Regulators Rewrite Rules, Flex Muscles Over S&Ls;, Banks


For banks and thrifts, 1990 has been a year of renewed regulation.

In Orange County and throughout the nation, federal banking and thrift regulators used a stiff, wide broom to sweep away anything remotely resembling trouble at the institutions they examined.

Empowered by the 1989 federal law--the Financial Institutions Reform, Recovery and Enforcement Act--that restructured the thrift industry, beefed-up federal agencies have been scrutinizing bank and savings and loan assets as never before.

The current economic downturn--a recession in many regions--has increased the pressure, as regulators have insisted on ever bigger write-downs in the value of loans, securities and other assets held by banks and S&Ls.;


And regulators are still rewriting the rules. Less than a year after the restructuring law mandated three strict capital tests, regulators are raising the level of one of those tests. The changes will continue into 1991.

It is a decimated thrift industry and a shaky independent banking industry, both of which have had difficulty raising needed capital, that must grapple with the change. There is certain to be more failures, putting more pressure on the federal deposit insurance fund.

“They’re still writing rules for the Charles Keatings of the world, and they’ve got most of them locked up already,” said James P. Giraldin, president of Irvine City Bank, an S&L.; “Why isn’t the government adding strength to the industry instead of sapping it?”

The pendulum has swung far since the days of deregulation that spawned a host of high-flying thrift owners like Keating. His Irvine-based Lincoln Savings & Loan expanded rapidly in the mid-1980s as he took advantage of expanded powers to put depositors’ money to work on desert land in Arizona, junk bonds and other highly risky ventures. But the thrift failed in 1989, and this year Keating was indicted on charges of state securities fraud. Lincoln is expected to cost taxpayers more than $2 billion to clean up.

Lincoln was not alone and the industry’s cleanup is likely to cost more than $500 billion over the next 40 years. So it is little wonder that regulators are using their new powers to flex their muscles as never before.

They are poring over loan files, checking to see that each loan is properly documented.

They are reviewing appraisal reports for real estate and other assets, and they are questioning how institutions account for the value of their assets, often requiring that some assets be marked to their current value regardless of whether those assets are for sale now. And they have come down hard on thrifts especially.

“We have been subjected to a full-fledged regulatory transformation,” said Fredric J. Forster, president and chief executive of ITT Federal Bank, an Irvine thrift. “There has been so much fear instilled into the system, with tougher capital requirements and much tougher write-down requirements, that it’s causing the thrift industry to have cardiac arrest.”


Orders to write down the values of assets, he said, can set off a chain reaction resulting in an institution’s nose-dive. Write-downs can wipe out earnings first and then capital, leaving institutions on the doorsteps of taxpayers.

On the banking side, closer scrutiny by regulators is only one aspect of the year-old federal law and the heightened awareness of troubles at financial institutions.

“The whole general attitude of the public and the regulators and the politicians has affected us more than anything else,” said Clyde H. Gossert, president and chief executive of CommerceBank in Newport Beach.

The negative attitude, he said, has led to deflated prices for bank stocks, which in turn makes it more difficult for banks to sell new stock and raise capital to make themselves stronger.


Fear of what regulators might do is so pervasive that bankers often engage in harsh self-regulation, refusing to make commercial construction loans, for instance, that might be criticized by federal agents, said Richard Boyle, president of Pioneer Bank in Fullerton.

But Boyle said that although regulators are tough, they won’t block loans that make financial sense. “My guess is that a lot of bankers use regulators as an excuse for not making certain kinds of loans,” Boyle said. “But regulators won’t stop you from making good loans.”

Top officials at federal agencies have been trying to reassure bank and thrift executives that regulators don’t want to overreact and prevent lenders from making quality loans, said Stephen W. Prough, president of Western Financial Savings Bank in Irvine.

Still, the tougher regulatory climate has played havoc with bank and thrift financial statements. Most S&Ls; have been limiting their growth and, in some cases, selling off assets as they try to shore up capital to comply with new rules.


More than 200 thrifts nationwide failed the three strict tests and fell into the hands of the federal government after the law was passed. And soon the test will get tougher. One standard now requiring a 3% ratio of capital to assets is being raised to 4%.

Bankers, fearing the fate that befell the thrifts, aren’t stepping in as they might to pick up the slack in home lending. And there aren’t many other places for them to put their money, either.

“When you see the flags flying, you’ve got to pay attention,” said William J. Mylymok, president of Sunwest Bank in Tustin. Besides facing a soft real estate market, bankers see unemployment creeping up and consumer spending going down, he said.

Gerry Findley, a Brea-based financial institutions consultant, said bankers are being pressured subtly by regulators to put their money into government securities. Such bonds are about the only assets that regulators aren’t criticizing.


“The demand for loans has not been strong,” he said. “And there’s been a shift of funding sources for consumer loans, like automobile loans, to non-bank lenders.”

Yet banks have been picking up billions of dollars in deposits this year by buying failed thrifts, and the only place the money can go quickly is into federal securities, he said.

By the time annual statistics are compiled early next year, Findley expects to see a drop in total assets among thrifts statewide and only a slight growth--about 5%--in the size of the state’s banking industry, which grew 16% the previous year.

In Orange County, banks are generally solid and are expected to remain profitable, he said, but local S&Ls; may be prevented from posting their first combined profit in years because of huge losses at Lincoln and FarWest Savings in Newport Beach.


The local thrift picture is improving if only because regulators sold four thrifts that failed this year and two that failed previously.

Lincoln is the only failed local thrift in government hands that is still operating and still for sale. FarWest, though insolvent, has not been seized.

For the first time in three years, a county-based bank was closed by regulators, bringing to 11 the number of banks that have collapsed in the last decade.

Far Western Bank in Tustin, which invested nearly all of its assets in low-quality automobile loans, was closed Dec. 14.


The four Orange County S&Ls; that failed this year bring to 19 the number of county-based thrifts that have collapsed in the last six years. No county in the state has seen more of its thrifts fail.

Not surprisingly, the public image of financial institutions nationwide took a beating at the hands of nearly everyone from comic Jay Leno to President Bush.

The President launched a special prosecution unit to tackle fraud in financial institutions, even while his son was being investigated for possible wrongdoing at a Denver thrift.

The FBI identified four failed Orange County thrifts--Lincoln, Mercury, Consolidated Savings and American Diversified Savings--as part of the nation’s 20 top-priority criminal investigations of thrifts.


And several thrift executives were convicted of fraud and sent to prison. More indictments and trials are expected next year.


Audits, Scandal and Insolvency

In 1990, many banks found it difficult to make good-quality loans. Most savings and loans were trimming loan portfolios. Now, loan demand is down, and both banks and S&Ls; are looking for other places to invest their deposits.


Audit Issues

Facing tougher laws and new regulations, banks and S&Ls; saw increased scrutiny in regulatory examinations this year. Among the major issues addressed in audits of financial institutions this year were:

* Forced write-downs in the value of loans, real estate investments, junk bonds and other assets to reflect current sale value rather than long-term market value.

* Severe limits on the amount of loans S&Ls; could make to one borrower.


* Increased costs of federal audits and federal deposit insurance.

* Closer scrutiny of appraisals on real estate and other assets and collateral.

* More criticism of certain types of loans, especially construction loans for office buildings.

* A likely increase in the amount of capital required of S&Ls; to meet one of three strict capital standards.


BANKS Assets In billions of dollars ’90*: $4.9 Net Income In millions of dollars ’90*: $22.1 SAVINGS & LOANS Assets In billions of dollars ’90*: $53.7 Net Income In millions of dollars ’90*: -$206 * As of June 30 Source: Findley Reports, Sheshunoff Information Services and Office of Thrift Supervision

Financial Failures

Four thrifts and one bank failed in Orange County in 1990. Here is a brief obituary:

Institution: Huntington S&L; Location: Huntington Beach Assets (in millions): $111 Date Seized: Feb. 9 Date Resolved: June 22 Outcome: Sold to American Savings Bank Cost to taxpayers (in millions): $4.5 Institution: Western Empire S&L; Location: Yorba Linda Assets (in millions): $228 Date Seized: Feb. 15 Date Resolved: Aug. 31 Outcome: Sold to Southern California Bank Cost to taxpayers (in millions): $24.1 Institution: Mercury S&L; Location: Huntington Beach Assets (in millions): $1,820 Date Seized: Feb. 23 Date Resolved: Sept. 14 Outcome: Sold to Security Pacific Nat’l. Bank Cost to taxpayers (in millions): $33.7 Institution: Charter Savings Bank Location: Newport Beach Assets (in millions): $262 Date Seized: June 15 Date Resolved: Dec. 7 Outcome: Pacific Heritage Bank Cost to taxpayers (in millions): $34.4 Institution: Far Western Bank Location: Tustin Assets (in millions): $144 Date Seized: Dec. 14 Date Resolved: Dec. 14 Outcome: Liquidated Cost to taxpayers (in millions): Not Available


Financial Figures in the News

* Charles H. Keating Jr., former owner of failed Lincoln Savings & Loan in Irvine, was indicted with three associates on 46 counts of securities fraud in connection with the sale of $200 million in bonds.

* Leonard Shane, former chairman of Mercury Savings & Loan in Huntington Beach, was given an honorary doctorate for his philanthropic donations just a month before his thrift failed because of changes in accounting rules and bad loans.

* Frank J. Mola, an Orange County developer, walked away from his multimillion investment in Charter Savings Bank in Newport Beach when the institution fell into insolvency. Charter’s problems stemmed from the purchase of a failed thrift.


* William Belzberg, chairman of the company that owns FarWest Savings in Newport Beach, has--with two brothers--resisted investing more money into the insolvent institution, making it a likely candidate for a federal takeover.