WILLIAM D. DAVIS : State Regulators Closing Shop : New Laws Encourage S&Ls; to Join Federal System

The state Department of Savings and Loan has a life expectancy that is much shorter than the institutions it regulates.

It is funded by fees assessed on thrifts with state charters, and thrifts have been fleeing the state system for the federal system since Congress passed the thrift industry restructuring measure last year to bail out the S&L; deposit insurance system.

Last month, William D. Davis was appointed by Gov. Deukmejian as commissioner of the agency. He replaced his boss, William J. Crawford, who retired.

Davis knows he’s a short timer. Even if the next governor keeps him on past Jan. 1, the department may not last past next July, he said.

The state-charter system has become a victim not only of the federal law but of its own ill-fated effort seven years ago to survive its first brush with fate. When Congress pieced together its last major industry deregulation law in 1982, state-chartered thrifts began converting to federal charters. With assessments cut drastically, the state agency reduced its staff to 42 employees and faced extinction.

Responding to the crisis in 1983, the Legislature enacted the so-called Nolan bill, named after its architect, Assemblyman Patrick J. Nolan (R-Los Angeles). The law--one of the most liberal set of banking rules in the nation--was designed to lure back all those who had traded in their California charters for federal ones.

It worked. The thrifts came back to the state system, the state agency’s coffers swelled and its staff tripled in size. It also brought in entrepreneurs as thrift magnates, and many of them didn’t know what they were doing or abused the wide powers the state law had given them. Both federal and state regulators seemed powerless to prevent failures, and the industry began to collapse.

In early 1985, Crawford and Davis stepped in as state commissioner and chief deputy, respectively. After tentative first steps, they became increasingly tough on California thrifts, taking action against such rogue operations as Ramona Savings & Loan in Orange and North American Savings & Loan in Santa Ana before federal regulators could move.

Now, though healthy S&Ls; will continue on, possibly as banks, the thrift industry’s future is clouded at best. The state S&L; agency is doomed.

Davis, 53, of Villa Park has worked in the industry since 1962. He was an executive at Belmont Savings & Loan in Long Beach, which was sold to Great Western Savings in 1970, and he was an executive at Mariners Savings & Loan in Newport Beach, sold to Fidelity Federal Savings in 1978.

The Honolulu native talked recently with Times staff writer James S. Granelli about the future of his agency and the fraud and insider abuse that has hurt so many thrifts.

Q. What is the latest word on the continued existence of your department?

A. We have just gone through the budget process where there was a difference of opinion. The Senate budget subcommittee wanted to give us a $5.5-million budget for one year, which was satisfactory and to our liking. The Assembly budget subcommittee wanted to give us a six-month budget, which was unsatisfactory. So there was this conflict and it went to a conference committee where they hash these things out. And just recently, the conference committee agreed on the Senate’s version. So we do have a one-year budget. We’ve sent out our assessment letter to the state-charter industry. So I think what we have left is going to be our base for the next year.

Q. Out of 161 S&Ls; still operating in California, how many have state charters?

A. We have currently 69 state-chartered savings and loans, out of a high of 156 in 1985. In the last few days of June before assessments were due, nearly 20 state charters converted either to federal thrift charters or to state bank charters. The number remaining is still far in excess of what we thought we’d have. At one point in time, we didn’t think we’d have any. The Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) flatly states that no state charter could exceed the authority of the federal charter.

Q. Does the state S&L; charter carry any advantage now?

A. There are no notable advantages. The advantages for the state system disappeared with FIRREA. There are some subtle advantages. I think officers and directors liability insurance is cheaper because of the state law, things like that. But no real notable advantages. The dual banking system as we have known it for the last 140 years, at least as far as California is concerned, is fading out. The reason these 69 institutions have elected to stay and pay the assessment is because they want to wait one more year to find out if Congress is going to make some kind of modification or amendment to FIRREA.

Q. Do you see Congress revising FIRREA soon?

A. Congress has already said that it will not make any revisions this year. So nothing is going to happen until 1991. If you talk to individual House members, for example, they will tell you that they like the dual banking system, that it’s worked well for a long time, that they realize that the concentration of regulatory power in Washington isn’t desirable for people in California. And yet, collectively, they voted to do away with the system. So how the industry plans to go back and lobby Congress, I don’t know.

Q. What needs to be changed in FIRREA?

A. Well, nobody has an agenda at this point, other than the obvious things like the rule limiting the amount of money that can be loaned to one borrower, which makes it difficult for a lot of institutions to get their business done. The (U.S.) Office of Thrift Supervision is certainly looking at some flexibility with that right now.

Q. These 69 that are hoping, waiting a year, is there anything specific that they might be looking for that would keep them in a state system?

A. I haven’t heard anything specific. The best example that I can think of would be what the state banking industry has. It is insured by Federal Deposit Insurance Corp. and supervised primarily by the state Banking Department, which works with FDIC. A state bank has some advantages over a national bank in California. For instance, it can put 10% of its assets into direct investments. The savings and loans would love to match that, to have a system where FDIC would be the insurer and the state Department of Savings & Loan would be the primary regulator. Many of them have a conflict with OTS, and they’re eager to get out from under the supervision of OTS.

Q. Do you see any possibility that lawmakers may leave some room for a state regulatory agency and a state regulatory charter system to exist.

A. I don’t hold out much hope that that’s going to happen. With the emphasis on the savings and loan tragedy--every day you pick up the newspaper or you see on television the aftermath of this tragedy--I don’t see how Congress would have the will to make changes that would appear to be softer than what’s out there right now. But, politics is funny. You think you understand a direction, then it changes quickly.

Q. You have taken over as the state’s top thrift supervisor, which ought to be a personal achievement of sorts, and it sounds more like you’re a pall bearer at a funeral.

A. That’s true. I am presiding over a diminishing entity, and I don’t expect that will change.

Q. The State Legislature is looking at two bills that would kill or drastically change the state-charter system. What’s the status of those measures?

A. One bill says that only federal savings and loans should be allowed in California, which, in essence, abolishes the department. The other says that perhaps we should create a new financial services agency that regulates savings and loans, banks, thrift and loans, credit unions and other financial entities. Legislative committees decided to put both bills on hold, so there will be no activity on them this year.

Q. Why are they holding off?

A. I think it’s more of a wait-and-see approach. A lot of people thought about it. They don’t like this concentration of power in Washington, where people may not be paying as much attention to California’s problems as California would. Nobody understands our marketplace like we do.

Q. And we had a good example of that recently.

A. Yes. An excellent example would be the statement made a few months ago by FDIC Chairman (L. William) Seidman concerning the prospect of a bad real estate market in California. The state banking superintendent responded with his own survey that showed the California market being far different than that perceived by Washington.

Q. At least, you already have a budget for next year.

A. Yes. Our problem really isn’t a budgetary problem next year. It’s going to be more of a problem in maintaining a viable department. We’ve lost a lot of employees, seasoned examiners who are concerned about their careers and had to take advantage of offers from other state agencies. So we don’t have the human resources to do the kind of job we’ve done in the past. We’re going to have to retool and take a completely different approach on how we do our job.

Q. What kind of approach would that be?

A. What we’re doing now, instead of doing these full-blown examinations, is a lot of field visits. We have a limited staff--about 48 from a high of 136 in 1987. The exams that we do are limited in scope so that we’re tightly focused on crucial issues--the major problem assets. We utilize the communication lines between our department and OTS and FDIC to help us define what the crucial issues are. That, plus our ability to take quick and effective enforcement action, allows our department to remain viable even though we’re doing our job in a little different way.

Q. Regulations and regulators have become tougher--so tough that builders, developers and other regular borrowers complain that they can’t get loans anymore even though their credit hasn’t changed. Are the stiffer criteria that lenders have set causing a credit crunch?

A. I don’t visualize a credit crunch in the foreseeable future, but keep in mind that the foreseeable future isn’t that far out. I think there are still viable projects that will be built and financed. There are a lot that are borderline and won’t be built now, and they are going to be delayed for a period of time.

Q. Do you see healthy thrifts shying away from construction or other major loans?

A. No, I don’t think they’re going to shy away from any transaction that is solid, not that they always didn’t try to make solid deals. But the industry still has to create earnings, and to generate the kind of income they need by making single-family loans may not quite do it for some of the major savings and loans.

Q. The president and the Congress have been escalating the war on thrift fraud. How much fraud and insider abuse has there been in the failure of S&Ls; in California?

A. My guess would be that out of 66 institutions that we’ve been involved in closing, perhaps 25% would be involved in direct outright fraud. A much higher percentage would be involved in mismanagement. There’s a fine line between mismanagement and fraud.

Q. With 19 failed thrifts, Orange County has been the home of a disproportionate share of the failures in the state. Has it also been home to a disproportionate share of the fraud?

A. Perhaps. But I hesitate to say more because there are some institutions at which there are prosecutions pending; no indictments have come out, but they’re in progress.

Q. Only three executives at two failed Orange County thrifts have been indicted and convicted of fraud. Does the lack of more indictments indicate anything? Lax law enforcement? Difficult cases?

A. All I can say is that it’s very frustrating as a regulator to know and understand what went on in an institution and then wait for the process to take place before you get an indictment and get to trial. I meet with the U.S. attorney’s office and the FBI and the OTS every month, and we go over a list of the pending criminal investigations. There are a number of Orange County institutions involved in that. I ask the same questions that you’re asking now: What is the status? How soon can we expect something? And the answer is really that these are very complicated cases. They’re difficult to prosecute. They’re extremely difficult to put into a context that a jury can understand. So it takes a lot longer than any of us would expect, and all I can tell you is that I am as frustrated with that process as much as anybody is.

Q. If it’s so difficult to prove, to present to a jury, does that imply that maybe it wasn’t fraud but simply greed and mismanagement and stupidity? You pointed out that there is a fine line.

A. Yes, it is a fine line. I believe that the more sophisticated the transaction, the more intent there was to defraud. Some of these transactions involve so many different parties, and it’s like a big circle. You have a starting point and the transaction flows through different companies, corporations, partnerships and individuals.

Q. With all of the public discussion recently on putting the criminals behind bars, are we creating an atmosphere in which the public, as potential jurors, would be more inclined to associate an S&L; defendant with fraud?

A. My guess is that there would be a greater tendency for public awareness of the problems. Whether that would have any effect on jurors, I don’t know. But there certainly is a far greater awareness today than there was three years ago.

Q. Is fraud causing S&Ls; to fail or is it contributing to losses that failing thrifts already had because of bad management, bad loans and the like?

A. I think for the most part, fraud is a contributing factor. It probably, in most cases, was not the primary factor. You can’t do so many fraudulent deals that you drive an institution into the ground. It’s always a combination of just frivolous, senseless managing and deliberate fraud.

Q. Are there any institutions that you could point to and say that fraud caused the demise?

A. If there is a clear example of that, I’d say it is probably North America Savings & Loan.

Q. That’s the Santa Ana thrift where the late owner and his consultant created phony deposit accounts, fake stock certificates and forged documents. The consultant, Janet F. McKinzie, was recently convicted of racketeering.

A. Right. We figured that the actual loss caused by fraud amounted to at least $40 million.