarious, with losses of $259,000 in 1989 and $15,000 for the first 2 months of 1990. Notwithstanding the restructuring of some of its loans, absent a massive capital infusion, this Bank could not reasonably be considered viable. Perhaps, as the Bank argues, termination of insurance will cause its failure. But from this record such seems a likely result in any case. The Respondent contends that liquidation costs on termination of insurance would be 30 percent of assets, which would not occur if termination is denied. But this argument assumes that the Bank is viable. But the record shows it is not. See FDIC 87-4a, slip op. 10.
   There is simply no evidence in this record to suggest that continuing to allow this Bank to operate in an unsafe and unsound conditions with minimal capital and high

{{2-28-91 p.A-1576}}levels of classified loads would be in the best interest of the insurance fund, the depositors or the public. Accordingly, I reject the Respondent's contention in this regard and conclude that this Bank's status as an insured institution ought to be terminated.
   Upon the foregoing, and the record as a whole, I hereby make the following:

FINDINGS OF FACT

   1. The Bank is a corporation existing and doing business under the laws of the State of Minnesota, with its principal place of business at Ely, Minnesota.
   2. The Bank has been and is an FDIC-insured bank, subject to the Federal Deposit Insurance Act, as amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989, 12 U.S.C. §§ 1811, et seq; the FDIC's Rules and Regulations, 12 C.F.R. Chapter III; and the laws of the State of Minnesota.
   3. From January 23, 1987, through March 3, 1989, the bank's total capital and loan loss reserves declined from $1,082,000 to $561,000. (FDIC Ex. 14a.)
   4. From January 23, 1987, through March 3, 1989, the Bank's "primary capital", as that term is defined at 12 C.F.R. § 325.2(b), declined from $958,000 to $183,000. (FDIC Ex. 14b.)
   5. From January 23, 1987, through March 3, 1989, the Bank's primary capital less half of the amount of assets adversely classified "Doubtful" ("adjusted primary capital") declined from $879,000 to a negative $48,000. (FDIC Ex. 14b.)
   6. From January 23, 1987, through March 3, 1989, the amount of Bank loans adversely classified "Loss" and half the amount of those adversely classified "Doubtful" increased from $182,000 to $476,000, and consistently exceeded the amount of the loan loss reserve, which increased from $77,000 to $383,000. (FDIC Ex. 14d.)
   7. As of March 3, 1989: (a) The Bank's ratio of primary capital to Part 325 total assets of 1.36 percent failed to meet the level required by 12 C.F.R. Part 325; and, (b) The Bank's ratio of adjusted primary capital to adjusted Part 325 total assets was a negative 0.36 percent, meaning there was no capital left after deducting the amount of Bank assets adversely classified "Loss" and half the amount of Bank assets adversely classified "Doubtful." (FDIC Ex. 3a p. 11.)
   8. As of March 31, 1989, the Bank's primary capital, without deducting assets adversely classified "Loss", was $273,000, consisting of a negative $129,000 total equity capital and loan loss reserves of $402,000. (FDIC Ex. 5a pp. 9–10.)
   9. As of March 31, 1989, the amount of the Bank's Part 325 total assets, without deducting assets adversely classified "Loss", was $13,081,000. (FDIC Ex. 5a p. 16.)
   10. As of March 31, 1989, the Bank's ratio of primary capital to Part 325 total assets, without deducting any assets adversely classified "Loss", was 2.08 percent.
   11. As of June 30, 1989, the Bank's primary capital, without deducting assets adversely classified "Loss", was $265,000, consisting of a negative $155,000 total equity capital and loan loss reserves of $420,000. (FDIC Ex. 5b pp. 9–10.)
   12. As of June 30, 1989, the Bank's Part 325 total assets, without deducting assets adversely classified "Loss", was $12,368,000. (FDIC Ex. 5b p. 19.)
   13. As of June 30, 1989, the Bank's ratio of primary capital to Part 325 total assets, without deducting any assets adversely classified "Loss", was 2.14 percent.
   14. As of September 30, 1989, the Bank's primary capital, without deducting assets adversely classified "Loss", was $272,000, consisting of a negative $149,000 total equity capital and loan loss reserves of $421,000. (FDIC Ex. 5c pp. 9–10.)
   15. As of September 30, 1989, the amount of the Bank's Part 325 total assets, without deducting assets adversely classified "Loss", was $13,198,000. (FDIC Ex. 5c p. 19.)
   16. As of September 30, 1989, the Bank's ratio of primary capital to Part 325 total assets, without deducting any assets adversely classified "Loss", was 2.06 percent.
   17. As of December 31, 1989, the Bank's primary capital, without deducting assets adversely classified "Loss", was $271,000, consisting of a negative $148,000 total equity capital and loan loss reserves of $419,000. (FDIC Ex. 5d pp. 9–10.)
   18. As of December 31, 1989, the amount of the Bank's Part 325 total assets, without deducting assets adversely classified "Loss", was $13,583,000. (FDIC Ex. 5d p. 19.)

{{2-28-93 p.A-1577}}

   19. As of December 31, 1989, the Bank's ratio of primary capital to Part 325 total assets, without deducting any assets adversely classified "Loss", was 1.99 percent.
   20. As of January 29, 1990, the Bank's ratio of total equity capital and loan loss reserves to total assets, without deducting any assets adversely classified "Loss", was 2.12 percent. (TR. 174–176, 212; FDIC Ex. 7 p. 3.)
   21. As of January 29, 1990, the Bank had restructured many of its classified loans which reduced the delinquency rate but has not positively affected the overall loan portfolio in a significant way. (TR. 172)
   22. The increase in capital to asset ratio as of January 29, 1990, from September 1989 (2.12 versus 1.96) was due to a decline in assets of approximately $1,000,000 (TR. 175.)
   23. As of March 28, 1990, the Bank's ratio of primary capital to Part 325 total assets was less than 3 percent. (TR. pp. 39–40; Brief of Respondent.)
   24. From January 23, 1987, through June 24, 1988, the Bank's adversely classified assets increased from $2,000,000 to $3,182,000, then declined to $2,989,000 as of March 3, 1989. (FDIC Ex. 14a.)
   25. As of June 25, 198: (a) The Bank's ratio of adversely classified assets to total assets was 25.1 percent; (b) The Bank's ratio of adversely classified loans and leases to total loans and leases was 29.3 percent; (c) The Bank's ratio of overdue loans and leases to total loans and leases was 20.65 percent; and, (d) $1,417,000 of loans were delinquent more than 90 days. (FDIC Ex. 2a pp. 10, 91.)
   26. As of March 3, 1989, the amounts of the Bank's adversely classified assets and total assets were $2,987,000 and $13,092,000, respectively. (FDIC Ex. 3a p. 10.)
   27. As of March 3, 1989, Bank assets adversely classified included $2,147,000 "Substandard", $462,000 "Doubtful", and $378,000 "Loss." (FDIC Ex. 3a p. 10.)
   28. As of March 3, 1989: (a) The Bank's ratio of adversely classified assets to total assets was 22.82 percent. Such a ratio in a high rated bank would only be about 3 percent; and (b) The ratio of adversely classified assets to total equity capital and reserves was 532 percent. (TR. pp. 79–82, 133; FDIC Ex. 3a p. 11.)
   29. As of March 3, 1989, the Bank's adversely classified loans was $2,716,000 and total loans and leases was $9,764,000. (FDIC Ex. 3a p. 10.)
   30. As of March 3, 1989, Bank loans and leases adversely classified included $2,011,000 "Substandard", $457,000 "Doubtful", and $248,000 "Loss." (FDIC Ex. 3a p. 10.)
   31. As of March 3, 1989: (a) The Bank's ratio of adversely classified loans and leases to total loans and leases was 27.82 percent; and (b) The ratio of overdue loans and leases to total loans and leases was 18.68 percent. (FDIC Ex. 3a p. 10.)
   32. From December 31, 1986, through December 31, 1988, the Bank's net income declined from $64,000 to a negative $533,000. (TR. p. 61; FDIC Ex. 14c.)
   33. As of March 3, 1989, the Bank reported 198 net income of $4,000. (FDIC Ex. 3a pp. 2, 12.)
   34. As of December 31, 1988, and March 3, 1989, the Bank's reported net income was overstated, because the Bank failed to make sufficient provisions to bring the loan loss reserve to an adequate level. (TR. 84–85, 134; FDIC Ex. 3a pp. 2, 12.)
   35. For 1989, the Bank had a net operating loss of $259,000 (TR. 143, 212; FDIC Ex. 5d p. 3.)
   36. As of January 26, 1990, the Bank had reported year-to-date earnings of $5,466. (FDIC Ex. 7 p. 3.)
   37. As of February 28, 1990, the Bank reported a year-to-date net loss of $15,126.59. (Bank Ex. 32.)
   38. As of March 3, 1989, the Bank's ratio of short-term liquid assets to total deposits and liabilities ("liquidity ratio") was 16.9 percent. (FDIC Ex. 3a p. 98.)
   39. As of March 3, 1989: (a) The Bank's entire securities portfolio was pledged; (b) The Bank had a large volume of adversely classified assets which could not be sold except at a considerable discount; (c) The Bank's ratio of loans to deposits was 75 percent; and, (d) Bank management did not adequately monitor the Bank's liquidity position. (TR 88–90; FDIC Ex. 3a pp. 3, 13.)
   40. As of March 3, 1989, the Bank's liquidity was inadequate to accommodate decreases

{{2-28-93 p.A-1578}}in deposits or other liabilities, or to fund asset growth. (TR. 88–90.)
   41. Bank management was responsible for failing to discover and correct inaccurate computer calculations of Bank earnings, which caused the bank to overstate its earnings by $56,000 and $18,000 as of December 31, 1988, and March 3, 1989, respectively. (TR. 83–86.)
   42. As of March 3, 1989, Bank management did not have the capability or expertise to address asset problems. (TR. 94–95, 127–128, 208, 293.)
   43. As of March 3, 1989, Bank management failed to reverse adverse trends in Bank capital, assets and earnings. (TR, 64. 95.)
   44. As of March 3, 1989, Bank management was inadequate for the needs of the Bank. (TR. 94, 95, 127, 208, 293; FDIC Ex. 3a p. 1.)
   45. The findings as of the March 3, 1989, examination have continued without significant change to the date of the hearing.

CONCLUSIONS OF LAW

   1. The FDIC has jurisdiction over the Bank and the subject matter of this proceeding.
   2. In an action to terminate a bank's insured status under, section 8(a) of the Act, 12 U.S.C. § 1818(a), for operating in an unsafe or unsound condition or engaging in an unsafe or unsound practice, the FDIC has the burden of establishing such condition or practice by a preponderance of the evidence.
   3. As of March 3, 1989, and thereafter, the Bank had an excessive volume of poor quality loans in relation to its total loans.
   4. As of March 3, 1989, and thereafter, the Bank engaged in the unsafe or unsound practice of hazardous lending and lax collection.
   5. As of March 3, 1989, and thereafter, the Bank operated with an excessive volume of poor quality assets.
   6. As of March 3, 1989, and thereafter, the Bank's capital and reserves were inadequate for the kind and quality of assets it holds.
   7. The Bank was and is operating with management whose policies were detrimental to the Bank and jeopardized the safety of the Bank's deposits.
   8. The Bank was and is in an unsafe or unsound condition to continue operations as an FDIC-insured institution within the meaning of section 8(a) of the Act, 12 U.S.C. § 1818(a) and section 325.4(c) of the FDIC Rules, 12 C.F.R. § 325.4(c).
   9. The FDIC has proved all statutory requirements of section 8(a) of the Act, 12 U.S.C. § 1818(a), to terminate the Bank's insured status.
   10. The FDIC may terminate the Bank's insured status under section 8(a) of the Act, 12 U.S.C. § 1818(a).
   Upon the foregoing findings and conclusions, and the entire record in this matter, I recommend that the FDIC Board issue the attached Order Terminating Federal Deposit Insurance.
   Dated, Washington, D.C. July 26, 1990.

ED&O Home | Search Form | Text Search | ED&O Help

Last Updated 6/6/2003 legal@fdic.gov