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Appeal of a Nonaccrual Status - (Third Quarter 2006)

Background

The boards of directors of a group of banks, collectively, appealed to the Ombudsman a decision rendered by the supervisory office to place a group of loans on nonaccrual status.  The banks also appealed the supervisory office's directive to re-file the Consolidated Reports of Condition and Income (call reports).

The various bank boards disagreed with the nonaccrual status because they consider the loans "well secured" and "in the process of collection" within the context of the call report instructions.  The boards requested that the Ombudsman's office review these loans to determine if accrual status on the affected loans is appropriate, thereby negating the need to re-file the call reports.

Discussion

The Ombudsman conducted a review of the information submitted by the bank and supporting documentation from the supervisory office.  The review included discussions with the banks' senior management as well as with members of the supervisory office.

The Ombudsman's analysis specifically focused on the issue of whether the loans were "well secured" and "in the process of collection," as defined in the call report instructions.  While the affected loans were collateralized by improved real estate, the value of the collateral was not supported by current independent appraisals or a comprehensive analysis that substantiated the banks' basis of valuation.  The appraisals maintained by the banks were outdated and did not provide full assurance that all principal, interest, and accruing fees would be received.  Furthermore, the guarantor provided no significant financial support to the credits due to an illiquid cash position and a high level of contingent liabilities.

A legal process was initiated by the borrower, with support from the bank, to have a court appointed receiver control the liquidation of the company.  While the Ombudsman acknowledged that a legal process was initiated as of a given quarter, there was no assurance that the loans would be restored to a current status within a reasonable time frame.

Conclusion

The Ombudsman concluded that the nonaccrual designation assigned by the supervisory office was appropriate.  While the banks had taken steps to support "in the process of collection," there was inadequate support for "well secured."  The banks were directed to place the loans on nonaccrual as of the same quarter the legal process was initiated and to reverse all accrued and uncollected interest, and other fees.  Any interest income recorded since the particular quarter in question should be applied towards principal until the remaining recorded investment in the asset (i.e., after charge off of identified losses, if any) is deemed fully collectible.  Additionally, the banks were directed to make the adjusting accounting entries and re-file the affected call reports.