Expert Advice on Loan Quality and Management Considerations in FDIC Directors and Officers Litigation

As the banking regulators and banking stockholders continue to file high-dollar directors and officers lawsuits involving failed banks and savings institutions, the gravamen often involves operative issues that gravitate to questions of (1) Loan Quality, (2) Lending Management, and (3) Overall Institutional Management.

In all three of these areas, the major and overriding consideration is whether or not the actions and inactions of the officers and directors conformed to nationwide industry standard policies, practices, principles and procedures for banking and savings institutions. Since there is no “big book

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of banking industry standards” that can be turned to for answers to these questions, those prosecuting or defending these directors and officers liability cases must rely on expert advice and testimony from seasoned industry professionals who have broad experience and a command of all of the issues at play in these complex and high-stakes cases.

Let’s take a closer look at the three potential problem areas mentioned above:

1. Loan Quality Considerations

Here are some examples – and this certainly is not an exhaustive list - of imprudent lending practices that I have seen in troubled and failed financial institutions:

• Exceeds legal and prudent Loan-To-Value guidelines, resulting in either inadequate collateral or an excessive loan amount – take your pick.
• Imprudent concentrations of credit in a few large borrowers, i.e., a loans to one person or one entity violation. One borrower tripping can cause a ripple effect throughout the other loans in the portfolio that rely on the borrower’s financial strength.
• Sales of property to family members and cronies that were obviously made to avoid loans to one borrower restrictions.
• Loan Applications incomplete, unsigned, or missing.
• Inadequate analysis of realistic and likely repayment possibilities.
• Failure to obtain personal or corporate guarantees where they would be appropriate.
• Missing credit reports. Notice credit reports what might be dated after the loan was approved or closed.
• Failure to heed warnings on credit reports.
• Lack of detail on financial statements. For example, citing a large figure for “Real Estate” or “Marketable Securities” without any other breakdown or detail.
• Lack of analysis of financial statements, such as the ability to make the equity payment and other closing costs required at closing, the ability to make debt service payments, and the ability to make required future equity contributions.
• Lack of verification of items on financial statements.
• Indicia of false financial statements such as, say for a hypothetical example, a borrower who has a $1,000,000 in jewelry and less than $10,000 in cash.
• Borrowers who claim significant value in domestic or foreign trusts, making their value questionable in terms of being able to support the loan.
• Cash required for closing not found on the borrower’s financial statements.
• Potential collateral on financial statements not taken as extra collateral where needed.
• Any signs that the Loan Committee Members or Directors ever asked for any additional information.
• Loans secured by closely-held stock where there was no evidence that the bank properly valued the stock.
• Loans secured by stock where there is no evidence that the lender actually held the stock and an assignment as collateral.
• Loans based on real estate where stock was the collateral, not real estate.
• Real estate loans that are structured as stock loans that make no allowance for other debt against the underlying real estate.
• Loan where the existence and value of the collateral was questionable, for example, a 50% profit participation. (What if there was no profit generated?)
• Loans where business value improperly was separated from real estate value.
• Stock brokerage investment account taken as additional collateral, but no sign of actual assignment.
• Inadequate control of collateral, such as allowing the draw-down of a collateral stock brokerage investment brokerage account or the cashing in of a collateral certificate of deposit.
• Issuance of a letter of credit to a corporation with no consideration from the corporation and no benefit to the lender.
• Inappropriate collateral, such as questionable accounts receivable, inventory, contracts, licensing agreements, and other assets that are difficult to value.
• Loan extensions that were not warranted. Extending a loan just because the borrower can’t afford to pay the interest is not an acceptable reason.
• Approvals that specify “Best efforts” on obtaining loan fees. Fees should be stated as a requirement since it is impossible to estimate a loan’s yield without knowing the upfront fee amount.
• Reliance on an interest reserve to be set up by the borrower and outside of the loan. This is similar to not insuring that a borrower has adequate cash to meet ongoing financial requirements throughout the life of the proposed loan.
• Many Director approvals by email, making it unlikely that they saw a full loan and credit package, asked questions, or had an opportunity to adequately discuss the loan.
• Disregard for inadequate or negative debt service coverage.
• Conflict situations such as where a Director writes insurance on a borrower’s property and also votes to approve the borrower’s loans, creating an obvious conflict of interest.

2. Overall Lending

• Commercial Real Estate loan concentrations that are appropriate to the size of the portfolio.
• Failure to implement recommendations set forth by internal and external auditors and governmental banking regulators regarding, among other things, risk assessments, contingency plans, market analysis, credit underwriting, and stress testing.
• Failure to implement an action plan to reduce problem assets.

3. Overall Institutional Management

• Over reliance on brokered deposits.
• Over reliance on one or a small group of large depositors.
• Standards for internal controls and information systems.
• Reasonable asset growth.
• Acceptable asset quality.
• Safeguards against conflicts of interest.

Conclusion

Take directors and officers liability litigation seriously. Obtain quality expert witness assistance that is knowledgeable in all of the areas of concern, and who has proven testifying experience.

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ABOUT THE AUTHOR: Banking and Lending Expert Witness Don Coker
Expert witness and consulting services. 525 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of expert witnesses recommended to both DRI and AAJ. Clients have included numerous individuals, 90 banks, and governmental clients such as the IRS, FDIC.

Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator.

B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School. Called on by clients in 32 countries for work involving 61 countries. Widely published, often called on by the media.

Copyright Don Coker

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.