Applications Pursuant to Section 24-of the Federal
Deposit Insurance Act for Consent to Continue to Indirectly Engage as Principal Through Majority-Owned Subsidiaries in Real Estate Investment Activities That May Not Be Permissible for a Subsidiary of a National Bank
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 FDIC's Rules and Regulations relating to applications by the Bank of Mulberry, Mulberry, Arkansas (the "Bank"), for consent to continue to indirectly engage as principal in real estate investment activities through General Enterprises Company, Inc., a whollyowned subsidiary, and West Second Street Partnership, a majorityowned subsidiary (the "Subsidiaries"). These activities may not be permissible for a subsidiary of a national bank. The Board of Directors has concluded that the applications should be denied, divestiture should be ordered, and the following conditions imposed pending divestiture.
Accordingly, it is hereby ORDERED, for the reasons set forth in the attached Statement, that the applications submitted by the Bank for consent to indirectly continue in real estate investment activities through the Subsidiaries in activities that may not be permissible for a subsidiary of a national bank be and the same hereby are denied, divestiture is required, and during the period of divestiture the following conditions shall be imposed:
1. That the Bank shall submit to the FDIC's Memphis Regional Director a plan for divestiture of the real estate investments presently owned by the Subsidiaries. The plan should be submitted within 60 days of receipt of this letter and in no event shall the divestiture period exceed December 31, 1997.
2. That the Bank and the Subsidiaries shall take the necessary actions to establish, and the Subsidiaries shall operate until divestiture in a manner so as to ensure, a separate corporate existence as a majorityowned 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 Subsidiaries that the Subsidiaries are separate organizations 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;
3. That the Bank shall not engage directly or indirectly through the Subsidiaries in any real estate investment 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;
4. That the Bank and the Subsidiaries shall not extend credit to any borrower to acquire real estate from the Subsidiaries 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 comparable transactions;
5. That before the consummation of a transaction between the Subsidiaries and any of the Bank's customers, any potential conflicts of interest be identified, be appropriately resolved, and be clearly disclosed to the board of directors and documented in the board's minutes;
6. That the Bank's capital level, after deducting the Bank's investment in the Subsidiaries, 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;
7. The Bank shall, on a quarterly basis, perform the capital adequacy calculations described in paragraph 6 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 submits to the FDIC an acceptable plan for restoring capital to a level required for a "well capitalized" institution;
8. That henceforth, 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;
9. That future transactions between the Bank and the Subsidiaries shall be made in accordance 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 Subsidiaries were affiliates of the Bank as defined under sections 23A and 23B; and
10. That during the divestiture period, 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 decision.
Dated at Washington, D. C., this 16th day of January, 1996.
BY ORDER OF THE BOARD OF DIRECTORS
FEDERAL DEPOSIT INSURANCE CORPORATION
IN RE: Bank of Mulberry Mulberry, Arkansas
Applications Pursuant to Section 24 of the Federal Deposit
Insurance Act for Consent to Continue to Indirectly Engage as
Principal Through Majority-Owned Subsidiaries in Real Estate
Investment Activities That May Not Be Permissible for a
Subsidiary of a National Bank
Pursuant to the provisions of section 24 of the Federal Deposit Insurance ("FDI") Act, Bank of Mulberry, Mulberry, Arkansas (the "Bank"), has filed two applications with the Federal Deposit Insurance Corporation ("FDIC"). The Bank requests the FDIC's consent to continue to indirectly engage as principal in real estate investment activities through General Enterprises Company, Inc. ("GEC"), a wholly-owned subsidiary of the Bank, and West Second Street Partnership ("WSSP"), a majority-owned subsidiary of the Bank (collectively, the "Subsidiaries"). The Subsidiaries own, manage, and lease to third parties 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. Arkansas state law permits the holding of real estate investment properties by banks and bank subsidiaries up to an aggregate amount equal to 20 percent of common stock, surplus, and undivided profits.
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, provides 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 that 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 these risks, 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.
The Board of Directors ("Board") of the FDIC has reviewed available information and has taken into consideration the financial and managerial resources and future earnings prospects of the Bank. The Board also considered the risks associated with real estate investment activities and the risks associated with owning and leasing the particular properties held by the Subsidiaries. The Bank is in compliance with applicable capital standards.
In determining if a significant risk to the deposit insurance fund exists in the proposal, the Board evaluated the specifics of the Bank's applications. In evaluating these applications, the Board considered the types of real estate investment activity proposed to determine if the activity is suitable for an insured depository institution. The Board reviewed the proposed subsidiary structure and its management policies and practices to determine if the Bank is adequately protected from litigation risk. Capital adequacy is analyzed to ensure that the Bank first devotes sufficient capital to its more traditional banking activities. Capital adequacy was determined by the Bank's "consolidated" and "bank only" leverage and risk based capital ratios, with all investments in the Subsidiaries excluded from capital in the "bank only" capital calculation. Limitations on investment in the Subsidiaries were evaluated in order to assure that the maximum risk exposure to the Bank is nominal. The Bank's policies relating to extensions of credit to third parties for subsidiary-related transactions were evaluated to determine if they protect the Bank from concentrations of risk. The Bank's policies on engaging in transactions in which insiders are involved were also reviewed to determine if they protect the Bank from potential insider abuse. The Bank's policies relating to the conditioning of loans on the purchase of real estate from the Subsidiaries and the extending of credit by the Bank to third parties for the purpose of acquiring real estate from the Subsidiaries were reviewed to determine if they prevent undesirable tying relationships and to determine if they are adequate to ensure that sound credit underwriting is maintained.
Having reviewed these areas, the Board is denying the Bank's request to continue real estate investment activities through GEC and WSSP. The Board is requiring a divestiture plan and is also imposing conditions for the period of the divestiture plan, which shall not extend beyond December 31, 1997. These conditions are imposed for prudential reasons due to the volatility and other risks which are inherent in the subject real estate activity, as well as to mitigate any potential insider conflicts of interest and to reduce risk to the deposit insurance fund.
Since 1988, GEC and WSSP have purchased real estate properties for the purpose of renovating, leasing, and holding the properties for investment purposes. As of September 30, 1995, the Bank's investments in the Subsidiaries represented approximately 25.87 percent of the Bank's Tier 1 capital and 2.1 percent of the Bank's total assets. On an individual basis, the Bank's investment in GEC and WSSP represents 20.63 percent and 5.24 percent, respectively. The Bank has divested of certain WSSP property, and the Bank intends to sell the remaining real estate and terminate the partnership.
The Bank's proposed conduct of real estate investment activities presents several supervisory concerns and the identified risks are such that the real estate investment activity could potentially present a significant risk to the Bank Insurance Fund. These concerns relate to the Bank's concentration of real estate investment in relation to capital resources; the higher-than-normal degree of risk exposure presented by certain of the real estate investments; management's less than satisfactory level of expertise in real estate investment, as evidenced by the condition and operating performance of WSSP and GEC; the lack of independent, knowledgeable outside director involvement; and the apparent conflicts of interest that have resulted from certain real estate transactions between the Bank and the Subsidiaries and Bank insiders or their related interests. In addition, the general partnership business structure of WSSP is considered objectionable, as such a structure exposes the Bank to risks that would not be present in a separately capitalized, incorporated subsidiary. It is also noted that the Bank is not now, and has not been for some time, in conformance with Arkansas state law relating to real estate investment limitations in that the Bank's total real estate investment represents in excess of 20 percent of its common stock, surplus, and undivided profits.
Pending divestiture, the following conditions will be imposed. GEC and WSSP shall take necessary action to operate in a manner so as to ensure a separate corporate existence, particularly the addition of an independent board member to the board of GEC in order to insulate the Bank from potential liabilities. The Bank and the Subsidiaries shall not engage directly or indirectly in real estate investments with insiders or their related interests without the prior written consent of the FDIC. The Bank's and the Subsidiaries' boards of directors shall prohibit, through policy formation and implementation, any extensions of credit by the Bank or the Subsidiaries to third parties for the purpose of acquiring real estate from the Subsidiaries except on terms consistent with safe and sound banking practices, 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, and not involving more than the normal degree of risk of repayment. Any such loans made by the Bank will be reviewed by examiners at each regular safety and soundness examination conducted by FDIC. Moreover, future transactions between the Bank and the Subsidiaries will be subject to sections 23A and 23B of the Federal Reserve Act, 12 U.S.C. §§ 371c and 371c-1, respectively, to the same extent as though the Subsidiaries were affiliates of the Bank as defined under sections 23A and 23B.
The Bank's capital category for purposes of Prompt Corrective Action and risk-adjusted deposit insurance premium assessment shall be calculated based on the Bank's capital after deducting all real estate investments, except when determining whether the Bank is "critically undercapitalized". In addition, the Bank shall notify the FDIC of any significant change in facts or circumstances, and the FDIC shall have the right to alter, suspend, or withdraw its decision upon receiving such notification.
THE BOARD OF DIRECTORS
FEDERAL DEPOSIT INSURANCE CORPORATION