Fraud Identification Training Sept-Oct 2022

CASE STUDY 16

THE CASE OF MISPLACED TRUST

Situation:

You are the Asset Manager (AM) of the 3-rated, $160 million People’s Trust Bank. The previous Management component was also rated a “3”. John N. Testate dominates virtually all phases of bank policy, operation, and Board direction. He serves as Director, Chief Executive Officer (CEO), Senior Lending Officer, and head of the bank’s small $15 million Trust Department. Although the Trust Department continues to be unprofitable due to its size, Mr. Testate contends the Department provides customer convenience and is a way of “giving the customers what they want.” No previous problems have been encountered in the Trust Department and the Examiner in Charge (EIC) has assigned an Assistant Examiner to prepare a 1-page report. During the pre-examination analysis you were responsible for scoping the loan sample using ALERT (Automated Loan Examination Report Tool). You also reviewed prior ROEs (Reports of Examination) that revealed deteriorating financial trends exhibited in shrinking assets due to high charge offs, large net losses resulting from higher provisions, and classified assets exceeding 100% of Tier 1 Capital. The ROEs also discussed Mr. Testate’s extremely liberal lending and collection philosophy evidenced by capitalization of interest on classified loans, lending funds without obtaining complete or appropriate credit documentation, failing to enforce repayment programs, and failing to monitor the bank’s collateral position. Additionally, you note a history of FRB 23A and Regulation O violations in the lending area involving participations purchased and overlines. Knowing the bank’s history of lending problems, you are very cautious upon entering the bank and initially set out to balance loans. No problems are encountered. When the Officer’s Questionnaire is returned, you review it for instances of interest capitalization. None are noted. You also review the listing of participations provided at the outset of the examination and have the Operations Manager (OM) verify the listing against confirmations received. Participations balance and verified amounts match your lines sheets, and none are with affiliates. Additionally, through this review, you confirm that previously cited lending-related violations have been corrected through the sale of loans to various third-party investors. Feeling somewhat better about the situation, you continue loan review. At the end of the first two weeks, your staff has not identified any unreported interest capitalization or overlines. Balances on several previously classified loans have also reduced, but the borrowers’ financial condition does not appear to have improved. Nevertheless, some of the previously reported weak lending practices continue, including failing to obtain complete and appropriate credit documentation. An example of the type of financial information obtained on a

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