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[¶11,952] In the Matter of Western State Bank, Duarte, California, Docket No.
02-110b (7-18-02).
A cease and desist order was issued, based on findings by the FDIC that
it had reason to believe that respondent had engaged in unsafe and
unsound practices.
[.1] ManagementQualifications Specified
[.2] Board of DirectorsIncrease Participation in Bank Affairs Required
[.3] CapitalMaintain Tier 1 Capital
[.4] Loan Loss ReserveEstablishment of or Increase Required
[.5] AssetsCharge-off or Collection
[.6] LoansExtensions of CreditTo Borrowers with Existing Adversely
Classified Credits
[.7] Loan PolicyPreparation or Revision of Policy Required
[.8, .16] AuditProgram Required
[.9] Strategic PlanPreparation of Required
[.10] Budget PlanPreparation Required
[.11] Violations of LawCorrection of Violations Required
[.12] Reports of Condition and IncomeAmendment Required
[.13] DividendsDividends Restricted
[.14] Information SystemsSteering CommitteeMinimum Requirements Specified
[.15] Data ProcessingManagement Reporting System Required
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[.17] Information SystemsBoard SupervisionMinimum Requirements Specified
[.18] Security ControlsImprovement Required
[.19] ShareholdersDisclosure of Cease and Desist Order Required
In the Matter of
WESTERN STATE BANK
DUARTE, CALIFORNIA
(Insured State Nonmember Bank)
ORDER TO CEASE AND DESIST
FDIC-02-110b
Western State Bank,, Duarte, California ("Bank"),
having been advised of its 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 of
its right to a hearing on the alleged charges under section 8(b)(1) of
the Federal Deposit Insurance Act ("Act"), 12 U.S.C.
§1818(b)(1), 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 July 17, 2002, whereby
solely for the purpose of this proceeding and without admitting or
denying the alleged charges of unsafe or unsound banking practices and
violations of law and/or regulations, the Bank 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 had engaged in unsafe or unsound banking
practices and had committed violations of law and/or regulations. The
FDIC, therefore, accepted the CONSENT AGREEMENT and issued the
following:
ORDER TO CEASE AND DESIST
IT IS HEREBY ORDERED, that 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 regulation:
(a) operating with inadequate management;
(b) operating with a board of directors which has failed to provide
adequate supervision over and direction to the active management of the
Bank;
(c) engaging in inadequate lending and collection practices;
(d) operating with inadequate capital in relation to the kind and
quality of assets held by the Bank;
(e) operating with a large volume of poor quality loans;
(f) operating with an inadequate loan valuation reserve;
(g) operating with inadequate internal routine and controls policies;
(h) operating in such a manner as to produce operating losses; and
(i) operating in violation of section 303.42(b)(3) of the FDIC's Rules
and Regulations, 12 C.F.R. §303.42(b)(3), as more fully described on
page 20 of the Report of Examination as of January 22, 2002; Part 323
of the FDIC's Rules and Regulations, 12 C.F.R. §323, as more fully
described on pages 26-27 of the Report of Examination as of January 22,
2002; Part 364 of the FDIC's Rules and Regulations, 12 C.F.R. §364,
as more fully described on pages 24 and 25 of the Report of Examination
as of January 22, 2002; Section 3372 of the California Financial Code,
as more fully described on pages 20-24 of the Report of Examination as
of January 22, 2002; and sections 215.4(a) and 215.4(b) of Regulation O
of the Board of Governors of the Federal Reserve System, 12 C.F.R.
§§ 215.4(a) and 215.4(b), made applicable to state nonmember
institutions by section 18(j)(2) of the Act, 12 U.S.C. §1828(j)(2),
as more fully described on pages 20-21 of the Report of Examination as
of January 22, 2002;
(j) operating with inadequate information systems policies and
procedures.
IT IS FURTHER ORDERED, that the Bank, its institution-affiliated
parties, and its successors and assigns, take affirmative action as
follows:
[.1]1. The Bank shall have and retain qualified management.
(a) Each member of management shall have qualifications and
experience commensurate with his or her duties and responsibilities at
the Bank. Management
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shall include a chief executive officer with
proven ability in managing a Bank of comparable size, and experience in
upgrading a low quality loan portfolio, improving earnings, and other
matters needing particular attention. Management shall also include a
senior lending officer with significant appropriate lending,
collection, and loan supervision experience and experience in upgrading
a low quality loan portfolio. Each member of management shall be
provided appropriate written authority from the Bank's board of
directors to implement the provisions of this ORDER.
(b) The qualifications of management shall be assessed on its ability
to:
(i) comply with the requirements of this ORDER;
(ii) operate the Bank in a safe and sound manner;
(iii) comply with applicable laws and regulations; and
(iv) restore all aspects of the Bank to a safe and sound condition,
including asset quality, capital adequacy, earnings, management
effectiveness, and liquidity.
(c) During the life of this ORDER, the Bank shall notify the
Regional Director of the FDIC's San Francisco Regional Office
("Regional Director") in writing when it proposes to add any
individual to the Bank's board of directors or employ any individual
as a senior executive officer. The notification must be received at
least 30 days before such addition or employment is intended to become
effective and should include a description of the background and
experience of the individual or individuals to be added or employed.
[.2]2. Within 30 days from the effective date of this ORDER, the board of
directors shall increase its participation in the affairs of the Bank,
assuming full responsibility for the approval of sound policies and
objectives and for the supervision of all of the Bank's activities,
consistent with the role and expertise commonly expected for directors
of Banks of comparable size. This participation shall include meetings
to be held no less frequently than monthly at which, at a minimum, the
following areas shall be reviewed and approved: reports of income and
expenses; new, overdue, renewal, insider, charged-off, and recovered
loans; investment activity; operating policies; and individual
committee actions. Board minutes shall document these reviews and
approvals, including the names of any dissenting directors.
[.3]3. (a) Within 90 days from the effective date of this ORDER, the Bank
shall have Tier 1 capital in such an amount as to equal or exceed eight
(8.0) percent of the Bank's total assets; and within 180 days from the
effective date of this ORDER, the Bank shall have Tier 1 capital in
such an amount as to equal or exceed eight and one-half (8.5) percent
of the Bank's total assets. Thereafter, during the life of this ORDER,
the Bank shall maintain Tier 1 capital in such an amount as to equal or
exceed eight and one-half (8.5) percent of the Bank's total assets.
(b) The level of Tier 1 capital to be maintained during the life of
this ORDER pursuant to subparagraph 3(a) shall be in addition to a
fully funded allowance for loan and lease losses, the adequacy of which
shall be satisfactory to the Regional Director as determined at
subsequent examinations and/or visitations.
(c) Any increase in Tier 1 capital necessary to meet the requirements
of Paragraph 3 of this ORDER may be accomplished by the following:
(i) the sale of common stock; or
(ii) the sale of noncumulative perpetual preferred stock; or
(iii) the direct contribution of cash by the board of directors and/or
shareholders of the Bank; or
(iv) any other means acceptable to the Regional Director; or
(v) any combination of the above means.
Any increase in Tier 1 capital necessary to meet the requirements
of Paragraph 3 of this ORDER may not be accomplished through a
deduction from the Bank's allowance for loan and lease losses.
(d) If all or part of the increase in Tier 1 capital required by
Paragraph 3 of this ORDER is accomplished by the sale of new
securities, the board of directors shall forthwith take all necessary
steps to adopt and implement a plan for the sale of such additional
securities, including the voting of any shares owned or proxies held 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
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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 the Federal securities laws. Prior
to the implementation of the plan and, in any event, not less than
fifteen (15) 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 Tier 1 capital is provided by the sale of noncumulative
perpetual preferred stock, then all terms and conditions relative to
interest rate and convertibility factor, shall be presented to the
Regional Director for prior approval.
(e) In complying with the provisions of Paragraph 3 of this ORDER, the
Bank shall provide to any subscriber and/or purchaser of the Bank's
securities, a written notice of any planned or existing development or
other changes which are materially different from the information
reflected in any offering materials used in connection with the sale of
Bank securities. The written notice required by this paragraph shall be
furnished within thirty (30) days from the date such material
development or change was planned or occurred, whichever is earlier,
and shall be furnished to every subscriber and/or purchaser of the
Bank's securities who received or was tendered the information
contained in the Bank's original offering materials.
(f) For the purposes of this ORDER, the terms "Tier 1 capital"
and "total assets" shall have, the meanings ascribed to them in
Part 325 of the FDIC Rules and Regulations, 12 C.F.R. §§ 325.2(t)
and 325.2(v).
[.4]4. Within 90 days from the effective date of this ORDER, the Bank shall
establish and thereafter maintain an adequate allowance for loan and
lease losses.
Additionally, within 30 days from the effective date of this ORDER, the
board of directors shall develop or revise, adopt and implement a
comprehensive policy for determining the adequacy of the allowance for
loan and lease losses. For the purpose of this determination, the
adequacy of the reserve shall be determined after the charge-off of all
loans or other items classified "Loss." The policy shall provide
for a review of the allowance at least once each calendar quarter. Said
review should be completed at least fifteen (15) days prior to the end
of each quarter, in order that the findings of the board of directors
with respect to the loan and lease loss allowance may be properly
reported in the quarterly Reports of Condition and Income. The review
should focus on the results of the Bank's internal loan review, loan
loss experience, trends of delinquent and non-accrual loans, an
estimate of potential loss exposure of significant credits,
concentrations of credit, and present and prospective economic
conditions. A deficiency in the allowance shall be remedied in the
calendar quarter it is discovered, prior to submitting the Report of
Condition, by a charge to current operating earnings. The minutes of
the board of directors meeting at which such review is undertaken shall
indicate the results of the review. Upon completion of the review, the
Bank shall increase and maintain its allowance for loan and lease
losses consistent with the allowance for loan and lease loss policy
established. Such policy and its implementation shall be satisfactory
to the Regional Director as determined at subsequent examinations
and/or visitations.
[.5]5. (a) Within 30 days from the effective date of this ORDER, the Bank
shall eliminate from its books, by charge-off or collection, all assets
classified "Loss" and one-half of the assets classified
"Doubtful" as of January 22, 2002, that have not been previously
collected or charged off. Elimination of these assets through proceeds
of other loans made by the Bank is not considered collection for the
purpose of this paragraph.
(b) On or before December 31, 2002, the Bank shall have reduced the
assets classified "Substandard" and those assets classified
"Doubtful" as of January 22, 2002 that have not previously been
charged off to not more than $8,000,000.
(c) On or before June 30, 2003, the Bank shall have reduced the assets
classified "Substandard" and those assets classified
"Doubtful" as of January 22, 2002 that have not previously been
charged off to not more than $7,000,000.
(d) On or before December 31, 2003, the Bank shall have reduced the
assets classified "Substandard" and those assets classified
"Doubtful" as of January 22, 2002 that have
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not previously been charged off to not more than $6,000,000.
(e) The requirements of subparagraphs 5(a), 5(b), 5(c) and 5(d) of this
ORDER are not to be construed as standards for future operations and,
in addition to the foregoing, the Bank shall eventually reduce the
total of all adversely classified assets. Reduction of these assets
through proceeds of other loans made by the Bank is not considered
collection for the purpose of this paragraph. As used in subparagraphs
5(b), 5(c), and 5(d) the word "reduce" means:
(i) to collect;
(ii) to charge-off; or
(iii) to sufficiently improve the quality of assets adversely
classified to warrant removing any adverse classification, as
determined by the FDIC.
[.6]6. (a) Beginning with the effective date of this ORDER, the Bank shall
not extend, directly or indirectly, any additional credit to, or for
the benefit of, any borrower who has a loan or other extension of
credit from the Bank that has been charged off or classified, in whole
or in part, "Loss" and is uncollected. Subparagraph 6(a) of this
ORDER shall not prohibit the Bank from renewing or extending the
maturity of any credit in accordance with the Financial Accounting
Standards Board Statement Number 15 ("FASB 15").
(b) Beginning with the effective date of this ORDER, the Bank shall not
extend, directly or indirectly, any additional credit to, or for the
benefit of, any borrower who has a loan or other extension of credit
from the Bank that has been classified, in whole or part,
"Substandard" or "Doubtful" without the prior approval of a
majority of the board of directors or the loan committee of the Bank.
[.7]7. (a) Within 90 days from the effective date of this ORDER, the Bank
shall revise, adopt, and implement written lending and collection
policies to provide effective guidance and control over the Bank's
lending function, which policies shall include specific guidelines for
placing loans on a non-accrual basis. In addition, the Bank shall
obtain adequate and current documentation for all loans in the Bank's
loan portfolio. Such policies and their implementation shall be in a
form and manner acceptable to the Regional Director as determined at
subsequent examinations and/or visitations.
(b) The initial revisions to the Bank's loan policy and practices,
required by this paragraph, at a minimum, shall include the following:
(i) provisions, consistent with FDIC instructions for the
preparation of Reports of Condition and Income, under which the accrual
of interest income is discontinued and previously accrued interest is
reversed on delinquent loans;
(ii) provisions which prohibit the capitalization of interest or loans
related expense unless the board of directors supports in writing and
records in the minutes of the corresponding board of directors meeting
why an exception thereto is in the best interests of the Bank;
(iii) provisions which require complete loans documentation, realistic
repayment terms and current credit information adequate to support
the outstanding indebtedness of the borrower. Such documentation
shall include current financial information, profit and loss statements
or copies of tax returns and cash flow projections;
(iv) provisions which incorporate limitations on the amount that can be
loaned in relation to established collateral values.
(v) provisions which specify the circumstances and conditions under
which real estate appraisals must be conducted by an independent third
party;
(vi) provisions which establish standards for unsecured credit;
(vii) provisions which establish officer lending limits;
(viii) provisions that require extensions of credit to any of the
Bank's executive officers, directors, or principal shareholders, or to
any related interest of such persons, to be approved in advance by a
majority of the entire board of directors in accordance with section
215.4(b) of Regulation O of the Board of Governors of the Federal
Reserve System, 12 C.F.R. §215.4(b);
(ix) provisions which prohibit the issuance of standby letters of
credit unless the letters of credit are fully secured by readily
marketable collateral and/or are supported by current and complete
financial information;
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(x) provisions that directors first determine that the lending staff
has the expertise necessary to properly supervise construction
loans and that adequate procedures are in place to monitor any
construction involved before funds are disbursed;
(xi) provisions which prohibit concentrations of credit in excess of 25
percent of the Bank's total equity capital and reserves to any
borrower and that borrower's related interests;
(xii) provisions which require the preparation of a loan "watch
list" which shall include relevant information on all loans in
excess of $1,000,000 which are classified "Substandard" and
"Doubtful" as of January 22, 2002 or by the FDIC or California
Department of Financial Institutions in subsequent Reports of
Examination and all other loans in excess of $2,000,000 which warrant
individual review and consideration by the board of directors as
determined by the loan committee or active management. The loan
"watch list" shall be presented to the board of directors for
review at least monthly with such review noted in the minutes; and
(xiii) the board of directors shall adopt procedures whereby officer
compliance with the revised loan policy is monitored and responsibility
for exceptions thereto assigned. The procedures adopted shall be
reflected in minutes of a board of directors meeting at which all
members are present and the vote of each is noted.
[.8]8. Within 90 days from the effective date of this ORDER, the Bank shall
develop an internal audit program that establishes procedures to
protect the integrity of the Bank's operational and accounting
systems. The program shall be in a form and manner acceptable to the
Regional Director as determined at subsequent examinations or
visitations.
[.9]9. Within 90 days of the effective date of this ORDER, the Bank shall
develop and submit to the Regional Director a written three-year
strategic plan. Such plan shall include specific goals for the dollar
volume of total loans, total investment securities, and total deposits
as of December 31, 2002, December 31, 2003, and December 31, 2004. For
each time frame, the plan will also specify the anticipated average
maturity and average yield on loans and securities; the average
maturity and average cost of deposits; the level of earning assets as a
percentage of total assets; and the ratio of net interest income to
average earning assets. The plan shall be in a form and manner
acceptable to the Regional Director as determined at subsequent
examinations and/or visitations.
[.10]10. (a) Within 90 days from the effective date of this ORDER, the Bank
shall formulate and fully implement a written plan and a comprehensive
budget for all categories of income and expense. The plan and budget
required by this paragraph shall include formal goals and strategies,
consistent with sound banking practices, to improve the Bank's net
interest margin, increase interest income, reduce discretionary
expenses, and improve and sustain earnings of the Bank. The plan shall
include a description of the operating assumptions that form the basis
for and adequately support, major projected income and expense
components. Thereafter, the Bank shall formulate such a plan and budget
by November 30 of each subsequent year.
(b) The plan and budget required by subparagraph 10(a) of this ORDER,
upon completion, shall be submitted to the Regional Director for review
and opportunity for comment.
(c) Following the end of each calendar quarter, the board of directors
shall evaluate the Bank's actual performance in relation to the plan
and budget required by subparagraph 10(a) of this ORDER and shall
record the results of the evaluation, and any actions taken by the
Bank, in the minutes of the board of directors meeting at which such
evaluation is undertaken.
[.11]11. Within 90 days from the effective date of this ORDER, the Bank
shall eliminate and/or correct all violations of law which are more
fully set out on pages 20-33 of the Report of Examination of the Bank
as of January 22, 2002. In addition, the Bank shall take all necessary
steps to ensure future compliance with all applicable laws and
regulations.
[.12]12. Within 30 days after eliminating from its books any asset in
compliance with Paragraph 5 of this ORDER, the Bank shall file with the
FDIC amended Consolidated Reports of Condition and Income which shall
accurately reflect the financial condition of the Bank as of December
31, 2001. Thereafter, during the life of this ORDER, the Bank shall
file with the FDIC Consolidated
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Reports of Condition and Income which
accurately reflect the financial condition of the Bank as of the end of
the period for which the Reports are filed, including any adjustment in
the Bank's books made necessary or appropriate as a consequence of any
California Department of Financial Institutions or FDIC examination of
the Bank during that reporting period.
[.13]13. The Bank shall not pay cash dividends without the prior written
consent of the Regional Director.
[.14]14. Within 30 days from the effective date of this ORDER, the board
shall formally establish a steering committee to give direction to
Information Systems ("IS") activities and to monitor performance.
The committee shall establish a mission statement, meet regularly, but
not less than quarterly, maintain minutes and establish periodic
reporting to the board on IS activities.
[.15]15. Within 60 days from the effective date of this ORDER, the board
shall establish a formal management reporting system to ensure adequate
evaluation and monitoring of data processing activities. Such reporting
system shall be in a form and manner acceptable to the Regional
Director as determined at subsequent examinations or visitations.
[.16]16. Within 60 days from the effective date of this ORDER, the board
shall establish and implement a comprehensive IS audit program that
includes the following:
(a) An audit policy defining the scope, frequency of audits,
techniques used in performing the audits and qualifications of
auditors.
(b) Periodic review of the overall condition of IS controls and
corrective measures identified in audit reports by the board, or
designated steering committee.
The audit program and its implementation shall be in a form and manner
acceptable to the Regional Director as determined at subsequent
examinations or visitations.
[.17]17. Within 90 days from the effective date of this ORDER, the board
shall provide supervision over IS functions by:
(a) Establishment of specific policies and procedures to secure the
IS from potential risks.
(b) Providing for training of appropriate personnel in IS policies and
procedures and in IS security issues.
(c) Establishment of procedures to properly safeguard non-public
customer information from misuse by employees and from intrusion of the
bank's computer networks.
(d) Assigning IS administrator and IS security officer duties to
different individuals.
(e) Ensuring that the maximum access rights assigned to bank employees
with critical control functions are "inquiry-only" for the areas
of their responsibility.
(f) Providing for an annual review of user access rights in relation to
internal control structure.
(g) Ensuring that Fedline settings and related practices are consistent
with Fedline recommended guidelines.
(h) Developing electronic banking policies and procedures to ensure
that the bank's Website is properly monitored.
(i) Developing a process to ensure that the Bank's contingency plan is
complete and current, which includes a procedure for annual testing of
the contingency plan.
(j) Developing procedures and monitoring tools to ensure compliance
with software licensing agreements.
[.18]18. Within 90 days from the effective date of this ORDER, the board
shall improve security controls including:
(a) Monitoring vendors' activities;
(b) Updating the operating systems with the latest service packs and
patches in a timely manner;
(c) Developing baseline security configurations to ensure that only
authorized changes are being made to the system; and
(d) Reviewing server logs on a daily basis.
[.19]19. Following the effective date of this ORDER, the Bank shall send to
its shareholders or otherwise furnish a description of this ORDER in
conjunction with the Bank's next shareholder communication and also 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 Section, Washington, D.C. 20429, at least
fifteen (15) days prior to dissemination to shareholders.
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Any changes requested to be made by the FDIC shall be made prior to dissemination
of the description, communication, notice, or statement.
20. Within 30 days of the end of the first calendar quarter following
the effective date of this ORDER, and within thirty (30) days of the
end of each 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 shall include a copy of the Bank's Report of
Condition and the Bank's Report of Income. 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.
This ORDER shall become effective ten (10) days from the date of its
issuance.
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.
Pursuant to delegated authority.
Dated at San Francisco, California, this 18th day of July, 2002.