‘Heritage’ of a Failed Bank: FDIC in Spotlight

The year since the state Banking Department closed Heritage Bank of Anaheim has brought a flood of legal actions and investigations, paper work and controversy, but no relief for the thousands of shareholders who lost an estimated $10 million in the bank’s collapse.

The Federal Deposit Insurance Corp., presiding over the liquidation of the bank’s $158 million in assets, has added more than 600 lawsuits to the already overcrowded state court docket. Another dozen or so suits were filed by some of the bank’s 2,500 shareholders against the bank and its management.

And the FDIC, which stepped in as receiver after the March 16, 1984 shutdown of the bank, has gained public attention in the usually invisible world of banking regulation.

It was the FDIC’s highly publicized exercise of a power it had long ignored that sparked much of the interest in Heritage as an example of how the federal regulatory agency handles community bank failures.

That power, embodied in the agency’s now-controversial market discipline policy, allows the agency to refuse insurance coverage on deposit balances that exceed its $100,000 limit. In the Heritage case, 65 depositors had more than $100,000 in the bank, and the FDIC has withheld reimbursement of almost $5 million of those excess deposits.

The agency is expected to have an even heavier workload this year than it did in 1984, when a post-Depression record number of U.S. banks--79--failed. Millions of depositors and shareholders could be affected by the FDIC’s continuing role, and its decisions as to when and where it uses its market discipline policy.

Only state banking departments or the U.S. Comptroller of the Currency can close a bank. But FDIC officials have complained privately that their agency takes the heat from disgruntled depositors, borrowers and investors because of its visibility as examiner and liquidator. And a bank closing can get hot, especially in small rural communities where the failing bank is the only one in town.

At Heritage, one of the 50 largest banks to fail in the United States since 1933, the heat came from the bank’s unpaid depositors and holders of its suddenly worthless stock, and especially from Douglas E. Patty, Heritage’s co-founder and one time chairman and chief executive officer.

Patty believes the FDIC engineered the bank’s failure and imposed market discipline on its customers to punish him for his outspoken criticism of the agency. Although many officials in Southern California’s banking community have little sympathy for Patty, in private conversations several have given credence to some of his complaints against the FDIC.

FDIC bank supervision officials have refused to comment on the Heritage closure, but more of what the agency thinks of Patty and his banking operation is expected to surface soon: Patty expects the FDIC soon to file a $40-million damage suit against him and other Heritage officers and directors.

The suit would open to public inspection the FDIC’s version of Heritage’s failure, and further expose the usually low-profile agency’s inner workings. In recent interviews with The Times, Patty said he will welcome the action as a forum for his contention that the FDIC was “overzealous” in using its powers.

“I want to go to trial with these people . . . . I want to see their people on the stand, explaining what they did to the (Heritage) directors and shareholders. And then I’ll be willing to let the jury and the people decide,” he said.

Patty redoubled his complaints against the FDIC when the agency abandoned its market-discipline power in its handling of the near-collapse of giant Continental Illinois Bank only a few months after the Heritage closure.

Gerry Findley, a California-based, independent banking consultant and analyst, said the publicity over FDIC’S treatment of Heritage and a few other failed community banks probably helped fuel a depositors’ run at Continental Illinois when its financial problems became known. To end that run, the Federal Deposit Insurance Corp. said it would guarantee all deposits at the big Chicago bank. It also masterminded a $4.5-billion federal bail-out for Continental.

Uneven Treatment Alleged

“The FDIC is certainly more stringent on smaller banks than on large banks,” said Findley, “and the Continental situation showed just a little bit of hypocrisy. They have continued to use market discipline on some small banks since Continental Illinois.”

Findley also believes the FDIC suit against Heritage, if tried, “is sure to reveal a lot about why things happen and when and how the regulators approach problem banks, and how they try to remedy the problems.”

Beginning in mid-1982, the FDIC conducted examinations of Heritage’s books and identified major loan problems at the bank. In May 1983, the FDIC was successful in ousting Patty as chairman and chief executive of the bank. The state Department of Banking closed Heritage after it determined the bank was not being operated in a safe manner and was nearly insolvent.

At the time of the closing, according to Banking Supt. Louis Carter, Heritage had a mere $31,000 net worth and $40 million in non-performing loans that were causing an operating deficit of about $500,000 a month.

Patty doesn’t deny that Heritage had serious financial problems but claims the bank could have survived if it had received even-handed treatment from the FDIC.

List of Complaints

Patty’s laundry list of complaints against the FDIC’s handling of the Heritage case includes the testimony given by FDIC officials at the federal court hearing that resulted in his ouster being upheld. Patty disputed an FDIC examiner’s statement that Patty had not been involved in the bank’s day-to-day operations for 11 months, a statement the judge said he relied on in his ruling against Patty.

In November, 1984, the FDIC recanted its position on Patty’s involvement with the bank, agreeing with Patty that his absence had been only 14 days. The FDIC attributed the statement to “an unintentional error which resulted from carelessness in the preparation and review” of its statement. Furthermore, the FDIC maintained that error was not instrumental to the outcome of the hearing.

The former banker also defends his charges against the FDIC’s actions by pointing out that the regulatory agency has never filed a criminal complaint against him.

Patty and other Heritage officials are still being investigated by the Securities and Exchange Commission, in connection with possible manipulation of stock in Heritage Bank and its holding company, Heritage Bancorp.