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   [5166] In the Matter of The Citizens State Bank of Cortez, Cortez, Colorado, Docket No. FDIC-89-220b(6-11-91).

   FDIC issues cease and desist order upon finding that Bank engaged in numerous unsafe or unsound banking practices.

   [.1] Cease and Desist Orders—Unsafe or Unsound Practices—Lending and Collection Policies
   Lack of adequate collateral, lack of adequate documentation, failure to collect interest due, and failure to establish or enforce repayment understandings are unsafe or unsound practices for which a cease and desist order is appropriate.

   [.2] Cease and Desist Orders—Unsafe or Unsound Practices—Frequency
   Once an institution has been found to have engaged in an unsafe or unsound practice, regardless of frequency, there is sufficient basis for a cease and desist order.

   [.3] Cease and Desist Orders—When Appropriate
   A cease and desist order is appropriate to correct adverse conditions that management has not adequately addressed and to prevent the recurrence of unsafe or unsound practices and violations of law.

   [.4] Loans—Classification—Examiner's Opinion
   An ALJ should not substitute his judgment for that of a trained examiner unless the factual basis for the classification is erroneous.

   [.5] Cease and Desist Orders—Unsafe or Unsound Practices—Management Deficiencies
   Management policies and practices can be found detrimental to the Bank, and thus unsafe or unsound practices, even though there are other factors (such as local economic conditions) having adverse effects on the Bank's condition.

   [.6] Securities Law—Applicable to Banks
   The issuance of securities by banks is subject to the antifraud provisions of the federal securities laws, whether or not the banks' stock is traded publicly.

In the Matter of

THE CITIZENS STATE BANK OF
CORTEZ

CORTEZ, COLORADO
(Insured State Nonmember Bank)
DECISION

I. BACKGROUND

   This proceeding was brought pursuant to section 8(b)(1) of the Federal Deposit Insurance Act ("FDI Act"), 12 U.S.C. § 1818(b) (1), against The Citizens State Bank of Cortez, Cortez, Colorado ("Insured Institution").
   On November 28, 1989, a Notice of Charges and of Hearing was issued against the Insured Institution, alleging certain unsafe and unsound banking practices, including hazardous lending and lax collection practices, failing to maintain adequate capital, failing to maintain an adequate reserve for loan losses, operating with an excessive volume of poor quality loans and loan-related assets, and operating with management whose policies and practices are detrimental to and jeopardize the safety of the Insured Institution. A cease-and-desist order prohibiting the unsafe or unsound banking practices and requiring the Insured Institution to take affirmative action to correct the conditions resulting therefrom was sought.
   The Board of Directors ("Board") of the Federal Deposit Insurance Corporation ("FDIC") has reviewed the record, the parties' briefs, the Recommended Decision and Order (collectively referred to as the "Recommended Decision") of the Administrative Law Judge ("ALJ"), and the parties' exceptions thereto. The Board agrees with the majority of the ALJ's findings and his conclusion that the Insured Institution has engaged in unsafe or unsound banking practices and adopts the ALJ's Recommended
{{10-31-91 p.A-1734.18}}Decision with certain modifications discussed herein.
   Specifically, the Insured Institution has engaged in the following unsafe or unsound banking practices: 1) operating with an inadequate loan loss reserve; 2) operating with inadequate capital; 3) operating with an excessive level of poor quality assets; 4) extending credit without adequate collateral; 5) renewing credit without collection of interest due; 6) extending credit without adequate documentation; and 7) failing to enforce repayment understandings. The Board agrees with the ALJ's recommendation that a cease-and-desist order issue, and adopts the ALJ's proposed order as modified herein.

II. STATEMENT OF THE CASE1

   On July 7, 1989, the FDIC completed an examination of the Insured Institution and determined that its overall condition had substantially deteriorated since the prior FDIC examination as of February 29, 1988. Adversely classified assets (loans and other real estate) had increased 60 percent since the prior examination to a total of $6,012,000, of which $2,573,000 consisted of loans classified "Substandard" and $519,000 loans classified "Loss." The Insured Institution also had $2,778,000 in other real estate, largely foreclosed properties, of which $2,596,000 was classified "Substandard" and $182,000 "Loss." Adversely classified assets represented approximately 17 percent of the Insured Institution's total assets and equalled 219.5 percent of total equity capital and reserves, or more than double the Insured Institution's capital. FDIC Ex. No. 1 at 1, 2.2
   In addition to the large volume of adversely classified loans, other areas of supervisory concern identified in the Report of Examination were the Insured Institution's liberal lending and credit renewal practices, weak collection efforts, inadequate capital position, insufficient loan loss reserve, poor earnings, and the failure of management to assess risk, recognize loss and take steps to

[Next page is A-1735.]


1 Citations to the record of this proceeding shall be as follows:
ALJ's Recommended Decision and Order "R.D."
Hearing Transcript, "Tr."
Exhibits, "FDIC Ex." or "Resp. Ex."

2 As noted by the FDIC examiners, the July 7, 1989, examination was the third consecutive examination to show a disturbing trend, first identified in April 1987, of an excessive and increasing volume of classified assets. FDIC Ex. No. 1 at 1.
{{9-30-91 p.A-1735}}address the Insured Institution's asset quality problems. The Report of Examination assigned the Insured Institution a Uniform Financial Institution Rating of 4, indicating that it could pose a threat to the insurance fund if corrective action is not taken.3 FDIC Ex. No. 1 at 1-a-2.
   On November 28, 1989, the Regional Director (Supervision) of the FDIC's Dallas Regional Office ("Regional Director"), pursuant to delegated authority, issued a Notice of Charges and of Hearing ("Notice") proposing that an order be issued under the FDI Act requiring the Insured Institution to cease and desist from engaging in the unsafe or unsound banking practices specified therein and to correct certain conditions. The Insured Institution filed an answer contesting the charges in the Notice on December 20, 1989, and a hearing was scheduled.
   A hearing was held before Administrative Law Judge Steven M. Charno in Denver, Colorado, on June 19–21, 1990, and August 28–30, 1990. The ALJ issued a Recommended Decision on February 15, 1991. Exceptions to the Recommended Decision were filed by the Insured Institution and by FDIC Enforcement Counsel.

III. THE ALJ'S RECOMMENDED DECISION

   With only one exception, the ALJ did not disturb any of the asset classifications made by the FDIC in the July 7, 1989, examination. The ALJ concluded that the Insured Institution had engaged in an unsafe or unsound practice by operating with an excessive level of poor quality assets. R.D. at 19.
   On the basis of the evidence related to numerous individual credit transactions, the ALJ also concluded that the Insured Institution had engaged in the following additional unsafe or unsound practices: operating with an inadequate loan loss reserve; operating with inadequate capital given the kind and quality of assets held; extending credit to a borrower without adequate security or documentation; and extending credit to a borrower without obtaining collateral sufficient to secure money advanced to pay interest. R.D. at 19.
   The ALJ further determined that the Insured Institution had extended credit to borrowers without the full collection of interest and failed to enforce repayment understandings "where so doing caused abnormal risk, loss or damage." R.D. at 19.
   Based on these findings and conclusions, the ALJ recommended that a cease-and-desist order be issued against the Insured Institution. The Insured Institution admitted most of the facts underlying the ALJ's conclusion that it had engaged in unsafe and unsound practices. However, the Insured Institution asserted, first, that some of its actions were not unsafe or unsound practices under the circumstances because of the allegedly slight degree to which, or relative infrequency with which, they occurred, and, second, that the practices were really "conditions" not caused by management and not within its control. The Insured Institution claimed that management had acted reasonably because there were few available alternatives and that it could only comply with certain provisions of the cease-and-desist order proposed by the FDIC by ceasing operation. See Post Hearing Brief of Citizens State Bank in Support of Findings of Fact and Conclusions of Law at 28–31.
   The ALJ, although agreeing with FDIC Enforcement Counsel that a cease-and-desist order should be issued, accepted the arguments of the Insured Institution that the deterioration in the Insured Institution's condition was the result of the declining local economy rather than management's policies or any failure of the Insured Institution's board of directors to adequately supervise other managers. R.D. at 20–21.
   FDIC Enforcement Counsel excepts to various findings of the ALJ relating to: 1) the degree of responsibility borne by management for the Insured Institution's condition; 2) the propriety of one loss classification rejected by the ALJ; and 3) whether the Insured Institution is subject to securities laws. FDIC Enforcement Counsel also excepts to the ALJ's failure to adopt certain of their


3 As of the July 7, 1989, examination, the loan loss reserve stood at $274,000, which was considered grossly inadequate given the volume of classified assets. Loan loss classifications alone were almost twice the reserve. FDIC Ex. No. 1 at 4. In addition, the Insured Institution's capital level had fallen by over six percent to 5.63 percent, below the statutory minimum. FDIC Ex. No. 1 at 3. Finally, it was believed that maintenance of an adequate loan loss reserve would have resulted in an operating loss for 1988, leading the FDIC examiners to consider the Insured Institution's earnings poor. FDIC Ex. No. 1 at 1-a-1.
{{9-30-91 p.A-1736}}proposed findings, mostly concerning allegations of individual instances of unsafe or unsound practices. In addition, FDIC Enforcement Counsel takes exception to certain portions of the Recommended Decision.
   The Insured Institution takes exception to the ALJ's findings concerning: 1) whether certain individual extensions of credit were unsafe or unsound; 2) whether certain practices claimed to be infrequent constituted unsafe or unsound practices; 3) the applicability of certain accounting standards to specific sale transactions; and 4) the appropriateness of certain portions of the Recommended Decision.

IV. DISCUSSION

   The Board has reviewed the record of this proceeding and concluded that most of the ALJ's findings of fact and conclusions of law are correct as to the unsafe or unsound practices engaged in by the Insured Institution. The Board also agrees with the ALJ's recommendation that a Cease and Desist Order should be issued. However, the Board disagrees with several of the ALJ's findings and with the ALJ's inclusion or failure to include certain provisions in the proposed cease-and-desist order. Accordingly, the Board adopts the ALJ's Recommended Decision and Order as modified herein.
A. Unsafe or Unsound Practices
   FDIC Enforcement Counsel filed exceptions to the ALJ's failure to adopt its proposed findings of fact regarding alleged unsafe or unsound practices in connection with numerous extensions of credit to various borrowers.4 FDIC Enforcement Counsel argues that each of these extensions of credit involved one or more of the following unsafe or unsound practices: 1) lack of adequate collateral; 2) lack of adequate or current documentation; 3) failure to collect interest due (i.e. capitalization of interest); and 4) failure to establish or enforce repayment understandings.
   The ALJ found that the Insured Institution had engaged in each of these practices at some time relevant to the proceeding. R.D. at 19. The ALJ also concluded that each of these practices constituted an unsafe or unsound practice within the meaning of section 8(b) of the FDI Act, 12 U.S.C. § 1818(b). R.D. at 21–22. Although the ALJ's proposed order did not explicitly address the Insured Institution's failure to establish or enforce repayment schedules or programs, it did expressly prohibit the Insured Institution from engaging in each of the other practices. R.D. at 22. The omission of a provision requiring the establishment and enforcement of repayment programs appears to have been inadvertent, since the ALJ made a specific finding of fact that the Insured Institution had engaged in this practice, R.D. at 19, and explicitly found that the practice was unsafe or unsound. R.D. at 22.

   [.1] The Board finds ample support in the record to sustain FDIC Enforcement Counsel's exceptions, but finds it unnecessary to address each credit transaction. Quite apart from the disputed credit transactions, the record clearly supports the ALJ's findings that the Insured Institution had extended credit without adequate collateral or adequate and current documentation and without collecting interest due. Furthermore, the ALJ recommended appropriate prohibitive relief relating to these practices. R.D. at 22.
   The Board further finds that, even if the disputed credit transactions are disregarded, the record establishes numerous other instances of failure to establish or enforce repayment terms or schedules as reflected in the ALJ's findings. See citations at R.D. at 19. The lack of an enforceable repayment program can conceal poor credit quality. See, e.g., Midland Bank and Trust Company v. Fidelity and Deposit Company of Maryland, 442 F. Supp. 960, 964 (D.N.J. 1977). Therefore, since the ALJ omitted to provide for prohibitive relief regarding this practice determined to be unsafe or unsound, the Board modifies the proposed relief to prohibit this practice as well.
   The Insured Institution excepted to the ALJ's finding of unsafe or unsound practices with respect to extensions of credit to * * * and * * *. The * * * loan was renewed with a reduction in the interest rate in order to refinance existing debt. The ALJ found that the Insured Institution capitalized interest as to the * * * and * * * loans and failed to enforce a repayment understanding as to the * * *. R.D. at 19. The Insured Institution excepts to the former finding and asserts that there was no evidence that interest was capitalized. It also argues that the re-


4 The extensions of credit at issue were made to: 1) * * * d/b/a * * *, * * * d/b/a * * *
{{9-30-91 p.A-1737}}duction in the interest rate did not increase the risk of loss.
   While the Board agrees that the record does not support the ALJ's finding that interest was capitalized on the * * * loan,5 there is substantial support in the record, for the ALJ's finding that the Insured Institution failed to enforce a repayment schedule. The EIC testified, and the examination report shows, that the Insured Institution did not improve its position and that the sizable reduction in the interest rate only resulted in renegotiation of the debt and lost interest income since the borrowers were having trouble servicing the debt. FDIC Ex. No. 1 at 2-a-2; Tr. at 196-97. The EIC also testified that written repayment understandings are important for a number of reasons—to evidence the nature of the agreement between the borrower and the lender, to place the borrower on notice of what the consequences may be if the debt is not repaid, and to serve as a management tool. Tr. at 161-62. The Board therefore adopts the ALJ's finding that the Insured Institution failed to enforce a repayment schedule as to the * * * loan, and further finds, contrary to the contention of the Insured Institution, that such failure increases the risk of loss to the Insured Institution. See FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e, ¶ 5049 (8-19-85) (failure to enforce a repayment program is inherently unsafe or unsound).
   The Insured Institution is also correct that the record does not support the ALJ's finding that interest was capitalized on the loan to * * *. However, the record clearly supports the ALJ's conclusion that the Insured Institution engaged in an unsafe or unsound practice when it renewed a credit extension to * * * without obtaining additional collateral. The collateral was valued below the total outstanding debt, and no current appraisals were on file. FDIC Ex. No. 1 at 2-a-6; Tr. at 216-17.
   The Board strongly disagrees with the Insured Institution that there was no need to get a new appraisal or additional collateral. The record shows that an additional $12,000 in credit had been extended to assist * * * with various expenses, including two payments due on a larger, pre-existing debt. FDIC Ex. No. 1 at 2-a-6. A three-year-old appraisal of collateral securing the borrower's prior debt was not sufficient under these circumstances. Accordingly, the Board adopts the ALJ's finding that the Insured Institution extended credit to * * * without adequate security or documentation, and that this constituted an unsafe or unsound practice.
   1. The Frequency of a Practice Does Not Determine Whether It Constitutes an Unsafe or Unsound Practice.

   [.2] The Insured Institution takes exception to the ALJ's finding that by capitalizing interest, it engaged in an unsafe or unsound practice. According to the Insured Institution, the safety and soundness of a practice depends upon the frequency with which it has occurred. It argues that the number of instances in which it capitalized interest, and the amounts involved, preclude a finding that it engaged in an unsafe or unsound banking practice. This is erroneous.
   The Board has unequivocally held that, under section 8(b) of the FDI Act, the FDIC may order an institution to cease and desist from an unsafe or unsound practice "if it is established that the [institution] has engaged in such a practice on even a single occasion." FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e, 1 P-H FDIC Enf. Dec. ¶ 5049 (1985). By the same logic, the amount of the interest capitalized is not necessarily determinative. The EIC's testimony clearly indicated that there is no absolute standard, and that the circumstances of the practice must be analyzed.6 Tr. 82–85. For example, a key factor is whether the borrower exhibits a likelihood of repaying the debt. Tr. at 82. Once an institution has been found to have engaged in an unsafe or unsound practice, such as extending credit without adequate documentation or without collecting interest due, there is sufficient basis for issuing an order to require the institution to cease and desist from such practices.


5 There was no mention of interest capitalization in the July 7, 1989, Report of Examination, and the testimony of the FDIC's Examiner-in-Charge ("EIC") indicates that there was no capitalization of interest on the loan to the * * *. See FDIC Ex. No. 1 at 2-a-2; Tr. at 198.

6 The EIC testified that, in the case of the Insured Institution, many of the borrowers with loans on which interest was capitalized were having serious difficulty paying the debt. Further, in direct contrast to the Insured Institution's factual assertions, the EIC stated that capitalizing interest was in fact a common practice at the Insured Institution and that he considered the volume of loans with interest capitalized to be "substantial." Tr. at 84.95.
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   Accordingly, the Board adopts the ALJ's conclusion that the Insured Institution's capitalization of interest constituted an unsafe or unsound practice.
   2. A Cease and Desist Order is Appropriate to Correct Adverse Conditions that Management has not Adequately Addressed.

   [.3] The Insured Institution contends that there is a distinction between an unsafe or unsound "condition," the existence of which was allegedly without the fault of management, and an unsafe or unsound "practice," and it suggests that this distinction should preclude prohibitive relief from being granted to the FDIC. The Board finds that the distinction urged by the Insured Institution is meaningless in the context of this case. While there may be certain broad economic conditions affecting an institution which may not be the direct result of its management, this case goes beyond that scenario; the record supports a finding of unsafe or unsound practices by this management for which prohibitive relief is appropriate.
   In addition, there are instances where a cease-and-desist order is necessary because of an institution's tendency, or that of management, to allow the unsafe or unsound conditions to go uncorrected. The objectives of a cease-and-desist order are twofold: to correct existing conditions and to prevent the recurrence of unsafe or unsound practices and violations of law. FDIC-84-191b, 1 P-H FDIC Enf. Dec. ¶ 5052 (1985); FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e, 1 P-H FDIC Enf. Dec. ¶ 5049 (1985).
   If the Insured Institution's proposition were accepted in this case, a cease-and-desist order would be ineffective to correct the problems that this institution is experiencing. Thus, for example, the Insured Institution would have no inducement to increase its inadequate level of capital. Accordingly, the Board adopts the ALJ's conclusions that the Insured Institution engaged in unsafe or unsound practices by operating with an inadequate loan loss reserve, inadequate capital, and an excessive level of poor quality assets.
B. Loan Classifications
   1. The * * * Loan
   The ALJ found that the FDIC examiners incorrectly classified $123,000 of credit extended to * * * as "Loss" in the July 7, 1989, Report of Examination. R.D. at 20. The FDIC excepts to this finding on two grounds: 1) that the parties agreed during the hearing before the ALJ that the relevance of the classification would be limited to the fashioning of a remedy, i.e., the amount of capital which the Insured Institution should infuse; and 2) that the evidence relating to the Insured Institution's $123,000 claim to the FDIC, as receiver for * * *, was submitted after the examination.
   While the record confirms that counsel for the parties did in fact agree at the hearing that the $123,000 "Loss" classification would be relevant only to the fashioning of a remedy, Tr. at 32, the impact of this stipulation in the context of this proceeding is not clear.7

   [.4] Here, however, the Board concludes that the ALJ was incorrect in concluding that the * * * loan was improperly classified.8
   Therefore, the Board rejects the ALJ's inclusion of the $123,000 in determining the capital level of the Insured Institution. See R.D. at 12, n. 72. The facts show that the Insured Institution has only a claim for $123,000 against the receiver. At most, the claim is a contingent credit, and the ALJ's "addition" of $123,000 to the Insured Institution's "capital account," see R.D. at 12, n. 72, distorts the true financial condition of the institution.
   2. The * * * Properties
   The Insured Institution excepts to the ALJ's finding that the record supported the classification by the FDIC examiners of $113,000 as "Loss" in connection with four sales of other real estate ("ORE") to the * * * and * * *. See R.D. at 20. In each transaction, the Insured Institution wholly financed the sale at a below-market interest rate and carried the asset on its books as a loan. FDIC Ex. No. 1 at 2-a-15, 2-a-18. The FDIC examiners noted that, in accordance with Statement of Financial Account-


7 If in fact the loss classification is correct, the stipulation would appear to permit the ALJ to reduce the amount of new capital necessary for the Insured Institution to achieve compliance with the capital standards. That is exactly what the ALJ did in this instance.

8 The ALJ should not substitute his judgment for that of the trained examiners unless the factual basis for the classification is erroneous. Sunshine State Bank v. FDIC, 783 F.2d 1580, 1582-94 (11th Cir. 1986).
{{9-30-91 p.A-1739}}ing Standards No. 66 ("FASB 66"), each asset sold under these circumstances is to continue on the institution's books as ORE until a sufficient payment of money is made to deem the transaction a sale. See discussion of the * * * transactions, FDIC Ex. No. 1 at 2-a-15, 2-a-15.
   The examiners also classified as "Loss" the portion of each credit consisting of deferred income, the difference between the yield from the loan based on the market rate of interest and the yield based on the actual, below-market rate of the loan.9 Id.
   The basis of the Insured Institution's exception is its assertion that the applicability of FASB 66 to the transactions precludes application of Accounting Principles Board Opinion No. 21 ("APB 21"), so that no discount is taken until a downpayment sufficient to record the transaction as a sale is received. The ALJ rejected this argument and found in favor of FDIC Enforcement Counsel on this issue, based on the express instructions set forth in FDIC Bank Letter 15–86 ("BL-15-86"), which was issued by the FDIC's Division of Bank Supervision (now Division of Supervision) on April 11, 1986, to the Chief Executive Officers of Insured State Nonmember Banks to explain the accounting treatment for restructured loans and sales of foreclosed properties.10
   The Insured Institution contends that BL-15-86 is not binding on it. However, BL-15-86 placed the Insured Institution on advance notice of the accounting treatment for sales of ORE.11 The Board finds no merit in the Insured Institution's contention that the bank letter is not binding. See First Nat. Bank of LaMarque v. Smith, 610 F.2d 1258, 1263-65 (5th Cir. 1980) (upholding issuance of informal letter directives by Comptroller of Currency as within his authority to prevent unsafe or unsound banking practices under FDI Act). Accordingly, the Board adopts the ALJ's finding that the $113,000 "Loss" classification in connection with the sales of ORE to the * * * and * * * was proper.
   The Insured Institution also excepts to the ALJ's finding that the Insured Institution's residential mortgage rate of 12.75 percent for purposes of discounting the transactions was proper. See R.D. at 20. The Board agrees with the ALJ's finding. The Insured Institution's expert witness testified that the Federal Home Loan Bank Board ("FHLBB") rate was typically three to four percentage points below the prime market rate extended to customers. Tr. at 737-38. Thus, use of the FHLBB rate would not allow an accurate discounting of the assets to market value. There is no indication in the record that the Insured Institution was not making mortgage loans at the going market rate, nor would it be expected to loan money at any rate other than the market rate. Accordingly, the Board adopts the ALJ's finding that the appropriate market rate was 12.75 percent.

C. The Responsibility of Management

   FDIC Enforcement Counsel excepts to several of the ALJ's findings on the responsibilities of the Insured Institution's management. The ALJ rejected FDIC Enforcement Counsel's proposed findings that the condition of the Insured Institution was the result of management's policies, that management failed to take adequate action to protect the Insured Institution from the local economic decline, and that the board of directors failed to adequately supervise the Insured Institution's other managers. See R.D. at 11–13. Furthermore, the ALJ held that management did not engage in unsafe or unsound practices under circumstances where "viable, beneficial alternatives existed." R.D. at 21.
   FDIC Enforcement Counsel contends that the FDIC's proposed findings are supported by the evidence in the record and argues that the existence of "viable, beneficial alternatives" is irrelevant to whether the Insured


9 The intended purpose of discounting this amount is to reflect the present or fair market value of the loan in accordance with APB 21. There is no dispute between the parties as to the requirements of FASB 66 and APB 21.

10 The bank letter discussed the application of APB 21 and FASB 66, as well as another accounting principle not relevant here. For example, APB 21 required a loan on foreclosed property at a below-market interest rate to be discounted to present value, and FASB 66 required that any gain on the transaction be deferred if the downpayment was less than 25 percent. This example is nearly identical to the * * * sales; they were fully financed and the loans were at below-market rates of interest.

11 The Insured Institution's argument that the bank letter merely constituted "guidance" is without merit. While FDIC bank letters, policy statements, and other regulatory issuances are intended to provide guidance to institutions insured by the FDIC, such issuances are to be followed. Insured institutions are not free to disregard FDIC issuances whenever they deem it advantageous or convenient to do so, and they do so at their own risk.
{{9-30-91 p.A-1740}}Institution engaged in unsafe or unsound practices.
   The Board first notes that steering a financial institution, or any enterprise, through adverse economic conditions is a challenging endeavor. The challenge involves making difficult choices. The ALJ stated, in response to the Insured Institution's contention that correction of certain practices was incapable of performance, that the Insured Institution confuses "possibility with palatability." R.D. at 14. The Board agrees and finds that the Insured Institution's management failed to take sufficient action to cope with the changing economic environment. Clearly, an institution which continues to operate as if economic conditions will remain static, instead of responding to downward trends, is headed for trouble. Ultimately, if adjustments are not made, or if risks are not realistically assessed and losses acknowledged, an institution insured by the FDIC will experience losses and pose a risk to the insurance fund.
   Two previous examinations of the Insured Institution, conducted in April 1987 and February 1988, identified the hazardous course which management was following and which continued until the July 7, 1989, examination.12 Resp. Ex. No. 47 at 1 through 1-a-1; Resp. Ex. No. 41 at 1 through 1-a-1.
   There is no allegation here, and the record does not indicate that management was not acting in good faith in attempting to weather the slumping local economy. Further, it is apparent that the choices available to management — such as increased foreclosures or the booking of additional losses — were not easy or attractive, as is often the case in situations involving banks with longstanding ties to local borrowers in the community. It is the failure, however, to take meaningful action which constituted unsafe or unsound practices.
   The ALJ sought to relieve management of any responsibility for the unsafe or unsound practices by finding that no "viable, beneficial alternatives existed." FDIC Enforcement Counsel contends that the qualifying phrase was improper.
   It is not clear precisely how the ALJ would define the "viable, beneficial alternative." Would a course of action designed to protect the deposit insurance fund at the expense of a bank's investors or management by "viable" or "beneficial?" The Board suspects that an insured institution would not consider such an action to meet either criterion. If an insured institution were to demonstrate that a particular action explicitly required by regulators were objectively impossible to perform, that fact might conceivably have some bearing on whether management's failure to take such action was unsafe or unsound. The Board need not decide that question in the instant case, however, because the Insured Institution has failed to establish that there was no reasonable course of action, however distasteful, that management could have taken to prevent or ameliorate the unsafe or unsound practices identified by the FDIC.
   One of the primary concerns of both the FDIC and Colorado state bank examiners was the tremendous increase in the volume of adversely classified assets held by the Insured Institution over the preceding several years and its operation with inadequate capital. It was not disputed that the local economy contributed in significant degree to these problems. The ALJ found in response to the Insured Institution's assertions that no options were available for it to follow and that it could not correct the problems. However, in the Board's view "[t]his argument confuses possibility with palatability." See R.D. at 14; supra at 19.
   For example, the Colorado state bank examiner, who was qualified as an expert witness on behalf of the Insured Institution, testified that in some circumstances, especially where the borrower shows an inability to repay and the collateral may offer insufficient protection, foreclosure would be preferable to restructuring the debt or capitalizing interest — even where market conditions suggest that the collateral may bring as little as 20 percent or 40 percent of the amount due. Tr. at 668-69. The state examiner also testified that the condition of the Insured Institution and the rating given management indicated that management was not fully doing its job to get the direction of the institution reversed. Tr. at 692.

12 Interestingly, the ALJ stated that in 1987, an FDIC examiner had "lauded the [Insured Institution's] capitalization of interest. . .as evidence of management's concern over the [Insured Institution's] condition and as indicative of management's attempts to minimize the [Insured Institution's] exposure to loss." R.D. at 13. However, in the Board's view, the examiner's comments in the April 7, 1987, examination were not laudatory, but instead identified signs of impending trouble.
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   The import of this testimony is that, while management did not exhibit bad faith, it did not take adequate action by making the different decisions necessary for the welfare of the Insured Institution. Even in the absence of alternatives more attractive to the Insured Institution's management than the course of action it chose, the continuation of practices which (as found by the ALJ) were unsafe or unsound would certainly not be beneficial to the condition of the Insured Institution, its depositors or to the insurance fund.

   [.5] The Board also concludes that the ALJ was in error in not finding that the Insured Institution engaged in an unsafe or unsound practice by operating with management whose policies and practices were detrimental to the Insured Institution. The ALJ incorrectly recast the issue as whether the condition of the Insured Institution was the "result" of policies adopted or implemented by management. R.D. at 20. There is no requirement that the policies and practices of management predominate over other factors, such as local economic conditions, in adversely impacting the condition of an institution before finding an unsafe or unsound practice. In this case, management's policies and practices evinced a clear failure to take sufficient action in response to local economic conditions.
   The examiners identified trends noted in prior examinations over a two-year period which reflected unsafe or unsound policies: repeated capitalization of interest, an excessive volume of classified assets,13 maintenance of a marginal level of capital, and an inadequate loan loss reserve. The perpetuation of these conditions and practices over several years in the face of warnings from the examiners is a clear indication that management's policies, while perhaps adequate in a previous business and banking environment, were deficient as of the 1989 examination. Accordingly, the Board finds that the Insured Institution engaged in an unsafe or unsound practice by operating with management whose policies and practices were detrimental to the Insured Institution and presented risks to its depositors and the insurance fund.
   The Board agrees with and adopts the ALJ's findings that the evidence did not establish a failure by the board of directors to adequately supervise the Insured Institution's other managers or that the Insured Institution failed to take any action to deal with the decline in the local economy. R.D. at 20. Management's feeble and often misguided attempts to restructure debts and keep loans in a paying status do not constitute inaction. Although the examiners were not pleased with the level of management's compliance with the Memorandum of Understanding dated August 24, 1988, the July 1989 examination report indicated that two objectives were achieved — management charged off assets previously classified "Loss" and had reviewed and revised lending and collection guidelines.14
   In addition, there is insufficient evidence in the record to conclude that the Insured Institution's board of directors failed to adequately supervise the institution's other managers. Although the board of directors is ultimately responsible for actions of the Insured Institution, it does not follow that every instance of an unsafe or unsound practice can be traced to a failure by the directors to adequately supervise. Accordingly, the Board adopts the ALJ's recommended findings that the evidence did not establish that the Insured Institution failed to take any action to protect itself from the local economic decline and that the evidence failed to establish a lack of adequate supervision by the board of directors over the Insured Institution's other managers.

D. Applicability of the Securities Laws to
the Insured Institution

   [.6] The Board rejects the ALJ's finding that, because the securities of the Insured


13 The April 7, 1989, Report of Examination stated that total classified assets had risen from $752,000 in 1984 to $3,581,000 in 1987, nearly a fivefold increase. See Resp. Ex. No. 47. The EIC noted that some of these assets consisted of classified ORE which management was holding off of the market because of depressed prices and stated that management was expected to handle the controlled marketing of the properties. Resp. Ex. No. 47 at 1.

14 Although the issue does not affect the FDIC Board's determination on this point, the Board does agree with FDIC Enforcement Counsel's objection to the exclusion from evidence of data from the Uniform Bank Performance Reports. The Board has found that such comparative evidence is relevant and should be received. See FDIC-83-172b, 1 P-H FDIC Enf. Dec. ¶5030 (1984). The Board acknowledges the ALJ's concerns as to the reliability of a comparison of the Insured Institution to a single peer-group institution, and other factors which could affect the objectivity of the comparison, but these are concerns properly addressed in determining the weight to be accorded the evidence.
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Institution are not publicly traded, and based on his view of the evidence, the Insured Institution is not subject to federal securities laws. R.D. at 29.15
   On July 2, 1989, the Board issued an FDIC Statement of Policy entitled "Offering Circular Requirements for Public Issuance of Bank Securities; Statement of Policy Regarding Use of Offering Circular in Connection with Public Distribution of Bank Securities." This policy statement noted, in accordance with settled authority, that the issuance of securities by banks is subject to the antifraud provisions of the federal securities laws. FDIC Enforcement Counsel's contention that the Insured Institution is subject to these laws is therefore correct. See Weaver v. Marine Bank, 637 F.2d 157, 164 (3rd Cir. 1981); Lehigh Valley Trust Co. v. Central Nat. Bank of Jacksonville, 409 F.2d 989, 993 (5th Cir. 1969); Peoples Bank of Danville v. Williams, 449 F. Supp. 254, 260 (W.D. Va. 1978); 2 A. Bromberg & L. Lowenfels, Securities Fraud & Commodities Fraud, Sec. 6.5(312), at 136.1 (1990).
   Whether the Insured Institution's stock is publicly traded or publicly held is of no relevance to this matter. As long as there is the possibility that securities of the Insured Institution may be offered to the public at any time in the future, the FDIC has the power to review and require changes to the offering materials to ensure that they are complete and contain no facial defects.16 Accordingly, the Board rejects the ALJ's finding that the Insured Institution is not subject to federal securities laws.
E. The Cease-and-Desist Order
   1. The Insured Institution's Exceptions
   The Insured Institution and FDIC Enforcement Counsel each raise exceptions to certain provisions of the proposed order to cease and desist. The Insured Institution asserts that the ALJ's findings do not support the relief set forth in paragraphs (d), (e), (f), and (g) of the prohibitive relief section.17 The Insured Institution asserts that it did not engage in any of the practices often enough to give rise to a finding of unsafe or unsound practices. The Board has addressed the rejected that argument, see supra at 11–12, and finds that there is sufficient evidence in the record to support the inclusion of these prohibitive provisions.
   The Insured Institution also argues that one instance of a missing loan document identified by the ALJ does not warrant a provision requiring the elimination and/or correction of loan document deficiencies. See R.D. at 26, paragraph 8. Assuming, arguendo, that the transaction identified by the ALJ represented an isolated instance of poor loan documentation, the Board's prior decisions have established that a cease-and-desist order may be issued to curb even an isolated occurrence. See FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e, 1 P-H FDIC Enf. Dec. ¶ 5049 (1985); supra at 11.18
   The Insured Institution also excepts to certain provisions of the proposed order on the alleged grounds that they bear no relationship to specific violations or actions; that they are vague and/or overbroad; that they fail to recognize the distinction between "conditions" and "practices"; and that they are incapable of compliance.
   Prior decisions of the Board and court precedent support the FDIC's broad authority and discretion to fashion an appropriate remedy to prevent future abuses. Groos National Bank v. Comptroller of Currency, 573 F.2d 889, 897 (5th Cir. 1978); FDIC-84-23b, FDIC-84-67k, 2 P-H Enf. Dec. ¶ 5061 (1986). Moreover, specific unsafe or unsound practices have been identified and were substantially admitted by the Insured Institution. These facts give rise to the provisions prohibiting the same or similar conduct.19

15 Although the erroneous determination is set forth in the ALJ's Findings of Fact, it is clearly a question of law.

16 The power of the FDIC to review and require changes to offering materials for completeness and facial validity in no way suggests or implies that the FDIC warrants or guarantees the accuracy of the materials.

17 The challenged provisions require the Insured Institution to cease and desist from: 1) extending inadequately secured credit to borrowers in weak financial condition; 2) renewing or extending credit with capitalization of interest; 3) extending credit without adequate supporting documentation; and 4) engaging in like or related lending or collection practices. R.D. at 22.

18 Further, the Insured Institution's reading of paragraph 8 is unduly narrow. The ALJ specifically referenced the detailed listing of deficiencies identified in the July 7, 1989, Report of Examination. See FDIC Ex. No. 1 at 2-d; 2-d-1.

19 The Insured Institution's contention that the prohibitive relief provisions are impermissible vague and overbroad is without merit. Similar relief has been ordered in numerous other proceedings and sustained by several courts of appeals.
{{9-30-91 p.A-1743}}
   The Insured Institution also takes exception to the provision in the proposed order which gives authority to the FDIC Regional Director to request and require modifications or amendments to the Insured Institution's capital plan. R.D. at 23. As set forth by FDIC Enforcement Counsel, this authority has express support in the FDI Act, see 12 U.S.C. § 1818(b)(6)(F), and the FDIC's regulations. See 12 C.F.R. § 325.6(b). Accordingly, the Board adopts the recommended provision.
   Finally, the Insured Institution contends that there is no basis for paragraph 3(d) of the proposed order, requiring the Insured Institution to charge off all assets classified "Loss." The Insured Institution asserts that such a requirement may only be established after the FDIC initiates a cease-and-desist proceeding alleging that the institution's failure to charge off these assets is unsafe or unsound.
   This contention is frivolous. As the Insured Institution is well aware, the FDIC and other federal banking regulators routinely require the charge-off of all assets classified "Loss," regardless of whether a cease-and-desist proceeding is brought at all. In the instant case, the FDIC has charged the Insured Institution with operating with an excessive volume of poor quality assets, and the record clearly supports that allegation. The charge-off of assets classified "Loss" will partially remedy this practice. It will prevent the Insured Institution from distorting its true financial condition by carrying virtually worthless loan and ORE on its balance sheet as "assets," and will present a more realistic picture of the adequacy of the Insured Institution's loan loss reserve.
   The failure to charge off assets classified "Loss" constitutes an unsafe or unsound practice. FDIC-83-252b&c, 84-49b, 84-50e, 1 P-H FDIC Enf. Dec. ¶ 5049 (1985). The Insured Institution had a full opportunity to challenge any or all of the loan classifications. Since none were reversed in favor of the Insured Institution, they are binding upon the Insured Institution. The Insured Institution invites the Board to adopt rules that no asset classified "loss" at any bank examination need be charged off unless and until the FDIC initiates, prosecutes, and prevails in an enforcement proceeding specifically directed at proving the self-evident proposition that assets classified "loss" should be charged off. This the Board declines to do.
   2. FDIC Enforcement Counsel's Exceptions
   FDIC Enforcement Counsel excepts to the ALJ's failure to include the following provisions in the proposed order: 1) the right of the Regional Director to review and require changes in public offering materials; 2) the Regional Director's prior approval of the terms and conditions of issues of perpetual preferred stock and/or mandatory convertible debentures; 3) prohibition of payment of dividends without the prior written consent of the Regional Director; 4) a plan to reduce the volume of assets classified "Substandard" subject to modifications or amendments by the Regional Director; and 5) establishment of a loan review committee and a compliance committee with a prescribed minimum composition of outside directors.
   The record supports inclusion of the requested provisions. The provision governing securities offerings — both the terms of those offerings and the disclosure materials related thereto — are standard remedial requirements, and are clearly related to the Insured Institution's financial condition. By reviewing and approving all offering materials, the Regional Director will have an opportunity to monitor the steps being taken by the Insured Institution to improve its deficient capital position.
   The record contains expert testimony regarding the need for the FDIC to review and change offering materials in any public offering. Case law supports the FDIC's policy that offering materials comply with the antifraud provisions of the federal securities laws and fully disclose material facts to investors and depositors. See discussion supra at 26. It is important that offering materials be drafted in a manner that will advance the Insured Institution's efforts to increase capital without either misleading the public or exposing the bank to potential financial liability for failure to comply with securities disclosure requirements. The provision proposed by FDIC Enforcement Counsel is consistent with the furthers that policy and, accordingly, is adopted.
   Similarly, the Regional Director should have an opportunity to ensure that the terms and conditions of perpetual preferred stock and mandatory convertible debentures will not place an undue financial strain on the
{{9-30-91 p.A-1744}}Insured Institution, and will enhance its ability to achieve and maintain the appropriate level of capital. The Board rejects the ALJ's finding that FDIC Enforcement Counsel waived the right to seek inclusion of a provision requiring the Regional Director's prior approval of the terms and conditions of issues of perpetual stock and/or mandatory convertible debentures. R.D. at 16. The fact that the issue was not specifically addressed in FDIC Enforcement Counsel's reply brief is not dispositive since it was briefed throughout the proceeding and testimony on the issue was presented at the hearing. See Tr. at 440-41. That testimony indicated that issues of perpetual stock and/or mandatory convertible debentures directly affect the earnings and capital level of the issuer, a fact which was not controverted. Tr. at 440-41. The right to approve the terms and conditions of issues of these classes of stocks and bonds allows the FDIC to monitor the condition of the Insured Institution and to minimize the possible adverse effect on earnings of proposed securities transactions. Accordingly, FDIC Enforcement Counsel's proposed finding is adopted.
   The Board also adopts FDIC Enforcement Counsel's proposed provision prohibiting the payment of dividends without the written prior consent of the Regional Director. The payment of dividends has a direct effect on capital. The proposed provision does not preclude the Insured Institution from paying dividends: "it simply places the FDIC in a position to assure that the [Insured Institution] does not undermine its capital adequacy by excessive cash dividends." FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e, 1 P-H FDIC Enf. Dec. ¶ 5049 (1985) (upholding identical provision). Given the undisputed fact in this proceeding that the Insured Institution is undercapitalized, R.D. at 19, this provision is clearly warranted.
   FDIC Enforcement Counsel also excepts to the ALJ's failure to include in the proposed order a provision requiring the Insured Institution to adopt any modifications or amendments requested by the FDIC to be made to the plan to reduce the volume of assets classified "Substandard." The ALJ found that the provision would essentially grant the FDIC a "right of veto." R.D. at 17.
   In the Board's view, the ALJ's concern that the FDIC would seek "to run the Bank," see R.D. at 17, under the proposed provision was unwarranted. The FDIC is not in the business of managing and operating institutions as going concerns, nor does it have time or resources to do so. Among its regulatory tasks, however, is the obligation to ensure that insured institutions are operated safely and prudently so that they will remain ongoing concerns and pose minimal risks to depositors and the insurance fund. To this extent, the proposed provision allows the FDIC to require the Insured Institution to develop a realistic strategy to deal with its excessive volume of classified assets.
   The FDIC's examination duties and regulatory powers over State nonmember banks such as the Insured Institution give it a broad overview of the types of problems affecting the Insured Institution. Deterioration of asset quality is a problem which affects financial institutions across the country, as economic trends shift from region to region. The FDIC draws on this national perspective in applying its regulatory expertise to ensure that insured institutions take preventive and corrective measures to counteract economic declines. If the FDIC's regulation of asset quality is limited to the power to comment, it would have no ability to prevent an institution from following a strategy which might be misguided or shortsighted.20 The Board concludes that the proposed provision should be included in the cease-and-desist order.
   The ALJ found that a provision requiring establishment of loan review and compliance committees composed of, respectively, one-half and one-third outside directors, is not needed to remedy an unsafe or unsound practice and lacked a factual basis. R.D. at 18. Although the Board disagrees that there is no factual basis for inclusion in the cease-and-desist order of some provision to insure the independence and objectivity of the committees, it finds that, on the record in this particular case, the composition of the committees is better left to the board of directors. The board of directors of the Insured Institution has the responsibility to make necessary management procedures and controls, including establishing the appropriate composition of executive committees to en-
20 The FDIC's previous experience in circumstances such as those presented in this case is illustrated by FDIC-83-172b, 1 P-H FDIC Enf. Dec. ¶5030 (1984), where the Board commented on the heightened responsibility of management operating an insured institution in an agricultural economy experiencing periodic declines.
{{9-30-91 p.A-1745}} sure the safe and sound operating of the Insured Institution.
   Thus, the ALJ's recommended provision concerning the loan review and compliance committees is adopted.
   Finally, the ALJ modified paragraphs (d)- (f), provisions of the cease-and-desist order related to four adverse lending practices, to include an additional qualification — "under circumstances which would create abnormal risk, loss or damage." R.D. at 22. FDIC Enforcement Counsel excepted to this change arguing that the prohibited lending practices are inherently unsafe or unsound.
   The Board is unsure what the ALJ intended by the qualification at issue. However, given the lending practices prohibited, the Board agrees with FDIC Enforcement Counsel and has not included such qualification in the Board's Order.

V. CONCLUSION
   The Board has carefully reviewed the entire record in this proceeding. The overall condition of the Insured Institution remains weak, due to an excessive volume of adversely classified assets, depleted capital, and inadequate loan loss reserves. The Board concludes that the Insured Institution has engaged in unsafe or unsound practices and is in a weakened financial condition. Therefore, the issuance of the accompanying Order to Cease and Desist is supported by substantial evidence and is in the best interest of the Insured Institution, its depositors, and the insurance fund.
   By direction of the Board of Directors.
   Dated at Washington, D.C. this 11th day of June, 1991.
   /s/ Hoyle L. Robinson
   Executive Secretary
In the Matter of
THE CITIZENS STATE BANK OF
CORTEZ
CORTEZ, COLORADO
(Insured State Nonmember Bank)

ORDER TO CEASE AND DESIST

   The Board of Directors ("Board") of the Federal Deposit Insurance Corporation ("FDIC"), having considered the record and the applicable law, finds and concludes that The Citizens State Bank of Cortez, Cortez, Colorado ("Insured Institution"), as set forth in the Decision, has engaged in unsafe and unsound banking practices, within the meaning of section 8(b)(1) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1818(b) (1):
   Accordingly, IT IS HEREBY ORDERED, that the Insured Institution, its directors, officers, employees, agents, successors, assigns, and other institution-affiliated parties cease and desist from the following unsafe and unsound banking practices:
   (a) operating without an adequate level of capital protection;
   (b) failing to provide an adequate reserve for loan losses;
   (c) operating with a large volume of poor quality loans or loan-related assets;
   (d) renewing or extending inadequately secured credit to borrowers in weak financial condition;
   (e) renewing or extending the due dates of loans without the collection of interest due;
   (f) extending credit without adequate supporting documentation;
   (g) failing to establish and enforce loan repayment terms, schedules or programs;
   (h) operating with management whose policies and practices are detrimental to the Insured Institution and jeopardize the safety of its deposits;
   (i) operating without adequate supervision and direction of management by the board of directors; and
   (j) engaging in any like or related lending or collection practice.
   IT IS FURTHER ORDERED, that the Insured Institution and institution-affiliated parties of the Insured Institution take affirmative action as follows:
   1. (a) Within 90 days after the effective date of this ORDER, the Insured Institution shall increase its primary capital by no less than an amount sufficient to cause primary capital to equal 7.5 percent of the Insured Institution's total assets; and, for so long thereafter as this ORDER is outstanding, to maintain adjusted primary capital equal to or greater than 7.5 percent of the Insured Institution's adjusted total assets. Such increase in primary capital and any increase in primary capital necessary to met the ration required by this ORDER may be accomplished by:
{{9-30-91 p.A-1746}
   (i) the sale of securities in the form of common stock; or
   (ii) the collection in cash of all or any portion of assets classified "Loss" as of July 7, 1989, and charged off in accordance with the provisions of this ORDER without loss or liability to the Insured Institution; or
   (iii) the collection in cash of assets charged off prior to July 7, 1989; or
   (iv) the direct contribution of cash subsequent to July 7, 1989, by the directors and/or shareholders of the Insured Institution; or
   (v) any other method approved by the Regional Director (Supervision) of the FDIC's Dallas Regional Office ("Regional Director").
   (b) If the ratio of adjusted primary capital to adjusted total assets is less than 7.5 percent as determined at an examination or visitation by the FDIC or the State banking department, the Insured Institution shall, within 30 days after receipt of a written notice of the capital deficiency from the Regional Director, present to the Regional Director a plan to increase the primary capital of the Insured Institution or to take other measures to bring the ratio to 7.5 percent. After the Regional Director responds to the plan, the board of directors of the Insured Institution shall adopt the plan, including any modifications or amendments requested by the Regional Director. Thereafter, the Insured Institution shall immediately initiate measures detailed in the plan, to the extent such measures have not previously been initiated, to increase its primary capital by an amount sufficient to bring the ratio to 7.5 percent within 90 days after the Regional Director responds to the plan.
   (c) If all or part of the increase in primary capital required by this ORDER is accomplished by the sale of new securities, the board of directors of the Insured Institution shall adopt and implement a plan for the sale of such additional securities, including soliciting proxies and the voting of any shares or proxies owned or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of Insured Institution Securities (including a distribution limited only to the Insured Institution's existing shareholders), the Insured Institution shall prepare offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Insured Institution and the circumstances giving rise to the offering, and any other material disclosure necessary to comply with Federal securities laws. Prior to the implementation of the plan, and in any event not less than 20 days prior to the dissemination of such materials, the plan and any materials used in the sale of the securities shall be submitted to the FDIC, Registration and Disclosure Section, Washington, D.C. 20429, for review. Any changes requested to be made in the plan or materials by the FDIC shall be made prior to their dissemination. If the increase in primary capital is provided by the sale of perpetual preferred stock and/ or mandatory convertible debentures, then all terms and conditions of the issue, including, but not limited to those terms and conditions relative to interest rate and any convertibility factor, shall be presented to the Regional Director for prior approval.
   (d) In complying with the provisions of this ORDER, and until such time as any such public offering is terminated, the Insured Institution shall provide to any subscriber and/or purchaser of Insured Institution Securities written notice of any planned or existing development or other change which is materially different from the information reflected in any offering materials used in connection with the sale of Insured Institution Securities. The written notice required by this paragraph shall be furnished within 10 days from the date such material development or change was planned or occurred, whichever is earlier, and shall be furnished to every purchaser and/or subscriber of Insured Institution's Securities who received or was tendered the information contained in the Insured Institution's original offering materials.
   (e) For purposes of this ORDER the terms "primary capital" and "total assets" shall have the meanings ascribed to them in Part 325 of the FDIC's Rules and Regulations, 12 C.F.R. §§ 325.2(h) and (k). "Adjusted primary capital" and "adjusted total assets" shall be calculated according to the methodology set forth in the Analysis of Capital section in a report of examination or visitation of the FDIC.
   2. While this ORDER is in effect, the
{{9-30-91 p.A-1747}}Insured Institution shall not declare or pay either directly or indirectly any cash dividend to shareholders without the prior written consent of the Regional Director.

       3. (a) Upon the effective date of this ORDER, the Insured Institution shall, to the extent that it has not previously done so, eliminate from its books, by charge-off or collection, all assets or portions of assets classified "Loss" by the FDIC as a result of its examination of the Insured Institution as of July 7, 1989. Reduction of these assets through proceeds of loans made by the Insured Institution is not considered "collection" for the purpose of this paragraph.
       (b) Within 60 days of the effective date of this ORDER, the Insured Institution shall submit a written plan to the Regional Director to reduce the remaining assets classified "Substandard" as of July 7, 1989. At a minimum, the plan shall include the following:
       (i) a schedule providing quarterly goals to reduce the remaining adversely classified assets as of July 7, 1989, to levels representing not more than a specified percentage of total equity capital and reserves as reported each quarter by the Insured Institution in its Consolidated Reports of Condition and Reports of Income and shall include no fewer than six consecutive quarterly target dates;
       (ii) an explanation showing the complete rationale used by the Insured Institution in constructing the reduction schedule; and
       (iii) a provision requiring, at a minimum, quarterly reviews by the Insured Institution's board of directors whereby the extent of the Insured Institution's compliance with the plan is expressly addressed with the results of each review to be recorded in the corporate minutes of the board of directors.
   (c) Upon written notice from the Regional Director that the submitted plan is not acceptable, the Insured Institution shall, within 30 days after receipt of such notice, submit amendments to the plan to the Regional Director, including any modifications or amendments requested by the Regional Director. Upon written notice that the plan is accepted, it shall be adopted by the board of directors of the Insured Institution. The Insured Institution shall thereafter immediately initiate measures detailed in the plan to the extent such measures have not previously been initiated.
   (d) For purposes of the plan, the reduction of the level of adversely classified assets as of July 7, 1989, to a specified percentage of total equity capital and reserves may be accomplished by:
       (i) charge off;
       (ii) collection;
       (iii) sufficient improvement in the quality of adversely classified assets so as to warrant removing any adverse classification, as determined by the FDIC; or
       (iv) increase of total equity capital and reserves.
   (e) While this ORDER is in effect, the Insured Institution shall eliminate from its books, by charge-off or collection, all assets or portions of assets classified "Loss" as determined at any examination or visitation conducted by the FDIC or the State banking department at such time as the report of examination or visitation is received by the Insured Institution. In addition, the Insured Institution shall submit amendments to the classified asset reduction plan as requested by the Regional Director to account for assets that might be classified adversely at future examinations or visitations.
   4. (a) Within 10 days of the effective date of this ORDER, the Insured Institution shall establish and thereafter maintain an adequate reserve for loan losses. Such reserve shall be established by charges to current operating income. Prior to the end of each calendar quarter, the board of directors of the Insured Institution shall review the adequacy of the Insured Institution's reserves for loan losses. Such reviews shall include, at a minimum, the Insured Institution's loan loss experience, an estimate of potential loss exposure in the portfolio, trends of delinquent and nonaccrual loans and prevailing and prospective economic conditions. The minutes of the board meetings at which such reviews are undertaken shall include complete details of the reviews and the resulting recommended increases in the reserve for loan losses.
   (b) Within 30 days of the effective date
{{9-30-91 p.A-1748}} of this ORDER, the Insured Institution shall review Consolidated Reports of Condition and Reports of Income filed with the FDIC on or after June 30, 1989, and amend said reports if necessary to properly reflect the financial condition of the Insured Institution as of the date of each such report. In particular, such reports shall contain an adequate provision for loan losses. All subsequent Reports of Condition and Reports of Income filed shall also accurately reflect the financial condition of the Insured Institution as of the reporting date.
5. (a) While this ORDER is in effect, the Insured Institution shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower who has an extension of credit with the Insured Institution that has been classified Loss, in whole or in part, and is uncollected, or to any borrower who is already obligated in any manner to the Insured Institution on any extension of credit, including any portion thereof, that has been charged off the books of the Insured Institution and remains uncollected. The requirements of this paragraph shall not prohibit the Insured Institution from renewing credit already extended to a borrower after full collection, in cash, of interest due from the borrower. The provisions of this subparagraph shall not prevent the Insured Institution from advancing additional funds for its own protection for taxes, insurance or other expenses incidental to the existing indebtedness if the Insured Institution's board of directors has signed a detailed written statement explaining why the failure to do so would be detrimental to the best interests of the Insured Institution. The statement shall be placed in the appropriate loan file and included in the minutes of the applicable board of directors' meeting.
   (b) While this ORDER is in effect, the Insured Institution shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower whose extension of credit is classified "Doubtful" and/or "Substandard," in whole or in part, and is uncollected, unless the Insured Institution's board of directors has signed a detailed written statement giving reasons why failure to extend such credit would be detrimental to the best interests of the Insured Institution. The statement shall be placed in the appropriate loan file and included in the minutes of the applicable board of directors' meeting.
   6. The Insured Institution shall have and retain qualified management. Each member of management shall have qualifications and experience commensurate with his or her duties and responsibilities at the Insured Institution. The qualification of management shall be assessed on its ability to: (i) comply with the requirements of this ORDER, (ii) operate the Insured Institution in a safe and sound manner, (iii) comply with applicable laws and regulations, and (iv) restore all aspects of the Insured Institution to a safe and sound condition, including asset quality, capital adequacy, earnings, management effectiveness, and liquidity. During the life of this ORDER, the Insured Institution shall notify the Regional Director in writing of any changes in management. The notification must include the names and background of any replacement personnel and must be provided prior to the individual assuming the new position. For purposes of this ORDER, "management" shall include any person who is an "executive officer" as that term is defined in section 215.2(d) of Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. § 215.2(d).
   7. Within 60 days of the effective date of this ORDER, the board of directors shall establish a committee of the board of directors with the responsibility to ensure that the Insured Institution complies with the provisions of this ORDER. The committee shall report monthly to the entire board of directors, and a copy of the report and any discussion relating to the report or the ORDER shall be included in the minutes of the board of directors. Nothing contained herein shall diminish the responsibility of the entire board of directors to ensure compliance with the provisions of this ORDER.
   8. Within 90 days of the effective date of this ORDER, the board of directors shall establish a loan review committee to periodically review the Insured Institution's loan portfolio and identify and categorize problem credits. The committee shall file a report with the board of directors. Such report shall include the following information:
       (a) the overall quality of the loan portfolio;
       (b) the identification by type and amount of each problem or delinquent loan;
       (c) the identification of all loans not in
    {{5-31-92 p.A-1749}}conformity with the Insured Institution's lending policy; and
       (d) the identification of all loans to officers, directors, principal shareholders or their related interests.
   9. Within 90 days of the effective date of this ORDER, the Insured Institution to the best of its ability using reasonable efforts, shall eliminate and/or correct all technical exceptions with regard to loan documentation existing in the Insured Institution as of July 7, 1989, as more fully set out on pages 2-d and 2-d-1 of the July 7, 1989, Report of Examination. In addition, the Insured Institution shall ensure complete and current loan documentation in the future on any new loans or renewals where additional credit is extended.
   10. After the effective date of this ORDER, the Insured Institution shall send to its shareholders or otherwise furnish a description of this ORDER, (1) in conjunction with the Insured Institution's next shareholder communication, and also (2) in conjunction with its notice or proxy statement preceding the Insured Institution's next shareholder meeting. The description shall fully describe the ORDER in all material respects. The description and any accompanying communication, statement, or notice shall be sent to the FDIC, Registration and Disclosure Section, Washington, D.C. 20429, for review at least 20 days prior to dissemination to shareholders. Any changes requested to be made by the FDIC shall be made prior to dissemination of the description, communication, notice, or statement.
   11. Within 30 days after the end of the first calendar quarter following the effective date of this ORDER, and within 30 days after the end of each calendar quarter thereafter, the Insured Institution shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. Such reports may be discontinued when the corrections required by this ORDER have been accomplished and the Regional Director has released the Insured Institution in writing from making further reports.
   12. The effective date of this ORDER shall be 30 days after the date of its receipt. This ORDER shall be binding upon the Insured Institution and all institution-affiliated parties of the Insured Institution.
   This ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provision of this ORDER shall have been modified, terminated, suspended, or set aside by the FDIC.
   By direction of the Board of Directors.
   Dated at Washington, D.C., this 11th day of June, 1991.
   /s/ Hoyle L. Robinson
   Executive Secretary

______________________________________
RECOMMENDED DECISION

In the Matter of
The Citizens State Bank of Cortez
Cortez, Colorado

Steven M. Charno, Administrative Law Judge:
   Pursuant to the provisions of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. §§ 1811-1831k, a Notice of Charges and of Hearing ("Notice") was issued by the Federal Deposit Insurance Corporation ("Petitioner" or "FDIC") on November 29, 1989 alleging that The Citizens State Bank of Cortez ("Respondent") had engaged in unsafe or unsound banking practices, including operating with an inadequate level of capital, operating with an excessive quantity of poor quality loans and loan related assets, failing to provide an adequate reserve of loan losses and engaging in hazardous lending and lax collection practices. Respondent's Answer partially admitted and partially denied the allegations of the Notice.
   This case was heard before me in Denver, Colorado on June 19 through 21 and August 28 through 30, 1990.1 Proposed findings of fact and proposed conclusions of law were filed by Petitioner and Respondent under due date of December 30, 1990, and post-hearing briefs were filed by the parties on January 15, 1991.

DISCUSSION

   This case may be divided into several categories for purposes of discussion: (1) certain uncontested allegations of unsafe or unsound banking practices, as to which the parties stipulated, (2) contested allegations concerning lending and collection practices, accounting principles applicable to real estate sales and the quality of Respond-


1 The unopposed transcript corrections submitted by Petitioner and Respondent are hereby adopted.
{{5-31-92 p.A-1750}}ent's management, all of which were the subject of evidentiary presentation and (3) the nature of an appropriate remedy, as to which both argument and evidence were offered.
   Turning briefly to the initial category of allegations, Respondent admits that it has an inadequate loan loss reserve, that it is undercapitalized and that it has an excessive number of adversely classified assets.2 It further concedes that its operation with inadequate capital and an inadequate loan loss reserve are unsafe or unsound banking practices.3 I find Respondent's operation with an excessive level of low quality loans and loan-related assets to be a further unsafe or unsound banking practice. See Docket No. FDIC-83-252b&c, et al., [1985] F.D.I.C. Enf. Dec. (P-H) ¶ 5049 at 6127.
A. Alleged Hazardous Lending and Lax Collection Practices
   Petitioner asserts that Respondent has engaged in additional unsafe or unsound banking practices involving the capitalization of interest, extending or renewing loans without securing additional collateral, extending or renewing loans without current documentation and failing to establish or enforce repayment understandings.4 Petitioner contends that these practices are demonstrated by 15 of Respondent's extensions of credit.
   In evaluating these allegations, I shall employ the definition set forth in Gulf Fed. S. & L. v. Fed. Home Loan Bank Bd., 651 F.2d 259, 264 (5th Cir. 1981), quoting 112 Cong. Rec. 26474 (1966):
   an "unsafe or unsound practice" embraces any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.
   1. Uncontroverted Allegations
   Petitioner alleges that Respondent's extension of credit to * * * evidenced an unsafe or unsound banking practice because Respondent extended the maturity of the loan without the full collection of interest.5 Respondent denies this allegations for reasons purportedly set forth in its post-hearing brief, but that brief contains no reference to the * * * loan. Because Respondent has effectively abandoned its opposition to this allegation, I shall adopt the finding sought by Petitioner.6
   Similarly, a loan to * * * and * * * is alleged to demonstrate unsafe or unsound banking practices because (1) interest was capitalized when the loan was renewed7 and (2) Respondent did not require additional collateral to secure the interest which was capitalized.8 As with the * * *, Respondent effectively abandoned its opposition to this allegation, and I shall adopt Petitioner's requested finding.9
   Finally, Petitioner alleges that a loan to * * * and * * * d/b/a * * * was an unsafe and unsound banking practice because Respond-
2 The parties stipulated as to reserves, and Respondent conceded in its post-hearing brief that "the Bank has not contested that it is undercapitalized nor that it has an excessive volume of adversely classified assets."

3 Respondent's Response to Federal Deposit Insurance Corporation's Proposed Findings of Fact and Conclusions of Law ("Respondent's Response") at 10.

4 In reply to Petitioner's allegations concerning repayment understandings, Respondent argues that it did not fail to establish such understandings because the 90-day notes which it executed contained all relevant terms and conditions of the obligations in question. While Petitioner's expert discussed this matter at some length, he was unable to explain how Respondent's use of a 90-day note with respect to any of the loans at issue had (a) failed to incorporate any necessary term or condition relating to the loan or (b) created an abnormal risk to the bank, where no such risk otherwise existed. Accordingly, I must reject Petitioner's proposed findings of fact which relate to Respondent's alleged failure to establish repayment understandings. Upon examination, it appears that Respondent's alleged failure to enforce repayment understandings consists of nothing more than the bank's renewal or extension of 90-day notes. The record contains no probative evidence that merely renewing or extending a loan, in the absence of other circumstances, can constitute an unsafe or unsound banking practice. Many of Petitioner's proposed findings of fact, however, specifically allege that the renewal or extension of a loan, in and of itself, constituted an unsafe or unsound practice. I disagree and will therefore reject those findings.

5 Petitioner's proposed finding of fact 96.

6 This finding is based on the parties' stipulation and the credited testimony of Petitioner's expert.

7 I am incapable of distinguishing between the renewal of a loan "without collection in cash of interest due" and renewing the loan "without requiring the full collection of interest." I shall therefore treat these allegations as identical concepts throughout this discussion and shall reject Petitioner's apparently duplicative proposed findings of fact as redundant.

8 Petitioner's proposed findings of fact 94 and 103.

9 This finding is based on the parties' stipulation and the credited testimony of Petitioner's expert.
{{9-30-91 p.A-1751}}ent capitalized interest when the loan was renewed.10 Respondent admitted the underlying facts but, without any citation of authority, denied the legal conclusion.11 Accordingly, I shall adopt the finding proposed by Petitioner.12
   2. * * * Loan
   Petitioner alleges that an extension of credit to * * * and * * * evidenced unsafe or unsound practices because (1) Respondent renewed the loan without the full collection of interest and (2) renewals of the loan involved an increase in the debt outstanding and a reduction in the interest rate.13 A $12,000 increase in debt is undisputed, and the record establishes that interest was capitalized14 and the interest rate was reduced to nine percent in May 1988.15 Respondent argues that it restructured the loan, rather than foreclosing on the real estate collateral, because it had a reasonable expectation that the * * * would be able to service their debt from farming income. I find Respondent's somewhat speculative expectation to be outweighed by the increased risk of loss brought about by an increase in the principal balance and by the capitalization of interest. Accordingly, I find that the May 1988 renewal demonstrates unsafe or unsound banking practices as alleged.16
   3. * * * Loan
   Petitioner alleges that the March 22, 1989 renewal of a loan to * * * d/b/a * * * involved unsafe or unsound banking practices because the loan was renewed (1) without adequate security17 and (2) without adequate documentation.18 It is uncontested that the principal due upon renewal was $90,000, the estimated value of the collateral was $57,000 and no further collateral could be secured. The borrower's financial statement was nine months old at the time of the renewal, which I find to be adequately current,19 and there was no proof in the loan file that the collateral was insured. Given the adequacy of * * *'s 1988 financial statement and the absence of any evidence that a failure to supply proof of insurance on the collateral for this loan, standing alone, exposed Respondent to abnormal risk, loss or damage, I find that the alleged documentation deficiencies do not constitute an unsafe or unsound banking practice. Respondent established that the renewal was a consolidation of a number of existing loans, which were restructured to provide for monthly payments during a six-month period when income was typically greatest. There is no question that a debtor with a seasonal income should be placed on a seasonal repayment schedule.20 This would appear to be especially true where, as here, the borrower had relatively limited liquid resources on an annual basis. The restructure of existing indebtedness in order to establish a necessary and prudent repayment schedule, although under-collateralized, was not shown to create the degree of risk, loss or damage required to demonstrate an unsafe or unsound banking practice. Indeed, it would appear that

10 Petitioner's proposed finding of fact 104.

11 Respondent's Response at 8.

12 This finding is based on the credited testimony of Petitioner's expert.

13 Petitioner's proposed finding of fact 98. Here, Petitioner alleged a "failure to enforce a repayment understanding" in conjunction with sufficient additional facts to raise the question of whether the practice gave rise to abnormal risk. Unlike those proposed findings involving only a failure to enforce, this allegation provides the factual basis for a finding that Respondent engaged in an unsafe or unsound banking practice.

14 I credit the admission of Respondent's Executive Vice President to the effect that the loan was extended without the full collection of interest due.

15 I give greater weight to the parties' stipulation to this effect than I do to the unsupported "belief" of Respondent's Executive Vice President.

16 These findings are based on the credited testimony of Petitioner's expert.

17 I am unaware of any practical difference between the renewal of a note "without adequate security" and the renewal of an under-collateralized note "without improving collateral margins." Because Petitioner's expert did not attempt to differentiate between these concepts, I shall treat them as identical throughout this discussion and shall reject Petitioner's apparently duplicative proposed findings as redundant.

18 Petitioner's proposed findings of fact 84 and 89.

19 The objection of Petitioner's expert to the vintage, and therefore the reliability, of this document appears to be based in part on financial statement as of May 31, 1989. Petitioner's expert also testified that a new statement was required because the borrower's condition was "deteriorating," although he previously stated that condition "seems to be improving but remains weak." Based on the internal inconsistency of the expert's testimony and because the financial information on which he relied was unavailable to Respondent at the time of the renewal, I find that Respondent did not have sufficient reason on March 22 to cause it to question that reliability of the nine-month old statement.

20 Respondent's expert credibly so testified.
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   Respondent improved its position with respect to the restructure without increasing its risk of loss in any significant respect.21 For the foregoing reasons, I find that the * * * restructure did not involve any unsafe or unsound banking practices.
   4. * * * Loan
   Petitioner argues that the February 1, 1989 modification of a $75,000 loan and a new $12,000 extension of credit on March 23, 1989 to * * * evidence unsafe or unsound banking practices by virtue of (1) inadequate security, (2) inadequate documentation and (3) the capitalization of interest.22 It is undisputed that the loans were secured by a first lien on raw land (valued at $20,000 but unappraised), a second lien on the borrower's residence (valued in a 1986 appraisal at $50,000) and on certain furniture, equipment and fixtures (none of which were appraised or valued), and the assignment of the death benefit of a life insurance policy (which had no cash value). Given the fact that real estate values had plummeted in Respondent's market area, 23 I find that the March 23 extension of credit was made without adequate security or documentation. These inadequacies increased Respondent's risk of loss on the subject transactions. Because a portion of the proceeds of the second loan were used to make two principal and interest payments on the first loan,24 I find that interest was capitalized. I therefore find that these extensions of credit demonstrate the unsafe or unsound banking practices alleged by Petitioner.25
   5. * * * Loan
   Petitioner alleges, in essence, that a seven-month extension of a May 1989 loan to * * * d/b/a * * * should not have taken place.26 Respondent established that it extended the note, instead of foreclosing on the collateral, because the borrower was actively marketing the collateral on Respondent's behalf. Respondent further demonstrated that it took this step based on (1) the borrower's previously demonstrated ability to successfully sell portions of the collateral and (2) a reasonable belief that the collateral was more likely to be sold during the season of the year covered by the extension.27 The benefits to Respondent of allowing the borrower to market the collateral include avoidance of the costs and uncertainties of attempting to foreclose on the property. Extension of this loan for a relatively short period in order to secure these benefits was not shown to create abnormal risk, loss or damage. Accordingly, I find that Petitioner failed to demonstrate the unsafe or unsound banking practice which it alleged.
   6. * * * Loan
   Petitioner alleges that Respondent's March 1989 modification of a $21,000 loan to * * * was an unsafe or unsound banking practice because it involved the capitalization of interest in the amount of $1,266.28 Respondent replies that the capitalization of interest is not an unsafe or unsound banking practice if the loan is well secured at the time interest is capitalized. This troubled loan was secured by vehicles, a mobile home and three acres of land, all of uncertain value, and was the subject of a $7,500 guarantee from the borrower's mother. Because the loan was not shown to be well secured at the time interest was capitalized, I find that the modification involved an unsafe or unsound banking practice.29
   7. * * * Loan
   Petitioner alleges that the March 1989 renewal of a note to the * * * was an unsafe or

21 Petitioner's expert indicated in response to a hypothetical question that an improvement in Respondent's position would change his opinion that the * * * restructure was an unsafe or unsound banking practice.

22 Petitioner's proposed findings of fact 85, 91 and 100.

23 This finding is based on the parties' stipulations and the credited, uncontroverted testimony of Respondent's expert.

24 The parties so stipulated.

25 This finding is based on the credited testimony of Petitioner's expert. Respondent's Response did not cite any evidence or argument in contravention of Petitioner's proposed findings concerning the March 23, 1989 loan. I therefore find that Respondent has waived its right to present such evidence or argument.

26 Petitioner's proposed finding of fact 97. See note 4, supra.

27 Findings concerning Respondent's showing are based on the uncontroverted testimony of its Executive Vice President.

28 Petitioner's proposed finding on fact 107. That finding also named ten other loans which Petitioner alleged to be unsafe or unsound banking practices due to the capitalization of interest. Because the cross-examination of Petitioner's expert established that the capitalization of interest is not invariably an unsafe or unsound banking practice and because Petitioner did not proffer sufficient evidence concerning the other ten loans to permit a determination of whether they were, in fact, unsafe or unsound practices, I find that Petitioner did not meet its burden of proof with respect to the other ten loans.

29 This finding is based on the credited testimony of Petitioner's expert.
{{9-30-91 p.A-1753}}unsound banking practice because it involved the capitalization of interest.30 Respondent alleges that no interest was capitalized at the time of the renewal but fails to cite any evidence to support this position.31 The allegation of an unsafe or unsound banking practice is supported by the record, and I shall make the finding sought by Petitioner.32
   8. * * * Loan
   Petitioner alleges that the May 1989 modification and renewal of a loan to * * * involved unsafe or unsound banking practices because it was made (1) without adequate security, (2) without adequate documentation33 and (3) without the full collection of interest.34 It is uncontested that, on May 31, 1989, (1) Respondent modified a loan to the borrower by capitalizing interest in the amount of $16,941 and adding to the principal balance approximately $17,500 which was paid to third parties in order to protect the collateral, (2) the loan balance was approximately $172,000, while the collateral had been valued at $280,000 in a 1985 appraisal, (3) Respondent's management felt that they did not need a new appraisal since they felt that "they had a good feel for the value of the property" and consequently believed the collateral value to be well in advance of the loan balance and (4) the borrower's financial information was dated December 1986 and the financial statement of the owner of the business was dated May 1987. Petitioner did not establish that the value of the collateral at the time of the modification had fallen below the loan balance, and I find that Petitioner failed to meet its burden of proof on this issue. I further find Respondent's reliance on the outdated collateral appraisal to be reasonable given the reasons therefor and the nature of the modification. Because Petitioner's expert based his testimony concerning inadequate documentation in part on the inadequacy of the collateral appraisal, it is impossible to determine whether he would have opined that the stale financial statements, standing alone, would constitute an unsafe or unsound banking practice. I therefore find that Petitioner also failed to meet its burden on this issue. Finally, the record demonstrates that the capitalization of interest at a time when a loan is well secured may not be an unsafe or unsound banking practice.35 Because the weight of the evidence establishes that the loan was well secured, I shall reject Petitioner's finding concerning the capitalization of interest.36
   9. * * * Loan
   Petitioner alleges that the June 15, 1988 renewal of a loan to a weak borrower, * * *, without improving collateral margins was an unsafe or unsound banking practice.37 It was stipulated that the loan balance at the time of the renewal was $28,800; the appraised value of the collateral on May 20, 1988 was $40,000.38 Respondent decided not to seek additional collateral based on its belief that the modified loan was well secured. The weight of the evidence does not contravene this belief. I shall therefore reject the finding sought by Petitioner.
   10. * * * Loan
   Petitioner alleges that the consolidation and renewal of three loans to * * * d/b/a * * * evidenced unsafe or unsound banking practices because it was done (1) without the full collection of interest and (2) without obtaining additional collateral to secure the money advanced for the purpose of paying

30 Petitioner's proposed finding of fact 106.

31 Respondent's proposed finding of fact II.F.2.

32 This finding is based on the credited testimony of Petitioner's expert.

33 Again, I find myself unable to discern a practical distinction between an extension of credit "without adequate and appropriate supporting documentation" and one made "without obtaining complete and current financial information." Since Petitioner cites the same evidence to support both allegations, I shall treat them as identical for purposes of this Discussion and shall reject Petitioner's apparently duplicative proposed findings of fact as redundant.

34 Petitioner's proposed findings of fact 87, 90, 93, 102 and 109.

35 I credit the admission to this effect of Petitioner's expert.

36 In its post-hearing brief, Petitioner asserts that Respondent's expert conceded that it was an unsafe or unsound banking practice to renew the loan to * * * under the circumstances of record. To the contrary, that witness testified in response to a hypothetical questions that it would be an unsafe or unsound banking practice to renew the loan if, inter alia, the collateral in question was completely unsalable, a contingency not established by Petitioner.

37 Petitioner's proposed finding of fact 88.

38 I credit the uncontroverted testimony to this effect of Respondent's President.
{{9-30-91 p.A-1754}}interest.39 At the time of the renewal, approximately $2,000 in interest was capitalized,40 the loan balance was $287,00041 and the collateral was valued at $550,000.42 As noted above, the capitalization of interest when ample collateral margins exist is not, without more, an unsafe or unsound banking practice. Similarly, the presence of already ample collateral margins logically eliminates any need to secure additional collateral.43 For the foregoing reasons, the findings sought by Petitioner shall be rejected.
   11. * * * Loan
   Petitioner alleges that the February 24, 1989 modification of a loan to * * * demonstrated unsafe or unsound banking practices because it was made (1) without adequate security and (2) without adequate documentation.44 The parties agree that (1) the balance due on the modified loan was $213,792,45 (2) collateral, which was estimated to be worth $227,000,46 consisted of a first lien on * * * ranch, water stock, machinery, equipment, crops and livestock and (3) documentation at the time of modification consisted of a real estate appraisal dated October 1986 and a "property statement" dated October 21, 1987. The estimated value of collateral, through unsupported by a recent appraisal, was not shown to be unreasonable.47 Respondent also had guarantees in the amount of $165,000 from * * * spouse,48 and the record contains no indication that she was incapable of performing her obligations thereunder. Given the demonstrated collateral margin, I find that Respondent's one-year extension of the note's maturity was not undertaken with a level of collateral so low as to expose Respondent to abnormal risk, loss or damage. In response to allegations that the value of collateral was inadequately documented, Respondent contends that (1) its officers were familiar with the value of the real estate collateral (which is supported by the manner in which they had reduced the appraised value49), (2) there was an "abundance" of collateral worth between $270,000 and $310,000 and (3) the bank was relying for repayment of a future inheritance of * * *'s spouse. The last contention must be rejected as excessively speculative, and the second was not established by probative evidence. Given the fact that Respondent's officers were shown to have had an accurate appreciation of the value of the real estate collateral at issue, I cannot find that the alleged documentary deficiencies created abnormal risk, loss or damage. I therefore find that extending the maturity of * * * loan did not demonstrate unsafe or unsound banking practices by Respondent.
   12. * * * Loan
   Petitioner alleges that December 1987 and January 1989 extensions of a loan to * * * and * * * d/b/a * * * involved unsafe or unsound banking practices because they were made (1) without the full collection of interest and (2) without obtaining additional collateral to secure the money advanced for the purpose of paying interest.50 The parties agree that (1) the loan balance in January 1989 was approximately $169,000, while

39 Petitioner's proposed findings of fact 95 and 99.

40 The parties so stipulated.

41 I find citation of the examination report to this effect by Petitioner's expert to be of greater probative value than the unsupported oral evidence of Respondent's President.

42 The appraised value of the borrower's building was stipulated to be $350,000, while Respondent's President credibly testified that the borrower's other assets, including inventory, equipment and machinery, were worth the remainder of the $550,000 figure. Petitioner's expert admitted that he had believed that the borrower's inventory, equipment and machinery were included in the building appraisal.

43 Petitioner's expert testified that an unsafe or unsound banking practice took place even if there was adequate collateral to cover any interest capitalized, but he did not explain how he was able to reach this conclusion in the absence of any evidence that the practice could cause an increased risk of loss. Because this expert opinion was without factual or logical basis, it must be rejected as arbitrary.

44 Petitioner's proposed findings of fact 86 and 108.

45 The parties so stipulated.

46 I find the parties' stipulation to this effect to be of greater probative value than the unsupported testimony of Respondent's Executive Vice President.

47 When the 1989 estimate of $227,000 is compared with the 1986 appraised value (adjusted to reflect partial sales of the collateral during the intervening period) of $542,000, it must be inferred that Respondent prudently reduced the value which is assigned the collateral in order to reflect the general decrease in real estate values between 1986 and 1989.

48 I credit the uncontroverted testimony of Respondent's Executive Vice President to this effect.

49 See note 47, supra.

50 Petitioner's proposed findings of fact 92 and 101.
{{9-30-91 p.A-1755}}the collateral, including real estate appraised at $200,000, was worth at least $245,000,51 (2) $6,000 in interest was capitalized in December 198752 and (3) $6,800 in interest was capitalized in January 1989.53 Respondent established that it was important for the bank to work with the borrowers to keep the restaurant open in order to maximize its sale value.54 Given the ample collateral margin, neither the capitalization of interest nor the failure to collect additional collateral gave rise to abnormal risk, loss or damage.55 For the foregoing reasons, I shall reject the proposed findings sought by Petitioner.
   13. * * * Loan
   Petitioner alleges that (1) the September 1987 extension of a loan to * * * and * * * was an unsafe or unsound banking practice because it represented a failure to enforce a repayment understanding56 and (2) the August 1988 extension of that loan was an unsafe or unsound practice because it was made without the full collection of interest.57 The record establishes that Respondent capitalized $1,041 in interest in 198758 and $3,498 in interest at the time of the 1988 modification.59 Respondent argues that it appeared in August of 1988 that the * * * might be able to make a significant principal reduction in the near future if the loan were extended. The weight of the evidence does not establish that the loan was adequately secured at the time of either modification. I shall therefore adopt the findings proposed by Petitioner.
B. Sales of Other Real Estate
   The parties agree that the accounting guideline embodied in APB Opinion No. 21 requires that a bank which sells an asset and finances that sale at a below-market interest rate must discount the loan and charge off the difference between the rate of interest charged and the market rate. The parties, however, disagree on (1) when APB Opinion No. 21 should be given effect and (2) how to determine a "market rate."
   The parties also agree that another accounting principle, FASB 66, requires that, under circumstances which are present in this proceeding, an asset sold and financed by a bank will continue to be reflected on the bank's books as "Other Real Estate" owned by the bank, rather than being recorded as a sale and a corresponding loan.60 The accounting treatment dictated by FASB 66 for the real estate transaction here at issue therefore prevents any sales from being booked and causes the associated loans to cease to exist for accounting purposes.61 Petitioner argues that the applicability of APB Opinion No. 21 is controlled by an April 15, 1986 "bank letter" from the FDIC to the chief executive officers of insured state nonmember banks. That document effectively directs banks to book a loss on the actual sale date, even though FASB 66 would require deferral of the recordation of a gain until a sale was recorded on the bank's books. No authority has been cited which would suggest that this direction was not binding on Respondent. Accordingly, I find that the "bank letter" was binding on Respondent and APB Opinion No. 21 was applicable to the four real estate transactions at issue.62

51 Respondent's proposed findings of fact II.K.3. through II.K.5. and Petitioner's responses thereto.

52 I find the parties' stipulation to this effect to be of greater probative value than the unsupported testimony of Respondent's Executive Vice President.

53 Respondent's proposed finding of fact II.K.2. and Petitioner's response thereto.

54 Respondent's Executive Vice President credibly so testified.

55 Petitioner's expert testified that the capitalization of interest on a loan "in a deteriorating situation" (a term otherwise undefined) is always an unsafe or unsound banking practice, regardless of the amount of real estate collateral pledged on the loan. In the absence of some qualification or explanation, I find this testimony to be irrational and, therefore, unworthy of deference.

56 Petitioner contends that the 1987 renewal, or "failure to enforce a repayment understanding," was unsafe or unsound by virtue of the capitalization of interest at that time. This allegation pleads sufficient facts in addition to the renewal in order to raise the question of whether the note caused abnormal risk, loss or damage. Thus, the allegation provides a factual basis for finding an unsafe or unsound banking practice.

57 Petitioner's proposed finding of fact 105.

58 Respondent's Executive Vice President credibly so testified.

59 This finding is based on the August 22, 1988 modification agreement, which is not inconsistent with the testimony of Respondent's Executive Vice President in response to questions from the bench.

60 Respondent's proposed findings of fact III.B.1, 3, 4, and 6 and Petitioner's responses thereto.

61 Respondent's accounting expert credibly so testified.

62 Respondent's accounting expert did not convincingly demonstrate why the dictates of the "bank letter" did not require him to modify his conclusion that APB Opinion No. 21 did not apply. I therefore find his conclusion to be without significant probative value.
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   Respondent contends that the Federal Home Loan Bank Board rate was the "market rate" because it was the lowest rate which Respondent could earn,63 but this argument must be rejected since the Federal Home Loan Bank Board rate "is generally lower than what a bank charges its customers."64 By asking Respondent's mortgage loan department for its rate for residential mortgages at the time of the sales in question, Petitioner arrived at a 12.75 percent "market rate" which it used to compute the loan discounts.65 I therefore find that Petitioner met its burden of going forward with the evidence by establishing that the "market rate" (1) was not the Federal Home Loan Bank Board rate and (2) was the 12.75 percent residential mortgage rate used by Respondent. Respondent replies that the "market rate" was actually the rate required on Federal Housing Administration mortgage loans,66 but the record contains no evidence that the four borrowers in question could qualify for such a favorable rate.67 Accordingly, I find that Respondent did not meet the shifted burden of proof on this issue. Because the record demonstrates that Petitioner's loss classification on the * * * and * * * properties were based on an appropriate market rate of interest, I find that the FDIC correctly classified $113,000 as "loss" from sales of real estate.68

C. Quality of Management

   Petitioner contends that Respondent "has engaged in an unsafe or unsound practice [by operating] with management whose policies and practices were detrimental to the Bank and jeopardize its deposits." In support of this contention, Petitioner argues that (1) management's policies have resulted in Respondent's weak financial condition, which is characterized by excessive poor quality assets, inadequate loan loss reserves and inadequate capital, and (2) management "must share in the responsibility" for those lending and collection deficiencies which were shown to be unsafe or unsound banking practices.69 Respondent demurs.
   In reply to the initial portion of Petitioner's argument, Respondent contends that its condition in 1989 was the result of a severely depressed economy in its market area, rather than the policies of its management. It is undisputed that, in 1987, the FDIC concluded that Respondent's loan quality problems were due in large part to the depressed local economy. The weight of the evidence established that both the local economy and Respondent's financial condition continued to decline between 1987 and 1989.70 Respondent's condition in 1989 was not, therefore, of recent origin. Indeed, Petitioner contends that 25 percent of Respondent's loans which were classified "substandard" in 1987 were classified "loss" in 1989, and the 1989 classifications were agreed to be long-term workouts of seasoned loans to borrowers who were experiencing financial difficulties. While the parties agree that Respondent's classified loans were significantly impacted by the downturn in major local industries, the record contains no suggestion that Respondent's management failed to take any action which might have protected the bank from the effects of the downturn.71 It would seem axiomatic that an excessive amount of poor quality credits, when charged off, would cause decreased, possibly inade-


63 Respondent's expert so testified.

64 Petitioner's proposed findings of fact 125 and 126 and Respondent's Response at 9.

65 Petitioner's proposed findings of fact 127 and Respondent's Response at 9.

66 Respondent's expert so testified.

67 Petitioner's proposed findings of fact 123 and 124 and Respondent's Response at 9.

68 Petitioner did not propose or support a conclusion of law that these losses evidenced an unsafe or unsound banking practice, and no such conclusion will be drawn.

69 The liability of Respondent's management for the bank's unsafe or unsound banking practices is beyond dispute. See Docket No. FDIC-, [1980] F.D.I.C. Enf. Dec. (P-H) ¶5003 at 5043.

70 Respondent's expert credibly so testified without controversion.

71 Petitioner's expert addressed this point on cross-examination, but his testimony is somewhat confusing:
    I think that by the types of loans it made and by the volume of lending, the Bank, in fact, did sustain more — I think injury from the admittedly — I accept that the economic conditions locally were adverse. [This quotation reflects Petitioner's transcript correction.]
Unfortunately, this matter was not pursued further, and the record is silent as to both the witness' rationale and whether there was any factual basis for his position.
{{9-30-91 p.A-1757}}quate, loan loss reserves which, in turn, could result in a capital inadequacy.72 I therefore find that Respondent's condition was shown to have resulted primarily from a collapse of the local economy. Under these circumstances, it would be irrational to find that an unsafe or unsound banking practice existed because of the admitted inability of Respondent's management to correct the bank's problems of loan quality, reserve inadequacy and capital inadequacy.73
   In reply to the second part of Petitioner's argument, Respondent contends that (1) the alleged unsafe or unsound lending and collection practices did not occur and that its attempts to work out problem credits with troubled borrowers were prudent and in the bank's best interest and (2) there is no evidence that management engaged in unsafe or unsound practices "under circumstances where viable alternatives existed that would have been more beneficial to the Bank." Of the 13 instances of unsafe or unsound lending or collection practices found herein, ten resulted from the capitalization of interest. I therefore find that Respondent's renewal of loans without the full collection of interest is the only unsafe or unsound lending or collection practice which occurred with sufficient frequency to permit the inference that it resulted from a policy of Respondent's management. In 1987, one of Petitioner's examiners lauded Respondent's capitalization of interest in the context of loan extensions as evidence of management's concern over the bank's condition and as indicative of management's attempts to minimize the bank's exposure to loss. I find it inconceivable that a policy of such apparent benefit to the bank in 1987 could be of such detriment only two years later. The deterioration in Respondent's condition between 1987 and 1989 does not explain such a reversal, since neither the policy nor the circumstances surrounding its implementation were shown to have changed as a result of that deterioration. The overwhelming weight of the evidence concerning Respondent's management requires rejection of Petitioner's proposed finding of fact.74

D. Remedy75

   While there is no disagreement that the FDIC, like other agencies which exercise their considerable expertise to effect the public interest, may exercise broad discretion when crafting a cease and desist order, Respondent argues that Petitioner's discretion is limited by the principle that "the sanction imposed must...have some relation to the violation found by the agency." City of Oakland v. Donovan, 703 F.2d 1104, 1106 (9th Cir. 1983). In support of its argument, Respondent quotes NLRB v. Express Pub. Co., 312 U.S. 426, 433 (1941), for the proposition that:

    the authority conferred on the Board to restrain the practice which it has found the employer to have committed is not an authority to restrain generally all other unlawful practices which is has neither found to have been pursued nor persuasively to

72 For the reasons set forth at pages 44 and 45 of Respondent's post-hearing brief, I hereby reaffirm my ruling at the hearing that Petitioner may not classify as "loss" Respondent's $123,000 claim against the FDIC in connection with the extension of credit. My ruling was based wholly on facts in existence at the time of the examination, and Petitioner's contention that it was unaware of those facts during the examination supports my finding. An expert opinion, which, as here, was based on incomplete or inaccurate facts is not entitled to deference. When $123,000 is added to Respondent's capital account, it becomes clear that Petitioner's proposed findings paint an inaccurate picture of Respondent's condition.

73 In response to inartfully phrased questions from the bench, Petitioner's expert ultimately settled on the position that it was not an unsafe or unsound banking practice for Respondent to operate with management who were "incapable of improving" the bank's condition.

74 Petitioner also asserted that Respondent had failed to comply with four of the six provisions of an August 24, 1988 Memorandum of Understanding between the FDIC and the bank. Three of the provisions required management to correct the bank's poor loan quality, loan loss reserve inadequacy and capital inadequacy; management's inability to do so has been discussed above. With respect to the fourth and fifth provisions, Petitioner's expert conceded that Respondent had reviewed and was amending its loan policy and that it had charged off assets previously classified as "loss." Finally, Respondent's management credibly testified and Petitioner's expert conceded that Respondent was regularly reviewing its overhead expenses as required by the sixth provision, although overhead had not been significantly lowered as a result of these reviews. For the foregoing reasons, I find that any failure by Respondent to fully comply with the Memorandum of Understanding does not reflect adversely on the bank's management.

75 Under due date of December 30, 1990, Petitioner submitted a proposed order which embodied the relief it requests in this proceeding. That order is the subject of the following discussion, and the paragraph and subparagraph references below refer exclusively thereto. Any request for relief made prior to December 30, which was not incorporated in the pleading which was due on that date, is deemed to have been waived.
{{9-30-91 p.A-1758}}
    be related to the proven unlawful conduct.
See also New York, New Haven & Hartford R.R. Co., v. ICC, 200 U.S. 361, 404 (1905), Swentek v. United States, 658 F.2d 791, 796 (Ct. Cl. 1981); Fairmont Foods Co. v. Hardin, 442 F.2d 762, 771 (D.C. Cir. 1971).
   Petitioner argues that the FDIC has held that the individual provisions of a cease and desist order need not relate directly to an unsafe or unsound banking practice and that only a reasonable connection is required between a remedial provision and any legislative purpose underlying the Act. See Docket Nos. FDIC-84-23b and FDIC-84-67k, [1986] F.D.I.C. Enf. Dec. (P-H) ¶5061 at 6517; Docket No. FDIC-85-165k, [1986] F.D.I.C. Enf. Dec. (P-H) ¶5065 at 6661.
   Whatever the intent underlying the FDIC decisions cited by Petitioner, it is clear that the Supreme Court has restricted the breadth of relief appropriate in an administrative proceeding to those provisions intended to remedy acts or practices which are "like or related" to those found to contravene the relevant statute or regulation. NLRB v. Express Pub. Co., supra at 437. Accordingly, I shall reject any requested relief which does not meet this criterion.

   1. Prohibitive Relief

   Petitioner seeks remedial provisions in this case which will prohibit the unsafe or unsound banking practices found to exist herein.76 Respondent has raised a number of objections to the requested prohibitive relief.
   First, Respondent notes that excessive classified assets, an inadequate reserve for loan losses and inadequate capital are, by definition, all condition, not practices. Respondent then cogently argues that the plain meaning of Section 8(b) of the Act directs that conditions be corrected by affirmative, rather than prohibitive, relief. While Respondent's argument does not lack logical appeal, I am bound by the FDIC's numerous holdings that the cited conditions are also practices is impossible of performance, arguing, in effect, that it cannot improve its condition and that, if ordered to do so, it would be required to cease operations. This argument confuses possibility with palatability, and I reject it.77 For these reasons, the prohibitive remedy sought by Petitioner will be imposed.
   Respondent's second objection relates to the general and allegedly vague language used to frame the remedial provisions requested by Petitioner. Four prohibitive provisions employ the concept of "adequacy" as it relates to collateral, documentation, reserves and capital. Determination of what constitutes adequacy will obviously vary depending on the factual context. While the concept is therefore somewhat subjective, it is certainly less so than "unsafe or unsound banking practice." In any event, I find the term to be "as specific as the circumstances will permit." FTC v. Colgate-Palmolive Co., 380 U.S. 374, 393 (1965).
   Respondent's final objection to the prohibitive relief proposed by Petitioner concerns the provision prohibiting the capitalization of interest. Respondent correctly notes that the record establishes that not every capitalization of interest constitutes an unsafe or unsound banking practice. Relying on this premise, Respondent argues that a blanket prohibition of capitalizing interest in overly broad. I agree and shall limit the relief granted herein to prohibiting only that capitalization of interest which transgresses the legal definition of an unsafe or unsound banking practice. See Gulf Fed. S. & L. v. Fed. Home Loan Bank Bd., supra. Similar limitations are appropriate for each of the provisions prohibiting lending and collection practices. The collective provision which prohibits all undesirable lending and collection practices must also be modified to reflect the strictures articulated in NLRB v. Express Pub. Co., supra.78


76 Because I rejected Petitioner's Proposed finding that the policies of Respondent's management constituted an unsafe or unsound banking practice and Petitioner offered no probative evidence that Respondent's board of directors failed to adequately supervise the bank's officers, I must reject the prohibitive relief requested by Petitioner concerning these matters. See NLRB v. Express Pub. Co., supra. The same result is required with respect to the parallel affirmative relief sought by Petitioner in paragraph six of its proposed order.

77 Because Petitioner's management witness testified that the affirmative relief which the FDIC requested was required to redress the unsafe or unsound banking practices found herein, the three prohibitive provisions relating to Respondent's found herein, the three prohibitive provisions relating to Respondent's condition will be modified in order to mirror, rather than conflict with, the corresponding affirmative relief. This modification would also appear to moot Respondent's contention that the prohibitive relief requested by Petitioner is impossible of performance.

78 I assume that this provision was intended to prohibit any failure to enforce a repayment understanding which could be shown to be an unsafe or unsound banking practice. Petitioner did not seek relief explicitly directed at such a failure.
{{9-30-91 p.A-1759}}
   2. Affirmative Relief
       a. Paragraph One
   Relying in part on Petitioner's erroneous "loss" classification in connection with the * * * extension of credit, Respondent correctly contends that a $700,000 capital infusion is not required in order for it to establish a capital ratio of 7.5 percent. I agree and shall delete the reference to a specific dollar amount, while retaining the required capital ratio proposed by Petitioner.
   Respondent also asks that this provision acknowledge that a bank's capital ratio may be increased by a transfer to the capital account of (1) retained earnings since the 1989 examination and (2) partial recoveries on previously charged off loans.79 Petitioner responds that it must "verify" Respondent's earnings before any transfer may be made to the capital account. This response confuses the question of what constitutes a permissible method of increasing capital, which is the subject of the remedial provision, with the question of when an addition to capital may be considered final and irrevocable.80 I therefore find Respondent's requested modification to be appropriate.
   Respondent further contends that the capital provision effectively grants Petitioner a veto over any plan which Respondent might devise in order to increase capital. I agree but do not find such an exercise of discretion to be beyond the scope of Petitioner's authority. See 12 U.S.C. § 1818(b)(6)(F); 12 C.F.R. §§ 324.4(b) and 325.6(b).
   Respondent objects to subparagraph 1(c), which given Petitioner the right to revise Respondent's offering materials if the bank makes an offering of securities in order to improve its capital position. Petitioner responds that this proviso is required to prevent Respondent's commission of securities fraud, the consequences of which could adversely affect the insurance fund if Respondent were to be liquidated. Respondent replies that its stock is not publicly traded, it is not subject to state or federal securities laws and it cannot, therefore, commit securities fraud within the meaning of those statutory schemes. Petitioner replies only that banks, in general, are not exempt from the antifraud provisions of the securities laws. Absent argument or the citation of evidence demonstrating that Respondent, in particular, is subject to the securities laws, I shall adopt the modification requested by Respondent.
   Respondent's last objection to the first paragraph of affirmative relief goes to the fact that Petitioner's proviso effectively gives the FDIC a veto over Respondent's ability to issue convertible debentures and preferred stock. Because Petitioner did not address this matter in its reply brief, I shall adopt the modification sought by Respondent. Finally, Respondent's unopposed request for greater specificity in describing the required method for calculating capital and assets will be granted.
       b. Paragraph Two
   This paragraph prevents Respondent from paying a dividend without Petitioner's prior approval. Because it is undisputed that Respondent has never paid an excessive dividend, it is obvious that this proviso is not intended to directly remedy an unsafe or unsound banking practice. Petitioner argues that this provision is required in order to give the FDIC an opportunity to verify Respondent's capital position before a dividend is paid, thereby insuring that the payment will not have an adverse impact on the bank's capital adequacy. Respondent correctly argues that the provision, as framed by Petitioner, gives the FDIC an absolute right to veto the bank's payment of dividends, regardless of capital adequacy. In this context, I find Petitioner's proposed relief to be arbitrary and unnecessary to any valid regulatory aim. I shall therefore adopt a remedial provision which meets the needs of both parties by (1) eliminating the right of veto and (2) requiring Respondent to give Petitioner ample notice of any intended dividend. In this manner, Petitioner will be able to prevent any possible abuse which could result in a further deterioration of the bank's condition. See Docket Nos. FDIC-84-23b and FDIC-84-67k, supra.
       c. Paragraph Three
   Subparagraph 3(a) requires Respondent to charge off all assets classified "loss" at the 1989 examination. It was established by credible and uncontroverted evidence that Re-

79 This request is based on admissions by Petitioner's management witness.

80 The provision sought by Petitioner would cause Respondent to violate the order in the event that Petitioner were unable to timely schedule an examination or visitation in order to verify the accuracy of Respondent's reported earnings.
{{9-30-91 p.A-1760}}spondent has already taken this action. The fact that Petitioner has not conducted an examination to "verify" a fact established on the record in this proceeding is wholly immaterial. Accordingly, subparagraph 3(a) will be deleted as meaningless.
   Respondent objects to subparagraph 3(c) because it would allow the FDIC (1) to veto any plan by Respondent to reduce classified loans, (2) to dictate to Respondent how specific loans are to be restructured and (3) to require Respondent to foreclose on specific collateral. Petitioner concedes that it does not intend to dictate Respondent's day-to-day operations,81 and it would not be appropriate for Petitioner to actually run the bank in the manner which the requested provision would allow. Petitioner replies only that the sweeping language which it requests is permissible "in light of the broad powers provided to the FDIC under 12 U.S.C. § 1818(b)(6)(F)." Given (1) the uncontested fact that the scope of Petitioner's proposed subparagraph 3(c) greatly exceeds the agency's intended use of that proviso and (2) Petitioner's failure to cite probative evidence supporting its purported need for relief of such breadth, I shall adopt a remedial provision which eliminates Petitioner's right of veto.
   Respondent objects to subparagraph 3(e), which requires the bank to charge off any assets classified "loss" in any future examination. This objection is premised on Respondent's purported right to contest any classification by the FDIC in an administrative proceeding. Respondent cites no authority for this proposition, and Petitioner maintains that no such authority exists. Because of Respondent's failure to support its argument, I shall adopt the provision sought by Petitioner.
       d. Paragraph Four
   Respondent objects to the purported subjective nature of the term "adequate" in subparagraph 4(a) and asks that it be qualified by the equally subjective term "materially." I find the requirement that Respondent maintain an "adequate" loan loss reserve to be "as specific as the circumstances will permit." FTC v. Colgate-Palmolive Co., supra; see also Docket No. FDIC-84-71b, [1985] F.D.I.C. Enf. Dec. (P-H) ¶5046 at 6093.
   Respondent also contests the propriety of subparagraph 4(b), which requires the bank to file amended call reports for the period on or after June 30, 1989 if necessary to accurately reflect Respondent's financial condition at the time of those reports. Respondent argues that this provision does not remedy any proven unsafe or unsound banking practice. Petitioner notes that modifications of Respondent's financial statements pursuant to other affirmative provisions will require such amendments and argues that the filing of accurate call reports is necessary for the FDIC to monitor the bank's condition82 and that requiring Respondent to file amended reports is within Petitioner's mandate to effect future compliance.83 I find Petitioner's arguments to be compelling and shall adopt the provision it requested.
       e. Paragraph Five
   Petitioner requests the adoption of subparagraph 5(a), which prevents the extension of additional credit to borrowers who received prior loans which were charged off, as necessary to prevent further losses to a bank which is in poor financial condition. Respondent replies that such loans may, upon occasion, be of benefit to the bank, citing the * * * loan in support of its position. Given my conclusion that the loan constituted an unsafe or unsound banking practice, I reject Respondent's argument and shall adopt the provision requested by Petitioner.
       f. Paragraphs Seven and Nine
   Respondent objects to these paragraphs to the extent that they require that two-thirds of the Compliance Committee and half the Loan Review Committee be outside directors. While Respondent presently has sufficient outside directors on its board to meet this requirement,84 Petitioner did not provide any evidence that there was a need for the requested relief. As Respondent points out, the requirements of the provision constitute "a radical departure from existing practice in the industry." Absent the need to remedy an unsafe or unsound banking practice or some other articulated and factually supported basis for the relief requested by Petitioner, I shall adopt the modification urged by Respondent.

81 Petitioner's management witness testified that the FDIC did not intend to dictate how loans should be restructured or whether Respondent should foreclose on collateral.

82 See Docket No. FDIC-85-18b, [1986] F.D.I.C. Enf. Dec. (P-H) ¶5066 at 6689-90.

83 See Docket No. FDIC-84-23a, supra.

84 Respondent's President so testified.
{{9-30-91 p.A-1761}}
       g. Paragraph Ten
   Respondent objects that the requirement that it provide "complete and current loan documentation" is unduly vague and asks that the bank simply be required to document loans in accordance with its own loan policy. This objection will be overruled because (1) Respondent's loan policy is uniquely within its own control and any provision based on that policy would therefore be meaningless and (2) the provision sought by Petitioner is not overly vague. See FTC v. Colgate-Palmolive Co., supra. The relief requested by Petitioner will be adopted.
       h. Paragraph Eleven
   Respondent objects to this provision which relates to disclosing the outcome of this proceeding to Respondent's shareholders and requires the bank to submit a disclosure statement to Petitioner and to make "any changes requested by the FDIC" prior to disseminating that statement. Respondent asks that its obligation to makes changes be limited to "material" changes. Petitioner's reply brief is confused,85 and I cannot determine whether Respondent's request is opposed. In any event, no evidentiary or legal argument has been advanced which would require rejection of Respondent's proposed modification. Accordingly, the word "material" will be added to the provision.

FINDINGS OF FACT86

   1. Respondent is, and has been at all times pertinent hereto, a corporation existing and doing business under the laws of Colorado, having its principal place of business in Cortez, Colorado.
   2. Respondent is, and has been at all times pertinent hereto, insured by the FDIC.
   3. Respondent is, and has been at all times pertinent hereto, a state nonmember bank.
   4. Respondent is, and has been at all times pertinent hereto, subject to the provisions of the Act, the Rules and Regulations of the FDIC, 12 C.F.R. Ch. III, and the laws of Colorado.
   5. As of July 7, 1989, Respondent had an inadequate loan loss reserve.
   6. As of July 7, 1989, Respondent had inadequate capital for the kind and quality of assets it held.
   7. As of July 7, 1989, Respondent had an excessive volume of adversely classified assets.
   8. Respondent extended credit to * * * and * * *, * * * and * * * and * * * the * * * and * * * and * * * without the full collection of interest due, where so doing caused abnormal risk, loss or damage.
   9. Respondent extended credit to * * * and * * * without obtaining collateral sufficient to secure the money advanced for the purpose of paying interest.
   10. Respondent failed to enforce repayment understandings with * * * and * * * and with * * * and * * * where so doing caused abnormal risk, loss or damage.
   11. Respondent extended credit to * * * without adequate security or documentation.
   12. APB Opinion No. 21 requires that a bank which sells an asset and finances that sale at a below-market rate must discount the loan and charge off the difference between the rate of interest charged and the market rate.
   13. APB Opinion No. 21 applies to Respondent's sale of the * * *, * * * and * * * properties.
   14. The appropriate market rate for determination of loan discounts on the * * * and * * * properties is 12.75 percent.
   15. The FDIC's $113,000 "loss" classification in connection with the sale of the * * * and * * * properties is supported by the record.
   16. Petitioner incorrectly classified $123,000 of an extension of credit to * * * d/b/a * * * as "loss."
   17. Most of the loans classified by the FDIC were (a) extensions or renewals of seasoned loans which had not been previ-


85 At page 45 of Petitioner's reply brief, there is a topic heading which reads "11. Modifications to proposed securities materials which may be distributed," but the text which follows deals solely with paragraph 1(c) of the affirmative relief proposed by Petitioner.

86 The parties were ordered to file proposed findings of fact and conclusions of law by December 30, 1990. I therefore regard any failure to include a desired finding or conclusion in the December 30 filings as a waiver of any right to later seek its adoption. Findings and conclusions not set forth below or treated in the foregoing discussion are found to be immaterial to the matters properly before me or to be statements of general principle which lack probative value absent any allegation of a specific factual context. Findings and conclusions appearing below but not previously discussed are based on the parties' stipulations or post-hearing pleadings.
{{9-30-91 p.A-1762}}ously criticized and (b) long-term workout arrangements with borrowers who had experienced some degree of financial difficulty.
   18. The FDIC has determined that Colorado is a region where real estate values have suffered a serious decline due to sever adverse economic conditions, and the increase in Respondent's classified loans has been impacted in a significant degree by a downturn in the major local industries.
   19. A large number of formerly classified loans have become Other Real Estate Owned and/or had collateral repossessed, and the FDIC's April 1987 Report of Examination notes that Respondent's management was reluctant to further flood a depressed and already saturated real estate market with additional offerings.
   20. The FDIC's April 1987 Report of Examination (a) concluded that the majority of Respondent's problems with its loan portfolio were due in large part to the depressed local economy, (b) stated that Respondent's management was concerned over the bank's condition, exhibited a cooperative attitude and dealt realistically with problem credits, (c) noted that Respondent had addressed the weakened ability of a substantial number of its borrowers to service their debt through extensions and the capitalization of interest and (d) acknowledged that these accommodations had resulted in the improvement of Respondent's collateral positions and was indicative of its attempts to minimize exposure to loss.
   21. The economy in Respondent's market area continued to decline between 1987 and 1989.
   22. A preponderance of the credible evidence does not establish that Respondent's condition was the result of policies adopted or implemented by Respondent's management.
   23. A preponderance of the credible evidence does not establish that Respondent failed to take any action which would have protected it from the effects of a declining local economy.
   24. A preponderance of the credible evidence does not establish that Respondent's board of directors failed to adequately supervise the bank's other managers.
   25. Respondent's extension of credit without the full collection of interest due was the only unsafe or unsound banking practice which occurred with sufficient frequency to be inferred to be the result of a policy on the part of Respondent's management. A preponderance of the credible evidence does not establish that Respondent's other unsafe or unsound lending and collection practices were the result of policies adopted or implemented by Respondent's management.
   26. A preponderance of the credible evidence does not establish that Respondent engaged in unsafe or unsound banking practices under circumstances where viable, beneficial alternatives existed.
   27. Respondent should maintain a ratio of adjusted primary capital to adjusted Part 325 total assets of 7.5 percent.
   28. Respondent's retained earnings are transferred to its undivided profits account at the end of every year and ultimately become capital.
   29. Respondent's securities are not publicly traded, and a preponderance of the credible evidence does not establish that Respondent is subject to federal or state securities laws.
   30. Respondent has charged off all assets classified "loss" at the 1989 examination.
   31. The remedial provisions requested by Petitioner were not intended to allow it to dictate to Respondent (a) how to restructure its loans or (b) when or whether to foreclose on real estate collateral.

CONCLUSIONS OF LAW

   1. The FDIC has jurisdiction over Respondent and the subject matter of this proceeding.
   2. At all times pertinent to this proceeding, Respondent was an insured state nonmember bank within the meaning of Sections 3(e)(2) and 8(b) of the Act.
   3. The FDIC has authority to issue a cease and desist order against Respondent pursuant to Section 8(b) of the Act.
   4. Petitioner's burden of proof is one of a preponderance of the evidence.
   5. An unsafe or unsound banking practices embraces any action, or lack or action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.
   6. Respondent has engaged in the following unsafe or unsound banking practices
{{9-30-91 p.A-1763}}within the meaning of Section 8(b) of the Act: (a) operating with an inadequate loan loss reserve, (b) operating with inadequate capital for the kind and quality of assets it holds, (c) operating with an excessive level of poor quality assets, (d) extending credit to borrowers without the full collection of interest, where so doing caused abnormal risk, loss or damage, (e) extending credit to a borrower without obtaining collateral sufficient to secure the money advanced for the purpose of paying interest, (f) extending credit to a borrower without adequate security or documentation and (g) failing to enforce repayment understandings, where so doing caused abnormal risk, loss or damage.
   7. A preponderance of the credible evidence does not establish that Respondent otherwise engaged in unsafe or unsound banking practices.
   8. Remedial provisions imposed by the FDIC herein (a) must have some reasonable relation to the unsafe or unsound banking practices found to exist in this proceeding and (b) must be sufficiently clear and precise so as to avoid raising serious questions as to their meaning or application.
   Based on the foregoing findings of fact and conclusions of law, and on the entire record in this proceeding, I hereby issue the following recommended:

ORDER TO CEASE AND DESIST

   IT IS ORDERED that The Citizens State Bank of Cortez ("Bank"), Cortez, Colorado, and institution-affiliated parties of the Bank, cease and desist from the following practices:

       (a) After 120 days from the effective date of this ORDER, operating the Bank without an adequate level of capital protection, unless the Bank has, pursuant to the requirements of this ORDER, adopted and implemented a plan to increase capital protection to an adequate level;
       (b) Failing to provide an adequate reserve for loan losses;
       (c) After 100 days from the effective date of this ORDER, operating the Bank with an excessive level of classified assets, unless the Bank has, pursuant to the requirements of this ORDER, adopted and implemented a plan to reduce classified assets;
       (d) Extending inadequately secured credit to borrowers in weak financial condition under circumstances which would create abnormal risk, loss or damage;
       (e) Renewing or extending the due date of a loan without the collection of interest due under circumstances which would create abnormal risk, loss or damage;
       (f) Extending credit without adequate supporting documentation under circumstances which would create abnormal risk, loss or damage; and
       (g) Engaging in any like or related lending or collection practice under circumstances which would create abnormal risk, loss or damage.
   IT IS FURTHER ORDERED, that the Bank and institution-affiliated parties of the Bank take affirmative action as follows:
    1. (a) Within 90 days after the effective date of this ORDER and for so long thereafter as this ORDER is outstanding, the Bank shall maintain adjusted primary capital equal to or greater than 7.5 percent of the Bank's adjusted total assets. Such increase in primary capital and any increase in primary capital necessary to meet the ratio required by this ORDER may be accomplished by:
         (i) The sale of securities in the form of common stock;
         (ii) The collection in cash of all or any portion of assets charged off as of or prior to July 7, 1989;
         (iii) The direct contribution of cash subsequent to July 7, 1989, by the directors and/or shareholders of the Bank;
         (iv) The crediting of retained earnings; or
         (v) Any other method approved by the Regional Director of the FDIC's Dallas Regional Office ("Regional Director").
       (b) If the ratio of adjusted primary capital to adjusted total assets is less than 7.5 percent as determined at an examination or visitation by the FDIC or the State banking department, the Bank shall, within 30 days after receipt of a written notice of the capital deficiency from the Regional Director, present to the Regional Director a plan to increase the primary capital of the Bank or to take other measures to bring the ratio to 7.5 percent. After the Regional Director responds to the plan, the
    {{9-30-91 p.A-1764}}board of directors of the Bank shall adopt the plan, including any modifications or amendments requested by the Regional Director. Thereafter, the Bank shall immediately initiate measures detailed in the plan, to the extent such measures have not previously been initiated, to increase its primary capital by an amount sufficient to bring the ratio to 7.5 percent within 90 days after the Regional Director responds to the plan.
       (c) If all or part of the increase in primary capital required by this ORDER is accomplished by the sale of new securities, the board of directors of the Bank shall adopt and implement a plan for the sale of such additional securities, including soliciting proxies and the voting of any shares or proxies owned or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Bank's securities (including a distribution limited only to the Bank's existing shareholders), the Bank shall prepare offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Bank and the circumstances giving rise to the offering, and any other material disclosures necessary to comply with Federal securities laws. Prior to the implementation of the plan, and in any event, not less than 20 days prior to the dissemination of such materials, the plan and any materials used in the sale of the securities shall be submitted to the FDIC, Registration and Disclosure Unit, Washington, D.C. 20429, for review.
       (d) In complying with the provisions of this ORDER and until such time as any such public offering is terminated, the Bank shall provide to any subscriber and/ or purchaser of the Bank's securities written notice of any planned or existing development or other change which is materially different from the information reflected in any offering materials used in connection with the sale of the Bank's securities. The written notice required by this paragraph shall be furnished within 10 days after the date such material development or change was planned or occurred, whichever is earlier, and shall be furnished to every purchaser and/or subscribed who received or was tendered the information contained in the Bank's original offering materials.
       (e) For the purposes of this ORDER the terms "primary capital" and "total assets" shall have the meanings ascribed to them in subsections 325.2(h) and (k) of the FDIC's Rules and Regulations, 12 C.F.R. § 325.2(h) and (k). "Adjusted primary capital" and "adjusted total assets" shall be calculated according to the methodology set forth in the Analysis of Capital section in a report of examination or visitation of the FDIC and as a six-month average every June and December.
   2. While this ORDER is in effect, the Bank shall not pay either directly or indirectly any cash dividend to shareholders without giving written notice of the intended dividend the Regional Director no later than 90 days before the date of payment.
    3. (a) Within 60 days after the effective date of this ORDER, the Bank shall submit a written plan to the Regional Director to reduce the remaining assets classified "substandard" as of July 7, 1989 to a minimum, the plan shall include the following:
         (i) A schedule providing quarterly goals to reduce the remaining adversely classified assets as of July 7, 1989 to levels representing not more than a specified percentage of total equity capital and reserves as reported each quarter by the Bank in its Consolidated Reports of Condition and Reports of Income and shall include no less than six consecutive quarterly target dates;
         (ii) An explanation showing the complete rationale used by the Bank in constructing the reduction schedule; and
         (iii) A provision requiring, at a minimum, quarterly reviews by the Bank's board of directors whereby the extent of the Bank's compliance with the plan is expressly addressed with the results of each review to be recorded in the corporate minutes of the board of directors.
       (b) This written plan shall be submitted to the Regional Director for review and comment. The Regional Director shall have 30 days to advise the Bank of any comments and the Bank shall give due consideration to any such comments. The board of directors shall adopt the plan within 10 days of receipt of any comments from the Regional Director, or 10 days after his comment period expires. The Bank shall thereafter immediately ini-
    {{6-30-92 p.A-1765}}tiate measures detailed in this plan to the extent such measures have not previously been initiated.
       (c) For purposes of the plan, the reduction of the level of adversely classified assets as of July 7, 1989, to a specified percentage of total equity capital and reserves may be accomplished by:
         (i) Charge off;
         (ii) Collection;
         (iii) Sufficient improvement in the quality of adversely classified assets so as to warrant removing any adverse classification, as determined by the FDIC; or
         (iv) Increase to total equity capital and reserves.
       (d) While this ORDER is in effect, the Bank shall eliminate from its books, by charge-off or collection, all assets or portions of assets classified "loss" as determined at any examination or visitation conducted by the FDIC or the State at such time as the report of examination or visitation is received by the Bank. In addition, the Bank shall submit amendments to the classified asset reduction plan as requested by the Regional Director to account for assets that might be classified adversely at future examinations or visitations.
    4. (a) Within 10 days after the effective date of this ORDER, the Bank shall establish and thereafter maintain an adequate reserve for loan losses. Such reserve shall be established by charges to current operating income. Prior to the end of each calendar quarter, the board of directors of the Bank shall review the adequacy of the Bank's reserves for loan losses. Such reviews shall include, at a minimum, the Bank's loan loss experience, an estimate of potential loss exposure in the portfolio, trends of delinquent and nonaccrual loans and prevailing and prospective economic conditions. The minutes of the board meetings at which such reviews are undertaken shall include complete details of the reviews and the resulting recommended increases in the reserve for loan losses.
       (b) Within 30 days after the effective date of this ORDER, the Bank shall review Consolidated Reports of Condition and Reports of Income filed with the FDIC on or after June 30, 1989, and amend said reports if necessary to properly reflect the financial condition of the Bank as of the date of each such report. In particular, such reports shall contain an adequate provisions for loan losses. All subsequent Reports of Condition and Reports of Income filed shall also accurately reflect the financial condition of the Bank as of the reporting date.
    5. (a) While this ORDER is in effect, the Bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower who has an extension of credit with the Bank that has been classified "loss," in whole or in part, and is uncollected or to any borrower who is already obligated in any manner to the Bank on any extension of credit, including any portion thereof, that has been charged off the books of the Bank and remains uncollected. The requirements of this paragraph shall not prohibit the Bank from renewing credit already extended to a borrower after full collection, in cash, of interest due from the borrower. The provisions of this subparagraph shall not prevent the Bank from advancing additional funds for its own protection for taxes, insurance or other expenses incidental to the existing indebtedness if the Bank's board of directors has signed a detailed written statement explaining why the failure to do so would be detrimental to the best interests of the Bank. The statement shall be placed in the appropriate loan file and included in the minutes of the applicable board of directors' minutes.
       (b) While this ORDER is in effect, the Bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower whose extension of credit is classified "doubtful" and/or "substandard," in whole or in part, and is uncollected unless the Bank's board of directors has signed a detailed written statement giving reasons why failure to extend such credit would be detrimental to the best interests of the Bank. The statement shall be placed in the appropriate loan file and included in the minutes of the applicable board of directors' meeting.
   6. Within 60 days after the effective date of this ORDER, the board of directors shall establish a committee of the board of direc-
{{6-30-92 p.A-1766}}tors with the responsibility to ensure that the Bank complies with the provisions of this ORDER. The committee shall report monthly to the entire board of directors, and a copy of the report and any discussion relating to the report or the ORDER shall be included in the minutes of the board of directors. Nothing contained herein shall diminish the responsibility of the entire board of directors to ensure compliance with the provision of this ORDER.
   7. Within 90 days after the effective date of this ORDER the board of directors shall establish a loan review committee to periodically review the Bank's loan portfolio and identify and categorize problem credits. The committee shall file a report with the board of directors. Such report shall include the following information:
       (a) The overall quality of the loan portfolio;
       (b) The identification by type and amount of each problem or delinquent loan;
       (c) The identification of all loans not in conformity with the Bank's lending policy; and
       (d) The identification of all loans to officers, directors, principal shareholders or their related interests.
   8. Within 90 days after the effective date of this ORDER, the Bank to the best of its ability using reasonable effort, shall eliminate and/or correct all technical exceptions with regard to loan documentation existing in the Bank as of July 7, 1989, as more fully set out on pages 2-d and 2-d-1 of the July 7, 1989 Report of Examination. In addition, the Bank shall ensure complete and current loan documentation in the future on any new loans or renewals where additional credit is extended.
   9. After the effective date of this ORDER, the Bank shall send to its shareholders or otherwise furnish a description of this ORDER, (1) in conjunction with the Bank's next shareholder communication, and also (2) in conjunction with its notice or proxy statement preceding the Bank's next shareholder meeting. The description shall fully describe the ORDER in all material respects. The description and any accompanying communication, statement, or notice shall be sent to the FDIC, Registration and Disclosure Unit, Washington, D.C. 20429, for review at least 20 days prior to dissemination to shareholders. Any material changes requested to be made by the FDIC shall be made prior to dissemination of the description, communication, notice, or statement.
   10. Within 30 days after the end of the first calendar quarter following the effective date of this ORDER, and within 30 days after the end of each calendar quarter thereafter, the Bank shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. Such reports may be discontinued when the corrections required by this ORDER have been accomplished and the Regional Director has released the Bank in writing from making further reports.
   11. The effective date of this ORDER shall be 30 days after the date of its issuance. This ORDER shall be binding upon the Bank and all institution-affiliated parties of the Bank.
   This ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provision of this ORDER shall have been modified, terminated, suspended, or set aside by the FDIC.
   Done at Rosslyn, Virginia, this 15th day of February, 1991.
   /s/ Steven M. Charno
   Administrative Law Judge

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