Federal Deposit
Insurance Corporation

   Bank and an institution-affiliated party to cease and desist from operating with an excessive volume of adversely classified asset; engaging in hazardous lending and lax collection policies; operating with inadequate capital; engaging in violations of laws and regulations; operating with management whose policies and practices are detrimental to the bank; operating with deficient loan documentation; engaging in practices which produce inadequate income and excessive losses; failing to provide adequate supervision; and operating with inadequate allowance for loan and lease losses. (This order was terminated as to the bank only, by order of the FDIC dated 10-5-92; see ¶ 15,532.)

   [.1] Management—Qualifications—Review
   [.2] Management—Management Plan—Review
   [.3] Board of Directors—Election—Independent Directors
   [.4] Board of Directors—Meetings—Frequency—Written Record Required
   [.5] Assets—Adversely Classified—Reduce/Eliminate
   [.6] Capital—Equity Capital—Increase/Maintain
   [.7] Allowance for Loan and Lease Losses—Adequacy—Maintain
   [.8] Loans—Risk Position—Reduce—Written Plan Required
   [.9] Loans—Extensions of Credit—Existing Borrowers—Curtail
   [.10] Loans—Accrual of Interest
   [.11] Loan Policy—Written Policy—Minimum Requirements—Review
   [.12] Profit Plan—Written Plan—Minimum Requirements—Review
   [.13] Funds Management—Written Plan—Minimum Requirements— Review
   [.14] Dividends—Restricted
   [.15] Violations of Law—Eliminate/Correct
   [.16] Audit—Specific Transactions—Review
   [.17] Institution-Affiliated Party—Transactions—Restitution Required
   [.18] Institution-Affiliated Party—Transactions—Written Policy Required
   [.19] Institution-Affiliated Party—Transactions Restricted
   [.20] Compliance—Progress Reports—Frequency
   [.21] Shareholders—Disclosure—Cease and Desist Order

In the Matter of
PAUL C. HUFNAGLE, individually,
and as an Institution-Affiliated Party of
FRANKLIN STATE BANK,
FRANKLIN, MINNESOTA
and
FRANKLIN STATE BANK
FRANKLIN, MINNESOTA
(Insured State Nonmember Bank)
ORDER TO CEASE AND DESIST

   Franklin State Bank, Franklin, Minnesota ("Bank" and Paul C. Hufnagle ("Individual Respondent"), individually, and as an institution-affiliated party in his capacity as a director, officer, and person participating in the conduct of the affairs of the Bank, having been advised of their right to a Notice of Charges and of Hearing detailing the unsafe or unsound banking practices and violations of law and/or regulations alleged to have been committed by the bank and Individual Respondent and of their right to a hearing on such alleged charges under section 8(b) of the Federal Deposit Insurance Act, 12 U.S.C. § 1818(b), and having waived those rights, entered into a STIPULATION AND CONSENT TO THE ISSUANCE OF AN ORDER TO CEASE AND DESIST ("CONSENT AGREEMENT") with counsel for the Federal Deposit Insurance Corporation ("FDIC"), dated December 26, 1990, whereby solely for the purpose of this proceeding and without admitting or denying {{12-31-92 p.C-730}}any unsafe or unsound banking practices or violations of law and/or regulations, the Bank and Individual Respondent consented to the issuance of an ORDER TO CEASE AND DESIST ("ORDER") by the FDIC.
   The FDIC considered the matter and determined that it had reason to believe that the Bank and Individual respondent had engaged in unsafe or unsound banking practices and had violated laws and/or regulations. The FDIC, therefore, accepted the CONSENT AGREEMENT and issued the following:

   IT IS HEREBY ORDERED, that the Individual Respondent, the Bank, its institution-affiliated parties, as that term is defined in Section 3(u) of the Act, 12 U.S.C. § 1813(u), and its successors and assigns cease and desist from the following unsafe and unsound banking practices and violations of law and/or regulations:
   A. operating with an excessive volume of adversely classified assets;
   B. engaging in hazardous lending and lax collection practices;
   C. operating with inadequate equity capital and allowance for loan and lease losses for the kind and quality of assets held;
   D. engaging in violations of applicable laws and regulations, including especially violations of Section 23A of the Federal Reserve Act, 12 U.S.C. § 371, and/or Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. Part 215;
   E. operating with management whose policies and practices are detrimental to the Bank or engaging in management policies and practices which are detrimental to the Bank;
   F. operating with deficient or inadequate loan documentation, including but not limited to current financial statements, insurance coverage, title searches or legal opinions, evidence of collateral perfection, and cash flow and/or operating information;
   G. engaging in practices which produce inadequate operating income and excessive loan losses;
   H. failing to provide adequate supervision and direction over the affairs of the Bank to prevent unsafe or unsound practices and violations of law and/or regulations; and
   I. operating with an inadequate allowance for loan and lease losses for the volume, kind and quality of loans held.
   IT IS FURTHER ORDERED, that the Individual Respondent, the Bank, its institution-affiliated parties, and its successors and assigns, take affirmative action as follows:

   [.1] 1. (a) (i) No more than 120 days from the effective date of this ORDER, the Bank shall have and thereafter retain qualified management. Such management shall include a qualified senior lending officer who shall be given stated written authority by the Bank's board of directors, including responsibility for implementing and maintaining the lending policies of the Bank. The senior lending officer shall have an appropriate level of lending, collections, and loan supervision experience to perform the duties assigned to that individual by the Bank's board of directors. The Bank shall promptly notify the Regional Director of the FDIC's Kansas City regional Office ("Regional Director") of the identity of said senior lending officer. Prior to the addition of any individual to the board of directors or the employment of any individual as a senior executive officer, the Bank shall comply with the requirements of section 32 of the act, 12 U.S.C. § 1831(i); and section 303.14 of the FDIC's Rules and Regulations, 54 Fed. Reg. 53040 and 53043 (to be codified at 12 C.F.R. § 303.14).
   (ii) The assessment of whether the Bank has "qualified management" shall be based upon management's conduct, both individual and joint, with respect to the Bank in: (A) complying with the requirements of this ORDER; (B) complying with applicable laws and regulations; and (C) not engaging in any unsafe or unsound banking practice which has an adverse effect on the bank's asset quality, capital adequacy, earnings, or liquidity.

   [.2] (b) The board of directors shall in no more than 90 days from the effective date of this ORDER develop a written analysis and assessment of the Bank's management and staffing needs ("management plan"), which shall include, at a minimum:

   (i) identification of both the type and number of officer positions needed to manage and supervise properly the affairs of the Bank;
   (ii) identification and establishment of such Bank committees as are needed {{3-31-91 p.C-731}}to provide guidance and oversight to active management;
   (iii) evaluation of each Bank officer, and in particular the senior lending officer, and staff member to determine whether these individuals possess the ability, experience and other qualifications required to perform present and anticipated duties, including adherence to the Bank's established policies and practices, and maintenance of the Bank in a safe and sound condition; and
   (iv) a plan of action to recruit and hire any additional or replacement personnel with the requisite ability, experience and other qualifications, which the board of directors determines are necessary to fill Bank officer or staff member positions consistent with the board's analysis, evaluation and assessment as provided in paragraphs 1(b)(i) and 1(b)(iii) of this ORDER.

   [.3] (e) (i) Within 90 days from the effective date of this ORDER, the board of directors shall prepare a list of potential candidates for the board of directors for consideration by the shareholders of the Bank. The list of candidates shall include individuals who are independent with respect to the Bank, in such number that, if elected, would cause a majority of the board of directors to be independent with respect to the Bank. The actions taken in identifying potential candidates, including any communication with such individuals, shall be documented and made a part of the minutes of the board of directors. Copies of these board minutes shall be provided to the Regional Director within 120 days from the effective date of this ORDER.
   (ii) At the next meeting of the shareholders of the Bank, and at each succeeding meeting of the shareholders at which Bank directors are to be elected, the members of the board of directors who are also shareholders shall nominate and support the election of candidates to the board of directors who are independent with respect to the Bank and who have agreed to stand for election to the board of directors, in such number as are necessary to cause a majority of the board of directors to be and to remain independent with respect to the Bank.
   (iii) For purposes of this ORDER, an individual who is "independent with respect to the Bank" shall be any individual (A) who is not an officer of the Bank, any subsidiary of the Bank, or any of its affiliated organizations and who does not own more than 5 percent of the outstanding shares of the Bank or any of its affiliated organizations, (B) who is not related by blood, marriage or common financial interest to an officer of the Bank, any subsidiary of the Bank, or any of its affiliated organizations or to any stockholder owning more than 5 percent of the outstanding shares of the Bank, any subsidiary of the bank, or any of its affiliated organizations, and (C) who is not indebted to the bank, directly or indirectly (including the indebtedness of any entity in which the individual has a substantial financial interest), in an amount exceeding 5 percent of the Bank's total equity capital and allowance for loan and lease losses.

   [.4] (f) Effective the date of this ORDER, the bank's board of directors shall follow a detailed written agenda at each meeting, which shall include consideration of actions of any committees. Nothing in the foregoing sentence shall pre- {{3-31-91 p.C-732}}clude the board from considering matters other than those contained in the agenda. Detailed written minutes of all board meetings shall be maintained and recorded on a timely basis.

   [.5] 2. No more than 10 days from the effective date of this ORDER, the bank shall eliminate from its books, by charge-off, collection, or other proper entries, all assets or portions of assets classified "Loss" as of November 17, 1989, which have not been previously collected, charged off, or otherwise eliminated by other proper entries. Reduction of these assets through use of proceeds of loans made by the bank does not constitute collection for the purpose of this paragraph.

   [.6] 3. (a) (i) During the period this ORDER is in effect, the Bank shall have total equity capital, exclusive of the allowance for loan and lease losses required to be maintained in accordance with paragraph 4(a) of this ORDER, at or in excess of 6 percent of the Bank's total assets ("equity capital ratio") and shall thereafter maintain its equity capital ratio at or in excess of such level as calculated herein while this ORDER is in effect. The terms "total equity capital" and "total assets" shall have the same meaning as those terms have in the prevailing Instructions for Preparation of Reports of Condition and Income ("Instructions").
   (ii) The equity capital ratio shall be calculated as of Report Date, as that term is used in the Instructions. For the purpose of calculating the equity capital ratio as of a given Report Date:
   (A) total equity capital shall be the amount of total equity capital required to be included in the bank's Report of Condition for the Report Date;
   (B) total assets shall be the average of total assets required to be included in the Bank's Report of Condition for the Report Date and is found in the Call Report Schedule of quarterly averages;
   (C) total equity capital and total assets reported in the bank's Report of Condition are to be calculated in accordance with the prevailing Instructions; and
   (D) the Bank shall have an adequate allowance for loan and lease losses in accordance with paragraph 4(a) of this ORDER.
   (b) If, during the period this ORDER is in effect, the equity capital ratio, exclusive of the allowance for loan and lease losses, declines below 6 percent, the Bank, within 30 days after the date on which the said ratio so declined, shall develop and implement a written plan to increase such ratio up to or in excess of 6 percent. No more than 60 days after the implementation of the written plan, the Bank's equity capital ratio, exclusive of the allowance for loan lease losses, shall equal or exceed 6 percent and the Bank shall thereafter maintain its equity capital ratio at or in excess of such level as calculated herein while this ORDER is in effect.
   (c) The Bank's board of directors shall maintain in its minutes a written record of all actions taken by the Bank to comply with the capital requirements of paragraphs 3(a) and 3(b) of this ORDER.

   [.7] 4. (a) The bank shall maintain an allowance for loan and lease losses in accordance with the prevailing requirements of the Instructions.
   (b) Reports of Condition and Income required to be submitted by the Bank as of each Report date, as that term is used in the Instructions, between and including November 17, 1989, and the effective date of this ORDER, shall at a minimum, reflect an allowance for loan and lease losses that should have been maintained in accordance with the Instructions. If necessary to comply with this paragraph, the Bank shall file amended Reports of Condition and Income within 10 days from the effective date of this ORDER.
   (c) Prior to the submission of any Report of Condition or Report of Income required to be filed by the Bank after the effective date of this ORDER, the board of directors of the Bank shall: (i) review the adequacy of the Bank's allowance for loan and lease losses, (ii) provide for an adequate allowance, and (iii) accurately report the allowance in any such Report of Condition and Income. The minutes of the board meeting at which such review is undertaken shall indicate the results of the review, including any increases in the allowance, and the basis for determining the amount of allowance provided.

   [.8] 5. (a) Within 30 days from the effective date of this ORDER, the board of directors shall develop a written plan of action to lessen the Bank's risk position in {{3-31-91 p.C-733}} each line of credit aggregating $15,000 or more which was classified "Substandard" as of November 17, 1989. In developing such plan, the Bank shall, at a minimum:

   (i) review the financial position of each such borrower, including source of repayment, repayment ability, and alternative repayment sources; and
   (ii) evaluate the available collateral for each such credit, including possible actions to improve the Bank's collateral position.

   [.9] 6. Effective the date of this ORDER, the Bank shall not extend, directly or indirectly, credit to, or for the benefit of, any borrower who has a loan or other extension of credit with the Bank that has been charged off or classified, in whole or in part, "Loss," "Doubtful," or "Substandard," and is uncollected, unless a majority of the Bank's board of directors first (a) determines that such advance is in the best interest of the Bank, (b) determines that the Bank has satisfied the requirements set out in paragraph 5 of this ORDER as to such borrower, and (c) approves such advance. A written record of the Board of directors' determination and approval of any advance under the terms of this paragraph shall be maintained in the credit file of the affected borrower(s) as well as the minutes of the board of directors. The requirements of this paragraph do not prohibit the Bank from renewing any credit already extended to the borrower.

   [.10] 7. Effective the date of this Order, the bank shall not accrue interest on any loan that is, or becomes, 90 days or more delinquent as to principal or interest, unless the loan is both well secured and in the process of collection; "well secured" and "in the process of collection" shall have the same meaning as those terms have in the prevailing Instructions for the Reports of Condition and Income. The Bank shall reverse on its books all previously accrued but uncollected interest on any loan that has ceased to accrue interest pursuant to this provision.

   [.11] 8. (a) No more than 30 days from the effective date of this ORDER, the Bank shall revise its written loan policy to include, at a minimum, detailed criteria for the issuance of credit cards, and for the role and the responsibility of the board of directors in the bank's credit card activities.
   (b) The revised written loan policies and any subsequent modification thereto shall be submitted to the Regional Director for review and comment. No more than 30 days after the receipt of any comment from the Regional Director, the board of directors shall approve the written loan policies and/or any subsequent modification thereto, which approval shall be recorded in the minutes of the board of directors. Thereafter, the Bank and its institution-affiliated parties shall follow the written loan policies and/or any subsequent modification thereto.

   [.12] 9. (a) No more than 30 days from the effective date of this ORDER, the Bank shall develop a written profit plan consisting of goals and strategies for improving the earnings of the Bank, which written profit plan shall include, at a minimum:

   (i) identification of the major areas in, and means by, which the board of directors will seek to improve the Bank's operating performance;
   (ii) realistic and comprehensive budgets;
   (iii) a budget review process to mon- {{3-31-91 p.C-734}}itor the income and expenses of the bank to compare actual figures with budgetary projections; and
   (iv) a description of the operating assumptions that form the basis for, and adequately support, major projected income and expense components.

   [.13] 10. (a) No more than 30 days from the effective date of this ORDER, the bank shall develop a written funds management policy which shall, at a minimum:

   (i) establish adequate recordkeeping systems to track the volume of (A) rate-sensitive assets and (B) rate-sensitive liabilities. Rate-sensitive assets and liabilities are generally defined as those that either mature or can be repriced during a specified time period (90 days, 180 days, 1 year, etc.);
   (ii) establish a range of acceptable ratios for rate-sensitive assets to rate-sensitive liabilities sufficient to protect the bank against excessive interest-rate risk and ensure that an adequate net interest margin is maintained;
   (iii) establish adequate recordkeeping systems to track the volume of (A) stable or core deposits and (B) volatile deposits;
   (iv) establish guidelines for offsetting a substantial portion of the bank's volatile deposits and borrowings with liquid, short-term assets;
   (v) establish investment guidelines for funds derived from negotiable-rate certificates of deposit and borrowings, including a maximum large liability dependency ratio. A large liability dependency ratio means the percentage of loans plus other long-term earning assets that may be funded by negotiable-rate certificates of deposit and borrowings;
   (vi) establish a range of acceptable loan-to-deposit ratios, taking into account seasonal deposit fluctuations;
   (vii) establish a borrowing policy which addresses: (A) when or under what conditions the bank may borrow, (B) maximum amounts that may be borrowed, (C) a list of acceptable creditors, and (D) which officers are authorized to borrow;
   (viii) establish contingency plans for meeting large, unexpected withdrawals, which should include: (A) curtailing lending activity with priority given to specific types of credit and (B) attempting to establish lines of credit with other financial institutions which will advance funds on short notice; and
   (ix) establish a funds-management committee to meet at least monthly to determine how best to allocate the bank's available funding sources among various asset categories after reviewing: (A) the bank's liquidity position, (B) outstanding commitments such as loan commitments and letters of credit, and (C) the bank's rate-sensitivity position and net interest margin.

   [.14] 11. The Bank shall not declare or pay any cash dividends unless:

   (a) such declarations and payments are made in accordance with applicable State and Federal laws and regulations;
   (b) after payment of such dividends, the equity capital ratio specified in paragraph 3(a) (i) shall not be less than 6 percent and the bank's allowance for loan

{{3-31-91 p.C-735}}and lease losses shall be adequate as described in paragraph 4 of this ORDER;
   (c) such declaration and payment of dividends shall be approved in advance by the board of directors of the Bank; and
   (d) such declaration and payment of dividends shall be approved in advance, in writing, by the Regional Director, which approval shall not be unreasonably withheld.

   [.15] 13. No more than 30 days from the effective date of this ORDER, the Bank shall eliminate and/or correct all violations of law and regulations allegedly committed by the bank as described on pages 6-1 through 6-1-g of the FDIC's Report of Examination of the Bank as of November 17, 1989.

   [.16] 14. (a) Within 60 days from the effective date of this ORDER, the Bank shall cause to be made by an individual or firm that is independent with respect to the Bank and that possesses recognized expertise in banking, a full study or audit of the following transactions between the Bank and Individual Respondent and/or his related interests between January 1, 1981, through the effective date of this ORDER:

   (i) the payments made by the Bank to Vic Sather & Associates, Inc. ("VSA"), in connection with the filing of any consolidated tax return;
   (ii) the payments with Bank funds of expenses incurred by, or on behalf of, the Individual Respondent and/or his related interests; and
   (iii) any other payments made by the bank which were used for the tangible economic benefit of, or were transferred to, the Individual Respondent and or his related interests.

   [.17] 15. Within 30 days of the date of the meeting of Bank's board of directors required by paragraph 14(a) of this ORDER, the Individual Respondent shall make restitution or provide reimbursement to the {{3-31-91 p.C-736}} Bank in accordance with the allocations made pursuant to paragraph 14(d) of this ORDER, for the following:

   (a) any and all payments made by the Bank to VSA in connection with the filing of any consolidated tax return which payment or payments exceeded the Bank's tax liability on a separate return basis:
   (b) any and all payments made by the Bank on behalf of Individual respondent and/or his related interests to pay for goods and services which were not in any way related to the conduct of the affairs of the Bank including, but not limited to, the following:

   (i) not less than 60 percent of rental and utility payments on an apartment located at Valley View Apartments, 341 Third St. E. #3, Franklin, Minnesota:
   (ii) credit card charges, including $222.75 at Benson Optical; and
   (iii) any other payments made by the Bank on behalf of Individual Respondent and/or his related interests discovered as a result of the independent study or audit required by paragraph 14 of this ORDER, which personally benefited, directly or indirectly. Individual Respondent and which did not materially benefit the Bank.

   [.19] 17. Effective the date of this ORDER:
   (a) For purposes of this ORDER:

   (i) the term "Bank insider" means any Institution-Affiliated Party of the Bank and any related interest of any such person;
   (ii) the term "related interest" has the meaning given in section 215.2(k) of Regulation 0. 12 C.F.R. §§ 215.2(k);
   (iii) the term "extension of credit" has the meaning given this term in section 215.3 of Regulation 0. 12 C.F.R. § 215.3; and
   (iv) the term "affiliate" and "covered transaction" have the meaning given these terms in section 23A(b)(1)(4), and (7), respectively, of the Section 23A of the Federal Reserve Act, 12 U.S.C. §§ 371c(b)(1), (4) and (7).

   (i) grant, approve, authorize or make any extensions of credit to any Bank insider;
   (ii) engage in any covered transaction with Bank affiliates:
   (iii) engage in any Bank transaction of any kind or nature whatever, other than payment of a reasonable salary and/ or directors' fees, which inures, directly or indirectly, to the tangible economic benefit or financial gain of Individual Respondent or his related interests.

   [.20] 18. The bank shall furnish written progress reports to the Regional Director detailing the form and manner of any action taken to secure compliance with this OR- {{12-31-91 p.C-737}}DER and the results thereof every 90 days, beginning 90 days from the effective date of the ORDER. In addition, the Bank shall furnish such reports on request of the Regional Director. All progress reports and other written responses to this ORDER shall be reviewed by the board of directors of the Bank and made a part of the minutes of the board meeting.

   [.21] 19. Following the effective date of this ORDER, the Bank shall send to its shareholders a description of this ORDER, (a) in conjunction with the bank's next shareholder communication, and also (b) 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 changes requested to be made by the FDIC shall be made prior to dissemination of the description, communication, notice, or statement.
   20. This ORDER shall become effective 10 days from the date of its issuance.
   The provisions of this ORDER shall be binding upon the Bank, its institution-affiliated parties, successors and assigns.
   The provisions of this ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provisions of this ORDER shall have been modified, terminated, suspended, or set aside by the FDIC.
   Dated this 4th day of January, 1991
   Pursuant to delegated authority.
Charles E. Thacker
Regional Director
Federal Deposit Insurance Corporation
Kansas City Regional Office.