Fraud Identification Training Sept-Oct 2022

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.

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