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Clovis Community Bank

FEDERAL DEPOSIT INSURANCE CORPORATION

IN RE: Clovis Community Bank Clovis, California

Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Continue to Indirectly Engage as Principal Through a Wholly-Owned Subsidiary in Real Estate Investment Activities That May Not Be Permissible for a Subsidiary of a National Bank

ORDER

The Board of Directors of the Federal Deposit Insurance Corporation ("FDIC") has fully considered all available facts and information relevant to section 24 of the Federal Deposit Insurance Act, 12 U.S.C. 1831a, and Part 362 of the FDIC's Rules and Regulations, relating to an application by Clovis Community Bank, Clovis, California (the "Bank"), for consent to continue to indirectly engage as principal through Clovest Corporation ("Subsidiary"), a wholly-owned subsidiary, in activities that may not be permissible for a subsidiary of a national bank. The Board of Directors, having found that the Bank is in compliance with applicable capital standards, and that the activities, with certain conditions imposed, do not appear to pose a significant risk to the deposit insurance fund, has concluded the application should be approved subject to certain conditions.

Accordingly, it is hereby ORDERED, for the reasons set forth in the attached Statement, that the application submitted by the Bank for consent to continue to indirectly engage as principal through its wholly-owned Subsidiary in Real Estate Investment activities that may not be permissible for a subsidiary of a national bank be and the same hereby is approved, subject to the following conditions:

1. Within ninety (90) days from the date of receipt of this Order, the Bank shall submit a plan to the FDIC to reduce the level of Real Estate Investment, as defined below, to not more than 30 percent of Tier 1 capital of the Bank, within five (5) years from the date of this Order.

2. The Bank's real estate activities shall be limited to the types of activities described in the Bank's application, and any new type of Real Estate Investment activity planned to be conducted by the Subsidiary must first be approved under the application procedures of Part 362. The real estate activities described in the application as being conducted by the Bank through its Subsidiary are as follows: land acquisition, site development, and the construction of residential homes, and developing and holding a senior citizen apartment complex, all in the Bank's trade area.

3. Within five (5) years from the date of this Order, notwithstanding Parts 325 and 327 of the FDIC's Rules and Regulations, 12 C.F.R. Parts 325 and 327, the Bank's capital category for purposes of Prompt Corrective Action and the Bank's risk-adjusted deposit insurance premium shall be calculated based on the Bank's capital after deducting all Real Estate Investments, except that such deductions shall not be made when determining whether the Bank is "critically undercapitalized" as defined under Part 325.

4. The Bank's capital level, after deducting all Real Estate Investments in the Subsidiary, shall equal or exceed the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations.

5. The Bank shall, on a quarterly basis, perform the capital adequacy calculations described above for the purpose of ascertaining its capital level, and that, in the event the Bank falls below the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations, the Bank shall notify the FDIC within 15 days and submit to the FDIC an acceptable plan for restoring capital to a level required for a "well capitalized" institution.

6. The Bank shall provide a progress report to the Regional Director of the FDIC's Division of Supervision on an annual basis that indicates the extent of the Bank's efforts to reduce its real estate investment activities to comply with the 30 percent approval limitation.

7. Once the Bank's level of Real Estate Investment Activity has been reduced to 30 percent, or below, of its Tier 1 capital, the Bank shall commence providing an investment plan to the FDIC's Regional Director of the Division of Supervision on an annual basis that indicates the extent of the Bank's planned investment in the Subsidiary and the manner in which concentration and diversification of risk issues within the Subsidiary will be addressed. If the Regional Director has not objected to the plan within 45 days, the Bank may proceed within the parameters of paragraphs (1), (2), (3) and (4) above.

8. The Bank and the Subsidiary shall take the necessary actions to operate the Subsidiary in a manner so as to ensure a separate corporate existence as a wholly-owned subsidiary which:

(a) is adequately capitalized,

(b) is physically separate and distinct in its operations from the operations of the Bank,

(c) maintains separate accounting and other corporate records,

(d) observes separate formalities such as separate board of directors' meetings,

(e) maintains a board of directors with one or more independent, knowledgeable outside directors and management expertise capable of conducting activities in a safe and sound manner,

(f) contracts with the Bank for any service on terms and conditions-comparable to those available to or from independent entities, and

(g) conducts business pursuant to separate policies and procedures designed to inform customers and prospective customers of the Subsidiary that the Subsidiary is a separate organization from the Bank, including the placement of specific language on any debt instrument or contract with a third party disclosing that the Bank itself is not responsible for payment or performance.

9. The Bank shall not engage directly, or indirectly through its Subsidiary, in any Real Estate Investment with insiders or their related interests without the prior written consent of the Regional Director of the FDIC's Division of Supervision.

10. The Bank shall not:

(a) condition any loan on the purchase or rental of real estate from the Subsidiary, or

(b) extend credit to any borrower to acquire real estate from the Subsidiary unless it is consistent with safe and sound banking practices and does not involve more than the normal degree of risk of repayment, and the credit is extended on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to the Bank, as those prevailing at the time for other comparable transactions.

11. Before the consummation of a transaction between the Subsidiary and any of the Bank's customers, any potential conflicts of interest shall be identified, appropriately resolved, and clearly disclosed to the board of directors and documented in the board's minutes.

12. Transactions relating to the Bank's indirect real estate activities shall comport with the restrictions of sections 23A and 23B of the Federal Reserve Act, 12 U.S.C. 371c and 371c-1, to the same extent as though the Subsidiary was an affiliate of the Bank as defined under sections 23A and 23B, except that the Bank's total investment in real estate shall not be subject to the 10 percent limit on covered transactions with one affiliate. In addition, End Loans, defined below, shall not:

(a) be subject to the 130 percent collateral margin requirement of section 23A, or

(b) be subject to the 10 percent or 20 percent aggregate limits on covered transactions in section 23A.

13. The consent granted herein is based on the facts and circumstances presented or otherwise known to the FDIC in connection with this application. The Bank shall notify the FDIC of any significant change in facts or circumstances. If the facts and circumstances change significantly, the FDIC shall have the right to alter, suspend, or withdraw its approval.

Definitions. Except as otherwise set forth in the Order, capitalized terms used herein shall have the meaning set forth below:

(a) "Real Estate Investment" means the Bank's investment in the Subsidiary, including, equity interests in the Subsidiary, debt obligations of the Subsidiary held by the Bank, Bank guarantees of debt obligations issued by the Subsidiary and held by others, extensions of credit or commitments of credit from the Bank to the Subsidiary, and any extension of credit to any third parties for the purpose of making a direct investment in the Subsidiary or an investment in any real estate asset in which the Subsidiary has an interest. However, Real Estate Investment shall not include End Loans.

(b) "End Loan" means any loan made by the Bank to a third party for the purpose of financing the bona fide sale of a Subsidiary asset and which meets the requirements of paragraph 10(b) of this Order.

(c) "New Real Estate" Investment Activity means any Real Estate Investment activity other than that conducted by the Barik and the Subsidiary, as described in the application dated February 4, 1994.

Dated at Washington, D. C., this 23rd day of January, 1996.

BY ORDER OF THE BOARD OF DIRECTORS


FEDERAL DEPOSIT INSURANCE CORPORATION

IN RE: Clovis Community Bank Clovis, California

Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Continue to Engage as Principal Through a Wholly-Owned Subsidiary in Real Estate Investment Activities That May Not Be Permissible for a Subsidiary of a National Bank

STATEMENT

Pursuant to the provisions of section 24 of the Federal Deposit Insurance ("FDI") Act, Clovis Community Bank, Clovis, California (the "Bank"), has filed an application with the Federal Deposit Insurance Corporation ("FDIC"). The applicant requests the FDIC's consent to continue to engage as principal indirectly in real estate investment activities through Clovest Corporation (the "Subsidiary" or "Clovest"), a wholly-owned subsidiary of the Bank which owns and develops real estate properties held for investment purposes.

The activity of holding real estate investment properties may not be a permissible activity for a national bank or a subsidiary of a national bank. State-chartered FDIC-insured banks may not engage as principal in an activity prohibited to nationally-chartered banks unless they obtain consent from the FDIC. Consent may not be granted unless the bank is in compliance with applicable capital standards and the FDIC determines that the activity poses no significant risk to the deposit insurance fund. California State law permits the holding of real estate investment properties by commercial banks and their subsidiaries.

Since 1987, the Subsidiary has purchased raw land for the purpose of the development of low-to-moderate income single family homes and senior citizen housing in its immediate market area. The Bank intends to continue real estate investment activities related to residential real estate development when both the community and the Bank benefit from the transaction and the acquisition is within the parameters of internal policies and State law.

In determining if a significant risk to the deposit insurance fund exists in the proposal, the Board of Directors of the FDIC (the "Board") considered the risk associated with real estate investment activities.

Investments in real estate, at any stage of the development process or even completed properties, can be generally characterized as quite risky in that there is a high degree of variability or uncertainty of returns on invested funds. The cyclical downturn in the real estate-market in the late 1980's and early 1990's, and the impact of that-downturn on financial institutions, provide an illustration of the market risk presented by real estate investment. In addition to the high degree of variability, real estate investments possess many risks that, while not entirely unique, are not readily comparable to typical equity investments (e.g., common stock). Real estate markets are for the most part localized, investments are normally not securitized, financial information flow is often poor, and the market is generally not very liquid.

Real estate investment risk is higher than for most traditional bank assets, such as loans or debt securities. Real estate investment can increase interest rate risk, optimum investment periods are typically long-term, real estate is relatively lacking in liquidity, and real estate is subject to specialized risks such as environmental liability. In addition, real estate investment is of questionable benefit in the diversification of a financial institution's portfolio of assets. The experience and expertise of management is a critical factor, and there is much anecdotal evidence to suggest that the lack of adequate management creates a significant level of risk of loss.

Due to the risks outlined above, real estate investment activities appear suitable to a financial institution only on a very limited scale and under restrictive conditions designed to control the various risks posed to the financial institution and the deposit insurance fund.

In addition to the general risks associated with real estate investment activities, the Board also considered the specifics of the Bank's application in determining if a significant risk to the deposit insurance fund exists.

In evaluating this application, the Board reviewed the following: (1) the type and level of the Bank's current and proposed real estate investment to determine if the type of activity and level of investment were suitable for an insured depository institution; (2) the financial and managerial resources and future earnings prospects of the Bank to determine its ability to support real estate investment activities; (3) capital adequacy (as assessed using the Bank's "consolidated" and "bank only" leverage and risk-based capital ratios, with all investments in the Subsidiary excluded from capital in the "bank only" capital calculation) to determine the impact to capital in the event that the entire real estate investment was lost; (4) the Subsidiary structure and its management policies and practices to determine if the Bank is adequately protected from litigation risk; (5) the Bank's policies relating to extensions of credit to third parties for Subsidiary related transactions to determine if they protect the Bank from concentrations of risk; (6) the Bank's policies on engaging in transactions in which insiders are involved to determine if they protect the bank from potential insider abuse; (7) the Bank's policies relating to the conditioning of loans on the purchase of real estate from the Subsidiary and the extending of credit by the Bank to third parties for the purpose of acquiring real estate from the Subsidiary to determine if they prevent undesirable tying relationships and to determine if they are adequate to ensure that sound credit underwriting is maintained; and (8) the provisions of sections 23A and 23B of the Federal Reserve Act to determine the appropriateness of applying these restrictions to the real estate investment activities. The Board also considered the parameters under which savings associations may engage in real estate investment activities.

As of September 30, 1995, the Bank's investment in the Subsidiary represented approximately 70.44 percent of the Bank's Tier 1 capital and 8.22 percent of the Bank's total assets. The Bank states in its application that its investment in the Subsidiary will be limited to 80 percent of its equity capital. Additionally, the Bank indicates that they will continue to only invest in residential real estate.

Generally, due to the risks associated with real estate investment activities, it is prudent to limit a bank's overall investment in real estate to a level which does not present concentration and/or diversification risks. In approving prior section 24 applications involving real estate investments the Board has imposed conditions designed to achieve that goal as well as to mitigate potential insider conflicts of interest and other risks. Among the conditions has been a requirement that a bank's investment in real estate subsidiaries be limited to no more than 10 percent of Tier 1 capital for any one subsidiary and no more than 20 percent of Tier 1 capital in the aggregate for all real estate investment in subsidiaries. The Board notes that while the 70 percent of Tier 1 capital level of real estate investment by the Bank is permissible under California law, it is well above that permitted by the FDIC in the case of prior applications. Having considered the facts of this case, however, the Board has determined that higher investment limits are warranted in this case and that such higher limits do not present a risk to the deposit insurance fund.

There are several reasons why the Board believes a higher real estate investment limit is appropriate in this case. First and foremost, Clovest has proven its ability to operate profitably over a long period of time (1987 to present). Clovest has contributed 20-23 percent of the Bank's pre-tax earnings over each of the past three years. In addition to being consistently profitable, several of Clovest's real estate development practices appear to minimize risk. Clovest undertakes detailed market feasibility studies before starting a real estate development. Additionally, all homes built, with the exception of model homes, are pre-sold before a construction loan is granted. The Bank's history with pre-sold activity since 1987 has been a default rate of less than 1 percent.

While the FDIC's prior orders have limited real estate investment to no more than _10 percent of Tier 1 capital in any one subsidiary, in this instance there is adequate justification for permitting the bank's entire investment to be in only one subsidiary. Risk can be minimized by either diversifying the types of real estate development engaged in (e.g., commercial, residential single family, residential multifamily, mixed use, etc.) or by developing real estate in different geographic areas. Clovest is developing two residential single family home developments for low-to-moderate income individuals, while the third project is building two senior citizens multifamily housing facilities. While Clovest's real estate developments are admittedly not geographically diversified, the developments target distinctly different parts of the residential real estate market: low-to-moderate income housing versus senior citizens housing. This diversification helps to minimize Clovest's exposure to a downturn in the residential real estate market as projects for different segments of the residential market are being developed. The Bank's current Tier 1 capital ratio supports a higher percentage of real estate investment to capital than in the case of some of the other applications on which the FDIC has acted. The Bank's current Tier 1 capital ratio is 12.16 percent, which is twice the amount required under federal regulations. The Bank's Tier 1 capital ratio falls below the "well capitalized" level to 3.56 percent, however, after deducting all of the Bank's current real estate investments. On the other hand, the Division of Supervision has calculated that if the Bank's real estate investments were limited to 30 percent of Tier 1 capital that its Tier 1 ratio would only drop to 8.81 percent, which is still well above the "well capitalized" level . The Board notes that Tier 1 capital for the Bank's peer group is 8.57 percent. Thus, even after deducting out the entire real estate investment the Bank will still be "well capitalized" and have Tier 1 capital comparable to its peer group.

Before permitting the Bank to engage in additional real estate investment activities, the FDIC shall require that the Bank's investment not represent more than 30 percent of Tier 1 capital. In order to ensure the Bank's capital is sufficient to support both traditional banking activities and real estate investment activities, the Board will also require that the Bank's capital, after deducting the Bank's investment in the Subsidiary, equal or exceed the level required for a "well capitalized" institution pursuant to Part 325.103(b)(1) of the FDIC's Rules and Regulations.

In order to monitor ongoing real estate investment activities (current and planned investments up to the 30 percent level) and to provide the FDIC with an opportunity to object to any planned investment which appears to contain excessive risk, the Board will require that the Bank submit an investment plan to the Regional Director of the FDIC's Division of Supervision annually.

In order to promote the concept that real estate investment activities should be conducted in a separately and adequately capitalized subsidiary and to ensure that the appropriate insurance fund is adequately compensated for, and sufficiently protected from, additional risk in the event that "bank only" capital levels fall below "well capitalized" levels, the Bank's capital category for purposes of Prompt Corrective Action will be determined, and the Bank's risk-adjusted deposit insurance premium will be assessed, based on "bank only" capital ratios. The deduction of these real estate investments, however, will not be used to determine whether the Bank is "critically undercapitalized" as defined under Part 325 of the FDIC's Rules and Regulations. However, because the Bank was unaware of this requirement at the time it made its investment decisions, the Board feels it would be unfair to impose this condition until expiration of the recommended five-year time frame to reduce the level of its real estate investment activities to no more than 30 percent of Tier 1 capital.

In order to protect the corporate veil between the Subsidiary and the parent, thus mitigating litigation risks, the Board will require that the Bank and the Subsidiary take the necessary actions to establish and the Subsidiary operate in a manner so as to ensure a separate corporate existence as a wholly-owned subsidiary which: is adequately capitalized; is physically separate and distinct in its operations from the operations of the Bank; maintains separate accounting and other corporate records; observes separate formalities such as separate board of directors' meetings; maintains a board of directors with one or more independent, knowledgeable outside directors and management expertise capable of conducting activities in a safe and sound manner; contracts with the Bank for any service on terms and conditions comparable to those available to or from independent entities; and conducts business pursuant to separate policies and procedures designed to inform customers and prospective customers of the Subsidiary that the Subsidiary is a separate organization from the Bank, including the placement of specific language on any debt instrument or contract with a third party disclosing that the Bank itself is not responsible for payment or performance.

In order to safeguard against conflicts of interest that may prejudice the interest of depositors or harm minority shareholders of the Bank, the Board will require that the Bank not engage, directly or indirectly through any subsidiary, in any real estate investment related activity or other transaction with insiders or their related interests, without the prior written consent of the Regional Director of the FDIC's Division of Supervision.

In order to maintain safe and sound underwriting standards and to reduce or preclude the potential for breaches of fiduciary duty, and thus protect the Bank and the deposit insurance fund on an on-going basis, the Board will require that: (a) the Bank not condition any loan on the purchase or rental of real estate from any subsidiary engaged in real estate investment activities, and (b) the Bank not extend credit to any borrower to acquire real estate from any subsidiary engaged in real estate investment activities unless it is consistent with safe and sound banking practices, does not involve more than the normal degree of risk of repayment and is made on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the Bank, as those prevailing at the time for comparable transactions.

The Board will require that any potential conflict of interest relating to real estate investment activities be identified, appropriately resolved if possible, and approved by the Bank's board of directors before consummation of any transaction.

To prevent objectionable transactions pertaining to these activities and to ensure that all transactions are conducted in a safe and sound manner, the Board will require that transactions relating to the real estate investment activities comport with the restrictions of sections 23A and 23B of the Federal Reserve Act to the same extent as though the Subsidiary was an affiliate of the Bank as defined under sections 23A and 23B, with the exception that (1) the 10 percent limitation on covered transactions with one affiliate shall not apply, and (2) the collateral requirements and investment limitations of section 23A shall not apply to loans made by the Bank to third parties to finance bona fide purchases of real estate from the Subsidiary provided such loans are consistent with safe and sound banking practices and do not involve more than the normal degree of risk of repayment and the loans are extended on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to the Bank, as those prevailing at the time for other comparable transactions. Any such loans made by the Bank will be reviewed by examiners at each regular safety and soundness examination conducted by the FDIC.

For the reasons outlined above, the Board has concluded that the proposed retention of interest in real estate investment activities does not pose a significant risk to the deposit insurance fund, provided certain conditions are observed, and therefore approval of the application, subject to conditions in the Order, is warranted.

THE BOARD OF DIRECTORS
FEDERAL DEPOSIT INSURANCE CORPORATION



Last Updated 03/24/2011 Legal@fdic.gov