Fraud Identification Training - Case Studies

CASE STUDY 21

THE AMORTIZING DEBT

Situation: This rural North Carolina bank has total assets of $125 million and is rated a composite “2”. President Gerald Bixby dominates bank policy even though he and his brother Harold, both of whom are Directors, each own 50% of the bank stock. The Board consists of the two brothers, their spouses, the Cashier (unrelated) and two outside directors. Shortly after the last FDIC examination two years ago, President Bixby’s only son and son-in-law jointly formed a livestock feeding operation. On 7-1-X7, the bank loaned $450M for this venture and the proceeds were used to construct feeding facilities. President Bixby’s son and son-in-law each incurred one half of the debt personally. The loans are at 8% and fully amortize with seven annual payments. Payments are due each July 1 st . Examiners included the credit lines in the loan sampling for the current examination. Based upon their review of the ALERT (Automated Loan Examination Report Tool) line sheets, the examiners determined the loans were properly structured; however, through their review of the credit files, the examiners learned that the operation has been heavily leveraged and without adequate working capital since formation. A 12-31-X9 financial statement shows total liabilities of $700M over net worth of $70M. The operating statements and tax returns documented in the credit files illustrate that the operation does not have sufficient cash flow to service the debt. But the file commentary written each year after the annual review by President Bixby states, and loan payment histories demonstrate, that the debt has amortized according to the loan terms since inception. During the examination, President Bixby stated he wants his son to replace one of the outside directors. Reportedly, outside Director Dwight Washburn resigned from the Board last month after a falling out with President Bixby. Supposedly, Director Washburn wanted to tighten lending standards, while President Bixby wanted to expand into credit card lending and begin purchasing loan participations from the correspondent bank. Bank dividends totaled $200M for the year. During a review of President Bixby’s personal checking account, as part of the audit, examiners saw a $100M credit on 7-2-X9. There were also two debits each for $43,216 on 6-30-X9.

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