Fraud Identification Training Sept-Oct 2022

First page Table of contents 1 Next page Last page

Fraud Identification Training - Case Studies

September 12 - October 13 , 2022

@ www.csbs.org � @csbsnews

CONFERENCE OF STATE BANK SUPERVISORS 1129 20th Street NW / 9th Floor / Washington, DC 20036 / (202) 296-2840

Fraud Identification Training Case Study Assignments

Week 1: Identify red flags and corrective measures for each of this week’s case studies. Email your findings to your CSBS Training Mentor at jim123mutual@hotmail.com.  Case Study 1: Augusta Bank and Trust  Case Study 2: Floor Plan Lending  Case Study 3: Phantom Accounts in Cyberspace  Case Study 4: The Case of The Lone Ranger Week 2: Identify reg flags and corrective measures for each of this week’s case studies. Email your findings to your CSBS Training Mentor at jim123mutual@hotmail.com.  Case Study 5: Second Avenue Bank  Case Study 6: The Broken Printer  Case Study 7: How Can We Lose?  Case Study 8: Please Release Me!  Case Study 9: Williams State Bank Week 3: Identify reg flags and corrective measures for each of this week’s case studies. Email your findings to your CSBS Training Mentor at jim123mutual@hotmail.com.  Case Study 10: Salvage Yard  Case Study 11: The Flip Side  Case Study 12: Wire Transfer Activity  Case Study 13: Jettison Bank Week 4: Identify reg flags and corrective measures for each of this week’s case studies. Email your findings to your CSBS Training Mentor at jim123mutual@hotmail.com.  Case Study 14: Aqua Valuation  Case Study 15: High Flying Bank Check Kiting  Case Study 16: Misplaced Trust  Case Study 17: PTC Arrangement Week 5: Identify reg flags and corrective measures for each of this week’s case studies. Email your findings to your CSBS Training Mentor at jim123mutual@hotmail.com.

 Case Study 18: It’s On The House  Case Study 19: A Friendly Fraud  Case Study 20: Accommodating Officer  Case Study 21: Amortizing Debt

Fraud Identification Training Case Study

Assignments WEEK ONE

Identify red flags and corrective measures for each of this week’s case studies. Email your findings to your CSBS Training Mentor at jim123mutual@hotmail.com. • Case Study 1: Augusta Bank and Trust • Case Study 2: Floor Plan Lending

• Case Study 3: Phantom Accounts in Cyberspace • Case Study 4: The Case of The Lone Ranger

CASE STUDY 1

AUGUSTA BANK AND TRUST Situation:

You are part of a team examining Augusta Bank and Trust, a $70 million commercial bank, and have been assigned the responsibility of gathering information regarding the bank’s system of internal routine and controls. Your responsibilities include verifying collateral and safekeeping. The Executive Vice President (EVP) will get you started in this effort. The EVP completes the first half, and the receptionist completes the second half of the combination lock and the main vault door is opened. After the receptionist leaves, then the EVP opens the vault compartment containing all of the bank's negotiable collateral. He states that they have a small number of loans secured by jewelry and precious metals. He then opens a vault box containing these items, which are properly recorded in the collateral register. With bank personnel present, the examiners check the collateral. A number of sealed packages found in the vault are unrecorded as to contents but are said to contain valuable silver pieces, old coins, and art work left by customers for safekeeping. Later that day, one of the Associate Examiners noticed that in numerous instances, there had been no deposits or withdrawals for six months or longer on a number of deposit accounts. In addition, the Associate Examiner reported that all exception reports covering dormant account activity are left with the Senior Vice President/Chief Lending Officer. The internal auditor spot checks dormant account electronic signature cards, which are accessible to all tellers in order to verify withdrawals. The Assistant Examiner assigned to review the cash accounts says that all cash items are held by the head teller and that these items are reported as a separate asset account on the general ledger. The Assistant Examiner notes that management maintains an adequate record of these items. The Assistant Examiner observed that when the paying and receiving teller next to the head teller's window is out, the loan officer handles the teller's cash temporarily. The Assistant Examiner also noted that tellers leave their cash drawer keys in an unlocked, empty drawer when they go to lunch. Additionally, the teller's bank stamp, date stamp, teller stamp, and some currency straps for the morning's opened packages are lying on the counter. During times of customer inactivity, the loan officer handling the teller's work uses the on-line memo post terminal to apply loan payments received in the mail. Using the teller supervisor override key, the loan officer is able to handle both the teller postings and loan entries with little problem.

CASE STUDY 1

During the examination, you balance the installment loan trial at the note teller's window so that the teller could explain any differences, should it become necessary. This teller was very helpful and cleared away several customers’ certificates of deposit (CD) that were taken to secure loans. During the balancing procedure, you observe that the officer who made the loan initials all notes. Also, several blank notes signed by the customer were in the note tray. The note teller stated these instruments are for the convenience of the bank’s best customers when they need additional funds and cannot get to the bank. The borrowers could call the bank and the proceeds would be credited to their checking accounts. After reviewing the Board minutes, you discover that the Board does not review any charged-off loans, giving the Chairman/President full discretion; however, charged off notes are segregated and under dual control. Since the bank utilizes an off-premise facility for its demand deposit accounting, you talk to the individual who is responsible for this area. The individual states that computer-rejects consist of items described as unposted and unprocessed. The unposted items are listed on a computer printout with an indication as to why they were not posted, such as: Non-Sufficient Funds (NSF), account closed, no such account number (unable to locate), hold account, etc. Another multiple-copy printout is provided on the NSF items. These NSF printouts are distributed each morning to all the lending officers for their review. The bookkeeping control clerk receives all the computer reports and any unprocessed items. Since these items were not captured during the initial sorting run due to illegible amounts or wrong account numbers, there is no printout. The control clerk then examines the unposted and unprocessed items to determine what is wrong. You notice that the control clerk also has access to an on-line computer terminal to input all demand deposit unposted or unprocessed items immediately after finding the error; however, not all demand deposit items are input by the control clerk. Some items are reprocessed with the current day's work. The control clerk explains, due to the loss of the user’s manual, some transactions have not been inputted. Any item the control clerk cannot correct and rerun is referred to an officer. You are informed that overdrafts are not carried as an asset but are deducted from demand deposits. During the examination, you have had a number of occasions to talk to the head bookkeeper that makes all journal entries to the general ledger. This person is extremely helpful and appears to be the only knowledgeable person about operations at the bank. In addition to general ledger work, the bookkeeper also works as part-time relief teller and performs monthly reconcilements of "due from" bank accounts. You check further on this matter and find that reconcilements are reviewed by the auditor and that the head bookkeeper is not authorized to sign checks drawn on these banks.

CASE STUDY 1

A spot check of debit and credit tickets reveals many instances of insufficient detail describing the transactions. Additionally, only the person making the entry initials the ticket. The examiner responsible for reviewing the securities portfolio informs you that a correspondent bank holds all securities for safekeeping and only the individual in charge of the bank's investment portfolio has the authority to move those securities. Such a request must be in letterform and sent to the correspondent bank. Other matters brought to your attention include accumulated cash over and shortage differences are maintained in two respective general ledger accounts. Such differences are not accumulated for individual tellers. Unissued official checks are held under the joint custody of a secretary and the auditor. Cashiers checks are numbered only when issued. All employees are required by management to maintain their checking accounts elsewhere other than subject bank. An Assistant Examiner informs you that in order for the bank to simplify its bookkeeping procedure, expense checks are not recorded until paid. After the preceding observations, you made an appointment with the auditor. The auditor is very cooperative and appears quite proud of the audit operation. The auditor explains that his department is directly responsible to the Vice President/Operations and to no one else. Detailed monthly audit reports are submitted to the vice president, and the auditor relies on this officer to furnish the Board with the substance of these reports. You then ask the auditor for the department's audit frequency schedule and the work papers covering audits performed this year. The auditor tries to give you full attention, but the phone rings continually as the auditor tries to answer inquiries from bank personnel regarding means and methods of handling certain operational matters.

CASE STUDY 1

IDENTIFY THE RED FLAGS

Is there Fraud at this Bank? Why or Why not? Explain your position.

CASE STUDY 2

Situation: FLOOR PLAN LENDING

During the course of an examination, you are reviewing the loan file of a recreation vehicle (RV) dealer. Total advances exceed $2.8 million. The following information is obtained from the loan file: The RV dealer and the bank entered into a financing agreement wherein the bank agreed to fund the purchase of new RVs. The bank made three advances totaling $2.8 million to fund the purchase of 22 vehicles. In return, the RV dealer provided the bank with the manufacturer’s statements of origin to the vehicles purchased. No financial information was on file and lien positions had not been perfected. No payments have been received since inception. Review of information regarding the loan officers and other lending relationships revealed the lending staff has little knowledge or experience in floor plan lending. This was confirmed in discussion with President Hefler. Given the lack of payment or perfected security interests in the vehicles, you encouraged President Hefler to perform a floor plan check. She immediately proceeded to act on your suggestion. The following week you inquired as to the results of the check, and she reported that the visit to the RV dealer’s lot had accounted for only two vehicles. The RV dealer had informed her that many of the vehicles were located at a Vacation and Travel Convention; however, a visit to the show site failed to locate the missing vehicles. Three days later she again visited the RV dealer and again found only the two vehicles seen previously. You suggested that she might want to ask the RV dealer to provide a location list for all vehicles on the floor plan. President Hefler indicated she would follow-up on that suggestion. At the wrap-up meeting the following week, President Hefler reported that a listing had been obtained from the dealer which showed six vehicles in other states and the remaining group at another show. A visit to that site, plus another site that was stated as a location, did not result in finding the missing vehicles. Therefore, you indicated that you would be listing the balance of the loan as loss in the Report of Examination (ROE).

CASE STUDY 2

IDENTIFY THE RED FLAGS

What actions should bank management take to prevent this situation?

CASE STUDY 3

PHANTOMACCOUNTS IN CYBERSPACE Situation:

You are on an examination of a $250 million community bank rated "2" for the past 10 years. The bank has a conservative board and management team who are well regarded by their peers. The bank has an in-house computer system that processes all applications except securities and credit cards. The bank's correspondent processes the securities portfolio reports and holds the securities in safekeeping. The bank issues credit cards with servicing provided by CardPlus of Ocala, Florida. CardPlus is a leading provider of turnkey card processing services for small and midrange financial institutions nationwide. Through a stand-alone CardPlus system, bank employees can process credit card payments, open new credit card accounts, and make other monetary and nonmonetary adjustments to accounts. Assistant Vice President (AVP) Paul Terguyst started with the bank three years ago as a note teller and is now a Junior Installment Loan Officer. His responsibilities include accounting for the bank's credit card program, monitoring construction loan disbursements, and processing SBA (Small Business Administration) loan payments. AVP Terguyst is a very outgoing person who is well liked by the bank's customers and staff. He is a very bright individual and is completing an MBA program while working full time at the bank. Reportedly, he has been very successful in the stock market and maintains a lifestyle that reflects his newfound wealth. You have been assigned to work on the detail/operations portion of the examination. Your assignment is to balance the loan accounts. After reviewing the bank's daily balancing procedures, researching the applicable suspense items, confirming items in process, and verifying other miscellaneous adjustments, you are satisfied that all loan categories balance, except for credit cards. While reviewing the bank's servicer-provided credit card system reports, you notice that the general ledger account does not balance with the report. As you know, the CardPlus system is a stand-alone bookkeeping system and as such, does not require offsetting transactions to the general ledger. Nonetheless, total outstanding credit card amounts should balance with the general ledger. Any difference between the two totals should have a reasonable and supportable explanation. Daily and monthly reconcilements prepared and initialed by AVP Terguyst show that the two ending balances are almost always different with little or no explanation as to the cause. The out-of-balance amounts are generally less than a thousand dollars and are not material from a financial reporting perspective. However, the frequency of the out-of-balance situations and lack of descriptive comments on the reconcilement sheets cause you concern.

CASE STUDY 3

You request a meeting with AVP Terguyst to discuss the reconcilement sheets. AVP Terguyst is very accommodating, yet somewhat elusive when fielding your direct questions. He relates that you probably don't fully understand how the CardPlus system works and that timing differences, which cause out-of-balance situations, are typical with the system. He further relates that he has too many duties at the bank and often does not have the time to record his entries on the system. AVP Terguyst concedes that documenting his reconcilements is important, and that moving forward, he will make a concerted effort to do so. He also agrees to provide you with written explanations for his balancing adjustments on the latest reconcilement sheet. You conclude from your discussion with AVP Terguyst that he has full electronic access to the bank's computer system and the stand-alone credit card system. This latest revelation does little to enhance your comfort level with regard to the bank's accounting procedures and controls. While discussing your findings with the Examiner in Charge (EIC), she relates that CardPlus services a number of banks in the area and she does not remember delays in processing causing a balancing problem. You decide to look a little more closely at AVP Terguyst's recently provided written explanations for his balancing entries. You request that bookkeeping run an activity report of the general ledger credit card loan account for the week to compare the entries with the CardPlus journal system report. Your review discloses that total postings on the CardPlus system do not balance with the general ledger because the bank's income accounts were not credited. Additionally, you note that there were a number of payments posted to individual cardholder accounts without corresponding entries to any general ledger accounts. You discuss your findings and concerns with the EIC. The EIC agrees that this situation requires further research. You and the EIC describe what you have found with the bank's Chief Operations Officer and request that the bank's internal auditor and bookkeeping department research the credit card accounts where the suspicious transactions are being posted.

CASE STUDY 3

IDENTIFY THE RED FLAGS

What is the impact of Cyber Fraud to this Bank's Risk Profile?

CASE STUDY 4

THE CASE OF THE LOAN RANGER

Situation:

You are the Examiner in Charge (EIC) of an $85 million 2-rated bank located in a remote area of the state. Four months ago, a $750 million regional out-of-state holding company purchased the bank, but the same management remains. President / Chief Executive Officer Brenda D. Seate has been with the bank for 11 years, controls most phases of bank operations, and is the senior lender. The holding company relies heavily upon bank management, who has been favorably regarded in prior Reports of Examination (ROE). As such, the holding company’s input has been limited to asset/liability management and the internal audit function. The previous ROE indicated a moderate increase in classified assets and loan administration weaknesses as well as the absence of an internal audit program. Additionally, the most recent external audit of the consolidated holding company and its eight subsidiary banks reflected an unqualified opinion. The external auditors performed an internal control review that evidenced various lending and operational deficiencies, but since the review was conducted for the holding company and subsidiaries, it was difficult to determine which deficiencies applied to this bank, if any. With this information in mind, you begin the on-site portion of the examination. Due primarily to the lack of an internal audit program at the previous examination and the internal control deficiencies noted by the external auditors, you instruct the Operations Manager (OM) to perform a thorough review of the bank’s internal controls and account balancing procedures. Since your OM will be reviewing controls for overdrafts, you also assign her the responsibility to discuss and classify the overdrafts as needed. Through discussion with the President, the OM determines that the holding company has not yet completed its initial internal audit. During her internal control review she notes that the President has sole authority to approve overdrafts and NSFs (Non-Sufficient Funds). Ms. Seate also reviews the overdraft and NSF reports, but another individual appropriately reconciles both areas. Additionally, the OM noted appropriate personnel balanced the Other Assets and Other Liabilities accounts daily, but two of the Other Assets account reconcilements did not include descriptions. These accounts were titled ‘Miscellaneous Suspense’ and ‘Miscellaneous Assets’ and represented relatively large balances in comparison to the bank’s asset size. Despite several requests to the head bookkeeper, no listing was provided. What is your next course of action?

CASE STUDY 4

The OM’s review of the overdraft listing reflected none over 30 days; however, overdrafts in four accounts titled ‘C&W I, II, III, and IV’ represented $65M of the $71M in total overdrafts. These overdrafts were cleared after the start of the examination. Somewhat curious, the OM researches these accounts and finds that C&W I, II, III, and IV are country and western-themed karaoke bars located in a large metropolitan area over 250 miles from the bank. Loan demand is weak in the bank’s trade area, and the President reportedly met C&W’s principals while on a business development trip. After the OM informs you about the C&W overdrafts, the type and location of C&W’s operations, the lax controls relative to overdraft and NSF review, and her difficulty in determining the composition of the two Other Asset accounts, you become concerned. Through review of the Customer Information File (CIF) and the loan trials, you note that C&W has four smaller loans (one to each entity) totaling $110M. Each of the four loans has a different CIF number.

IDENTIFY THE RED FLAGS

__________________________________________________________________

What actions should bank management take to prevent the situation?

_______________________________________________________________________________

__________________________________________________________________

_______________________________________________________________________________

Fraud Identification Training Case Study

Assignments WEEK TWO

Identify reg flags and corrective measures for each of this week’s case studies. Email your findings to your CSBS Training Mentor at jim123mutual@hotmail.com.

• Case Study 5: Second Avenue Bank • Case Study 6: The Broken Printer • Case Study 7: How Can We Lose? • Case Study 8: Please Release Me! • Case Study 9: Williams State Bank

CASE STUDY 5

SECOND AVENUE BANK

Situation:

You have been assigned to review several loans from two particular loan officers of Second Avenue Bank. Review the information obtained from the following loan files and formulate questions and examination techniques to answer your particular questions/suspicions:

CASE A

8/18/X8

Loan #319 in the name of Pressley Jones for $186,882. Proceeds of $185M were issued in the form of a cashier’s check #9150 to the borrower. The purpose of the loan was listed as “purchase”, with real estate pledged as collateral. A mortgage in the name of Pressley and Dana K. Jones was filed on 8- 21-X8. The address listed on the loan is 150 miles from the bank. No loan application, credit report, financial statement, income information, appraisal or title work was in the credit file. Loan #375 in the name of Fay L. Grogan, Jr., for $180,937. Proceeds of $179M were issued in the form of a cashier’s check #9165 to the borrower. The purpose of the loan was listed as “real estate purchase”. A mortgage on real estate was pledged as collateral and filed of record on 8-26-X8. The address listed on the loan is approximately 130 miles from the bank. A Uniform Residential Real Estate Application was in file. The application was blank except for the signature of Fay L. Grogan, Jr. No financial statement, income information, credit report, appraisal or title work was in file. Loan #389 in the name of Scott J. Arnett for $169,812. Proceeds of $168M were issued in the form of a cashier’s check #9179 to the borrower. The purpose of the loan was noted as “purchase real estate”. A mortgage on real estate was filed on 8-27-X8. A commitment for title insurance, effective 8-18-X8 for $169M, was in file. The commitment stated title to the real estate was vested in the name of Ted E. and Rayleen M. Hush. No appraisal, credit report, or income information was in the credit file on the borrower. A financial statement on the borrower dated 8-2-X8 is in the file but the signature on the financial statement appears to be different than those on the note and mortgage.

8/20/X8

8/21X98

CASE STUDY 5

8/21/X8

Loan #938 dated 8-21-X8 to D&D Trucking, by John Roy, in the amount of $121,242. Proceeds of this loan were distributed in the form of a cashier’s check #1396 dated 8-24-X8 for $120M to the borrower. The purpose of the loan was listed as “purchase vehicles” and collateral pledged were financing statements and lien entries on two- Freightliner trucks. These financing statements and lien entries do not appear to be filed of record. No loan application, borrowing resolution, credit report, financial statement, or income information on either the business or individual was in the file. Loan #945 dated 8-24-X8 to J. Albert Roy, in the amount of $166,792. Proceeds of this loan were distributed to the borrower in the form of a cashier’s check #1402 for $165M. A blank residential real estate application is in the file signed by J. Albert Roy. Purpose on the loan indicated the proceeds were to be used for “purchase real estate”. Mail sent to the address on the loan was returned undeliverable (no such number). No credit report, financial statement, income information, appraisal, or title work was in the file. Loan #962 in the amount of $172,357 was made on 9-8-X8 to Roy Albert. Proceeds of this loan were distributed in the form of a cashier’s check #8784 in the amount of $170M made payable to Roy Albert. The mortgage in file does not show being recorded. There was no loan application, financial information, appraisal, or credit report in file.

8/24/X8

9/8/X8

CASE B:

Name of Borrower

Loan No.

Loan Date

Gary Heskitt

778 982

9-15-X8 2-16-X9

Proceeds of #778 were reportedly used to purchase trenching equipment, which was pledged as collateral. The funds were disbursed in the form of a cashier’s check #15, dated 9-3-X8 made payable to Lake County Bank (LCB). No credit report was in the file when the loan was made. No financing statement was filed on the equipment. Loan #982 paid-off loan #778, with additional funds advanced. The additional funds were disbursed by cashier’s check #54 dated 2-17-X9 and issued to LCB. Two additional advances were made on loan #982. One, dated 3-2-X9, was issued to LCB, and the second, dated 3-29-X9 was in the form of a cashier’s

CASE STUDY 5

check to Luke Rodman. An Infiniti was pledged as additional collateral on #982 but no filed lien was found.

Name of Borrower

Loan No.

Loan Date

Kevin D. Gillon

720

2-25-X9

On 2-25-X9, loan #720 was made to Kevin D. Gillon reportedly for the purchase of a vehicle. The proceeds were disbursed in the form of a cashier’s check #759, dated 2-18-X9. The cashier’s check was issued to William J. Avery, Attorney, Trust Account and the remitter was listed as Leslie Butler/Second Avenue Bank. A Chevrolet Suburban was pledged against the loan, but no lien entry was ever filed.

Name of Borrower

Loan No.

Loan Date

Dwight Pearl

731 744

7-14-X9 8-17-X9

The purpose of loan #731 was listed as “John Deere Tractor”, which was pledged against the debt. The proceeds were disbursed in the form of two cashier’s checks. One, #3557 dated 7-13-X9, was made payable to Dwight Pearl. Mr. Pearl’s signature looks very similar to that of the loan officer, David Little. The second, #3562 also dated 7-13-X9, was made payable to View and Noise, a local appliance retailer. The personal loan worksheet on Mr. Pearl stated that Mr. Little had “known Dwight many years – Buying appliances – Bonus check in Oct. ‘X9 to pay off loan.” Mr. Pearl’s loan application listed his employer as the Wyoming State Wildlife Department. No credit report was in file as of the loan date. Loan #744 listed its purpose as “business expense.” It renewed the above note and additional funds were advanced and paid in the form of a cashier’s check. This check #9222, dated 8-11-X9, was made payable to American Title Company. No filings on any collateral were found in file.

CASE STUDY 5

IDENTIFY THE RED FLAGS

__________________________________________________________________

What actions should bank management take to prevent this situation?

__________________________________________________________________

CASE STUDY 6

THE BROKEN PRINTER Situation :

The Field Office is planning for an upcoming examination of a metropolitan bank. The proposed Examiner in Charge (EIC) sent the bank a list of information to be gathered for pickup during a one-day pre-exam visit. When the EIC and the Operations Manager (OM) arrived at the bank, the President had the requested items stacked on the Board table ready for review. The data was not well organized because much of the information had to come from different departments of the bank. Additionally, the mainframe printer did not work on the day of their visit, so the President had to manually prepare some of the reports. Nevertheless, the material gathered for the examiners was voluminous and appeared complete. The material included, but was not limited, to the following: manual transcripts of the undivided profits, the Allowance for Loan and Lease Losses, and tax accounts; general ledgers and corresponding income statements for the 3 previous year ends, and the asset review date; a loan trial; watch list; overdraft report; securities listing; strategic plan; and budget. The EIC, through the Field Office’s off-site monitoring system and his preparation of the SCOPE memo, is aware of the holding company’s and bank’s aggressive posture regarding growth. Within the last five years, the holding company acquired three other small institutions, increasing the chain total to five banks with composite ratings of “1” or “2”. This bank also opened two branch locations. The asset mix of the bank has not changed over the years and the bank continually has demonstrated satisfactory earnings performance, approximate 1.20% Return on Average Assets (ROAA) over the last three years. Likewise, asset quality is strong and improving with sound loan administration procedures in place. Despite the growth of the bank, 14% two years ago and 13% last year, the bank has maintained a Tier 1 Leverage Capital Ratio no lower than 6.18% and a Total Risk-Based Capital Ratio no less than 10.40%. Examiners knew the dividend to net income ratio would be high because of the debt servicing requirements resulting from the acquisitions; however, the capital level remained satisfactory and management was heralded as very capable in the prior Reports. The President told the examiners that management wants to retain the public’s confidence in the bank by maintaining strong capital as illustrated in the Call Reports. He stated the bank’s growth was met with periodic but timely capital injections, which demonstrate management’s continual attentiveness to the bank’s capital level. According to the President, injections were made on 9-29-X7 for $500M, on 6-30-X8 for $1.3 million, on 12-31-X8 for $700M, on 6-30-X9 for $1 million and on 9-30-X9 for $600M. He also tracks the bank’s Tier 1 Leverage Capital Ratio and supplied the examiners with the following capital activity dating back to the last examination:

CASE STUDY 6

Date

Mgmt.- Computed Tier 1 Ratio

3-Year History Annual Income

Tier 1 Lev.Capital

12-31-X7 19X7 Net Income of $2,018M 12-31-X8 19X8 Net Income of $2,316M 12-31-X9 19X9 Net Income of $2,648M

$10,905M $12,421M $14,169M

6.18% 6.35% 6.39%

Date

Dividend Schedule

Yearly Total

10-15-X7 Dividend of $800M 04-09-X8 Dividend of $200M 07-05-X8 Dividend of $800M 10-10-X8 Dividend of $1,000M 01-03-X9 Dividend of $1,000M 04-04-X9 Dividend of $500M 10-01-X9 Dividend of $1,000M

$1,500M

$2,000M

$2,500M

While at the visit, examiners checked management’s report of Tier 1 Capital and dividend to net income ratios against the UBPR (Uniform Bank Performance Report). They found the management-prepared reports to be accurate. Primary schedules of the Call Report and supporting work papers were reviewed for accuracy and completeness. No errors were noted and, because examiners have never had a problem with this bank’s Call Reports, supporting RC (Report of Condition) and RI (Report of Income) schedules were not reviewed. Team members drafted comments in the Field Office while the EIC determined loan review lists with the use of ALERT (Automated Loan Examination Report Tool). The examination began as scheduled, with the entire examination team focusing on loan review, except the OM and two other individuals. Those individuals completed the remaining detail tasks, reported the findings to the EIC, finalized comments, and put loan classifications and technical exceptions into the Report of Examination (ROE). The examiners were ready to leave the bank to begin the off-premises portion of the examination. In preparing for the exit review with the President, the EIC performed a cursory review of the ROE comments before putting his agenda together. Before the exam commenced, he had reviewed the latest available UBPR and remembered seeing a large amount of “Other Increases/Decreases” flowing in and out of capital. The capital comment did not provide an explanation of this and the EIC was ready to conclude that the OM received an explanation of the activity (possible miscoding) from management. Nonetheless, he inquired and found out no one looked into it. The OM stated he wasn’t aware of the activity because there wasn’t a need to check the supplemental schedules of the Call Reports. Additionally, he stated the President didn’t tell anyone about the activity in the capital account during the pre-exam visit, nor was any questionable activity detailed in any of the manual reports provided.

CASE STUDY 6

The EIC instructed the OM to get a complete transcript of the account from the Cashier, while he performed a wrap up with the President. The OM was unable to get the transcript because the Cashier had already left for the day. During the meeting with the President, the EIC asked about the activity flowing through the capital account. As suspected, the President explained that the amounts stemmed from entries miscoded by the new proof operator followed by correcting entries. The President stated he would have the Cashier call the Field Office next week if further explanation was needed. The EIC informed the President that he wanted the Cashier to call the OM. On Wednesday of the following week the OM still hadn’t heard from the bank so the EIC called the Cashier about the transactions. The Cashier reported he never received the message about calling the Field Office. When the EIC asked him to provide information about the activity of the capital account to the Field Office, the Cashier was reluctant. He suggested that the EIC come early for the Board meeting to meet with him.

CASE STUDY 6

IDENTIFY THE RED FLAGS/EXAM PROCEDURE WEAKNESSES

Since the Bank is not providing requested data to start the exam timely in proper format, what are the EIC's alternatives prior to the start of the Exam?

CASE STUDY 7

THE CASE OF HOW CAN WE LOSE?

Situation:

You are a team member assigned to the detail portion of an examination at an $80 million bank in Eastern Iowa. Historically, the bank has not been viewed as a problem, but prior Reports of Examination (ROE) have indicated that President Sylvester (Sly) Fox also is the bank’s Investment Officer and management is not very sophisticated. Nevertheless, the bank operates in a rural location and management has typically “kept it pretty simple.” Your first assignment is to review the bank’s investments. You appropriately review the Investment Policy, Investment Committee minutes, investment portfolio printout, and safekeeping receipts. This review reveals that the $18 million portfolio generally conforms to parameters in the Investment Policy, with the exception of $4 million in what appears to be long-term (30-year maturity), zero-coupon certificates of deposit (CD) from various banks nationwide. This type of investment is not discussed in the Investment Policy and you are unclear as to how it fits with the bank’s investment strategy. These CDs are held in safekeeping at the Arizona location of Wild West Trust Company (WWTC), an affiliate of Western Frontier Brokers, Reno, Nevada (WFB). The safekeeping receipts received from WWTC match information on the investment portfolio printout. After discussing your initial findings with the Operations Manager (OM) and Examiner In Charge (EIC), you scan the purchase invoices for more information and determine the CDs were obtained from WFB. WFB is not on the Board-approved securities dealer list. You also note that the invoices and safekeeping receipts reflect Average Annual Yields (AAY) that appear to be in line with market yields. Before discussing your investment questions with President Fox, the OM suggests that you begin your next task, which is to review the bank’s asset/liability management practices. Your review of the pre-examination planning memo indicated that the bank has had some difficulty attracting core deposits for funding, as has been the case at many banks, and obtained approximately $10 million in broker-placed CDs. You review the Asset/Liability Management Policy, noting that the use of brokered deposits is permitted. Because you have not encountered brokered deposits before, the OM directs you to review the broker contract, interest rates, and maturities as a training exercise. You note that the brokered CDs were also placed by WFB. The CDs have maturities of one year or less and interest rates well below those for comparable size and maturity CDs in the local market.

CASE STUDY 7

What is your next course of action?

You discuss the WFB tie-in of the zero-coupon CDs and brokered CDs with your OM and EIC. The EIC thinks additional investigation may be needed, but first wants to talk with President Fox. Mr. Fox stated the transactions with WFB had occurred over the past 13 months, and the bank had not gotten around to updating the Investment Policy and securities dealer list. When questioned about the transactions, President Fox indicated that a broker from WFB originally approached him about taking “market rate” brokered deposits (liabilities). This contact was a ‘cold call.’ President Fox reasoned that the bank could pay market rate for local deposits of this size just as easily, so he declined the offer. Several weeks later, the broker approached President Fox with something he called a “reverse arbitrage” transaction. According to President Fox, the WFB representative explained that the bank would buy long-term zero-coupon CDs in return for accepting below market funding from brokered CDs. President Fox stated that he made no attempt to check the asset yields and relied on the broker’s expertise; however, he reasoned that since the assets were at market rate and the liabilities were below market rate, there was “no way the bank could lose.” He indicated that the bank used WWTC for safekeeping of the CDs because that is whom WFB normally used. No due diligence checks were performed on either WFB or WWTC.

CASE STUDY 7

IDENTIFY THE RED FLAGS

__________________________________________________________________

_______________________________________________________________________________

__________________________________________________________________

What action should bank management take to prevent this situation?

__________________________________________________________________

_______________________________________________________________________________

__________________________________________________________________

CASE STUDY 8

THE CASE OF PLEASE RELEASE ME

Situation:

You are assigned to review loans for Karsten State Bank, a $250 million institution. Historically, the bank has been an “on again, off again” problem institution. Over the previous six examinations, the bank has been rated anywhere from a composite “2” to a composite “4”. The institution is currently operating under a C&D (Cease & Desist Order); however, the composite recently improved from a “4” to a “3.” Improvement is largely attributable to the positive influence of a new president. Part of your assignment is to review the bank’s indirect lease financing program, which has been in place for several years. A review of the previous Report Of Examination (ROE) indicates that there have been no problems noted in the lease portfolio. You note that lease growth has been rapid since the previous examination, despite significant non-recourse sales of leases to unaffiliated financing companies. The lease portfolio now totals approximately $35 million, which is nearly double the level noted at the previous examination. The bank currently has a master lease agreement with only one company, Pacific Industrial Credit Corp (Pacific). The master agreement specifies that Pacific will originate industrial equipment leases in accordance with underwriting terms specified by the bank. Upon the bank’s funding of the lease amount, Pacific will assign the leases to the bank. Borrowers will then remit payments directly to the bank. Under the agreement, Pacific warrants that each lease is bona fide, genuine, valid, and enforceable, and that the leased equipment has been delivered to and was accepted by the lessee. Additionally, Pacific agrees to repurchase any leases that fail to conform to those representations and to compensate the bank for failure to do so. An addendum to the master lease agreement indicates that Pacific’s president, John Barkhouse, guarantees all leases. You ask Senior Vice President (SVP) of Lending Stephen Baird for copies of financial statements for John Barkhouse and Pacific. SVP Baird indicates that the bank did not obtain financials for either Barkhouse or Pacific. SVP Baird states that there is no need to analyze financials for either entity, since it is the lessee’s financial capacity that dictates repayment and also determines whether the bank will purchase any given lease. Your review of the past-due report indicates a low level of past-due leases. Therefore, classifications per the uniform retail credit policy will be minimal.

CASE STUDY 8

You review the various lending policies for guidance on leases and note that there are still no written guidelines for this type of lending, which was noted at the previous examination. The policy does not specify desirable or undesirable types of leases or underlying collateral, structuring terms, concentration levels, collection procedures, or approval standards. When you ask SVP Baird whether you perhaps were not provided with a copy of the policy, he indicates that the bank has operated this area without formal guidance since inception. Mr. Baird indicates that he reviews and approves all lease purchases. In his opinion, the leases are similar to small consumer installment loans, and there is no need to either aggregate the credits or require Board approval. SVP Baird questions why you are doing such an extensive review of this area, when examiners have never had any problems with leases in the past. He tells you that your time would probably be better spent reviewing some of the bank’s commercial real estate loans, since that is where the past problems have been centered. He also mumbled something about conducting risk-focused examinations. You thank him for his input but tell him that you would still like to sample a few of the lease files. Your review of the files indicates that lessee financial capacity appears satisfactory in all instances. Some files do not include UCCs (Uniform Commercial Code), but a checklist in each file indicates that the customer called in to verify receipt of equipment. With some of the newer files, you note that the certificates of insurance show a single insurance carrier with signatures by John Barkhouse as agent. You also note that the equipment appraisals for some of the newer leases were prepared and signed by John Barkhouse. A quick discussion with SVP Baird indicates that the bank has not had an independent review of lease operations. SVP Baird stated that bank personnel have been too busy for such matters, since they have been required to implement all recommendations previously made by examiners to improve the bank’s overall condition and ensure that enforcement actions were lifted. Besides this, Mr. Baird also emphasizes that the level of past-due leases is low, and the lease portfolio has never been one of the bank’s problems.

CASE STUDY 8

IDENTIFY THE RED FLAGS

__________________________________________________________________

What course of action do you take?

__________________________________________________________________

What is the improper practice?

__________________________________________________________________

What actions should bank management take to prevent this situation?

__________________________________________________________________

CASE STUDY 9

WILLIAMS STATE BANK

Situation:

The bank is located in Redrock, a small community 30 miles outside of Memphis. Because of the lower housing costs and real estate taxes, cheap gas, and the proximity of the airport, a large number of people are moving out of Memphis and into Redrock. Frank Furter, the former bank president, no longer knew everyone in town. Rather than incur credit risk with individuals he hadn’t known his entire life, he decided to sell the bank, which he had owned for over 40 years. Mr. Furter shopped the bank until he found buyers willing to pay 2.7 times book up to 8% capital. Employees of this simple, very conservative bank at the time of the sale included the 67-year old president, Cashier Olga Wessel, and two teller/bookkeepers. The prospective buyers, Bill Yates and John Taylor, each have 15 years of lending and management experience and were able to arrange suitable financing for the purchase. Information on both Yates and Taylor obtained from other ROEs was limited to name and title only. In a letter to the Regional Office, the prospective owners stated that the present Board would remain intact for at least one year. Required approvals for forming the holding company and purchasing the bank's stock were obtained. Following consummation of the purchase, both men owned 15% of the one-bank holding company and Taylor’s relatives owned the remaining 70%. Yates became bank President and Taylor became Executive Vice President (EVP). During the preplanning phase of the upcoming examination scheduled for 1-15- X9, Examiner in Charge (EIC) Doug Clark became aware of the bank’s changed financial condition. Here is a profile of the bank’s performance since the purchase:

9X8

6/X8

3/X8

12/X7

12/X6

6/X5

95,500

83,700

66,400

58,300

35,200

11,000

Gross Loans

840

750

675

650

400

130

ALLL

4,500

4,400

4,200

3,650

5,300

17,200 29,700

Investments Total Assets

110,000

95,000

74,000

65,000

42,900

50,780 17,750 27,600

46,750 18,890 18,550

39,800 14,050 13,410

37,850 10,100 10,650

29,700

25,100

Core Deposits

4,600 3,950 4,250

850

> $100M

Borrowings

8,075

7,225

6,220

5,950

3,450

Equity Capital

1,400

850 525 105

385

970 800 250

400 250 150

175

Net Income Dividends

990 215

50 25

40 15

ALLL Provision

Page 2 Page 3 Page 4 Page 5 Page 6 Page 7 Page 8 Page 9 Page 10 Page 11 Page 12 Page 13 Page 14 Page 15 Page 16 Page 17 Page 18 Page 19 Page 20 Page 21 Page 22 Page 23 Page 24 Page 25 Page 26 Page 27 Page 28 Page 29 Page 30 Page 31 Page 32 Page 33 Page 34 Page 35 Page 36 Page 37 Page 38 Page 39 Page 40 Page 41 Page 42 Page 43 Page 44 Page 45 Page 46 Page 47 Page 48 Page 49 Page 50 Page 51 Page 52 Page 53 Page 54 Page 55 Page 56 Page 57 Page 58 Page 59 Page 60 Page 61 Page 62 Page 63 Page 64 Page 65 Page 66 Page 67 Page 68 Page 69 Page 70 Page 71 Page 72 Page 73 Page 74 Page 75 Page 76 Page 77 Page 78 Page 79 Page 80 Page 81 Page 82 Page 83 Page 84 Page 85 Page 86 Page 87

Made with FlippingBook - Online Brochure Maker