Failed Bank’s Broken Vows Mean Little
SEP 18, 2014 | REPUBLISHED BY LIT: APR 16, 2022
Covering up a sign in June 2009 at a branch of the failed Cooperative Bank in Jacksonville, N.C.
[Credit…John Althouse/Jacksonville Daily News]
Where were the regulators when small banks across the country were succumbing to the lure of easy money and embarking on a strategy of rapid growth that would end up destroying many of them?
In at least some cases, the answer is that the regulators told the banks to change course and were ignored.
Last week, a federal judge in North Carolina summarily dismissed a suit filed by the Federal Deposit Insurance Corporation against nine former officers and directors of Cooperative Bank, a century-old bank in Wilmington, N.C., that pursued an ultimately disastrous growth strategy that depended on the continued soaring of local real estate prices.
Bank examiners had repeatedly tried to persuade Cooperative to change its practices and had issued official warnings. But to the judge, those warnings were irrelevant.
The bank’s most innovative loan program allowed customers of certain real estate developers to buy overpriced building lots with no money down and no payments — of principal, interest or even closing costs — for two years.
Unsurprisingly, many of those loans did not work out well for the bank, which failed in 2009.
In his decision, Federal District Court Judge Terrence W. Boyle brushed aside all the regulators’ warnings, pointing to the grades regulators had given the bank before it collapsed. Those grades are called “Camels” ratings by regulators, short for capital, asset quality, management, earnings, liquidity and sensitivity to market risk.
Nearly all banks are rated 1 or 2, according to one former regulator, and banks rated below that — at 3, 4 or 5 — go on lists indicating that special oversight and reforms are needed.
“The facts show,”
the judge wrote,
“that the process the defendants used to make the challenged loans were expressly reviewed, addressed and graded by F.D.I.C. regulators”
in the same 2006 examination that criticized its lending practices.
“The regulators assigned defendants a passing grade of ‘2’ in the Camels system and to now argue that the process behind the loans is irrational is absurd. Further, each of the loans at issue was subject to substantial due diligence and an approval process that defies a finding of irrationality.”
It is not easy to understand why the bank received that 2 rating.
A later review by the F.D.I.C.’s inspector general said that the rating took into account “management’s agreement to address the weaknesses identified during the examination,” but it added that the concerns expressed by the examiner “are not consistent” with such a rating.
There was a general aversion to regulation in those happy days, when no bank had failed for years, and it is possible that standards had slipped.
The judge said his review of information presented to the court
“fails to reveal any evidence that suggests any defendant engaged in self-dealing or fraud, or that any defendant was engaged in any other unconscionable conduct that might constitute bad faith.”
The F.D.I.C. complaint made accusations that certainly sounded as if there were some bad faith.
It said officers of the bank regularly ignored the bank’s own lending rules and ignored repeated warnings from state and federal bank examiners.
It said the board made no effort to force the bank officers to abide by the bank’s own rules, let alone comply with the examiners’ recommendations.
So what facts indicated there was no bad faith?
That is hard to tell.
The judge sealed many documents, including the F.D.I.C.’s arguments against the summary judgment.
A lawyer for the defendants, Ronald R. Glancz of the Venable law firm, told me that he had been surprised by the extent of the sealed documents and thought some had been sealed without a request by either side.
He promised to seek to have some additional documents released, but none were.
If the F.D.I.C.’s claims are accurate — and the judge does not comment on that either way — it is easy to see why someone might view the actions of Cooperative managers as being improper.
They certainly were very risky.
The F.D.I.C. complained about nine large loans to land developers that it said the board had approved with at best a cursory review that failed to reveal extremely low underwriting standards.
But the most amazing accusations concern the lot loans.
Even without hindsight, it is hard to understand why any bank would think such loans were a good idea.
Here’s how the program worked:
A customer would attend an investment seminar and be convinced that he or she could buy a building lot, with water views, without putting up any money for two years.
By then, that person could flip the lot to someone else as property values continued to climb.
The regulators had expressed concern about “the large number of interest-only and no-equity loans in the bank’s portfolio,”
the F.D.I.C. said,
but the bank’s chief executive, Fredrick Willetts III, told the bank’s board that the lot loans would all have equity of at least 10 percent and would not be no-interest loans.
Was that accurate?
From the bank’s perspective, perhaps.
From the borrower’s point of view, not at all.
The bank lent 80 percent of the purchase price and received a 20 percent down payment.
But the company selling the property lent the down payment to the buyer and promised to make all interest payments for the first two years.
According to the F.D.I.C., the developer who lent the down payment would normally buy the lots only after it had found a buyer who was willing to pay twice what the developer had to pay.
That left the developer with a substantial profit from the money lent by Cooperative, even if the buyer never made a single payment on the loans.
An appraiser was found to certify that the doubled price was reasonable, based on the fact that other buyers had paid the inflated charges on similar lots.
The F.D.I.C. cited 78 particular lot loans, all but two to people who lived outside of North Carolina, and said many of them were approved even after the board learned that they violated several of the bank’s loan policies.
The lots were not cheap; the loans ranged up to $999,000 and they added up to $21.8 million. The F.D.I.C. says the bank lost 66 percent of the amount it lent.
The F.D.I.C. says it has filed 97 suits against officers and directors of failed banks and recovered $641 million from officials at 26 banks.
All but one of those cases were settled, the exception being an F.D.I.C. victory in a jury trial involving directors of IndyMac Bank of California, which collapsed in 2008.
Terrence William Boyle (born December 22, 1945) is a United States District Judge of the United States District Court for the Eastern District of North Carolina.
He was Chief Judge of that court from 1997 to 2004. He served a second term as Chief Judge from 2018 to 2021.
From 1991 to 1993 and again from 2001 to 2007, he was a nominee to the United States Court of Appeals for the Fourth Circuit.
His federal appellate nomination from 2001 to 2007 is the longest in history not to be acted upon by the United States Senate. (Wikipedia).
The F.D.I.C. said that it would appeal the Cooperative ruling, but it declined to comment further.
Mr. Glancz, the defense lawyer, said he thought Judge Boyle’s verdict would be widely followed in other courts and was needed to avoid scaring qualified people away from serving as bank directors.
He added that Cooperative had needed to make risky loans to compete with larger banks that had been expanding in the Wilmington area.
Business judgment rules vary and often depend on judicial interpretation.
In a related case, against directors of the failed Buckhead Community Bank in Atlanta, the Georgia Supreme Court ruled in July that in some cases the rule would not protect negligent directors in the state.
Judge Boyle took a far more expansive view of the North Carolina rule.
No doubt the examiners should have been tougher with Cooperative.
But they did receive promises the bank would change its ways, promises that evidently were not kept.
If this ruling is widely followed, it could mean that if a bank can somehow get a 2 rating from the examiner, it can safely ignore anything else the examiner says.
A version of this article appears in print on Sept. 19, 2014, Section B, Page 1 of the New York edition with the headline:
Failed Bank’s Broken Vows Mean Little.
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