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Appeals of Material Supervisory Determinations: Guidelines & Decisions

SARC-95-01 (July 14, 1995)

Your appeal of material supervisory determinations has been decided. Rulings not in your favor were made by the Supervision Appeals Review Committee (“Committee”) of the Federal Deposit Insurance Corporation (“FDIC”) on July 12, 1995, and are conveyed in this letter. The other appeal issues and comments on other matters related to the examination process were resolved by Nicholas J. Ketcha Jr., Acting Director, Division of Supervision. Mr. Ketcha’s findings are conveyed in a separate letter.

The Committee’s finding on each item decided against your bank is presented below along with an explanation of the reason for the decision.

1. Violations of Law and Regulations

A. State Code Violation/Holding Chattel Property in Excess of One Year
Deputy Commissioner Charles Griffith of the Oklahoma State Banking Department confirmed for the Committee that the apparent violation is properly cited. The fact that the borrower (*****) continues to be the registered owner is understood. However, the relevant determinations for purposes of interpreting the Code are that the property is considered to be under the bank’s control and that the bank has privileges normally associated with ownership. In this case, the debt is in default and collateral is being liquidated to pay on the loan balance. To determine that one could avoid the State code by simply not registering (in instances where ownership is recorded) property in the bank’s name would be contradictory to the Code’s apparent purpose.

B. Violations of FDIC Rules and Regulations on Real Estate Appraisals
The Committee reviewed all six apparent real estate violations cited in the examination report. Determinations against the bank are that X and Y can be cited as apparent violations because the bank did not have the required real estate evaluations as of the transaction date or the examiner’s asset review date.

2. Allowance for Loan Losses
Judgments about the adequacy of loan loss reserves are based on variables that can sometimes support different conclusions. However, in your case, the reserve inadequacy cannot reasonably be disputed since loans classified Loss, and over which there is not stated disagreement, exceeded the allowance for loan losses. The provision expense would have been large ($156,000) just to replenish the reserve to the pre-examination level. Even then, the reserve balance would represent only 1.03 percent of loans, a level which appears short of your stated practice maintaining reserves at “well over 1 percent with an additional amount for classified loans.” The examination report requested the reserve be restored to an amount higher than the pre-examination level in order to provide adequate coverage for high risk in the loan portfolio.

Higher reserve coverage is warranted due to the following factors. The remaining adversely classified and special mention loans as of the examination date would represent 4.7 times a reserve replenished to its prior level and a sizable 45 percent of total capital and reserves as of the examination after charge-offs. The examination report notes that the loan loss reserve methodology the bank has been using does not follow your own loan policy guidelines. The examination report also indicates that loan administration is weak, as evidenced by a high volume of adversely classified and special mention loans and other real estate, a large volume of documentation exceptions, and an ineffective loan review system. Lastly, pre-examination reserve coverage was low relative to peers as evidenced by the loan loss reserve to total loan level being well below average (13th percentile) while net charge-offs and noncurrent and high risk levels were considerably above average (82nd, 70th, and 91st percentiles, respectively).

These determinations constitute the final decision of the Federal Deposit Insurance Corporation.

By direction of the Supervision Appeals Review Committee of the Federal Deposit Insurance Corporation.