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FDIC Office of Inspector General, Office of Material Loss Reviews, Report No. MLR-10-034 Material Loss Review of American United Bank, Lawrenceville, Georgia, May 2010


FDIC OIG Executive Summary


Material Loss Review of American United Bank,
Lawrenceville, Georgia
  Report No. MLR-10-034
May 2010
Why We Did The Audit

On October 23, 2009, the Georgia Department of Banking and Finance (DBF) closed American United Bank (AUB), Lawrenceville, Georgia and named the FDIC as receiver. On November 6, 2009, the FDIC notified the Office of Inspector General (OIG) that AUBís total assets at closing were $113.9 million and the estimated material loss to the Deposit Insurance Fund (DIF) was $43.8 million. As of December 31, 2009, the loss had increased to $45.2 million. As required by section 38(k) of the Federal Deposit Insurance (FDI) Act, the OIG conducted a material loss review of the failure of AUB.

The audit objectives were to (1) determine the causes of AUBís failure and the resulting material loss to the DIF and (2) evaluate the FDICís supervision of AUB, including the FDICís implementation of the Prompt Corrective Action (PCA) provisions of section 38.

Background

AUB opened for business on December 20, 2004 as a state nonmember bank regulated by the FDIC and the DBF. AUB operated a single office in Lawrenceville, Georgia, located about 25 miles north of Atlanta, Georgia. AUB pursued a traditional business plan and engaged principally in commercial real estate (CRE) and acquisition, development, and construction (ADC) lending that consisted of residential and commercial ADC and hotel/motel lending. In addition, AUB purchased and sold CRE and ADC participation loans. The bankís lending programs also included loans originated under the U.S. Small Business Administration guarantee programs.

Although AUB did not have any brokered deposits, the bank used high-priced time deposits and Federal Home Loan Bank borrowings as non-core funding sources. AUB was wholly-owned by American United Bancorp, Inc., a non-complex one-bank holding company. The bankís Board controlled 22 percent of holding company shares.

Audit Results

Causes of Failure and Material Loss

AUB failed primarily because the Board and bank management did not effectively oversee the bankís operations, particularly, by failing to ensure there were adequate risk management controls over CRE and ADC lending activities. The institution grew rapidly after opening and quickly developed CRE and ADC concentrations. As a result of inadequate controls and declining economic and real estate market conditions, the quality of AUBís loan portfolio and the bankís financial condition began to deteriorate in 2007. The bankís condition steadily declined until June 2009, when examiners determined it to be critically deficient. The associated losses and provisions depleted AUBís earnings and capital. Ultimately, AUBís capital position became Critically Undercapitalized, resulting in an insolvent institution. AUB was closed due to the overall deterioration in the bankís financial condition, including its loan portfolio, earnings, and capital.






Executive Summary

Material Loss Review of American United Bank,
Lawrenceville, Georgia
  Report No. MLR-10-034
May 2010

The FDICís Supervision of AUB

From February 2005 until the bank failed in October 2009, the FDIC, in conjunction with the DBF, provided ongoing supervision of AUB through five onsite risk management examinations and four visitations. During the de novo period, examiners generally concluded that AUBís overall financial condition was sound and managementís performance and oversight was satisfactory. However, the DBFís February 2009 visitation identified significant deterioration in AUBís financial condition, which examiners determined had become more pronounced at the time of the joint June 2009 examination. Through their supervisory efforts, the FDIC and the DBF identified and brought key risks to the attention of the bankís Board and management, including the concerns regarding AUBís Board and management oversight, high levels of CRE and ADC concentrations, and associated weak risk management practices.

The FDIC and the DBF initiated enforcement actions in 2009 to address risk management deficiencies and AUBís deteriorating financial condition. Although the FDIC and the DBF closely monitored AUB, and the FDIC downgraded certain component ratings at the October 2007 examination, an additional rating downgrade and supervisory actions may have been warranted. Specifically, given the deficiencies and risks identified at the 2007 examination, it may have been prudent for the FDIC to downgrade AUBís management rating and/or include provisions to address management and asset quality in the supervisory action taken at that time, in light of the bankís level of asset concentrations. In addition, supervisory action may have been prudent when offsite monitoring indicated increasing risk at AUB after the October 2007 examination and before the DBFís February 2009 visitation.

With respect to issues discussed in this report, the FDIC has issued guidance that reemphasizes managing risks associated with CRE and ADC concentrations and de novo institutions, as well as addresses communicating and following up on identified risks and deficiencies. The FDIC also implemented an examiner training initiative that emphasizes the need to assess a bankís risk profile using forward-looking supervision. The training, among other things, addressed the need for examiners to consider management practices as well as the bankís financial performance or trends in assigning ratings as allowable under existing examination guidance.

With respect to PCA, we concluded that the FDIC had properly implemented applicable PCA provisions of section 38 based on the supervisory actions taken for AUB.

Management Response

After we issued our draft report, we met with management officials to further discuss our results. Management provided additional information for our consideration, and we revised our report to reflect this information, as appropriate. On May 5, 2010, the Director, Division of Supervision and Consumer Protection (DSC), provided a written response to the draft report. That response is provided in its entirety as Appendix 4 of this report.

In its response, DSC reiterated the OIGís conclusions regarding the causes of AUBís failure. With respect to our assessment of supervision, DSC noted AUBís significant growth between 2006 and 2008 and stated that examiners identified key risks including inadequate Board and management oversight, the bankís high CRE and ADC concentrations, and associated weak risk management practices. In addition, DSC stated that the AUB Board entered







Executive Summary

Material Loss Review of American United Bank,
Lawrenceville, Georgia
  Report No. MLR-10-034
May 2010

into an Memorandum of Understanding with the FDIC and the DBF to address weaknesses identified at the February 2009 visitation and that the FDIC and DBF took action through a formal Cease and Desist Order when AUBís management and Board were unable to sufficiently address the cited problems.

Regarding de novo institutions, DSC stated that the supervisory program for these banks has been extended so that these institutions receive a full-scope examination every year for 7 years, as opposed to 3 years. In addition, DSC stated that business plans are receiving careful analysis prior to an institutionís opening and are being closely monitored against approved financial projections throughout the 7-year period. Further, DSC stated that a Financial Institution letter issued in August 2009 describes the program changes for de novo institutions and warns that changes to business plans undertaken without required prior notice may subject institutions or their insiders to civil money penalties.




























Contents

Page
Background 2
Causes of Failure and Material Loss 2
Board and Management Oversight 3
CRE and ADC Lending Strategy, Including Participation Loans 6
Credit Risk Management Practices 9
Allowance for Loan and Lease Losses and Adversely Classified Items 10
The FDICís Supervision of AUB 11
Supervisory History 12
Supervisory Response to Board and Management Oversight 14
Supervisory Response to CRE and ADC Concentrations, Including Participation Loans 15
Supervisory Response to Offsite Monitoring Findings 18
Supervisory Response to Credit Risk Management Practices 19
Implementation of PCA 20
Corporation Comments 22
Appendices  
1. Objectives, Scope, and Methodology 23
2. Glossary of Terms 25
3. Acronyms 27
4. Corporation Comments 28
Tables  
1. Selected Financial Information for AUB 2
2. AUBís Projected and Actual Levels for Real Estate-Related Loans 5
3. AUBís CRE and ADC Concentrations as a Percentage of Total Capital 8
4. AUBís Adversely Classified Items and ALLL by Examination and Visitation Dates 11
5. AUBís Supervisory History from 2005 to 2009 12
6. AUBís Offsite Monitoring Results for Select 2008 Call Report Periods 18
7. AUBís Capital Ratios Relative to PCA Thresholds for Well Capitalized Banks 21
Figure  
Composition and Growth of AUBís Loan Portfolio 6






FDIC, Federal Deposit Insurance Corporation, Office of Material Loss Review,  3501 Fairfax Drive, Arlington, VA 22226-3500
DATE: May 6, 2010
 
MEMORANDUM TO:Sandra L. Thompson, Director
Division of Supervision and Consumer Protection
 
FROM:Stephen M. Beard [Electronically produced version; original signed by Stephen M. Beard]
Assistant Inspector General for Material Loss Reviews
 
SUBJECT: Material Loss Review of American United Bank,
Lawrenceville, Georgia (Report No. MLR-10-034)
 

As required by section 38(k) of the Federal Deposit Insurance (FDI) Act, the Office of Inspector General (OIG) conducted a material loss1 review of the failure of American United Bank (AUB), Lawrenceville, Georgia. The Georgia Department of Banking and Finance (DBF) closed the institution on October 23, 2009, and named the FDIC as receiver. On November 6, 2009, the FDIC notified the OIG that AUBís total assets at closing were $113.9 million and the estimated material loss to the Deposit Insurance Fund (DIF) was $43.8 million. As of December 31, 2009, the loss had increased to $45.2 million.

When the DIF incurs a material loss with respect to an insured depository institution for which the FDIC is appointed receiver, the FDI Act states that the Inspector General of the appropriate federal banking agency shall make a written report to that agency. The report is to consist of a review of the agencyís supervision of the institution, including the agencyís implementation of FDI Act section 38, Prompt Corrective Action (PCA); a determination as to why the institutionís problems resulted in a material loss to the DIF; and recommendations to prevent future losses.

The objectives were to (1) determine the causes of AUBís failure and the resulting material loss to the DIF and (2) evaluate the FDICís supervision2 of AUB, including the FDICís implementation of the PCA provisions of section 38 of the FDI Act. This report presents our analysis of AUBís failure and the FDICís efforts to ensure that AUBís Board of Directors (Board) and management operated the institution in a safe and sound manner. The report does not



1As defined by section 38(k)(2)(B) of the FDI Act, a loss is material if it exceeds the greater of $25 million or 2 percent of an institutionís total assets at the time the FDIC was appointed receiver.
2The FDICís supervision program promotes the safety and soundness of FDIC-supervised institutions, protects consumersí rights, and promotes community investment initiatives by FDIC-supervised insured depository institutions. The FDICís Division of Supervision and Consumer Protection (DSC) (1) performs examinations of FDIC-supervised institutions to assess their overall financial condition, management policies and practices (including internal control systems), and compliance with applicable laws and regulations and (2) issues related guidance to institutions and examiners.










contain formal recommendations. Instead, as major causes, trends, and common characteristics of financial institution failures are identified in our material loss reviews, we will communicate those to management for its consideration. As resources allow, we may also conduct more in-depth reviews of specific aspects of DSCís supervision program and make recommendations, as warranted. Appendix 1 contains details on our objectives, scope, and methodology. Appendix 2 contains a glossary of key terms and Appendix 3 contains a list of acronyms. Appendix 4 contains the Corporationís comments on this report.

Background

AUB opened for business on December 20, 2004 as a state nonmember bank regulated by the FDIC and the DBF. AUB operated a single office in Lawrenceville, Georgia, located about 25 miles north of Atlanta, Georgia. AUB pursued a traditional business plan and engaged principally in commercial real estate (CRE) and acquisition, development, and construction (ADC) lending that consisted of residential and commercial ADC and hotel/motel lending. In addition, AUB purchased and sold CRE and ADC participation loans.3 The bankís lending programs also included loans originated under the U.S. Small Business Administration guarantee programs.

Although AUB did not have any brokered deposits, the bank used high-priced time deposits and Federal Home Loan Bank borrowings as non-core funding sources. AUB was wholly-owned by American United Bancorp, Inc., a non-complex one-bank holding company. The bankís Board controlled 22 percent of holding company shares.

Table 1 summarizes selected elements of AUBís financial condition for the quarter ending September 2009, and for the 5 preceding calendar years.

Table 1: Selected Financial Information for AUB
Financial Measure Sept-09 Dec-08 Dec-07 Dec-06 Dec-05 Dec-04
(Dollars in Thousands)
Total Assets 110,094 118,737 104,739 65,958 27,124 10,727
Total Loans 82,734 90,374 73,910 41,501 20,549 0
Total Deposits 102,386 103,710 87,571 56,615 18,163 1,089
Net Income (Loss) (6,908) (2,183) 239 230 (636) (84)
Source: Uniform Bank Performance Reports (UBPR) for AUB.

Causes of Failure and Material Loss

AUB failed primarily because the Board and bank management did not effectively oversee the bankís operations, particularly, by failing to ensure there were adequate risk management




3 Some of AUBís participation loans were purchased from and sold to other failed financial institutions, including Haven Trust Bank, Alpha Bank & Trust, and Security Bank, all of which were located in the Atlanta, Georgia area.



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controls over CRE and ADC lending activities. The institution grew rapidly after opening and quickly developed CRE and ADC concentrations. As a result of inadequate controls and declining economic and real estate market conditions, the quality of AUBís loan portfolio and the bankís financial condition began to deteriorate in 2007. The bankís condition steadily declined until June 2009, when examiners determined it to be critically deficient. The associated losses and provisions depleted AUBís earnings and capital. Ultimately, AUBís capital position became Critically Undercapitalized, resulting in an insolvent institution. AUB was closed due to the overall deterioration in the bankís financial condition, including its loan portfolio, earnings, and capital.

Board and Management Oversight

During its short existence, AUBís Board and management failed to effectively supervise bank operations and promote the overall welfare of the institution. According to DSCís Risk Management Manual of Examination Policies (Examination Manual), the quality of bank management, including its Board and executive officers, is probably the single most important element in the successful operation of a bank. The Board has the overall responsibility and authority for formulating sound policies and objectives for the institution and for effectively supervising the institutionís affairs. Executive management has the primary responsibility of implementing the Boardís policies and objectives into the bankís day-to-day operations and affairs. Therefore, an interested, informed, and vigilant Board and the selection of a competent executive management team are both critical to the successful operation of any bank.

Given AUBís de novo status,4 the knowledge, experience, and involvement of the bankís Board and executive officers were especially critical to ensure the success of AUBís operations. Previously, the FDIC had determined that certain problems at newly-chartered banks during their first 6 years were attributable to various risk factors, including weak oversight by management, inexperience and turnover in key positions, rapid asset growth, and concentrations in CRE and ADC loans. As described below and in other sections of this report, AUBís management was deficient in critical duties and responsibilities and experienced many of these previously identified risk factors.

Inexperience of AUBís Board and Senior Management

Examiners first noted concerns regarding AUBís proposed management during the FDICís pre-opening investigation. Examiners particularly noted that none of the Board members, with the exception of the Chief Executive Officer (CEO), had any banking experience. Therefore, the




4De novo institutions are subject to additional supervisory oversight and regulatory controls, including the development and maintenance of a current business plan and increased examination frequency. When AUB received its deposit insurance in 2004, the de novo period for institutions was 3 years. However, in August 2009, the FDIC issued Financial Institution Letter (FIL) 50-2009, entitled Enhanced Supervisory Procedures for Newly Insured FDIC-Supervised Depository Institutions, that extended the de novo period for newly-chartered institutions to 7 years for supervision, examinations, capital, and other requirements and supplemented existing guidance for processing deposit insurance applications for de novo institutions for which the FDIC is the primary federal regulator.



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FDICís Final Order for Deposit Insurance5 required AUB to appoint at least two additional directors that had previous banking and/or bank director experience to the Board. During the November 2005 examination,6 examiners determined that AUB had complied with this provision of the Final Order.

Examiner concern regarding managementís lack of experience was also noted at the bankís first examination conducted in June 2005. Those concerns related to (1) managementís inattention to primary responsibilities, (2) the Chief Lending Officerís (CLO) lack of experience in ADC lending, (3) the CEO/Presidentís lack of lending experience, and (4) managementís inability to originate loans during the bankís first 6 months of operations.

Inattention to Primary Responsibilities

At the DBF June 2005 examination and concurrent FDIC visitation, examiners noted that executive officers, such as the President and CLO, appeared to be more involved with the day-to-day operations of the bank than their primary areas of responsibility of making loans and other duties. Further, during the DBFís June 2005 examination, examiners observed that four directors had had less than satisfactory attendance at Board meetings. Concerns regarding poor attendance at Board meetings and other committee meetings, such as the Asset/Liability Committee and Audit Committee, were reported at the subsequent November 2005 and October 2006 examinations.

Key Management Turnover

The continuity of individuals hired for critical management positions became a problem early in AUBís existence due to significant turnover in senior level positions. Examiners noted that finding and retaining qualified individuals had been challenging for the institution and by 2007 AUB had employed three CLOs and two Chief Financial Officers (CFO). Adding to the lack of continuity of AUBís management was the removal of four directors from the Board, termination of five senior management members during 2008, and the retirement and resignation of two senior bank officials during 2009.

Failure to Ensure Compliance with Laws, Rules, and Regulations

AUB was cited for apparent violations of state and/or federal laws, rules, and regulations or contraventions to interagency policy in each of the bankís five examinations. Those apparent violations and contraventions related, but were not limited to, inadequate risk management




5 The Final Order for Deposit Insurance imposed 15 conditions on AUB to comply with during its first 3 years of operation. The conditions were related, but not limited to: (1) operating within the parameters of the bank's business plan with notification to the FDIC of major deviations from the plan within 60 days; (2) maintaining Tier 1 Capital at not less than 8 percent and an adequate Allowance for Loan and Lease Losses (ALLL); and (3) obtaining annual audits of the bank's financial statements by an independent auditor for at least the first 3 years of operation.
6 Unless otherwise noted in this report, references to examination and visitation dates will refer to the month and year of the examination or visitation start dates.



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practices for purchased participation loans,7 inadequate real estate lending standards, the lack of an election for an internal auditor, and an inadequate methodology for the ALLL. In addition, AUB management failed to ensure that the bank complied with Regulation O of the Federal Reserve Act, with apparent violations of Regulation O cited at two of the bankís five examinations.

Deviation from Its Business Plan8

Soon after AUB opened, the bank rapidly grew, with annual loan growth rates of 153 percent in 2005 and 143 percent in 2006. Although AUBís business plan included CRE lending, AUB quickly and substantially exceeded financial projections related to its real estate lending activities based on actual year-end financial data, as indicated in Table 2, and significantly increased the risk to the bank.

Table 2: AUBís Projected and Actual Levels for Real Estate-Related Loans
Period Ended Real Estate Loans Percentage of Total Loans
Projected Actual Projected Actual
  (Dollars in Thousands) (Percentages)
December 2005 $7,800 $19,663 51.32 95.69
December 2006 $21,000 $38,066 50.60 91.72
December 2007 $34,650 $71,324 51.22 96.50
Source: OIG analysis of AUBís business plan, examination reports, and UBPRs.

AUBís business plan did not specifically indicate that the bankís lending strategy would result in concentrations in higher-risk CRE and ADC loans. On the contrary, the business plan stated that AUB would (1) not engage in speculative lending and (2) diversify the bankís loan portfolio by including commercial and industrial and other consumer loans in its portfolio. By the October 2007 examination, which was based on financial data as of June 30, 2007, the level of CRE and speculative residential construction loans totaled $62.1 million and represented 642 percent of the bankís Tier 1 Capital. As indicated by Table 2 above, the level of CRE loans as of June 30, 2007 was almost twice the level AUB had projected for December 2007.

AUBís noncompliance with its business plan also involved the failure to adhere to other controls that, in part, were the basis for the FDICís decision to approve the bankís




7Rule 80-1-5.04(1) of the Georgia DBF states that the portion of a loan which is sold by the originating bank to another bank must conform to all laws and regulations applicable to that category of loan to the same extent as if the purchasing bank had originated the loan itself (i.e., collateral documentation, maturity, loan-to-value, maximum loan limits, etc.). During the June 2005 examination, examiners noted that files for some of AUBís purchased participations did not contain adequate loan documentation.
8 The FDICís Final Order for Deposit Insurance contained a provision that required the bank to operate within the parameters



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application for deposit insurance. For example, the business plan stated that AUB would:

  • carefully manage its commercial loans in order to limit the risk associated with this type of lending. Instead, AUB concentrated its loan portfolio in high-risk CRE loans, which significantly increased the risk to the bank, and failed to follow adequate risk management controls to mitigate such risk.
  • review the bankís business plan on an annual basis and revise it as appropriate. However, AUBís Board did not review or revise the bankís business plan during the de novo period to address changing economic conditions and mitigate the risk to the bank.

CRE and ADC Lending Strategy, Including Participation Loans

From its inception, AUB pursued a business strategy to concentrate its loan portfolio in CRE and ADC and to include an extensive amount of purchased participations in the portfolio.

CRE and ADC Loan Concentrations

As shown in Figure 3, CRE and ADC accounted for $17 million, or 85 percent of the bankís loan portfolio as of December 31, 2005, and continued to be the focus of AUBís lending strategy in the ensuing years.

Composition and Growth of AUBís Loan Portfolio
[ D ]







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Extensive growth in AUBís assets occurred between 2005 and 2008. During that period, other CRE lending increased from $7 million to $45 million (peaking at $54 million during 2007) and ADC lending increased from $10 million to $36 million. In addition, AUBís annual loan growth exceeded the bankís peer group9 in 2006 and 2007. Although growth in a bankís loan portfolio is expected during the de novo phase, such growth should be accomplished in a prudent manner and accompanied by adequate risk management controls to mitigate the risk.

As AUBís loan portfolio grew, the concentration of CRE and ADC loans to Total Capital increased the risk to the bank and, as the quality of those loans deteriorated, AUBís capital levels and earnings eroded. While AUBís Total Risk-Based Capital ratio was slightly above its peer group in December 2006, this capital ratio progressively fell below the bankís peer group during 2007 and continued to decline until the bank failed. In addition, the bankís earnings significantly declined between December 2007 and December 2008 with deterioration continuing throughout 2009.

The FDIC, the Office of the Comptroller of the Currency, and the Board of Governors of the Federal Reserve System issued joint guidance in December 2006, entitled, Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices (Joint Guidance).10 Although the Joint Guidance does not establish specific CRE lending limits, it defines criteria to identify institutions potentially exposed to significant CRE concentration risk. According to the guidance, a bank that has experienced rapid growth in CRE lending, has notable exposure to a specific type of CRE, or is approaching or exceeds the following supervisory criteria may be identified for further supervisory analysis of the level and nature of its CRE concentration risk:

  • Total reported loans for construction, land development, and other land (referred to in this report as ADC) representing 100 percent or more of Total Capital; or
  • Total CRE loans representing 300 percent or more of Total Capital where the outstanding balance of the institutionís CRE loan portfolio has increased by 50 percent or more during the prior 36 months.

As indicated in Table 3, AUBís CRE and ADC concentrations exceeded the levels outlined in the 2006 Joint Guidance that may be identified for further supervisory analysis from 2007 through June 2009.




9Institutions are assigned to 1 of 15 peer groups based on asset size, number of branches, and whether the institution is located in a metropolitan or non-metropolitan area. Through 2008, AUBís peer group included institutions established in 2004 with assets less than $750 million. In 2009, AUBís peer group included all commercial banks with assets between $100 million and $300 million in a metropolitan area with two or fewer full-service offices.
10 On April 1, 2010, DSC issued guidance, entitled, Clarification of Calculation in Guidance on Commercial Real Estate, to provide procedures for calculating the total CRE loan ratio specified in the 2006 Joint Guidance and referenced in the March 17, 2008 FIL entitled, Managing Commercial Real Estate Concentrations in a Challenging Environment (FIL-22-2008).



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In addition, AUBís Loan Policy recognized the need to closely monitor concentrations for adverse financial or economic conditions, stated that concentrations would be limited, and established guidelines for concentrations based on the perceived risk. However, in 2007, AUBís CRE level significantly increased from 359 percent of 557 percent; and in 2008, AUB began to exceed the risk limits of 600 percent and 300 percent of Total Capital established in the bankís Loan Policy for CRE and ADC concentrations, respectively, and continued to exceed those limits in 2009.

Table 3: AUBís CRE and ADC Concentrations as a Percentage of Total Capital
  Dec-05 Dec-06 Dec-07 Dec-08 June-09b
CREa 195% 359% 557% 601% 885%
ADC 114% 90% 128% 414% 569%
Source: UBPRs for AUB.
a Percentages for 2007 through June 2009 exclude owner-occupied CRE loans.
b The increase in risk exposure in June 2009 was due primarily to the decline in AUBís capital level.

The Joint Guidance states that the agencies had observed an increasing trend in the number of institutions with concentrations in CRE loans and noted that rising CRE concentrations could expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the general CRE market. Indeed, AUBís earnings were significantly and negatively impacted as CRE and ADC risk increased amid the economic downturn. Between December 2006 and December 2008, AUBís net income decreased from $230,000 to negative $2.2 million. AUBís earnings continued to deteriorate through September 2009, decreasing to negative $6.9 million.

Participation Loans

Further increasing AUBís risk profile was the bankís difficulty in originating loans and decision to include a significant number of purchased participation loans in its loan portfolio. Examiners first expressed concern regarding the extent of those loans and the lack of adequate risk management controls at the June 2005 examination and noted that an alarming level of purchased participations represented 75 percent of the bankís loan portfolio. Examiners recommended that AUB increase the bankís originated loans to aid in the long-term profitability of the institution. By the November 2005 examination, purchased participations still represented the majority of the loan portfolio, at 51 percent.

Eventually, many of the participation loans were adversely classified. Adverse loan classifications totaled $4 million during the October 2007 examination. The six loans adversely classified in 2007 were primarily commercial and CRE-related loans and included two participation loans. Adverse loan classifications increased to $33 million during the June 2009 examination. In 2009, all but one of the classifications were CRE loans and $7 million, or about 21 percent, were participation loans. By July 2009, AUBís participation loans accounted for 19 percent of the bankís total gross loans and 19 percent of the bankís CRE loans.







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Credit Risk Management Practices

AUBís Board did not ensure that management established effective risk management practices sufficient to limit the bankís exposure to CRE and ADC concentrations and purchased participations, allowing the bank to grow significantly without risk limits and monitoring practices commensurate with the increased risk associated with AUBís loan portfolio.

The FDIC has recognized the need for effective risk management controls for ADC concentrations, in particular, and CRE concentrations, in general, as indicated below.

  • FIL-110-98, entitled, Internal and Regulatory Guidelines for Managing Risks Associated with Acquisition, Development, and Construction Lending, dated October 8, 1998, states that ADC lending is a highly specialized field with inherent risks that must be managed and controlled to ensure that the activity remains profitable.
  • In addition, according to the Joint Guidance, strong risk management practices are important elements of a sound CRE lending program, particularly when an institution has a concentration in CRE loans.

Further, according to the Examination Manual, institutions that purchase loan participations must make a thorough, independent evaluation of the transactions and the risks involved before committing any funds. Institutions should also apply the same standards of prudence, credit assessment, approval criteria, and ďin-houseĒ limits that would be employed if the purchasing organization were originating the loan.

Nevertheless, examiners identified deficiencies in AUBís loan underwriting and administration at most of the bankís examinations. Such deficiencies included, but were not limited to:

  • loan underwriting and credit administration weaknesses related to purchased participations, including inadequate documentation of appraisals and loans that exceeded the Supervisory Loan-to-Value (LTV);
  • a lack of established limits for the bankís speculative construction loans, the need to implement more detailed monitoring procedures for the developing ADC concentration, and the lack of current borrower financial statements and tax returns; and
  • an inadequate Loan Policy as it related to establishing appropriate maximum percentages to Total Capital for CRE and ADC lending and addressing other risk management controls outlined in the Joint Guidance.

In addition, at the June 2009 examination, examiners concluded that AUBís risk management controls were less than satisfactory and were responsible for the bankís high level of adversely classified assets. Control weaknesses related to AUBís failure to:







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  • comply with its internal Loan Policy, considering the concentration in CRE exceeded the bankís 600 percent policy limit;
  • include global cash flow reviews, balance sheet analyses, comprehensive financial analyses, projected debt service coverage or debt-to-income ratios, where appropriate, in the bankís underwriting process;11
  • identify adequate secondary sources of repayment and limit reliance on the use of interest reserves and interest-only loans, which represented $20.3 million of the total $33 million of adversely classified items; and
  • adequately underwrite and administer loan participations, which represented $7 million, or 21 percent, of the adversely classified items.

Allowance for Loan and Lease Losses and Adversely Classified Items

The Interagency Policy Statement on Allowance for Loan and Lease Losses Methodologies requires an institution to maintain an appropriate ALLL level, discusses items that need to be addressed in written policies and procedures, and describes methodologies that institutions need to use to determine an appropriate level. In addition, the DBFís Approval of Articles of Incorporation for American United Bank, dated July 12, 2004, required AUB, during the de novo period, to maintain an ALLL that represented at least 1 percent of the bankís outstanding loans. Although AUB complied with this requirement, the substantial deterioration in the bankís loan portfolio eventually rendered the allowance inadequate.

Prior to 2007, examiners concluded that AUB did not have any adversely classified items and the bankís ALLL methodology and funding level were adequate. However, beginning with the October 2007 examination, examiners began to identify and express concerns regarding AUBís ALLL methodology and/or funding.

  • The October 2007 examination noted that AUB needed to expand its ALLL methodology to include Financial Accounting Standards (FAS) 5 and FAS 114 considerations.12
  • Subsequent examinations and visitations conducted in February 2009 and June 2009 determined that AUBís ALLL methodology still needed improvement. The June 2009 joint examination determined that management had failed to (1) correctly implement FAS 5 and



11FIL-22-2008, entitled, Managing Commercial Real Estate Concentrations in a Challenging Environment, issued March 17, 2008, provides key risk management processes for institutions with CRE concentrations, one of which is to maintain updated financial and analytical information for borrowers, and states that global financial analyses of obligors should be emphasized.
12Statement of Financial Accounting Standards No. 5, Accounting for Contingencies and FAS No. 114, Accounting by Creditors for Impairment of a Loan.



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    FAS 114, resulting in a contravention to the Interagency Policy Statement on Allowance for Loan and Lease Losses Methodologies, and (2) adequately fund the ALLL.

Further, examiners reported that significant deterioration in AUBís asset quality, initially noted at the October 2007 examination, had become substantial, as indicated in Table 4.

Table 4: AUBís Adversely Classified Items and ALLL by Examination and Visitation Dates
Category Jun-05 Nov-05 Oct-06 Oct-07 Feb-09 Jun-09
(Dollars in Thousands)
Adversely Classified Items 0 0 0 3,991 11,574 33,209
Adversely Classified Coverage Ratio 0 0 0 39% 117% 339%
ALLL Funding 40 96 328 593 2,453 2,453
Source: Examination reports for AUB and the DBF February 2009 visitation of AUB.

As noted previously, of the loans that were adversely classified, all but one was CRE-related. As the bankís asset quality deteriorated and the level of adversely classified items increased, AUBís earnings and capital were negatively impacted. Specifically, earnings decreased from $230,000 at December 31, 2006, to negative $6.9 million as of September 30, 2009. The decrease in AUBís capital is discussed later in the Implementation of PCA section of this report.

The FDICís Supervision of AUB

From February 2005 until the bank failed in October 2009, the FDIC, in conjunction with the DBF, provided ongoing supervision of AUB through five onsite risk management examinations and four visitations. During the de novo period, examiners generally concluded that AUBís overall financial condition was sound and managementís performance and oversight was satisfactory. However, the DBFís February 2009 visitation identified significant deterioration in AUBís financial condition, which examiners determined had become more pronounced at the time of the joint June 2009 examination. Through their supervisory efforts, the FDIC and the DBF identified and brought key risks to the attention of the bankís Board and management, including the concerns regarding AUBís Board and management oversight, high levels of CRE and ADC concentrations, and associated weak risk management practices.

The FDIC and the DBF initiated enforcement actions in 2009 to address risk management deficiencies and AUBís deteriorating financial condition. Although the FDIC and the DBF closely monitored AUB, and the FDIC downgraded certain component ratings at the October 2007 examination, an additional rating downgrade and supervisory actions may have been warranted. Specifically, given the deficiencies and risks identified at the 2007 examination, it may have been prudent for the FDIC to downgrade AUBís management rating and/or include provisions to address management and asset quality in the supervisory action taken at that time, in light of the bankís level of asset concentrations. In addition, supervisory action may







11






have been prudent when offsite monitoring indicated increasing risk at AUB after the October 2007 examination and before the DBFís February 2009 visitation.

With respect to issues discussed in this report, the FDIC has issued guidance that reemphasizes managing risks associated with CRE and ADC concentrations and de novo institutions, as well as addresses communicating and following up on identified risks and deficiencies. The FDIC also implemented an examiner training initiative that emphasizes the need to assess a bankís risk profile using forward-looking supervision. The training, among other things, addressed the need for examiners to consider management practices as well as the bankís financial performance or trends in assigning ratings as allowable under existing examination guidance.

Supervisory History

The FDIC and the DBF provided ongoing supervision of AUB through risk management examinations, onsite visitations, offsite monitoring, and supervisory actions. Table 5 summarizes key information related to AUBís onsite examinations and visitations, including the bankís supervisory ratings.13

Table 5: AUBís Supervisory History from 2005 to 2009
Examination or Visitation Start Date Agency Supervisory Ratings (UFIRS) Supervisory or Enforcement Actions
02/18/2005* DBF Not applicable None
06/13/2005 DBF 222312/2 None
06/20/2005* FDIC Not applicable None
11/07/2005 FDIC 112312/2 None
10/09/2006 DBF 112312/2 None
10/29/2007 FDIC 222222/2 Bank Board Resolution (BBR)ĖEffective 02/26/2008.
07/16/2008* DBF Not applicable None
02/17/2009* DBF 433422/4
(interim downgrade)
Memorandum of Understanding (MOU)ĖEffective 05/14/2009.
06/29/2009 Joint 555544/5 PCA DirectiveĖEffective 8/18/2009. Problem Bank MemorandumĖ8/28/2009. Cease and Desist Order (C&D)ĖEffective 10/9/2009.
Source: Examination reports and DSC Supervisory History for AUB.
* Denotes visitations.

AUB consistently received composite ď2Ē CAMELS ratings during its de novo period from December 2004 through December 2007. AUBís examination cycle changed to an




13Financial institution regulators and examiners use the Uniform Financial Institutions Rating System (UFIRS) to evaluate a bankís financial condition and operations in six components represented by the CAMELS acronym: Capital adequacy, Asset Quality, Management practices, Earnings performance, Liquidity position, and Sensitivity to Market Risk). Each component, and an overall composite score, is assigned a rating of 1 through 5. A 1 indicates the highest rating, strongest performance and risk management practices, and least degree of supervisory concern, while a 5 indicates the lowest rating, weakest performance, inadequate risk management practices, and, therefore, the highest degree of supervisory concern.



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18-month period once its de novo period ended because the bank met the applicable conditions. Accordingly, AUBís next examination was not performed until June 2009.

The October 2007 examination concluded that the overall condition of AUB was satisfactory and the level of classified assets was moderate. Although examiners noted that AUB needed to improve the monitoring of the bankís significant CRE portfolio and the management of its information systems, they concluded that bank management was working to address the noted deficiencies. Examiner concerns with the bankís management information system resulted in AUB adopting a BBR to address those deficiencies. The BBR did not, however, address risk management deficiencies related to (1) significant growth during the de novo period and a lack of compliance with the business plan, (2) substantial CRE and ADC concentrations, (3) the level of adversely classified assets, or (4) the high risk limits for CRE-related lending established in AUBís Loan Policy.

By February 2009, the risk management deficiencies, in conjunction with the economic downturn, resulted in significant deterioration in the bankís CRE and ADC concentrations that the Board and management would not be able to rectify. The DBFís February 2009 visitation found substantial deterioration in AUBís financial condition and, based on that deterioration, downgraded all of the bankís CAMELS ratings, except liquidity and sensitivity to market risk. Examiners also downgraded the bankís composite rating to a ď4Ē, indicating, in part:

  • serious financial or managerial deficiencies that resulted in unsatisfactory performance;
  • weaknesses and problems that were not being satisfactorily addressed or resolved by the Board and management;
  • unacceptable risk management practices relative to the institutionís size, complexity, and risk profile; and
  • generally unsafe and unsound practices or conditions.

As a result, the DBF and the FDIC issued an MOU, effective May 2009, which required AUB to:

  • improve management, including submitting a management plan;
  • increase the bankís capital and improve and sustain earnings;
  • perform a risk segmentation analysis of the credit concentrations and establish and maintain an appropriate ALLL; and
  • review the bankís liquidity position and develop or revise, adopt, and implement a written contingency liquidity plan (CLP).






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As AUBís financial condition continued to deteriorate, the FDIC and the DBF took additional supervisory actions during 2009 to address AUBís condition as indicated below.

  • Because of the continued deterioration in AUBís financial condition identified during the June 2009 examination, the DBF, in consultation with the FDIC, issued a C&D to AUB in October 2009 that included provisions related to (1) capital, adversely classified items, credit concentrations, and restrictions of credit; (2) management, strategic planning, violations of laws and regulations and the ALLL; and (3) funds management, brokered deposits, and a written CLP.
  • The FDIC also issued a PCA Directive in August 2009 that established an immediate and enforceable timeline for the bankís recapitalization, sale, or merger.
  • Additionally, the FDIC drafted a Problem Bank Memorandum in August 2009 identifying the significant deterioration in the bankís financial condition and recommended interim rating changes.

Unfortunately, the supervisory actions in 2009 and AUBís efforts to address them were too late to reverse the deterioration in the bankís financial condition.

Supervisory Response to Board and Management Oversight

Examiner concern regarding AUBís Board and management was first expressed in the FDICís Report of Investigation,14 dated May 7, 2004. Such concern resulted in the FDIC requiring AUB to (1) include at least one outside director with prior banking experience, (2) appoint experienced outside director(s) to the bankís Loan Committee, and (3) employ an acceptable Senior Lending Officer and CFO. Similarly, the FDICís Final Order for Deposit Insurance, dated June 7, 2004, also included conditions related to the need for experienced directors and management and the FDICís approval.

Prior to the DBFís February 2009 visitation, AUBís management had consistently been rated a ď2Ē. Each of the visitations and examinations conducted from June 2005 through June 2009, however, raised a number of concerns and made recommendations related to the inexperience of Board members and senior management, turnover in key management positions, and poor risk practices, and made recommendations to improve those deficiencies. However, examiners did not:

  • note specific deficiencies or concerns regarding the bankís noncompliance with the financial projections included in the business plan,



14The Report of Investigation contains conclusions and recommendations that present an overview of the application, analyzes and summarizes findings, and concludes with the investigating examiner's recommendation of whether the FDIC should grant federal deposit insurance to proposed financial institutions.



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  • request that AUB update its business plan, or
  • take action to ensure the bankís loan portfolio was diversified commensurate with the loan mix included in the bankís business plan.

Supervisory actions to address examiner concerns regarding AUBís Board and management began in 2009 after the bankís financial condition worsened. Specifically, during the DBFís February 2009 visitation, examiners identified concerns regarding AUBís financial deterioration and asset concentration and downgraded AUBís management rating to a ď3Ē. A ď3Ē rating indicated that management and Board performance needed improvement and that risk management practices were less than satisfactory given the nature of the bankís activities. In addition, examiners took informal action in the form of an MOU that required AUB to take specific actions in regard to the bankís management and submit a management plan commensurate with the need for increased oversight of the bankís affairs, especially with regard to its lending activities.

During the June 2009 joint examination, examiners further downgraded AUBís management rating to a ď5Ē, indicating that AUBís management was critically deficient, and issued a C&D that included provisions to address management deficiencies. Examiners also reminded the Board that the overall condition of the bank was a direct reflection of the Boardís management oversight.

In retrospect, earlier and stronger supervisory attention may have been warranted to address the bankís longstanding management weaknesses. Specifically, the FDICís October 2007 examination noted that although AUBís Board and management performance were acceptable, immediate attention was needed to address the bankís problems in obtaining and retaining qualified management and support staff. However, the BBR agreed to by AUB in 2007 did not address these issues.

Further, it may have been prudent for the FDIC to downgrade the management component rating and/or require the bank to develop a management plan in 2007 considering that AUBís management exhibited many of the known risk factors for de novo banks. Even though AUBís overall financial condition was considered satisfactory at the October 2007 examination, a stronger supervisory response in 2007 may have resulted in more formal Board and management commitment to implement controls to effectively manage the bankís operations before the supervisory actions that were taken in 2009.

Supervisory Response to CRE and ADC Concentrations, Including Participation Loans

Examiners consistently identified AUBís CRE and ADC concentrations and made recommendations related to the associated risk and risk management practices. Risks associated with de novo and young banks were apparent and AUBís risk profile was increasing based on offsite monitoring activities. Nevertheless, a supervisory action was







15






not taken to address those risks, including the rapid growth in CRE and ADC concentrations, until February 2009. That action, an MOU, was effective in May 2009.

November 2005 Examination

Examiners concluded that AUBís asset quality was strong. To review the bankís compliance with its business plan, examiners compared the bankís actual level of real estate-related loans, as of September 2005, to AUBís first-year projection for such loans. The examiners determined that AUB had exceeded the first year projections by more than $4.9 million, a variance of 53 percent. Despite this variance, examiners concluded that AUB was operating within the bankís original business plan.15

The examiners recommended that AUB implement additional management and policy controls because the bank was substantially exceeding its projected loan growth, and ADC loans were 80 percent of Tier 1 Capitalóapproaching the level designated as a concentration. These controls included:

  • monitoring procedures for the bankís increasing volume of ADC loans; establishing limits on speculative construction loans; and implementing more detailed procedures to monitor speculative construction loans, including, but not limited to, monitoring (1) total debt obligations, (2) borrowersí liquidity positions, (3) economic conditions, and (4) construction reports; and
  • ensuring that real estate loans that exceeded LTV limits were adequately documented and reported to the Board.

October 2007 Examination

AUBís CRE concentration began to exceed the levels described in the December 2006 Joint Guidance and the bank had adversely classified assets for the first time. AUBís CRE concentration continued to increase, representing over 90 percent of the bankís total loans and 642 percent of Tier 1 Capital. Examiners also identified $4 million of adversely classified assets, or 39 percent, of the bankís Tier 1 Capital and ALLL but considered the level to be moderate.

Although the examination report concluded that concentrations were not inherently bad, examiners noted that concentrations add a dimension of risk that management should consider. Examiners further stressed various risk management practices to AUB that are included in the Joint Guidance and noted that the ability to adapt to rapid fluctuations in




15At the time these events occurred, the FDIC had not issued guidance to examiners that defined what would constitute a major change or deviation in a business plan. However, in August 2009, the FDIC issued guidance to its examiners, which noted that examiner judgment is critical in determining a major change or material deviation in the business plan. The guidance also specified selected circumstances that would be considered a major change or deviation in a business plan. FIL-50-2009, also issued during August 2009, advised financial institutions of the requirement for prior FDIC approval of any proposed material changes or deviations in business plans.



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CRE markets depends heavily on the bankís risk management practices and capital levels.

February 2009 Visitation

In February 2009, the DBF performed a visitation at which examiners identified substantial deterioration in AUBís financial condition, including a significant increase in adversely classified assetsófrom 39 percent in 2007 to 117 percent of Tier 1 Capital and ALLL. ADC loans represented 414 percent and non-owner occupied CRE loans represented 601 percent of Total Capital, respectively, as of December 31, 2008. Based on the results of the visitation, the DBF downgraded AUBís CAMELS ratings and issued an MOU, effective in May 2009, which contained various provisions, including one that required AUB to perform a risk segmentation analysis of its credit concentrations.16

June 2009 Examination

A joint June 2009 examination determined that AUBís loan portfolio had continued to deteriorate, the bankís overall financial condition had become critically deficient, and asset quality represented a serious threat to the institutionís viability. Adversely classified assets had risen to $33 million and all but $1.2 million of those impaired assets were CRE loans. Consequently, examiners downgraded the bankís capital, asset quality, management, and earnings each to ď5Ē and liquidity and sensitivity to market risk to a ď4Ē.

Further, AUBís risk profile had significantly increased. Specifically, AUBís total CRE concentration, as of June 30, 2009, totaled approximately 1,200 percent of Tier 1 Leverage Capital and significantly exceeded the bankís Loan Policy limit of 600 percent. In addition, the bankís level of non-owner occupied CRE, which represented more than 800 percent of Total Capital, significantly exceeded the leveló300 percentóthat the Joint Guidance concluded may be identified for further supervisory analysis.

Examiners made several recommendations addressing the bankís CRE and ADC concentrations, including that AUB revise its Loan Policy to comply with the December 2006 Joint Guidance and implement procedures to manage CRE and ADC loans and loan workouts. Examiners also issued a C&D, effective October 2009, which imposed strict deadlines for the bank to review and revise its concentration strategies and policies and to perform a risk segmentation analysis.

Participation Loans

Examiner concern regarding AUBís purchased participation loans was noted at the June 2005 examination when the loans comprised 75 percent of the bankís loan portfolio. At that examination, examiners advised AUB that the majority of loans on the bankís balance sheet should not be participations that had been purchased from other institutions. Although AUBís




16AUB performed this analysis according to the June 2009 examination.



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total loan growth had exceeded projections by almost $4 million at the November 2005 examination, and the bank had decreased participation loans to 51 percent of the bankís loan portfolio, a significant portion of the portfolio still consisted of participation loans. As such, examiners encouraged AUB to continue developing local loan relationships. The October 2006 and October 2007 examinations did not specifically discuss AUBís participation loans. During the June 2009 examination, examiners adversely classified a significant number of CRE-related participation loans. Of the loans reviewed at that examination, $16.3 million were participation loans, of which about $7 million were adversely classified, representing 21 percent of the $33 million in total adverse classifications.

Supervisory Response to Offsite Monitoring Findings

Throughout AUBís existence, examiners identified significant risks at AUB through offsite monitoring, including the bankís rapid growth and concentrated loan portfolio. Examiners flagged AUB for offsite review beginning in December 2005 based on the $17 million in asset growth that occurred at the bank between December 2004 and December 2005 and again based on $23 million in asset growth between March 2005 and March 2006. By September 2007 and continuing through the June 2009 Call Report period, AUB was flagged for offsite reviews based on multiple risk indicators. While the FDIC completed the required assessments and continued close monitoring of AUB, offsite review results did not substantially alter the supervisory strategy for AUB prior to January 2009.

Although AUB reported no past due loans as of the second quarter of 2007, by the third quarter of 2007, the FDICís offsite review noted an increased volume of nonperforming and nonaccrual loans and provision expenses, reflecting increasing risk. By December 2007, offsite monitoring noted some deterioration in asset quality with adversely classified assets increasing and representing 39 percent of Tier 1 Capital and the ALLL. As indicated in Table 6, offsite monitoring conducted for the first through third quarters of 2008 identified increased exposure in the total CRE concentration, and increasing deterioration in the loan portfolio manifested in higher percentages for non-performing and past due loans.

Table 6: AUBís Offsite Monitoring Results for Select 2008 Call Report Periods
Call Report Date Offsite Review Completion Date CRE ADC Non Performing Loans Past Due Loans
Percent of Total Capital Percent of Tier 1 Capital Plus ALLL Percent of Total Loans
03/31/2008 06/30/2008 501% 143% 26% 3.72%
06/30/2008 10/08/2008 690% 140% 34% 6.93%
09/30/2008 01/06/2009 737% 136% 55% 7.00%
Source: Offsite monitoring for AUB.

AUB continued to be flagged for offsite monitoring through June 2009 with an increasing level of risk noted at each review.







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The FDICís offsite reviews identified various risks for AUB that included:

  • rapid growth in ADC loans,
  • high concentrations in CRE loans,
  • increases in past due loans,
  • increases in adversely classified loans, and
  • the need for an increased ALLL.

The FDICís offsite review program is designed to identify emerging supervisory concerns and potential problems so that supervisory strategies can be adjusted appropriately. However, despite the continuing deterioration in AUBís financial condition identified during offsite monitoring, the findings did not result in a substantial change in AUBís supervisory activities. Rather, as discussed previously, specific action to address the bankís CRE and ADC concentrations was not taken until:

  • the February 2009 visitation when the DBF downgraded the bankís CAMELS ratings and issued an MOU, in conjunction with the FDIC, about 3 months later to address the deficiencies and develop a plan to reduce undue concentrations, and
  • October 2009, when the C&D issued by the FDIC and the DBF required AUB to review and, if necessary, revise its written plan detailing appropriate strategies for managing ADC and CRE concentration levels, including a contingency plan to reduce or mitigate concentrations given current adverse market conditions.

Supervisory Response to Credit Risk Management Practices

Examiners expressed concern regarding AUBís credit risk management practices during each of the bankís examinations except the October 2006 examination. During the June and November 2005 examinations, examiners noted problems primarily related to loan documentation, loan underwriting, credit administration, loans in excess of LTV limits, and policies and procedures for managing CRE and ADC concentrations.

The October 2007 examination identified further concern regarding the bankís credit risk management policies and practices and noted that improvements were needed in AUBís:

  • internal loan grading system,
  • planning and monitoring practices for the CRE loan portfolio,
  • Loan Policy for diversifying risk, and
  • loan review criteria and the maximum percentages allowed for each loan category to Total Capital.

Examiner concerns regarding credit risk management were further heightened during the June 2009 examination when the deficiencies identified were considered to be significant causes for the bankís high level of adversely classified assets and losses. Deficiencies







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identified by examiners included AUB managementís failure to implement sufficient credit risk management policies, procedures, practices, and controls to identify, limit, and manage the CRE loan portfolio concentration.

Despite the repeated concerns, a supervisory action did not occur until the May 2009 MOU, which required AUB to:

  • perform a risk segmentation analysis with respect to the credit concentrations;
  • identify concentrations by product type, geographic distribution, underlying collateral or other asset groups which are considered economically related and in the aggregate represent a large portion of AUBís capital;
  • refer to the interagency guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices; and
  • develop a plan to reduce any segment of the portfolio which the supervisory authorities deemed to be an undue credit concentration in relation to AUBís capital.

As with other deficiencies identified at AUB, earlier supervisory action may have been warranted to better mitigate risk.

Implementation of PCA

The purpose of PCA is to resolve problems of insured depository institutions at the least possible long-term cost to the DIF. Part 325, Capital Maintenance, of the FDICís Rules and Regulations implements PCA requirements by establishing a framework for taking PCA against insured state-charted nonmember banks that are not Adequately Capitalized. Based on the supervisory actions taken with respect to AUB, we concluded that the FDIC properly implemented applicable PCA provisions of section 38.

Although AUBís capital ratios substantially exceeded PCA thresholds for Well Capitalized banks during its de novo period, each subsequent year resulted in a significant decline in the bankís capital levels. As indicated in Table 7, AUB was still considered to be Well Capitalized as of December 2007 and December 2008. However, during this period, the bankís capital ratios were substantially reduced and that decline continued through 2009, resulting in changes in the bankís designated capital category.







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Table 7: AUBís Capital Ratios Relative to PCA Thresholds for Well Capitalized Banks
    Dec-07 Dec-08 Mar-09 Jun-09 Sept-09b
Capital Category PCA Thresholds AUBís Capital Ratios
Percentages
Tier 1 Leverage Capital 5% or more 9.84 6.05 6.29 3.19 0.48
Tier 1 Risk-Based Capital 6% or more 11.13 7.68 7.54 3.91 0.58
Total Risk-Based Capital 10% or more 12.39 8.93 8.68 5.08 1.16
PCA Categorya W W W A SU CUb
Source: UBPRs for AUB.
aWell Capitalized, UĖUndercapitalized, SUĖSignificantly Undercapitalized, CUĖCritically Undercapitalized
b The FDIC notified AUB on September 14, 2009, that the bank was considered to be Critically Undercapitalized based on the Tangible Equity Capital ratio as of August 31, 2009, and informed AUB of the applicable restrictions based on section 38 of the FDI Act and Section 325 of the FDIC Rules and Regulations.

AUB submitted an application for the Troubled Asset Relief Program (TARP)17 Capital Purchase Program for $2.9 million in capital on November 13, 2008. AUB subsequently withdrew the application on March 12, 2009.

Significant steps taken by the FDIC and the DBF to address the bankís capital during 2009 included the following:

  • May 26, 2009. The FDIC notified AUB that the bank was Adequately Capitalized based on the March 31, 2009 Call Report capital ratios and, as such, access to brokered deposits became restricted based on section 29 of the FDI Act and Part 337.6 of the FDIC Rules and Regulations.
  • August 7, 2009. The FDIC notified AUB that the bank was Significantly Undercapitalized based on the June 30, 2009 Call Report capital ratios.
  • August 18, 2009. The FDIC issued a PCA Directive requiring AUB to, among other things, (1) submit an acceptable capital restoration plan that met the requirements of section 325 of the FDICís Rules and Regulations within 14 days; (2) increase its Tier 1 Leverage and Total Risk-Based Capital ratios to 8 percent and 10 percent, respectively, within 30 days or sell or merge the bank with another depository institution; and (3) comply with other restrictions related, but not limited, to compensation, capital distributions, and asset growth.
  • September 14, 2009. The FDIC notified the bank that AUB was Critically Undercapitalized as of August 31, 2009.



17TARP was established under the Emergency Economic Stabilization Act of 2008. The Act established the Office of Financial Stability within the Department of the Treasury. Under TARP, Treasury will purchase up to $250 billion of preferred shares from qualifying institutions as part of the Capital Purchase Programs.



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  • October 9, 2009. The C&D issued to AUB by the DBF, in consultation with the FDIC, became effective requiring the bank to, among other things, submit a capital plan and substantially increase the bankís Tier 1 Capital incrementally, so that within 60 days the level would equal or exceed 8 percent of the bankís total assets, and maintain that level for the period during which the C&D was in effect.

Although the FDIC followed PCA guidance, by the time AUBís capital levels fell below the required thresholds necessary to implement PCA, the bankís condition had deteriorated to the point at which the institution could not raise additional capital. The bank was also unable to find a suitable acquirer and, therefore, was closed on October 23, 2009.

Corporation Comments

After we issued our draft report, we met with management officials to further discuss our results. Management provided additional information for our consideration, and we revised our report to reflect this information, as appropriate. On May 5, 2010, the Director, DSC, provided a written response to the draft report. That response is provided in its entirety as Appendix 4 of this report.

In its response, DSC reiterated the OIGís conclusions regarding the causes of AUBís failure. With respect to our assessment of supervision, DSC noted AUBís significant growth between 2006 and 2008 and stated that examiners identified key risks including inadequate Board and management oversight, the bankís high CRE and ADC concentrations, and associated weak risk management practices. In addition, DSC stated that the AUB Board entered into an MOU with the FDIC and the DBF to address weaknesses identified at the February 2009 visitation and that the FDIC and DBF took action through a formal C&D when AUBís management and Board were unable to sufficiently address the cited problems.

Regarding de novo institutions, DSC stated that the supervisory program for these banks has been extended so that these institutions receive a full-scope examination every year for 7 years, as opposed to 3 years. In addition, DSC stated that business plans are receiving careful analysis prior to an institutionís opening and are being closely monitored against approved financial projections throughout the 7-year period. Further, DSC stated that a FIL issued in August 2009 describes the program changes for de novo institutions and warns that changes to business plans undertaken without required prior notice may subject institutions or their insiders to civil money penalties.







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Appendix 1

Objectives, Scope, and Methodology

Objectives

We performed this audit in accordance with section 38(k) of the FDI Act, which provides, in general, that if a deposit insurance fund incurs a material loss with respect to an insured depository institution, the Inspector General of the appropriate federal banking agency shall prepare a report to that agency reviewing the agencyís supervision of the institution. The FDI Act requires that the report be completed within 6 months after it becomes apparent that a material loss has been incurred.

Our audit objectives were to (1) determine the causes of the financial institutionís failure and resulting material loss to the DIF and (2) evaluate the FDICís supervision of the institution, including implementation of the PCA provisions of section 38.

We conducted this performance audit from November 2009 to April 2010 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Scope and Methodology

The scope of this audit included an analysis of the application process for AUB and AUBís operations from December 2004 until its failure in October 2009. Our review also entailed an evaluation of the regulatory supervision of AUB over the same period.

To achieve the objectives, we performed the following procedures and techniques:

  • Analyzed examination and visitation reports and supporting workpapers prepared by FDIC and DBF examiners from February 2005 through June 2009.
  • Reviewed the following:
    • Pertinent DSC policies and procedures and documentation for offsite monitoring activities performed by the FDIC.
    • Bank data and correspondence maintained at DSCís Atlanta Regional Office and Atlanta Field Office.
    • Reports prepared by the Division of Resolutions and Receiverships and DSC relating to the bankís closure and bank data.
    • Audit reports prepared by AUBís external auditors, Maulden & Jenkins, for the years ended 2004 through 2008.



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Appendix 1

Objectives, Scope, and Methodology

    • Actions that DSC implemented to comply with (1) provisions of section 29 of the FDI Act and FDIC Rules and Regulations, Part 337, Unsafe and Unsound Banking Practices restricting AUBís use of brokered deposits; and (2) section 38 of the FDI Act, including, but not limited to, issuing PCA notification letters and a PCA Directive, and restricting AUBís growth and payment of dividends, when applicable, based on AUBís capital category.
  • Interviewed (1) DSC management in Washington, D.C. and the Atlanta Regional Office; and examiners from the DSC Atlanta Field Office, who conducted examinations and visitations of AUB; and (2) officials from the DBFís Atlanta, Georgia office.

Internal Control, Reliance on Computer-processed Information, Performance Measurement, and Compliance with Laws and Regulations

Consistent with the audit objectives, we did not assess DSCís overall internal control or management control structure. We relied on information in DSC systems, reports, reports of examination, and interviews of examiners to understand AUBís management controls pertaining to causes of failure and material loss as discussed in the body of this report.

We obtained data from various FDIC systems but determined that information system controls were not significant to the audit objectives and, therefore, did not evaluate the effectiveness of information system controls. We relied on our analysis of information from various sources, including reports of examination, correspondence files, and testimonial evidence to corroborate data obtained from systems that were used to support our audit conclusions.

The Government Performance and Results Act of 1993 (the Results Act) directs Executive Branch agencies to develop a customer-focused strategic plan, align agency programs and activities with concrete missions and goals, and prepare and report on annual performance plans. For this material loss review, we did not assess the strengths and weaknesses of DSCís annual performance plan in meeting the requirements of the Results Act because such an assessment is not part of the audit objectives. DSCís compliance with the Results Act is reviewed in program audits of DSC operations.

Regarding compliance with laws and regulations, we performed tests to determine whether the FDIC had complied with provisions of PCA and limited tests to determine compliance with certain aspects of the FDI Act. The results of our tests were discussed, where appropriate, in the report. Additionally, we assessed the risk of fraud and abuse related to our objectives in the course of evaluating audit evidence.









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Appendix 2

Glossary of Terms

Term Definition
Adversely Classified Assets Assets subject to criticism and/or comment in an examination report. Adversely classified assets are allocated on the basis of risk (lowest to highest) into three categories: Substandard, Doubtful, and Loss.
Allowance for Loan and Lease Losses (ALLL) The ALLL is an estimate of uncollectible amounts that is used to reduce the book value of loans and leases to the amount that is expected to be collected. It is established in recognition that some loans in the institutionís overall loan and lease portfolio will not be repaid. Boards of directors are responsible for ensuring that their institutions have controls in place to consistently determine the allowance in accordance with the institutions' stated policies and procedures, generally accepted accounting principles, and supervisory guidance.
Bank Board Resolution (BBR) A BBR is an informal commitment adopted by a financial institutionís Board of Directors (often at the request of the FDIC) directing the institutionís personnel to take corrective action regarding specific noted deficiencies. A BBR may also be used as a tool to strengthen and monitor the institutionís progress with regard to a particular component rating or activity.
Call Report The report filed by a bank pursuant to 12 United States Code (U.S.C.) 1817(a)(1), which requires each insured State nonmember bank and each foreign bank having an insured branch which is not a Federal branch to make to the Corporation reports of condition in a form that shall contain such information as the Board of Directors may require. These reports are used to calculate deposit insurance assessments and monitor the condition, performance, and risk profile of individual banks and the banking industry.
Cease and Desist Order (C&D) A C&D is a formal enforcement action issued by a financial institution regulator to a bank or affiliated party to stop an unsafe or unsound practice or a violation of laws and regulations. A C&D may be terminated when the bankís condition has significantly improved and the action is no longer needed or the bank has materially complied with its terms.
Concentration A concentration is a significantly large volume of economically related assets that an institution has advanced or committed to a certain industry, person, entity, or affiliated group. These assets may, in the aggregate, present a substantial risk to the safety and soundness of the institution.
Problem Bank Memorandum A problem bank memorandum documents the FDICís concerns with an institution and the corrective action in place or to be implemented and is also used to effect interim rating changes on the FDICís systems.






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Appendix 2

Glossary of Terms

Term Definition
Prompt Corrective Action (PCA) The purpose of PCA is to resolve the problems of insured depository institutions at the least possible long-term cost to the Deposit Insurance Fund. Part 325, subpart B, of the FDIC Rules and Regulations, 12 Code of Federal Regulations, section 325.101, et. seq., implements section 38, Prompt Corrective Action, of the FDI Act, 12 United States Code section 1831(o), by establishing a framework for determining capital adequacy and taking supervisory action against depository institutions that are in an unsafe or unsound condition. The following terms are used to describe capital adequacy: (1) Well Capitalized, (2) Adequately Capitalized, (3) Undercapitalized, (4) Significantly Undercapitalized, and (5) Critically Undercapitalized.

A PCA Directive is a formal enforcement action seeking corrective action or compliance with the PCA statute with respect to an institution that falls within any of the three undercapitalized categories.
Troubled Asset Relief Program (TARP) TARP was established under the Emergency Economic Stabilization Act of 2008, which established the Office of Financial Stability within the Department of the Treasury. Under TARP, Treasury will purchase up to $250 billion of preferred shares from qualifying institutions as part of the Capital Purchase Program.
Uniform Bank Performance Report (UBPR) The UBPR is an individual analysis of financial institution financial data and ratios that includes extensive comparisons to peer group performance. The report is produced by the Federal Financial Institutions Examination Council for the use of banking supervisors, bankers, and the general public and is produced quarterly from Call Report data submitted by banks.













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Appendix 3

Acronyms


ADC Acquisition, Development, and Construction
ALLL Allowance for Loan and Lease Losses
BBR Bank Board Resolution
C&D Cease and Desist Order
CAMELS Capital, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risk
CEO Chief Executive Officer
CFO Chief Financial Officer
CLO Chief Lending Officer
CLP Contingency Liquidity Plan
CRE Commercial Real Estate
DBF Department of Banking and Finance
DIF Deposit Insurance Fund
DSC Division of Supervision and Consumer Protection
FDI Federal Deposit Insurance
FIL Financial Institution Letter
LTV Loan-to-value
MOU Memorandum of Understanding
OIG Office of Inspector General
PCA Prompt Corrective Action
TARP Troubled Asset Relief Program
UBPR Uniform Bank Performance Report
UFIRS Uniform Financial Institutions Rating System



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Appendix 4

Corporation Comments

May 5, 2010
MEMORANDUM TO:Stephen Beard
Assistant Inspector General for Material Loss Reviews
 
FROM:Sandra L. Thompson [Electronically produced version; original signed by Sandra L. Thompson]
Director
 
SUBJECT:Draft Audit Report Entitled, Material Loss Review of American United Bank,
Lawrenceville, Georgia (Assignment No. 2010-011)
 

Pursuant to Section 38(k) of the Federal Deposit Insurance Act, the Federal Deposit Insurance Corporationís Office of Inspector General (OIG) conducted a material loss review of American United Bank (AUB), Lawrenceville, Georgia, which failed on October 23, 2009. This memorandum is the response of the Division of Supervision and Consumer Protection (DSC) to the OIGís Draft Report (Report) received on April 21, 2010.

The Report concludes AUB failed because its Board of Directors (Board) and management did not provide effective oversight and risk management practices for its strategy centered in commercial real estate (CRE) and acquisition, development, and construction (ADC) loans. The lack of a diversified loan portfolio, coupled with inadequate risk management controls, made AUB vulnerable to the downturn in the economy and real estate market in the Atlanta metropolitan area.

The FDIC and Georgia Department of Banking and Finance (DBF) jointly and separately conducted five examinations and four visitations from 2005 through 2009. Between 2006 and 2008, AUB experienced significant growth in CRE and ADC loan portfolios. Examiners identified key risks including inadequate Board and management oversight; the high CRE and ADC concentrations; and associated weak risk management practices. The AUB Board entered into a Memorandum of Understanding with the FDIC and the DBF to address weaknesses identified at the February 2009 visitation. FDIC and DBF took action through a formal Order to Cease and Desist when AUBís management and Board were unable to sufficiently address the cited problems.

In recognition that stringent supervisory attention is necessary for de novo institutions, DSC has extended its supervisory program so that these institutions receive a full scope examination every year for seven years, as opposed to three years. De novo business plans are receiving careful analysis prior to an institutionís opening and being closely monitored against approved financial projections throughout the seven year period. A Financial Institution Letter issued in August 2009 describes the program changes for de novo institutions and warns that changes in business plans undertaken without required prior notice may subject an institution or its insiders to civil money penalties.

Thank you for the opportunity to review and comment on the Report.











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Last updated 9/21/2010