What happened at the Bank of Whitman? Inspector General’s report outlines causes for bank failure

Causes of failure of the Bank of Whitman based in Colfax have been listed in a review conducted by the Office of the Inspector General for the Federal Reserve Board.

Posted on the Federal Reserve Board‘s web site, the March 22 report notes the Inspector General conducted the review because of the loss sustained by the Federal Deposit Insurance Corporation (FDIC) when the bank was closed down Aug. 5, 2011, by the Washington State Department of Financial Institutions.

Reported loss to the FDIC at that time was $134.8 million which equaled 24.6 percent of the bank’s total assets of $548.6 million.

The report notes the required threshold for such an Inspector General review under the FDIC Act is a $200 million loss, but the Bank of Whitman failure, which was under the threshold, was subjected to the review because it presented “unusual circumstances.”

Under the law, the Inspector General of the appropriate banking agency is required to review the agency’s supervision and why the loss was incurred. It is also required to make recommendations for preventing such losses in the future through changes in FRB supervision.

The review finding noted Bank of Whitman was supervised by the Federal Revue Board of San Francisco which conducted regular monitoring. It added the San Francisco office did not take “decisive action to resolve the weaknesses” until September of 2009, four years after discovering problems at the bank.

The FRB composite supervisory ratings for Bank of Whitman, called the CAMELS rating, remained at a level two through five reviews between the start of 2005 until May of 2009. The rating then dropped by two notches, to a four, after November of 2009, and dropped again to a five, six months later. It remained there for the final review in late May of 2011, two months before the bank was shut down.

The CAMELS rating, a standard used in the industry, stands for a composite grading of a bank’s condition as applied to capital, assets, management, earnings, liquidity and sensitivity to market risk.

After the Bank of Whitman was closed on a Friday in August of 2011, Columbia State Bank opened eight of the 20 branches on the next Monday and 12 branches remained closed.

Under the agreement, accounts at all branches were transferred to Columbia Bank which picked up $314.4 million of Whitman’s assets. The agreement left FDIC to cover $134.8 million, or 24.6 percent of the bank’s $548.6 million in total assets. The FDIC was named receiver for the bank after closure and has been charged with recovery of assets which would offset the loss.

The FDIC reserves derive from premium payments made by member banks which become part of the operating expenses of the banks.

The inspector general’s report said weak corporate governance by the bank board allowed the bank’s senior management to dominate the institution’s affairs and undermine the effectiveness of key control functions.

The Bank of Whitman’s 2011 shutdown had been preceded eight months earlier by the retirement of Jim Tribbett, chief executive officer, and departure of Craig Conklin, chief lending officer of the bank.

Tribbett as CEO also served as chairman of the bank board, and the Chief Lending Officer and Chief Financial Officer were also members of the board.

Nepotism

The report notes in 2010 the state financial office issued a consent order that required the bank’s board of directors to engage in an independent assessment of the bank’s management. The report by an external firm, hired by the board, noted an unwillingness of many employees to communicate concerns to the CEO regarding issues impacting the bank because they felt fear of retaliation.

The external firm’s assessment also pointed out conflicts of interest related to nepotism. During the five years prior to closure, the hiring of several family members related to the chief officers added a strain on what was already a weak management system, according to the report.

Federal banking laws do not prohibit hiring relatives in small community banks, but bank examiners are required to be especially alert when reviewing offices staffed by the members of the same family.

The report said extensive nepotism at Bank of Whitman compromised several key control functions. In one instance, a daughter of the CEO served as a compliance officer while also serving as a loan officer for her own portfolio.

Commercial lending

The Inspector General’s report said the bank’s management decision to convert from a traditional ag lender to commercial lending with a high concentration in real estate loans played a big part in the failure.

“Whitman’s credit concentrations and poor credit risk management practices, along with a decline in the real estate market, resulted in asset quality deterioration and significant losses,” the report said. “The escalating losses, depleted earnings, eroded capital left the bank in a critically undercapitalized position which led to its closure.”

The report included a graph which shows the bank’s commercial real estate (CRE) loans as a percent of the bank’s total risk-based capital exceeded 1,000 percent. The graph compares the bank’s CRE loan percent to the supervisory guidance rate of around 300 percent and a peer group rate which show banks in the same classification approaching 400 percent in the 2008 era and then declining to the supervisory norm.

A 2008 report by state examiners noted legal lending limit violations to eight individual borrowers. At that time, Whitman’s lending limit to individual borrowers was approximately $10.2 million, but loans to the eight individuals totaled $277 million, or $196 million over the limit.

Single borrower exposure

Loans to one borrower totaled $60 million. The borrower identified in the report, Sunwest Management Inc., was operator of a large national group of retirement homes based in Salem, Ore. Sunwest also ran into problems with the credit crunch and became the object of a suit filed by the Securities and Exchange Commission in San Francisco in March of 2009.

Bank of Whitman loans to Sunwest totaled approximately $60 million and accounted for 118 percent of the bank’s capital.

A 2009 Federal Reserve Board audit report said lending to Sunwest was the root cause for 38 percent of the bank’s classified loans and ultimately resulted in significant losses. A classified loan, according to the report glossary, is a loan which exhibits “well-defined weaknesses and a distinct possibility of loss.”

The SEC suit against Sunwest was filed in U.S. District Court in Oregon in 2009, more than two years before the Bank of Whitman failure. The suit alleged Sunwest sought hundreds of millions of dollars from investors through a massive fraud. At the core of the fraud was Sunwest representation that potential investors could purchase ownership in a specific retirement home which would generate a 10 percent annual return.

The suit contends Sunwest actually operated as a single integrated enterprise which used investor funds to pay all operating expenses and returns to investors. The supposed profitability of each investment was largely dependent on the success of other properties in the chain and continued availability of credit for future refinancings.

According to Sheila O’Callaghan, a trial lawyer with the SEC in San Francisco, Oregon US Judge Michael Hogan granted the SEC a summary judgment to appoint a receiver and enjoin Sunwest from continued operation.

O’Callaghan said the appointed receiver is Michael Grassmeuck. His internet postings note a final return to Southwest claimants is expected by the end of this year.

O’Callaghan said the initial SEC filing against Sunwest compared the operation to a Ponzi scheme in which revenue from late investors and lenders was used to pay margins to early investors. The Ponzi comparison was cited in the March report this year by the Inspector General, but O’Callaghan explained, unlike a classic Ponzi scheme, the Sunwest clash did involve development of assets, the retirement homes.

Sunwest was hurt by the onset of the credit crunch in the summer of 2008. It was unable to maintain revenue when credit tightened and became unable to make payments to investors and creditors like the Bank of Whitman. The collapse eventually led to the SEC filing March of 2009.

A Dec. 20, 2010, report by the Grassmeuck group said 3,139 checks had been sent out to investors for a total of more than $155.8 million in a first round distribution of assets which were proceeds from the sale of the Sunwest retirement homes. The payments represented 40 cents on the dollar recovery for investors and creditors.

A second distribution, which had an anticipated return of another 20 percent, followed the first.

Concealment measures

The Inspector General’s report alleged as Bank of Whitman’s assets deteriorated, senior management used various measures to conceal the extent of the problem loans and mask the bank’s true conditions.

One of the alleged measures was replacing secured loans with unsecured loans that had questionable structures and liberal underwriting.

The report said FRB and state examiners identified a strategy that frequently involved selling a troubled note or a 100 percent participation in a troubled note to a new borrower. The bank financed the arrangement by extending an unsecured loan to the new borrower.

The report also noted a letter from several employees alleged that senior management coerced them into obtaining personal loans to purchase Bank of Whitman stock in an attempt to bolster the bank’s capital standing.

In March of 2011, five months before the bank was closed, bank employees alleged senior managers told them arrangements were being made to secure loans for them from another bank to purchase stock in Bank of Whitman.

An FRB interviewer, the report said, determined employees were presented with completed loan applications to sign, and an examination report in May of 2011 said bank officers had received lines of credit to facilitate the stock purchases.

The report noted the process appeared to be a violation of U.S. banking rules which prohibit banks from lending on or purchasing their own stock and FRB San Francisco filed appropriate notification forms.