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Board Report: 2013-IE-B-002 March 22, 2013

Review of the Failure of Bank of Whitman

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Conclusions, Lessons Learned, and Recommendation


Whitman failed because of the convergence of several factors. The bank altered its traditional agricultural lending strategy and expanded into new market areas, which resulted in rapid growth and high CRE concentrations as well as credit concentrations to individual borrowers. Whitman's corporate governance weaknesses allowed the bank's senior management to dominate the institution's affairs and undermine the effectiveness of key control functions. Whitman's credit concentrations and poor credit risk management practices, along with a decline in the local real estate market, resulted in asset quality deterioration and significant losses. At that point, management engaged in a series of questionable practices to mask the bank's true condition. The escalating losses depleted earnings, eroded capital, and left the bank in a PCA critically undercapitalized condition, which prompted the State to close Whitman and appoint the FDIC as receiver on August 5, 2011.

With respect to supervision, FRB San Francisco complied with premembership requirements and examination frequency guidelines for the time frame we reviewed, 2005 to 2011. FRB San Francisco also responded to situations involving suspicious activity in accordance with the expectations outlined in CBEM 5020.1 and filed the appropriate notification forms.

Fulfilling our mandate under section 38(k) of the FDI Act provides an opportunity to determine, in hindsight, whether additional or alternative supervisory actions could have been taken to reduce the likelihood of a bank's failure or a loss to the DIF. Our analysis of FRB San Francisco's supervision of Whitman revealed that FRB San Francisco identified the bank's fundamental weaknesses during its first examination in 2005 but did not take decisive action to resolve those weaknesses until September 2009. Whitman exhibited a number of recurring and pervasive corporate governance weaknesses, such as dominant management, conflicts of interest and nepotism, a deficient board of directors, weak credit risk management and internal controls, and an ineffective internal audit function. Further, we believe that Whitman's inability to resolve internal control weaknesses, risk management issues, and federal regulatory and state legal lending limit violations constituted an early warning sign regarding the effectiveness of management, the board of directors, and the internal audit function.

In our opinion, FRB San Francisco had multiple opportunities from 2005 to 2009 to take stronger supervisory action by implementing more aggressive enforcement actions. For example, FRB San Francisco and Whitman entered into a commitment letter based on the results of the 2005 examination, which identified regulatory violations and multiple deficiencies, including unsafe and unsound practices related to construction lending. In our opinion and based on the criteria outlined in the CBEM, Whitman's violations and deficiencies warranted a stronger supervisory response than a commitment letter, such as a memorandum of understanding, to better convey the severity of the issues and the urgent need to resolve them. We also believe FRB San Francisco should not have upgraded the management rating in January 2007 without having the opportunity to validate the effectiveness of recent control enhancements. In our opinion, FRB San Francisco also had opportunities to downgrade Whitman's CAMELS composite or component ratings to address the bank's persistent deficiencies prior to the September 2009 examination. While we believe that FRB San Francisco had opportunities for earlier supervisory responses, it is not possible for us to predict the effectiveness or outcome of any measures that might have been taken. Therefore, we cannot evaluate the degree to which an earlier or alternative supervisory response would have affected Whitman's financial deterioration or the ultimate cost to the DIF.

The need for stronger supervisory action sooner has been a consistent theme in our prior failed bank reviews, as highlighted in our September 2011 Summary Analysis of Failed Bank Reviews. A recommendation in that report noted the need for examiner training sessions to reinforce the importance of, among other areas, escalating supervisory actions based on management's failure to resolve examination comments. In the case of Whitman, management's failure to resolve recurring weaknesses demonstrated the need for escalating supervisory actions.

This review resulted in a unique observation regarding the approach to premembership examinations. Whitman satisfied the eligible bank criteria and did not require a premembership examination. During its first examination in 2005, FRB San Francisco identified regulatory violations and internal control deficiencies, which resulted in an enforcement action and downgrades to the bank's asset quality and management component ratings. Several of the deficiencies had been identified by prior regulators. We did not conclude that the lack of a premembership examination contributed to Whitman's failure. However, in our opinion, the deficiencies and regulatory violations that FRB San Francisco identified during its initial examination evidence the need to revisit the approach to premembership examinations.

Lessons Learned

We believe that Whitman's failure offers lessons learned that can inform future supervision of banks with similar characteristics and circumstances. Whitman's failure illustrates the risks associated with

  1. unresolved corporate governance weaknesses, including ineffective board of directors' oversight, a dominant CEO and senior management, a weak internal audit program, and an internal audit function that lacks independence
  2. pursuing a rapid growth strategy in a new business activity, particularly when it is outside the bank's traditional market area
  3. high concentrations in CRE and concentrations of credit to individual borrowers without an adequate credit risk management program

Furthermore, this failure highlights

  1.  the need for close scrutiny and immediate and forceful supervisory action when examiners detect significant and pervasive corporate governance deficiencies and/or increased credit risk exposure coupled with a lack of appropriate controls
  2.  the importance of examiners taking appropriate supervisory action to correct early indicators of internal control weaknesses and holding management accountable for failing to address fundamental and persistent weaknesses

Although Whitman did not require a premembership examination, FRB San Francisco identified significant internal control and corporate governance weaknesses during its first examination of Whitman in 2005. While we did not conclude that this situation caused the failure, we believe that it indicates the need to revisit the supervisory approach to premembership examinations.


We recommend that the Director of the Division of Banking Supervision and Regulation

  1. Review the supervisory approach for premembership examinations and determine whether enhancements to the current approach outlined in SR Letter 11-2 are appropriate

Management's Response

In the response dated March 11, 2013, the Division Director of BS&R acknowledged the conclusions and lessons learned in the report. Specifically, the Division Director noted, "Whitman's failure illustrates the risks associated with aggressive growth and high concentrations of credit and the importance of establishing appropriate corporate governance, internal controls, and credit risk management practices. It further illustrates the need for scrutiny and forceful supervisory action where significant and unresolved weaknesses exist."

Additionally, the Division Director concluded, "Because some of Whitman's weaknesses were identified at the first examination of the bank after it became a state member bank, BS&R staff will follow up on the report's recommendation to review the supervisory approach for pre-membership examinations and determine whether enhancements to the current approach outlined in SR Letter 11-2 are needed."

OIG Comment

In our opinion, the actions described by the Division Director are responsive to our recommendation. The recommendation will remain open pending follow-up on the actions to ensure that the recommendation is fully addressed.