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Appeals of Material Supervisory Determinations: Guidelines & Decisions

SARC-2004-01 (January 4, 2004)

[Bank] (the “Bank”), filed an appeal with the Federal Deposit Insurance Corporation’s (“FDIC”) Division of Supervision and Consumer Protection (“DSC”) by letter dated November 12, 2003, received November 17th. In its appeal, the Bank asked the FDIC to reconsider the risk ratings assigned to three adversely classified loans at the June 9, 2003, joint FDIC/State of New York examination. The Bank submitted supplemental information by letter dated December 2, 2003.

The DSC Director referred the appeal the Supervision Appeals Review Committee (“Committee”) for review pursuant to the FDIC’s Guidelines for Appeals of Material Supervisory Determinations. 1 As provided by the Guidelines, the Committee reviewed the appeal to determine if the examination findings were consistent with the policies and practices of the FDIC. The Committee also weighed the overall reasonableness of, and the support offered for, the positions advanced by the Bank and examination staff. In accordance with the Guidelines, the review was limited to the facts and circumstances as they existed at the time of the examination.

After careful consideration of all relevant information, the Committee has determined that the Bank’s appeal must be denied. The Committee finds that the risk ratings assigned to the three adversely classified loans in question were appropriate, given the facts available at the time of the examination. The reasons for the Committee’s decision are summarized below.

Analysis and Findings

X Corporation

The FDIC’s Manual of Examination Policies sets forth the following definition:

Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.

The loan to X Corporation was adversely classified Loss in the amount of $140,000 at the examination. The Bank contends that the loan should have been adversely classified Doubtful.

The loan contains severe credit quality weaknesses, including the fact that the company is no longer in business and the Bank is relying on the guarantor for any potential payment. The Bank asserts that it will receive payment from equity in the guarantor’s personal residence, which is reportedly worth $750,000, subject to a first lien of approximately $380,000. The Bank suggests that the apparent equity of $370,000 is sufficient to cover the Bank’s debt. However, the guarantor’s whereabouts are unknown, complicating the Bank’s collection efforts. Moreover, the guarantor transferred his ownership interests in his personal residence to his spouse, who is not a guarantor on the debt. The protracted litigation necessary for any possibility of collection indicates that it is not practical to defer writing off this loan. The Committee concurs with the examination analysis of the loan and the assigned Loss classification.

The Bank’s loans to Y consisting of two notes, were adversely classified Loss in the aggregate amount of $284,000 at the examination. As with X Corporation credit, the Bank suggests the credit should have been adversely classified Doubtful rather than Loss.

At the time of the examination, available information indicated the business was suffering substantial operating losses. Both notes were unsecured. The Bank had obtained a judgement against one guarantor, …, but he had not been cooperative in honoring his guaranty. A financial statement on Mr. …, which was outdated, suggested that he may have some financial strength. This statement also showed, however, that his financial position was illiquid: his net worth was largely in non-marketable securities and various residential properties. One of Mr. … principal assets, his personal residence, was owned jointly with his spouse, and she is not a guarantor for the debt. As of the close of the examination, the Bank’s legal counsel had been unable to attach any of Mr. … other assets.

Based on the facts and circumstances known and existing at the time of the examination, the Committee concurs with the Loss classification assigned by the examiners.

Although the Committee is upholding the examiners’ findings, we are encouraged to learn that the Bank obtained partial payment for a guarantor of the Y loans. While receipt of this payment does not alter the classification assigned at the time of the examination, only the uncollected balance must be charged off as of year-end 2003, consistent with the direction given the Bank concerning the disposition of assets classified Loss in the Report of Examination.

The third credit, Z, was adversely classified Substandard in the amount of $324,000. The total debt was $436,000, but $112,000 was not adversely classified due to cash collateral. The Bank contends that the more appropriate designation for the credit is Special Mention rather than Substandard. The Borrower, an importer and wholesaler of neckties and scarves, has experienced poor operating results, which the Bank acknowledges. Collateral for the indebtedness consists of $112,000 in previously mentioned deposits held at the Bank and second liens on the company’s assets and on the guarantor’s personal residence. Net equity in the house is approximately $342,000. The debt was adversely classified Substandard due to poor cash flow generated by the business and an insufficient collateral margin provided by junior liens on illiquid collateral.

The FDIC’s Manual of Examination Policies defines Substandard and Special Mention loans as follows:

Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.

A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Regarding Special Mention loans, the FDIC Manual of Examination Policies further states:

Ordinarily, Special Mention credits have characteristics which corrective management action would remedy. Often the bank’s weak origination and/or servicing policies are the cause for the Special Mention designation.

The company’s poor operating performance and the insufficient collateral margin provided by the Bank’s secondary position in illiquid collateral are well-defined weaknesses consistent with the definition of a Substandard loan. Additionally, the debt does not appear to possess characteristics which corrective management action would remedy, as in the case of a Special Mention loan. The Committee concurs with the examination’s assessment of the loan and with the assigned Substandard classification.

For the reasons set forth above, the Bank’s appeal is denied.

This decision is considered a final supervisory decision by the FDIC.

By direction of the Supervision Appeals Review Committee of the FDIC dated January 5, 2004.


1 60 Fed. Reg. 15923 (March 28, 1995)