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PENN SQUARE BANK FAILURE

HEARINGS
BEFORE THE

COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
NINETY-SEVENTH CONGRESS
SECOND SESSION

PART 1
JULY 15; AND AUGUST 16, 1982

Serial No. 07-92
Printed for the use of the
Committee on Banking, Finance and Urban Affairs

U.S. GOVERNMENT P R I N T I N G O F F I C E
97-830 O




WASHINGTON : 1982

HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
FERNAND J. ST G R V
EJ
HENRY S. REUSS, Wisconsin
HENRY B. GONZALEZ, Texas
JOSEPH G. MINISH, New Jersey
FRANK ANNUNZIO, Illinois
PARREN J. MITCHELL, Maryland
WALTER E. FAUNTROY, District of
Columbia
STEPHEN L. NEAL, North Carolina
JERRY M. PATTERSON, California
JAMES J. BLANCHARD, Michigan
CARROLL HUBBARD, JR., Kentucky
JOHN J. LAFALCE, New York
DAVID W. EVANS, Indiana
NORMAN E. D'AMOURS, New Hampshire
STANLEY N. LUNDINE, New York
MARY ROSE OAKAR, Ohio
JIM MATTOX, Texas
BRUCE F. VENTO, Minnesota
DOUG BARNARD, JR., Georgia
ROBERT GARCIA, New York
MIKE LOWRY, Washington
CHARLES E. SCHUMER, New York
BARNEY FRANK, Massachusetts
BILL PATMAN, Texas
WILLIAM J. COYNE, Pennsylvania
STENY H. HOYER, Maryland




M Rhode Island, Chairman
,
J. WILLIAM STANTON, Ohio
CHALMERS P. WYLIE, Ohio
STEWART B. McKINNEY, Connecticut
GEORGE HANSEN, Idaho
JIM LEACH, Iowa
THOMAS B. EVANS, JR., Delaware
RON PAUL, Texas
ED BETHUNE, Arkansas
NORMAN D. SHUMWAY, California
STAN PARRIS, Virginia
ED WEBER, Ohio
BILL McCOLLUM, Florida
GREGORY W. CARMAN, New York
GEORGE C. WORTLEY, New York
MARGE ROUKEMA, New Jersey
BILL LOWERY, California
JAMES K. COYNE, Pennsylvania
DOUGLAS K. BEREUTER, Nebraska
DAVID DREIER, California

(II)

CONTENTS
(Witnesses listed in order of appearance)

Pa e

Hearings held on—
July 15, 1982
August 16, 1982 (Oklahoma City, Okla
JULY 15,

e
1
Ill

1982

WITNESSES

Hon. C. T. Conover, Comptroller of the Currency, accompanied by Paul M.
Homan, Senior Deputy Comptroller for Bank Supervision, Office of the
Comptroller of the Currency
,
Hon. William M. Isaac, Chairman, Federal Deposit Insurance Corporation

4
50

ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD

Conover Hon. C. T., prepared statement with attached appendixes
Homan, Paul M., letter regarding removal powers under 12 U.S.C. § 1818(e),
dated July 29, 1982
Isaac, Hon. William M., prepared statement
St Germain, Chairman Fernand J., excerpts from Public Law 95-630:
"Removal from office, notice of intent"
"Section C. Removal and Suspension of Insiders"
AUGUST 16,

8
97
55
93
96

1982

PANELS OF WITNESSES

Eldon Beller, president, Penn Square Bank, N.A
John Preston and Richard Dunn
Richard Haugland, James G. Randolph, Gary Cook, Elizabeth Merrick Coe,
W. A. Ross, Jerry Richardson, and Gene Smelser
Frank Murphy, former president of Penn Square Bank; J. C. Cravens, Ken L.
Kenworthy, C. F. Kimberling, Dr. Marvin K. Margo, H. Mead Norton, Bill
Stubbs, and Ron Burks
Jim Blanton, managing partner, and Dean York, engagement partner, Peat,
Marwick, Mitchell & Co., Oklahoma City, Okla
Harold Russell, Arthur Young & Co
Clifton A. Poole, Jr., Regional Administrator, Office of the Comptroller;
Jimmy Frank Barton, Regional Director for Special Surveillance; and
Steven Plunk, National Bank Examiner
Roy E. Jackson, Regional Director, FDIC; and James Hudson, FDIC liquidator
in charge of Penn Square
Roger Guffey, president, Kansas City Federal Reserve Bank
J.D.Allen
William Jennings, Bill G. Patterson, and Carl Swan

116
131
165
204
225
300
371
430
444
457
458

ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD

Barnard, Hon. Doug, Jr.:
Memorandum from C. Dean York of Peat, Marwick, Mitchell & Co.,
referred to in colloquy




mi)

246

IV
Barnard, Hon. Doug, Jr.—Continued
"Oklahoma's Penn Square Bank, Maverick Oil Patch Lender, Some Say
It's Bet Too Heavily on Energy," article, American Banker, April 21,
1982
Blanton, James D., statement providing a 10-month chronology relationship
with the Penn Square Bank
Federal Deposit Insurance Corporation, statements of witnesses:
James P. Hudson
Roy E. Jackson
First Penn Corp., filing with Federal Reserve bank, received in records section J u n e 22, 1981
St Germain, Chairman Fernand J.:
Charts and graphs prepared by staff of Banking, Finance and Urban
Affairs Committee
Letters, dated—
February 11, 1980, regarding First Penn Corp's yearend 1979 consolidated statements
February 18, 1980, Arthur Young & Co. "Management Letter"
J a n u a r y 6, 1981, from Arthur Young & Co. regarding the scope of
yearend 1980 audit
J a n u a r y 28, 1981, from John R. Lytle, vice president Continental
Illinois National Bank & Trust Co. of Chicago
Response from Arthur Young & Co., in regard to the J a n u a r y 28,
1981, letter of John R. Lytle
March 13, 1981, "qualified" audit letter
May 20, 1981, Arthur Young & Co. "Management Letter"
November 20, 1981, from Bill P. Jennings to Harold L. Russell,
Arthur Young & Co., informing that Peat, Marwick, Mitchell & Co.
will do yearend 1981 audit
July 29, 1982, from Senior Deputy Comptroller for Bank Supervision
P a u l M . Homan
August 9, 1982, from law offices of Williams & Connolly, Washington,
D.C., counsel for witness Carl Swan
August 12, 1982, from Chairman St Germain to law offices of
Williams & Connolly, Washington, D.C., counsel for witness Carl
Swan
Response of John K. Villas of Williams & Connolly, dated August
16, 1982
August 16, 1982, from law offices of Scott, Douglass & Keeton, Houston, Tex., counsel for witness J. D. Allen
September 28, 1982 from Comptroller of the Currency C. T. Conover,
submitted in regard to testimony of witnesses from the Office of
the Comptroller
Memoranda from Peat, Marwick, Mitchell & Co. mentioned in testimony
of Witness Jim Blanton:
Dated March 4, 1981, from C. Dean York
Dated December 30, 1981, from J. M. Guinan
Memorandum, dated December 8, 1981, to James J. Gunter, executive
vice president of financial planning, Penn Square Bank, from Arlyn C.
Hill, vice president, entitled "Interest Advances to Participating Banks
on Commercial Loans"
Peat, Marwick, Mitchell & Co. documents inserted by unanimous consent
agreement:
Dated May 4, 1982, to board of directors, Penn Square Bank
Dated J u n e 14, 1982, to Penn Square Bank Executive Vice President
James J. Gunter
"Penn Square Warned in 1980 To Get House in Order" news article,
Daily Oklahoman, August 1, 1982

Pa e

s
382

226
438
435
329
387
307
308
319
161
306
322
323
370
401
465
469
470
463
426
237
236

141
266
260
189

APPENDIXES
ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD

Appendix A: Confidential offering circular of the First Penn Corp
Appendix B: Minutes of the meetings of the board of directors of Penn Square
Bank:
April 14, 1981
May 19, 1981




473
517
523

V
Appendix B—Continued
June 9, 1981
July 29, 1981
August 11, 1981
September 15, 1981
October 13, 1981
November 10, 1981
December 8, 1981
December 17, 1981
January 12, 1982
February 16, 1982
March 16, 1982
April 2, 1982
April 20, 1982
May 18, 1982
June 15, 1982
Appendix C: Submissions of the Comptroller of the Currency
Appendix D: "Growing With Energy," annual report (1981) of Penn Square
Bank
Appendix E: "Penn Square Bank, N.A., Annual Report, 1982"
Appendix F: Filings of First Penn Corp. with the Federal Reserve Bank,
received in Record Section, June 4, 1982, which includes amendments to
organizational documents, First Penn Corp. minutes of special shareholders'
meeting, Tuesday, June 14, 1981, and consolidated and parent holding
company financial statements with Peat, Marwick, Mitchell & Co report
thereon
Appendix G: Excerpt from Conduct of Monetary Policy hearing of July 21,
1982
Appendix H: Submissions of the Federal Reserve Bank of Kansas City




Page

528
531
539
543
547
550
553
556
558
562
567
570
572
575
578
588
671
690

700
732
736

PENN SQUARE BANK FAILURE
THURSDAY, JULY 15, 1982
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,

Washington, D.C.
The committee met, pursuant to call, at 2 p.m., in room 2128,
Rayburn House Office Building, Hon. Fernand J. St Germain
(chairman of the committee) presiding.
Present: Representatives St Germain, Gonzalez, Minish, Annunzio, Patterson, LaFalce, Oakar, Vento, Barnard, Garcia, Schumer,
Patman, Hoyer, Stanton, Wylie, McKinney, Leach, Parris, Weber,
Roukema, Bereuter, and Dreier.
The CHAIRMAN. The committee will come to order.
The witnesses will take their places at the witness table.
The Chair has an opening statement. This committee has looked
at many bank failures through the years. Never has a single case
presented such a wide-ranging catalog of banking issues as the collapse of Penn Square.
Clearly, the sifting of the debris from the crash has just begun,
but already Penn Square bears the earmark of a classic case.
Once again, we have before us a major question about bank supervision. What did the regulators know? When did they know it?
And what did they do about it?
Certainly, this committee needs the answers to these questions.
But other questions cut a wide swath across banking practices and
areas under the direct jurisdiction of this committee.
How were some of the Nation's most sophisticated financial institutions, with all variety of expertise at hand, lured like moths to
the glow of this go-go bank sitting in a shopping center in Oklahoma City?
And how did so many small financial institutions decide, in
effect, to delegate their judgments and responsibilities to brokers
who peddled Penn Square's get-rich-quick interest rates like cotton
candy at a carnival?
If no questions were raised about the fact that a shopping center
bank in Oklahoma was offering some unique interest-rate bargains,
surely someone, somewhere, would have thought to double-check
an institution that had a 1,500-percent growth in 7 years?
Unhappily, the Penn Square case brings us up against the ageold question of disclosure in an industry and a regulatory structure
built on secrecy.
Penn Square may well cause a rethinking about the banking industry's penchant for nondisclosure.




(l)

2

We do know that the Comptroller of the Currency, as the primary regulator of Penn Square, did know as early as the spring of
1980 that this bank had serious problems.
We do know that as early as September 1980, that the problems
had become so severe that the Comptrollers Office forced the bank
and its directors to enter into a formal written agreement to cease
and desist from unsound and illegal practices. A written agreement
that had all the sting of a flogging with a wet noodle.
These facts, of course, were not revealed to the public. They were
not revealed to the financial institutions who swallowed the loan
packages from Penn Square. They were not revealed to the individuals, the credit unions, and savings and loan associations who invested their depositors' money in Penn Square long after the
Comptroller's Office knew the bank had gone sour.
I know the many rationalizations which are presented for this
type of nondisclosure. I attempted to deal with the problem in the
Safe Banking Act, following the Bert Lance revelations of 1977, but
we were only partially successful.
I realize that the regulators are, indeed, sincere in their belief in
secrecy on such matters. But, Penn Square brings the issue before
us in stark outlines—hundreds of investors placed money—other
people's money—in an institution which an agency of the U.S. Government knew to be unsound.
Public moneys were used to examine the bank, to collect data, to
analyze the condition, but the public did not receive the results of
the work for which they paid.
I am even more concerned, however, about the allegations flowing out of Oklahoma that this bank—like many other failures—
was beset with insider and self-dealing problems.
This is an area where this committee has time and time and
time again tried to focus regulatory attention.
We have conducted oversight efforts and we have pushed
through statutory changes to help regulators deal with the problem.
I am going to be sorely disappointed if at the end of this trail, we
find that once again nothing effective was done to curb practices
early on.
The supervisors have received enough warnings in this area, and
I see little excuse for anything but specific quick action on any unsound insider practices.
As I said in the Bert Lance investigation 5 years ago, these banks
are not playpens for their officers and directors. They are chartered for the convenience and needs of the community and they
deal with other people's money.
I do not see a middle ground on this issue.
We do intend to pursue our look at the Penn Square case in a
vigorous manner and when these hearings are complete, we will
have a clear and total picture of what happened and what did not
happen.
As has been true in earlier efforts of this committee, our pursuit
of the facts does not suggst that we believe that this case is necessarily indicative of financial practices across the Nation.
In fact, I am personally convinced from my many years on this
committee that the great majority of depository institutions are,




3

indeed, run well and controlled by boards of directors and officers
who understand the responsibilities and duties imposed by their institutions' public charters. But the issues raised are serious. They
must be pursued objectively.
As I announced, today's session is structured as a briefing from
the two regulatory bodies closest to the details of the Penn Square
failure.
Our interrogation today will be limited and we will be asking
representatives of these two agencies back when we open formal
hearings and after the staff has completed initial factfinding efforts
in August.
We have, of course, begun the process of gathering documents
and other data. This will be pursued in the coming weeks. I am
hopeful that all concerned will be forthcoming with material pertinent to the case.
It is premature, in my opinion, to talk about subpenas. If this becomes necessary to elicit the information required to understand
the case, I am sure, and I hope that we will have support from both
sides.
Let's cross that bridge when we reach it. We have not yet.
I do appreciate the fact that the Comptroller of Currency, C. T.
Conover, and the FDIC Chairman, Bill Isaac, have agreed to appear
today on such short notice.
We will need and ask your cooperation in the coming weeks as
this effort continues.
Both of you will hear what you may consider to be some harsh
judgments from time to time, but I am certain you understand the
constitutional and statutory responsibilities of this committee.
I will remind everyone that both of these gentlemen have recently assumed their respective jobs and neither was in place at the
time that the Penn Square problem was discovered.
Also in fairness to them, I am sure that both agencies have a
great deal of investigations to make before they can give us the
final definitive picture of what happened from their view.
Mr. Stanton.
Mr. STANTON. Thank you very much, Mr. Chairman. I welcome
you in scheduling this briefing here this afternoon.
I compliment you on the program that you have laid out explaining, as you have so well, the responsibilities of this committee in its
oversight operations of the regulatory agencies.
I also wish to compliment those participating in the briefing this
afternoon because it is my understanding that the chairmen of the
related regulatory agencies themselves decided to appear themselves.
The CHAIRMAN. On a voluntary basis, rather than send staff,
that is correct.
Mr. STANTON. SO, thus the hearings are off to a good start. Once
again, I compliment you on the timing of these hearings and look
forward to the testimony here this afternoon.
The CHAIRMAN. At this point, I will recognize the Comptroller of
the Currency, Mr. C. T. Conover.
I understand that you filed your statement. We will put your
entire statement in the record.
I think you have some appendixes as well.




4
STATEMENT OF HON. C. T. CONOVER, COMPTROLLER OF THE
CURRENCY, ACCOMPANIED BY PAUL M. HOMAN, SENIOR
DEPUTY COMPTROLLER FOR BANK SUPERVISION, OFFICE OF
THE COMPTROLLER OF THE CURRENCY
Mr. CONOVER. Yes, I do, Mr. Chairman.

The CHAIRMAN. Without objection, they will be placed in the
record as well.
Mr. CONOVER. If I may, I would like to read my statement this
afternoon.
Mr. Chairman and members of the committee, I welcome this opportunity to describe the Office of the Comptroller of the Currency's actions concerning the Penn Square Bank of Oklahoma City,
Okla., which I declared insolvent at 7:05 p.m., central daylight savings time, on July 5, 1982.
In brief, the story of the Penn Square Bank is one of rapid and
uncontrolled growth centered principally in poor-quality loans. As
is typical of banks with asset problems, Penn Square suffered from
a variety of related ills, including in this case, insufficient capital
and liquidity.
The Comptroller's Office has devoted special supervisory attention to Penn Square since early 1980 when problems were first
identified.
Since that time, the OCC's supervisory efforts have included five
examinations of the bank, two formal enforcement actions against
it, a number of special meetings with the bank's board of directors,
and a significant amount of supervisory correspondence.
In the end, however, the bank proved unresponsive to these efforts. Massive losses exceeded the bank's net worth, which, coupled
with a liquidity and confidence crisis, rendered the bank insolvent.
By way of history, Penn Square was chartered in 1960 and in
1976 became 100-percent owned by First Penn Corp. From the time
it was chartered until 1977, the bank experienced normal growth
and was not subject to any unusual supervisory action.
From May of 1977 until its closing, the bank experienced a
period of rapid growth.
The bank became a matter of supervisory concern following an
examination, dated February 29, 1980, which was concluded in
early April of 1980.
This examination revealed, among other things, rapid growth of
bank loans and assets, insufficient liquidity, inadequate capital, an
increase in classified assets and violation of banking laws.
The majority of the growth experienced by the bank was in the
area of oil- and gas-lending, resulting in a concentration of credit.
Participations in many of these loans were sold to other banks.
Because of the problems identified, the bank was designated by our
Dallas regional office as requiring special supervisory attention and
was rated three pursuant to the Uniform Financial Institutions
Rating System.
On June 9, 1980, the deputy regional administrator forwarded
the report of examination to the board of directors, detailing many
of his concerns and requesting a full board meeting in the Dallas
regional office.




5
On the same date, the deputy regional administrator also recommended to Washington that the OCC take enforcement action.
Such action is a routine practice for a bank with the magnitude
of problems identified and is in accordance with our standard operating procedures.
On June 19, 1980, the regional administrator and his staff met
with the chairman of the board and the executive vice president of
the bank to discuss the findings of the examination.
At that meeting, the regional administrator informed the chairman of the board that the bank had been placed in the OCC's special projects program because it required special supervision.
He also said that in light of the bank's problems, it would be
placed under formal administrative action by this office pursuant
to the cease-and-desist process.
At the request of the regional administrator, the board of directors of the bank convened a meeting on August 27, 1980, in our
Dallas regional office to discuss the results of the examination.
At the meeting, the board of directors was presented with a
formal agreement pursuant to the cease-and-desist statute (12
U.S.C. 1818(b)).
On September 9, 1980, the board of directors individually signed
and consented to the formal agreement, which required the bank
to take remedial action to eliminate the problems identified in the
report and to establish procedures to prevent them from recurring.
[Summary of formal agreement is attached to my prepared statement as appendix D].
From September 9 through September 11, 1980, we visited the
bank to review previously criticized loans, past-due loans, new
loans, the bank's capital plans, and its liquidity.
The examination disclosed rapid growth with funding heavily dependent upon rate-sensitive deposit sources. Liquidity was strained,
and the existing staff was overtaxed by business volume. The
bank's capital adequacy was deteriorating.
A general examination, as of December 31, 1980, was conducted
from January 5 through February 27, 1981. It disclosed further deterioration in the bank's overall condition.
Major concerns continued to be inadequate capital, poor asset
quality, ineffective loan administration, inadequate staffing and
policy development, weak internal controls, and deficient liquidity,
asset, and liability management practices.
During 1980, the bank had more than doubled in size. Most of
this growth continued to be concentrated in the energy-related
businesses. Additionally, violations of banking laws and of the
formal agreement were cited in the report.
In a comprehensive letter to the board of directors dated July 1,
1981, the Regional Administrator informed the board that the
report indicated that the board and management had failed to supervise prudently the bank's activities.
The letter, which accompanied the report, pointed out, among
other things, that this lack of supervision had manifested itself in
the following: Numerous violations of banking laws; inordinate
asset/liability management risk; high levels of poor-quality assets;
uncontrolled growth of bank resources; and noncompliance with
the formal agreement.




6

The letter requested that the board of directors arrange a board
of directors' meeting in our Dallas Regional Office to discuss the
report and to determine future action to be taken by the board and
management.
On July 29, 1981, a full board of directors' meeting was held in
the regional office with the directors, management, and representatives of the Office of the Comptroller of the Currency regional and
Washington offices.
At the meeting, the OCC representatives expressed in detail our
supervisory concerns.
A special supervisory examination as of September 30, 1981, was
conducted during the period October 8 through October 30, 1981.
This examination revealed modest improvement but the bank's
overall condition remained of concern, with particular concern regarding the bank's contingent liabilities.
Although certain problems were highlighted, the report noted
that various programs and systems had been established and that
there was improvement in the bank's lending staff, its loan policy,
and its controls.
In light of the problems still remaining in the bank, representatives of the OCC attended the board of directors' meeting of the
bank on January 12, 1982, to discuss the results of the examination.
In addition, the board was informed that a more detailed examination would be conducted near the end of the first quarter of
1982.
As early as June 1980, the OCC supplemented its examinations
of the bank by requiring the bank to submit periodic reports on
matters of concern to the regional administrator.
The OCC's initial request for periodic progress reports on criticized assets and liquidity, which was made in June 1980, was supplemented by further reporting requirements imposed by the September 1980 formal agreement.
In addition, the Regional Administrator's July 1, 1981 letter
highlighting the problems disclosed at the then-recently completed
examination requested yet additional periodic reports from the
bank.
By requesting and reviewing such reports, the OCC is able to
monitor banks on a more constant basis than is permitted through
the formal examination process.
Generally, the periodic reports submitted by the Penn Square
Bank disclosed progress. Management repeatedly gave assurances
that the required corrective actions had been or would be accomplished.
In fact, certain of the promised improvements were noted by our
examiners in their October 1981 examination of the bank.
As late as January 1982, we believed the outlook to be favorable
and that all substantive areas of concern were being addressed and
corrected.
On April 19, 1982, the OCC commenced the examination that led
to the bank's being declared insolvent. Several we^ks into the examination, the Regional Administrator notified the Washington
office that potentially serious problems were being uncovered in
the bank.




7
Also, the bank's activities and condition had begun to be the subject of attention in the press and in the financial marketplace.
As it does with all banks requiring special supervisory attention,
the OCC had shared information regarding Penn Square's condition with the FDIC since early 1980.
On June 23, 1982, the Regional Administrator informed the
FDIC's regional director of the conditions disclosed by the ongoing
examination.
Subsequently, the OCC notified the FDIC in Washington that the
problems had grown significantly worse. Responding to the growing
public and industry concern over the bank's condition, and mindful
that the concern could create a severe liquidity strain on the bank,
the OCC invited the FDIC to join its ongoing examination for contingency purposes.
Based on the preliminary findings of this examination, the OCC
issued a notice of charges and a temporary order to cease and
desist on June 30, 1982, to require immediate actions to rehabilitate the bank.
When the OCC determined that the viability of the bank required an immediate injection of additional capital, the temporary
order to cease and desist was amended to require the bank to
obtain $30 million in new equity by the close of business on July 2,
1982.
No additional capital was injected. The OCC subsequently
amended the notice of charges and the temporary order to limit
transactions with affiliates.
The OCC, in a letter dated July 2, 1982, formally requested that
the FDIC begin preparations for a potential purchase and assumption transaction or payout of insured depositors.
The letter explained that the examination in progress reflected
losses nearly equaling the bank's total capital funds with additional losses likely.
It further pointed out that the bank had begun to experience adverse publicity which affected market confidence and caused substantial deposit withdrawals.
On July 5, 1982, the Comptroller's Office delivered a letter to the
Federal Reserve Bank of Kansas City briefly reviewing the situation and asking to be informed of the Federal Reserve Bank's intentions of providing further loans to the bank.
In a response received the same day, the Federal Reserve Bank
of Kansas City indicated that it was not prepared to extend further
credit to the bank in its current condition.
Based upon the review done by the examiners, I determined, as
of July 5, 1982, that the losses then identified exceeded the capital
funds of the bank. I further determined that the bank would not be
able to continue meeting the demands of its creditors and depositors.
I became satisfied on July 5, 1982, of the insolvency of the bank.
Accordingly, on that date, acting pursuant to my statutory duties,
at 7:05 p.m. (CDST), I declared the bank insolvent and appointed
the FDIC as receiver.
That ends my formal statement, Mr. Chairman, and at this time,
I would be happy to answer questions along with Mr. Paul Homan,
Senior Deputy Comptroller for Bank Supervision.




8
[The prepared statement of Mr. Conover follows:]
STATEMENT OF
C. T. CONOVER
COMPTROLLER OF THE CURRENCY
BEFORE THE
COMMITTEE ON BANKING, FINANCE,
AND URBAN AFFAIRS
U.S. HOUSE OF REPRESENTATIVES
JULY 15, 1982

Mr. Chairman and Members of the Committee:

I welcome this opportunity to describe the Office of the
Comptroller of the Currency's actions concerning the Penn Square
Bank, N.A., of Oklahoma City, Oklahoma, which I declared
insolvent at 7:05 p.m. (CDST) on July 5, 1982.

(Attached as

Appendix A is a brief chronology of events.)
In brief, the story of the Penn Square Bank is one of rapid
and uncontrolled growth centered principally in poor-quality
loans.

As is typical of banks with asset problems, Penn Square

suffered from a variety of related ills, including, in this case,
insufficient capital and liquidity.
The Comptroller's Office has devoted special supervisory
attention to Penn Square since early 1980 when problems were
first identified.

Since that time, OCC's supervisory efforts

have included five examinations of the bank, two formal




9
enforcement actions against it, a number of special meetings with
the bank's board of directors, and a significant amount of
supervisory correspondence.
In the end, however, the bank proved unresponsive to these
efforts.

Massive losses exceeded the bank's net worth which,

coupled with a liquidity and confidence crisis, rendered the bank
insolvent.
Penn Square was chartered in 1960 and in 1976 became 100%
owned (less directors' qualifying shares) by the First Penn
Corporation.

From the time it was chartered until 1977, the bank

experienced normal growth and was not subject to any unusual
supervisory action.

From May of 1977 until its closing, the bank

experienced a period of rapid growth.
The bank became a matter of supervisory concern following an
examination dated February 29, 1980, which concluded on April 4,
1980.

This examination revealed, among other things, rapid

growth of bank loans and assets, insufficient liquidity,
inadequate capital, an increase in classified assets, and
violation of banking laws.

The majority of the growth

experienced by the bank was in the area of oil and gas lending,
resulting in a concentration of credit.
of these loans were sold to other banks.

Participations in many
Because of the problems

identified, the bank was designated by our Dallas Regional Office
as requiring special supervisory attention and was rated "3"
pursuant to the Uniform Financial Institutions Rating System.
(Appendix B.)




10
On June 9, 1980, the Deputy Regional Administrator forwarded
the Report of Examination to the board of directors, detailing
many of his concerns and requesting a full board meeting in the
Dallas Regional Office.

On the same date, the Deputy Regional

Administrator also recommended to Washington that the OCC take
enforcement action.

Such action is a routine practice for a bank

with the magnitude of problems identified and is in accordance
with our standard operating procedures.

(Appendix C.)

On June 19, 1980, the Regional Administrator and his staff
met with the chairman of the board and the executive vice
president of the bank to discuss the findings of the examination.
At that meeting, the Regional Administrator informed the chairman
of the board that the bank had been placed in the OCC's Special
Projects program because it required special supervision.

He

also said that in light of the bank's problems it would be placed
under formal administrative action by this Office pursuant to the
cease and desist process.
At the request of the Regional Administrator, the board of
directors of the bank convened a meeting on August 27, 1980, in
our Dallas Regional Office to discuss the results of the
examination.

At the meeting, the board of directors was

presented with a formal Agreement pursuant to the cease and
desist statute (12 U.S.C. §1818(b)).

On September 9, 1980, the

board of directors individually signed and consented to the
formal Agreement, which required the bank to take remedial action




11
to eliminate the problems identified in the report and to
establish procedures to prevent them from recurring.

(Summary of

formal Agreement attached as Appendix D.)
From September 9 through September 11, 1980, we visited the
bank to review previously criticized loans, past-due loans, new
loans, the bank's capital plans, and its liquidity.

The

examination disclosed rapid growth with funding heavily dependent
upon rate-sensitive deposit sources.

Liquidity was strained, and

the existing staff was overtaxed by business volume.

The bank's

capital adequacy was deteriorating.
A general examination, as of December 31, 1980, was
conducted from January 5, 1981, through February 27, 1981.

It

disclosed further deterioration in the bank's overall condition.
Major concerns continued to be inadequate capital, poor asset
quality, ineffective loan administration, inadequate staffing and
policy development, weak internal controls, and deficient
liquidity, asset, and liability management practices.
1980, the bank had more than doubled in size.

During

Most of this

growth continued to be concentrated in the energy-related
businesses.

Additionally, violations of banking laws and of the

formal Agreement were cited in the report.
In a comprehensive letter to the board of directors dated
July 1, 1981, the Regional Administrator informed the board that
the report indicated that the board and management had failed to
supervise prudently the bank's activities.

The letter, which

accompanied the report, pointed out, among other things, that
this lack of supervision had manifested itself in the following:

97-830 0 - 8 2 - 2




12
Numerous violations of banking laws;
Inordinate asset/liability management risk;
High levels of poor-quality assets;
Uncontrolled growth of bank resources; and
Noncompliance with the formal Agreement.
The letter requested that the board of directors arrange a
board of directors* meeting in our Dallas Regional Office to
discuss the report and to determine future action to be taken by
the board and management.
On July 29, 1981, a full board of directors1 meeting was
held in the Regional Office with the directors, management
(including several new members of management), and
representatives of Regional and Washington Offices.

At the

meeting, the OCC representatives expressed in detail our
supervisory concerns.
A special supervisory examination as of September 30, 1981,
was conducted during the period October 8 through October 30,
1981.

This examination revealed modest improvement but the

bank's overall condition remained of concern, with particular
concern regarding the bank's contingent liabilities.

Although

certain problems were highlighted, the report noted that various
programs and systems had been established and that there was
improvement in the bank's lending staff, its loan policy, and its
controls.

In light of the problems still remaining in the bank,

representatives of the OCC attended the board of directors'
meeting of the bank on January 12, 1982, to discuss the results
of the examination.

In addition, the board was informed that a

more detailed examination would be conducted near the end of the
first quarter of 1982.




13
As early as June, 1980, the OCC supplemented its
examinations of the bank by requiring the bank to submit periodic
reports on matters of concern to the Regional Administrator.

The

OCC's initial request for periodic progress reports on criticized
assets and liquidity, which was made in June, 1980, was
supplemented by further reporting requirements imposed by the
September 1980 formal Agreement.

In addition, the Regional

Administrator's July 1, 1981 letter highlighting the problems
disclosed at the then-recently completed examination requested
yet additional periodic reports from the bank.

By requesting and

reviewing such reports, the OCC is able to monitor banks on a
more constant basis than is permitted through the formal
examination process.
Generally, the periodic reports submitted by the Penn Square
Bank disclosed progress.

Management repeatedly gave assurances

that the required corrective actions had been or would be
accomplished.

In fact, certain of the promised improvements were

noted by our examiners in their October 1981 examination of the
bank.

As late as January 1982, we believed the outlook to be

favorable and that all substantive areas of concern were being
addressed and corrected.
On April 19, 1982, the OCC commenced the examination that
led to the bank's being declared insolvent.

Several weeks into

the examination the Regional Administrator notified the
Washington Office that potentially serious problems were being




14
uncovered in the bank.

Also, the bank's activities and condition

had begun to be the subject of attention in the press and in the
financial marketplace.
As it does with all banks requiring special supervisory
attention, the OCC had shared information regarding Penn Square's
condition with the FDIC since early 1980.

On June 23, 1982, the

Regional Administrator informed the FDIC's regional director of
the conditions disclosed by the ongoing examination.
Subsequently, the OCC notified the FDIC in Washington that the
problems had grown significantly worse.

Responding to the

growing public and industry concern over the bank's condition,
and mindful that the concern could create a severe liquidity
strain on the bank, the OCC invited the FDIC to join its ongoing
examination for contingency purposes.
Based on the preliminary findings of this examination, the
OCC issued a Notice of Charges and a Temporary Order to Cease and
Desist on June 30, 1982, to require immediate actions to
rehabilitate the bank.

(Summary of Notice of Charges and

Temporary Order is attached as Appendix E.)

When the OCC

determined that the viability of the bank required an immediate
injection of additional capital, the Temporary Order to Cease and
Desist was amended to require the bank to obtain $30 million in
new equity capital by the close of business on July 2, 1982.
additional capital was injected.

The OCC subsequently amended

the Notice of Charges and the Temporary Order to limit
transactions with affiliates.




No

15
The OCC, in a letter dated July 2, 1982, formally requested
that the FDIC begin preparations for a potential purchase and
assumption transaction or payout of insured depositors.

The

letter explained that the examination in progress reflected
losses nearly equalling the bank's total capital funds with
additional losses likely.

It further pointed out that the bank

had begun to experience adverse publicity which affected market
confidence and caused substantial deposit withdrawals.
On July 5, 1982, the Comptroller's Office delivered a letter
to the Federal Reserve Bank of Kansas City briefly reviewing the
situation and asking to be informed of the Federal Reserve Bank's
intentions of providing further loans to the bank.

In a response

received the same day, the Federal Reserve Bank of Kansas City
indicated it was not prepared to extend further credit to the
bank in its current condition.
Based upon the review done by the examiners, I determined,
as of July 5, 1982, that the losses then identified exceeded the
capital funds of the bank.

I further determined that the bank

would not be able to continue meeting the demands of its
creditors and depositors.
I became satisfied on July 5, 1982, of the insolvency of the
bank.

Accordingly, on that date, acting pursuant to my statutory

duties, at 7:05 p.m. (CDST) I declared the bank insolvent and
appointed the FDIC as receiver.
At this time, I will be pleased to answer your questions.




1
6
Appendix A
CHRONOLOGY OF OCC SUPERVISION
OF PENN SQUARE BANK, N.A.
JANUARY 1, 1980 - JULY 5, 1982
February 29, 1980
Conducted a specialized examination as of February 29,
1980.
Commenced March 3, 1980, completed April 4,
1980.
Revealed rapid and uncontrolled growth.
Bank
rated "3".
June 9, 1980
Forwarded examination to the board of directors by
letter from the Deputy Regional Administrator.
The
letter identified certain of the major problems and
directed the board to within 5 days convene a special
meeting to review the report and take remedial action.
The letter also requested a full board meeting in the
Dallas
Regional
Office
and
requested
additional
reporting.
June 19, 1980
Meeting between Regional Administrator and Chairman of
the Board Jennings and executive vice president to
discuss the examination report.
June 24, 1980
Notified Federal Reserve Board and FDIC of contemplated
enforcement action against the bank.
July 14, 1980
Letter to Deputy Regional Administrator from bank
president indicating, among other things, that steps
were being taken to improve liquidity. He recognized
the need for supervision over the energy credits and
indicated that additional people had been added and
would be added. More monitoring would be done by the
directors and the violations of law had been corrected.
July 15, 1980
Letter to Deputy Regional Administrator from chairman
of the board discussing bank's capital plans and growth
limits.




17
August 14, 1980
Letter from Regional Office to the board of directors
identifying weaknesses in the capital plan and asking
for submission of an acceptable one.
August 27, 1980
Full board of directors' meeting in Dallas Regional
Office at which time Regional Office staff discussed
the results of the examination. At that meeting, the
formal Agreement was presented to each member of the
board with a full explanation.
September 9, 1980
Board of directors individually signed and consented to
the formal administrative Agreement which was forwarded
to the Regional Office on September 10, 1980, with a
letter by the chairman of the board who indicated the
holding company had agreed to sell stock with $3.3
million to be contributed to the bank.
September 9, 1980
Commenced visitation September 9, 1980, completed
September 11, 1980. Limited review. Rating "3".
October 8, 1980
Sent visitation report to board of directors.
December 31, 1980
Conducted a general examination as of December 31,
1980, beginning January 5, 1981, completed February 27,
1981.
Disclosed further deterioration in the bank's
overall condition. Rated "3".
July 1, 1981
Letter from Regional Administrator to the board of
directors identifying the problems and demanding action
including a full board of directors' meeting in the
Dallas Regional Office.




18
July 29, 1981
Full board of directors' meeting plus management in the
Dallas Regional Office where the Regional Administrator
and his staff and Washington staff identified the
problems and demanded correction.
Correction was
promised.
September 30, 1981
Conducted a special supervisory examination as of
September
30, 1981, beginning
October
8, 1981,
completed October 30, 1981.
Identified areas of
continuing concern but revealed some improvement and
establishment of programs and systems. Rated "3".
December 1, 1981
Regional
Administrator
forwarded
the
special
supervisory examination to the board of directors.
January 12, 1982
Board of directors' meeting at which time Regional
staff of the OCC highlighted the problems as identified
in the report.
April 19, 1982
Commenced general examination.
May 11, 1982
Regional Administrator notified
problems being uncovered.

Washington

Office

of

June 23, 1982
Regional Administrator notified
about problems in the bank.

FDIC

regional

office

June 30, 1982
Issued a Notice of Charges and Temporary Order to Cease
and Desist.




19
June 30, 1982
Asked FDIC to send examiner to assess the prospects for
an FDIC-assisted purchase and assumption or payout.
July 2, 1982
Amended Order to Cease and Desist, requiring immediate
injection of capital.
July 2, 1982
Sent letter to FDIC formally requesting assessment of
prospects for an FDIC-assisted transaction.
July 4, 1982
Amended Notice and Temporary Order to prevent violation
of 12 U.S.C. S371c.
July 5, 1982
Sent letter to Federal Reserve Bank of Kansas City
advising it of bank's condition and asking
its
intentions regarding loans to bank.
July 5, 1982
Received letter from Federal Reserve Bank saying it
would not extend further credit to bank in its present
condition.
July 5, 1982
Declared bank insolvent at
appointed FDIC as receiver.




7:05

p.m.

(CDST)

and

20

o

eu-ioychJiv;
Appendix B

Comptroller of the Currency
Administrator of National Banks

T p : Examining Circular 159
ye
(Revised)
TO:

S b e t uniform Financial Institutions
ujc
Rating System

All Regional Administrators and Examining Personnel

SCOPE
This examining circular revises and rescinds Examining Circular 159
(Revised) dated May 19, 1978.
Mr. Heimann has approved the use of the Uniform Financial Institutions
Rating System by this agency.
The System (copy attached) which was recommended recently for adoption
by the Federal Financial Institutions Examination Council (FFIEC)
provides a general framework for evaluating the soundness of federally•
supervised banks and thrift institutions and their compliance with law.
In addition, the rating system is meant to assist the public and the
Congress in assessing the aggregate strength and soundness of our
financial system.
The Uniform Financial Institutions Rating System revises the system
adopted by the three federal commercial bank regulators on May 12, 1978.
The FFIEC1s action if adopted by the National Credit Union Administration
and the Federal Home Loan Bank Board would bring federally chartered
credit unions and savings and loan associations under the System.
The examiner-in-charge will continue to grade each of the five individual
categories and the Regional Administrator or his designee shall assign
a composite rating consistent with the criteria and evaluating factors
defined in the revised rating system.
In order that these composite ratings remain current, the procedures
to change a bank's composite rating between examinations (Examining
Circular 160) remain in effect. Changes in composite ratings should
continue to be forwarded to the attention of the Special Projects
Division on Form CC 9060-05.

Paul M. Homan
/
Senior Deputy Comptroller
for Bank Supervision
Attachment

Date: December 1 0 , 1979




21
November 13, 1979
UNIFORM FINANCIAL
INSTITUTIONS RATING SYSTEM•
Introduction
The rating system provides a general framework for evaluating and assimilating
all significant financial, operational and compliance factors in order to assign a
summary or composite supervisory rating to each Federally regulated commercial
bank, savings and loan association, mutual savings bank and credit union. The purpose
of the rating system is to reflect in a comprehensive and uniform fashion an
institution's financial condition, compliance with laws and regulations and overall
operating soundness.

In addition to serving as a useful tool for summarizing the

condition of individual institutions, the rating framework will also assist the public
and Congress in assessing the aggregate strength and soundness of the financial
industry.
Although it is acknowledged that to some degree each type of financial
institution poses its own set of supervisory issues and concerns, the uniform rating
system is predicated upon certain features and functions, including qualitative and
quantitative factors, common to all categories of institutions. In general, financial
institutions provide a wide range of essential credit, depository and related financial
services to individuals, private commercial enterprises and governments. In so doing,
financial institutions play an important and integral role In the stability and growth of
economic activity at the local, regional, national or international level.

Institutions

ire best able to carry out these essential functions and accommodate the demand for
financial services when they are operated in a sound and prudent manner in full
compliance with relevant laws and regulations.

*T,w. term "financial institution" with respect to the rating system refers to certain
insitutions whose primary Federal- supervisory agencies are represented on the
Federal Financial Institutions Examination Council, i.e., Federally supervised
conmercial banks, savings and loan associations, mutual savings banks and credit
unitns.




22
Overview
Each financial institution is assigned a -uniform composite rating that is
predicated upon an evaluation of pertinent financial and operational standards, criteria
and principles. The rating is based upon a scale of one through five in ascending order
of supervisory concern. Thus, T

represents the highest rating and, consequently, the

lowest level of supervisory concern; while "5" represents the lowest, most critically
deficient level of performance and, therefore, the highest degree of supervisory
concern. Each of the five composite ratings is described in greater detail below.
In assigning a composite rating, all relevant factors must be weighed and
evaluated. In general, these factors include: the adequacy of the capital base, net
worth and reserves for supporting present operations and future growth plans; the
quality of loans, investments and other assets; the ability to generate earnings to
maintain public confidence, cover losses and provide adequate security and return to
depositors; the ability to manage liquidity and funding; the ability to meet the
community's or membership's legitimate needs for financial services and cover all
maturing deposit obligations; and the ability of management to properly administer all
aspects of the financial business and plan for future needs and changing circumstances.
The assessment of management and administration Includes the quality of internal
controls, operating procedures and all lending, investment and operating policies;
compliance with relevant laws and regulations; and the involvement of the directors,
shareholders and officials.

In general, assignment of a composite rating may

incorporate any other factors that bear significantly on the overall condition and
soundness of the financial institution.
Notwithstanding the use of common summary ratings, specific performance
benchmarks, standards and principles will continue to recognize existing structural,
operational and regulatory distinctions among different types of financial Institutions.




23
Thus, while each financial institution will be evaluated upon criteria relating to its
particular industry, the assignment of a uniform composite rating will help to direct
uniform and consistent supervisory attention in such a way that does not depend solely
upon the nature of an institution's charter or business, or the identity of its primary
Federal regulator.

While distinctions among credit unions, savings and loan

associations, commercial banks and mutual savings banks are recognized, overall
uniformity and consistency of supervision will be strengthened by the existence of
common supervisory ratings.
The primary purpose of the uniform rating system is to help identify those
institutions whose financial, operating or compliance weaknesses require special
supervisory attention and/or warrant a higher than normal degree of supervisory
concern. In an effort to accomplish this objective, the rating system identifies certain
institutions whose financial, operational or managerial weaknesses are so sewerc as to
pose a serious threat to continued financial viability.

These institutions are,

depending upon degree of risk and supervisory concern, rated Composite "V* or "5".
Such institutions are generally characterized by unsafe, unsound or other seriously
unsatisfactory conditions and carry a relatively high possibility of failure or
insolvency. The uniform identification of such institutions will help to ensure:

1)

That the degree of supervisory attention and the type of supervisory
response are based upon the severity and nature of an institution's
problems;

2)

That supervisory attention and action are, to the extent possible,
administered uniformly and consistently,

regardless of

institution or the identity of the regulatory agency; and




the type of

24
3)

That appropriate supervisory action is taken to address'those institutions
whose financial problems entail the greatest potential for hardship or
inconvenience to depositors, borrowers or the public; or those institutions
whose potential weaknesses would most seriously disrupt the proper and
efficient functioning of the financial system.

The rating system also identifies a category of institutions that have some
combination of financial or compliance deficiencies that, while posing little or no
threat to financial viability under present circumstances, do warrant more than normal
supervisory concern. These institutions are not deemed to present a significant risk of
failure, or of loss or hardship to depositors, borrowers, or the public, but do require a
higher than normal level of supervision. The delineation of this category will assist
supervisory authorities In separating the most serious and critical problem institutions
whose viability may be in question from those institutions whose financial or
compliance deficiencies may require a specific supervisory response but do not
constitute a significant risk of failure, insolvency or bankruptcy.

Institutions that

warrant some supervisory concern but do not entail a relatively high possibility of
failure or insolvency are generally rated Composite "3".

Composite Ratings
Composite ratings are defined and distinguished as follows:
Composite 1
Institutions in this group are basically sound in every respect; any critical
findings or comments are of a minor nature and can be handled in a routine
manner.

Such institutions are resistant to external economic and financial

disturbances and more capable of withstanding the vagaries of business
conditions than institutions with lower ratings. As a result, such institutions
give no cause for supervisory concern.




25
Composite 2
Institutions i n this group are also fundamentally sound, but may r e f l e c t modest
weaknesses correctable in the normal course of business.

The nature and

severity of deficiencies, however, are not considered material and, therefore,
such institutions are stable and also able to withstand business fluctuations
quite well. * While areas of weakness could develop into conditions of greater
concern, the
adjustments

supervisory
are

resolved

response

is

limited

in the normal

to

course

the

extent

that

and operations

minor

continue

satisfactory.
Composite 3
Institutions in this category exhibit a combination of financial, operational or
compliance weaknesses ranging from
When weaknesses relate
vulnerable

to the

to

onset of

moderately

severe to

unsatisfactory.

financial condition, such institutions may be
adverse business conditions and could

easily

deteriorate if concerted action is not effective in correcting the areas of
weakness. Institutions which are in significant non-compliance with laws and
regulations may also be accorded this r a t i n g . Generally, these institutions give
cause for supervisory concern and require more than normal supervision to
address deficiencies. Overall strength and financial capacity, however, are still
such as to make failure only a remote possibility.
Composite »
Institutions in this group have an immoderate volume of serious financial
weaknesses or a combination of other conditions that are unsatisfactory.

Major

and serious problems or unsafe and unsound conditions may exist which are net
being satisfactorily addressed or resolved.

Unless- effective action i i taker, e©

correct these conditions, they could reasonably develop into a situation th.it




26
could impair future viability, constitute a threat to the interests of depositors
and/or pose a potential for disbursement of funds by the insuring agency. A
higher potential for failure is present but is not yet imminent or pronounced.
Institutions in this category require close supervisory attention and financial
surveillance and a definitive plan for corrective action.
Composite 5
This category is reserved for institutions with an extremely high immediate or
near term probability of failure. The volume and severity of weaknesses or
unsafe and unsound conditions are so critical as to require urgent aid from
stockholders or other public or private sources of financial assistance. In the
absence of urgent and decisive corrective measures, these situations will likely
require liquidation and the payoff of depositors, disbursement of insurance
funds to insured depositors, or some form of emergency assistance, merger or
acquisition.




27
Performance Evaluation
The five key performance dimensions -- capital adequacy,
asset quality, management/administration, earnings, and liquidity-are to be evaluated on a scale of one to five. Following is a
description of the gradations to be utilized in assignment performance ratings:
Rating No. 1 ^ indicates strong performance.
It is the highest rating and is indicative of performance
that is significantly higher than average.
Rating No. 2 - reflects satisfactory performance.
It reflects performance that %s average or above; it includes
performance that adequately provides for the safe and sound
operation of the bank.
Rating No. 3 - represents performance that is flawed to some
degree; as such, is considered fair. It is neither satisfactory nor marginal but is characterized by performance
of below average quality.
Rating No. 4 - represents marginal performance which is
significantly below average; if left unchecked, such
performance might evolve into weaknesses or conditions
that could threaten the viability of the institution.
Rating No. 5 - is considered unsatisfactory.
It is the lowest rating and is indicative of performance
that is criticially deficient and in need of immediate
remedial attention. Such performance by itself, or in
combination with other weaknesses, could threaten the
viability of the institution.
Capital Adequacy
Capital is rated (1 thru 5) in relation to: (a) the volume of
risk assets; (b) the volume of marginal and inferior quality assets;
(c) bank growth experience, plans, and prospects; and (d) the
strength of management in relation to (a), (b) and (c). In addition,
consideration ma be given to a bank's capital ratios relative to
its peer group, its earnings retention and its access to capital
mj:rket« or O*'I'T appropriate sources of financial assistance.




28
Banks rated 1 or 2 are considered to have adequate capital,
although the former's capital ratios will generally exceed those of
the latter. A 3•rating should be ascribed to a bank's capital
position when the relationship of the capital structure to points
(a), (b) or (cj is adverse even giving weight to management-as a
mitigating factor. In most instances, such banks would have" capital
ratios below peer group averages. Banks rated 4 and 5 are clearly
inadequately capitalized, the latter representing a situation of
such gravity as to threaten viability and solvency. A S rating also
denotes a bank that requires urgent assistance from shareholders or
other external sources of financial support.
Asset Quality
Asset quality is rated (1 thru S) in relation to (a) the level,
distribution and severity of classified assets; (b) the level and
composition of nonaccrual and reduced rate assets; (c) the adequacy
of valuation reserves; and (d) demonstrated ability to administer
and collect problem credits. Obviously, adequate valuation reserve:and a proven capacity to police and collect problem credits mitigate
to some degree the weaknesses inherent in a given level of classifi.
assets. In evaluating asset quality, consideration should also be
given to any undue degree of concentration' of credits or investments,
the nature and volume of special mention classifications, lending
policies, and the adequacy of credit administration procedures.

Asset quality ratings of 1 and 2 represent situations involving
a minimal level of concern. Both ratings represent sound portfolios
although the level and severity of classifications of the latter .
generally exceed those of the former. A 3 asset rating indicates a
situation involving an appreciable degree of concern, especially
to the extent that current adverse trends suggest potential future
problems. Ratings 4 and 5 represent increasingly more severe asset
problems; rating S, in particular, represents an imminent threat to
bank viability through the corrosive effect of asset problems on
the level of capital support.
Management/Administration
Management's performance must be evaluated against virtually all
factors considered necessary to operate the bank within accepted
banking practices and in a safe and sound manner. Thus, management
is rated (1 thru 5) with respect to (a) technical competence, leadership and administrative ability; (b) compliance with banking regulations
and statutes; (c) ability to plan and respond to changing circumstances; (d) adequacy of and compliance with internal policies; (e)
depth and succession; (f) tendencies toward self-dealing; and (g)
demonstrated willingness to serve the legitimate banking needs of
the community.




29
A 1 rating is indicative of management that is fully effective
with respect to almost all factors and exhibits a responsiveness and
ability to cope successfully with existing and foreseeable problems
that may arise in the conduct of the bank's affairs. A 2 rating
reflects some deficiencies but generally indicates a satisfactory
record of performance in light of the bank*s particular circumstances.
A rating of, 3 reflects performance that is lacking in some measure
of competence desirable to meet responsibilities of the situation
in which management is found. Either it is characterized by modest
talent when above-average abilities are called for, or it is
distinctly below average for the type and size of bank in which it
operates. Thus, its responsiveness or ability to correct less than
satisfactory conditions may be lacking. The 4 rating is indicative
. of a management that is generally inferior in ability compared to
the responsibilities with which it is charged. A rating of 5 is
applicable to those instances where incompetence has been demonstrated.
In these cases, problems resulting from management weakness are of
such severity that management must be strengthened or replaced before
sound conditions can be brought about.
Earnings
Earnings will be rated (1 thru S) with respect to (a) the ability
to cover losses and provide for adequate capital; (b) earnings trends;
(c) peer group comparisons; and (d) quality and composition of net
income. Consideration must also be given to the interrelationships
that exist between the dividend payout ratio, the rate of growth of
retained earnings and the adequacy of bank capital. A dividend
payout rate that is sufficiently high as to cause an adverse relationship to exist suggests conditions warranting a lower rating despite
a level of earnings that might otherwise warrant a more favorable
appraisal. Quality is also an important factor in evaluating this
dimension of a bank's performance. Consideration should be given to
the adequacy of transfers to the valuation reserve and the extent
to which extraordinary items, securities transactions, and tax
effects contribute to net income. Earnings rated 1 are sufficient to
make full provision for the absorption of losses and the accretion of
capital when due consideration is given to asset quality and bank
growth. Generally, banks so rated will have earnings well above peer
group averages. A bank whose earnings are relatively static or even
moving downward may receive a 2 rating provided its level of earnings ft
is adequate in view of the considerations discussed above. Normally,
banks so rated will have earnings that are in line with or slightly
above peer group norms. A 3 should be accorded earnings that are not
sufficient to make full provision for the absorption of losses and
the accretion of capital in relation to bank growth. The earnings
pictures of such banks may be further clouded by static or inconsistent earnings trends, chronically insufficient earnings, a high
dividend payout rate or less than satisfactory asset quality.
Earnings of'such banks are generally below peer group averages.
Earnings rated 4, while generally positive, may be characterized by




30
erratic fluctuations in net income, the development of a downward
trend, intermittent losses or a substantial drop from the previous
year. Earnings of such banks are ordinarily substantially below
peer group averages. Banks with earnings accorded a 5 rating should
be experiencing losses or reflecting a level of earnings that is
worse than defined in No. 4 above. Such losse.« may represent a
distinct threat to the bank's solvency through the erosion of capital.
Liquidity
Liquidity is rated (1 thru 5) with respect to (a) the volatility
of deposits; (b) reliance on interest-sensitive funds and frequency
and level of borrowings; (c) technical competence relative to structure
of liabilities; (d) availability of assets readily convertible into
cash; and (e) access to money markets or other ready sources of cash.
Ultimately, the bank's liquidity must be evaluated on the basis of
its capacity to promptly meet the demand for payment of its obligations »
and to readily fill the reasonable credit needs emanating from the
communities which it serves. In appraising liquidity, attention should
be directed to the bank's average liquidity over a specific time
period as well as its liquidity position on any particular date.
Consideration should be given where appropriate to the overall
effectiveness of asset-liability management strategies and compliance
with and adequacy of established liquidity policies. The nature,
volume and anticipated usage of a bank's credit commitments are
also factors to be weighed in arriving at an overall rating for
liquidity.
A liquidity rating of 1 indicates a more than sufficient volume
of liquid assets and/or ready and easy access on favorable terms to
external sources of liquidity within the context of the bank's overall asset-liability management strategy. A bank developing a trend
toward decreasing liquidity and increasing reliance on borrowed
funds, yet still within acceptable proportions, may be accorded a
2 rating. A 3 liquidity rating reflects an insufficient volume of
liquid assets and/or a reliance on interest-sensitive funds that is
approaching or exceeds reasonable proportions for a given bank.
Rating of 4 and 5 represent increasingly serious liquidity positions.
Banks with liquidity positions so critical as to constitute an
imminent threat to continued viability should be accorded a S rating.
Such banks require immediate remedial action or external financial
assistance to allow them to meet their maturing obligations.




31

Appendix C

rouais & m©©EoyRES I M K L
Comptroller of the Currency
Administrator of National Banks

S c i n Bank Supervision and
eto.
Sbet
ujc
Enforcement and Compliance Division

TO:

Formal and Informal
Administrative Actions

Deputy Comptrollers, Regional Administrators, Department and
Division Heads and Regional Counsels

PURPOSE
This issuance sets forth policies and procedures governing formal
and informal administrative actions.
RESPONSIBILITY
Responsibility for the initial decision on whether to commence a
formal or informal administrative action rests with the Regional
Office. In reaching this decision, involved personnel must adhere
to these policies and procedures which are designed to promote
uniform regulation of national banks throughout the OCC.
I.

Enforcement Policy
A.

Banks rated 4 and 5 - It is OCC policy to take formal
administrative action against all banks rated 4 or 5.
Formal administrative actions are typically Agreements
or Cease and Desist Orders executed pursuant to the
Financial Institutions Supervisory Act of 1966
and the Financial Institutions Regulatory and Interest
Rate Control Act of 1978 (12 U.S.C. §1818).

B.

Banks rated 3 - It is OCC policy to consider formal
administrative action with respect to all banks
rated 3. If formal action is determined to be
inappropriate for any 3 rated bank, it is OCC policy to
undertake informal remedial action through the use of a
Memorandum of Understanding between the Regional
Administrator and the bank.

C.

Banks rated 1 and 2 - Nothing in these policies
precludes the use of either formal or informal
administrative actions on a 1 or 2 rated bank.

D#

Exceptions - Conditions prevailing in individual banks
may occasionally warrant deviation from the general
'policies set forth above. The following procedure
should be followed in those cases where an exception
from the general policy is appropriate.




32

Comptroller of the Currency
Administrator of National Banks

c c i n Bank Supervision and
*to
Enforcement and Compliance Division

S b e Formal and Informal
ult
Administrative Actions

1.

Banks rated 4 or 5 - The Regional Office's
written recommendation which supports an
exception to the general enforcement policy
and outlining the reasons why formal
administrative action is inappropriate must
be sent to the Special Projects Division
(SP). The Regional Office's memorandum
should detail what other remedial action will
be taken in lieu of formal administrative
actions. SP, with personnel from the
Enforcement and Compliance Division (E&C)
will review the recommendation. SP and E&C
will develop a joint, or individual if
required, written recommendation(s) which
will be forwarded, together with the Regional
Office's recommendation, to the Deputy
Comptroller for Special Surveillance. The
Regional Office will concurrently be provided
with a copy of the SP/E&C recommendation via
telecopier. The Deputy Comptroller for
Special Surveillance will decide whether an
exception from the general policy is
warranted, and will communicate his decision
to the Region.

2.

Banks rated 3 - The same exception procedure
as applies in the case of 4 or 5 rated banks
is to be used except that the matter will be
referred for decision to the Deputy Comptroller
for Special Surveillance only if the SP/E&C
recommendation varies with that of the Regional
Office.

Miscellaneous Administrative Actions - The OCC is
vested with statutory authority to undertake
various administrative actions apart from those
discussed above. Included among available
proceedings are the following:
1.
2.
3.

publication of the Report of Examination;
imposition of a conservatorship;
recommendations to FDIC for termination of




33

0

PPM- 6100 - 1

Comptroller of the Currency
Administrator of National Banks

S c i n Bank Supervision and
eto
Enforcement and Compliance Division

4.
5.

S b e t F o r m a I a n a mrormai
ujc
Administrative Actions

deposit insurance;
commencement of action to remove individuals
from participation in the affairs of the bank;
and
assessment of civil money penalties.

Initiation of such proceedings will depend upon the
facts presented in the individual case and banking
situations where such supervisory tools can most
effectively be employed. In the absence of specific
instructions to•the^contrary, recommendations to
undertake administrative actions not covered in these
policies and procedures should be sent to SP and E&C.
It should be emphasized that these remedies can be used
either in lieu of, or in addition to, the Agreement,
Cease and Desist Order or Memorandum of Understanding.
II.

Matters Delegated to Regional Office
Regional Administrators, or their designees in specific
instances, are hereby authorized to execute and terminate
formal written Agreements, within the meaning of 12 U.S.C.
51818(b), and Memoranda of Understanding with banks rated 1,
2, or 3, having assets of less than $50 million.




A.

Procedure on Delegated Matters
1.

Banks rated 1 or 2 - Copies of execut d
Memoranda of Understanding and Agreements
on banks with less than $50 million shall
be sent to SP within ten (10) days of
execution for recordkeeping and
statistical purposes.

2.

Banks rated 3 - Memoranda of Understanding - aliTTgFeements with banks having
assets less than $50 Million are
governed by the following procedures:
a.

Form and Content - When administrative action is to be taken, the
Regional Office will provide SP with

34

rouaEt

& (PtROxsEoy^is [Mi^y'AL

Comptroller of the Currency
Administrator of National Banks

S c i n Bank Supervision and
eto
soe
u i a p o r m a i a n d Informal
Enforcement .and Compliance Division
Administrative Actions




a written memorandum indicating the
type of action to be taken and topics
to be addressed. The Regional
Officers reasoning supporting the
type of action to be taken should be
included in this written memorandum.
b.

SP Comments - SP will, within ten
(10) days after receiving sufficient
information, either concur with the
Region's recommended course of action
qr suggest an alternative. (Such
information normally will include a
copy of the pencil or final Report of
Examination, the examiner's SP memo
and form 9060-04.)

c.

Drafting and Serving Documents - It
is the responsibility of Regional
personnel, including the
examiner-in-charge, to draft and
present Memoranda of Understanding
and Agreements to the Boards of
Directors of involved banks. Upon
execution of the appropriate
document(s), a duplicate signed
original shall be forwarded, to SP
within ten (10) days, for recordkeeping and periodic review purposes.

d.

Failure to sign - When, while
proceeding with administrative
action against a bank, Regional
personnel encounter a Board of
Directors which is unwilling to
execute the remedial document
presented, the matter must be
referred immediately to SP/E&C for
consideration of alternative
action, together with the Regional
Office's recommended course of
action. In these cases, the

35

FOLOG

€isi

Comptroller of the Currency
Administrator of National Banks

Section B a n k supervision and
Enforcement and Compliance Division

Sob,ecl

Formal and Informal
Administrative Actions

procedures outlined in section III.
below, should be employed.
Periodic review - SP and E&C shall
conduct periodic reviews of the
Region's activities on delegated
matters to ascertain: (a) Regional
adherence to policy, (b) extent of
coverage of problem areas in executed
administrative actions, (c) general
effectiveness and appropriateness of
administrative actions taken,
(d) legal sufficiency of the
documents.
III. Non-Delegated Matters
Administrative action required by this enforcement policy or
which is otherwise appropriate and has not been delegated to
Regional Administrators in section II., above, should be
initiated pursuant to the following procedures. Regional
Administrators are not delegated authority unless it is
specifically given on a case-by-case basis for the
following:
all Notices of Charges and Cease and Desist Orders
all administrative actions on banks rated 4 or 5
all Agreements and Memoranda of Understanding on
banks exceeding $50 million in assets
administrative actions set forth in section
I.E. (above)
A.

Procedures on Non-delegated Matters
1. . Regional draft - Documents (Memoranda of Understanding, Agreements, Cease and Desist Orders and
Notices of Charges) should be submitted in draft to
SP. The input of the examiner-in-charge should be
sought in drafting of the documents.
2.




Washington review - SP and E&C personnel will
review available information regarding the

36

0

PPM-

6100 - 1

PQUCDES & FBQOEDUIRIES i^^y^i

Comptroller of the Currency
Administrator of National Banks

Section' BgLn]c supervision and
*®pa Formal and Informal
Enforcement and Compliance Division
Administrative Actions
involved bank, together with the draft enforcement
document(s) submitted by the Regional staff. Upon
completion of their Review, SP and E&C representatives will arrange a conference call with the
Regional Administrator or his representatives to
discuss any proposed modifications to the
enforcement document. Any disagreements between
Regional and SP/E&C personnel regarding the proper
form or content of administrative actions which
exist after the conference call will be resolved
when the Enforcement Review Committee considers
the action.
Enforcement Review Committee
(a)

Members
(i) Senior Deputy Comptroller for Bank
Supervision (Chairman)
(ii) Deputy Comptroller Multinational Banking
(iii) Deputy Comptroller Specialized ^
Examinations
*
""
"
(iv) Deputy Comptroller Special Surveillance
(v) Chief National Bank Examiner
(vi) Director, Enforcement and Compliance
Division
(vii) Director, Special Projects Division
(viii) Regional Administrator or Designee, at
Regional Administrator's option.

(b)

Matters reviewed
(i) all non-delegated actions

(c)

Documents reviewed in advance of
committee meeting
(i) summary memorandum, prepared by SP,
which contains:
a)
general information on "the bank,
e.g. ownership, affiliation,
unusual items, rating, etc.;
b)
the problems to be addressed in the
administrative document, together
with brief background information




37

Q

POIOES & FTOeiOy^ii B^WAE

Comptroller of the Currency
Administrator of National Banks

S c i n Bank Supervision and
eto
Enforcement and Compliance Division




S b e t Formal and Informal
ujc
Administrative Actions

on the more important topics
covered;
the Regional Office position;
the*recommendation of SP;
the recommendation of E&C;
suggested modifications still in
dispute; and
g)
a listing of proposed Washington
attendees, if any, as well as the
Region's selected attendees at the
Board of Directors meeting at which
„ the documents will be presented.

c)
d)
e)
f)

(ii) the most recent Statistical Data Sheet
(iii) the proposed administrative document(s)
(d)

Decisions The Committee will resolve all issues which
remain unsettled at the time of its meeting,
including, if necessary, the form and content
of the document, as well as the attendees at
the Board of Directors meeting. The Deputy
Comptroller for Special Surveillance will
promptly inform the Regional Administrator by
telephone and/or telecopy, of any substantive
changes resulting from the meeting.

Preparation of final documents - After the
Enforcement Review Committee meeting, E&C
personnel will prepare the appropriate documents
in final form and route them for necessary
signatures. Documents for the Comptroller's
signature must be routed, under a brief summary
memorandum highlighting significant elements,
through at least:
(a)
(b)
(c)
(d)

Director, E&C;
Director, SP;
Deputy Comptroller for
Special Surveillance; and
Senior Deputy Comptroller for
Bank Supervision.

38

O
Comptroller of the Currency
Administrator of National Banks

S c i n Bank Supervision and
eto
Sbet
ujc:
Formal and Informal
Enforcement and Compliance Division
Administrative Actions

Whenever the particular enforcement action
involves novel or unusually significant legal or
policy issues, the documents must also be routed
through the Chief Counsel or Deputy Chief Counsel.
After signature by the Comptroller, the E&C
attorney will effect delivery of the documents to
the Region.
* 5.

Presentation of documents - The Regional
Administrator or his designee will chair the
meeting to be held with the Board. The E&C
attorney will be charged with the responsibility
of presenting the administrative action. If an E&C
attorney is not present, the Regional Counsel should
present the documents. If an SP examiner is
designated to attend the meeting as a representative
of the Comptroller, he will actively participate in
the proceedings to an extent mutually agreed by the
Director, SP and the Regional Administrator.

6.

Litigated enforcement proceedings - Upon service
of a Notice of Charges (or Notice of Assessment in
the case of civil money penalties) enforcement
proceedings move into an adjudicative posture. At
this point, the OCC is formally represented
in the proceeding by E&C. The E&C attorney
handling the individual case will make all
necessary arrangements for and will represent
the Office at any formal administrative hearing.
After the service of the Notice, the E&C attorney
will also represent the OCC in any settlement
discussions with counsel or other representatives
of the opposing party or parties. The E&C
attorney will consult with the Regional
Administrator and SP in settlement decisions.
All contacts or information relevant to the involved
case which are directed to the Regional or
Washington office must promptly be brought to the
attention of the E&C attorney.




39
PPM- 6100 - 1

0

royals & ^©©soures KMJIUM,

Comptroller of the Currency
Administrator of National Banks
Sub a
Section: B a n k supervision and
^
Enforcement and Compliance Division

IV#

Formal and Informal
Administrative Actions

Trust Departments and EDP Centers
"K". Trust Departments and EDP Centers Rated 5
It is OCC policy to take formal administrative action,
either a Cease and Desist Order or an Agreement under the
Financial Institutions Supervisory Act of 1966 and the
Financial Institutions Regulatory and Interest Rate
Control Act of 1978 (12 U.S.C. $1818), on all 5-rated
trust departments or EDP data centers*
B.

Trust Departments and EDP Centers Rated 4
It is OCC policy to consider formal administrative action
under the financial Institutions Supervisory Act of 1966
for all 4-rated trust departments and EDP centers. If
formal administrative action is considered inappropriate,
the OCC policy is to take administrative action through
use of a "Memorandum of Understanding" between the
Regional Administrator and the bank.

c

*

Trust Departments and EDP Centers Rated 1,2, or 3
Nothing in these policies precludes the use of either
formal or informal administrative actions against 1,2,
or 3-rated Trust departments or EDP centers.

D.

Exceptions
Conditions may require exceptions to this policy.
Before adminstrative action is waived by the
Regional Administrator, the concurrence of the Deputy
Comptroller for Specialized Examinations must be
specifically sought under the following procedures:
1.




The Regional Office's written recommendation shall
be submitted to the Trust Examinations Division or
the EDP Examinations Division outlining the
reasons an administrative action is considered
inappropriate and indicating alternative remedial
supervisory actions proposed. The Trust
Examinations Divisions or EDP Examinations
Divisions will review each request for an

40

Q

Pf»DE0)U[RIS MINIUM,

Comptroller of the Currency
Administrator of National Banks

S c i n Bank Supervision and
eto:
Sbet
ujc.
Formal and Informal
Enforcement and Compliance Division
Administrative Actions

exception to the general policy and make
their recommendations to the Deputy Comptroller
for Specialized Examinations who will decide
whether an exception is warranted.
E.

Matters Delegated to the Regional Office relating to
Trust Departments and EDP CenteTi"
Regional Administrators or their designees in specific
instances are authorized to execute and terminate
written Agreements and Memoranda of Understanding with
Trust Departments and EDP Centers rated 1,2, or 3,
which are departments of banks having assets of less
than $50 million dollars. The procedures to be
followed are those detailed in Section II.A above,
with representatives of the Trust Examinations Division
or the EDP Examinations Division substituting for the
Special Projects Division personnel.

P.

Non-delegated Trust Departments and EDP Centers..
-

All Notices of Charges and Cease and Desist Orders
All actions on Trust Departments or EDP Centers
rated 4 or 5 and on all independent EDP Centers.
All Agreements and Memoranda of Understanding on
banks having assets in excess of $50 million.

The procedures to be followed are those detailed in
section III.A, above with representatives of the Trust
Examinations Division or EDP Examinations Division
substituting for Special Projects Division personnel.
V.

Monitoring and Evaluation of Administrative Actions
The Regional Office is responsible for monitoring compliance
with all administrative actions. Special care should be
taken to evaluate compliance with such documents on ah
ongoing basis. Additionally, the Regional Office is
responsible for initiating additional supervisory action and
informing SP when significant areas of noncompliance art
found'to exist.




41

0

rouoEi &ra©©Eoures^ S & L

Comptroller of the Currency
Administrator of National Banks

Scin
eto:
Bank Supervision.and
Sbet
ujc:
Enforcement and Compliance Division

Formal and Informal
Administrative Actions

As part of their regular responsibilities when conducting an
examination, examining personnel should complete the
attached form (Exhibit A) with respect to those national
banks, Trust Departments or EDP Centers operating under a
Memorandum of Understanding, a formal Agreement, or an Order.
Upon completion, the contents of the form should be included
in the confidential portion of the report of examination or
supervisory examination. Additionally, copies of the
completed form, together with appropriate comments and
recommendations from the Regional Administrator, should be
sent to SP, Trust or EDP Examination Divisions, as
appropriate.
VI.

Termination or Modification of Administrative Actions
Generally, termination of an action will not be considered
unless the bank's overall condition has significantly
improved and it has substantially complied with the terms
of the action.
A.

Delegated Actions - Regional Administrators are"
authorized to modify or terminate any action falling
within the scope of the delegation contained in
section II., above. Copies of the memoranda supporting
the need for the modification or termination as well as
the documents accomplishing these results should be
forwarded, upon completion, to SP, Trust or EDP
Divisions, as appropriate.

B.

Non-delegated Actions - Regional Administrators are
responsible for recommending modification or
termination of actions on non-delegated matters.
Regional recommendations are to be in writing and
forwarded to SP for joint review and recommendation
with E&C. In the case of non-delegated Memoranda of
Understanding, Regional and-Washington recommendations are forwarded to the Deputy Comptroller for
Special Surveillance (Deputy Comptroller for
Specialized Examinations) who is empowered to authorize
•Regional modification or termination of the document.
For other types of non-delegated action, the
recommendations are fowarded for consideration of the




42

moaEDURES MMmftL
Comptroller of the Currency
Administrator of National Banks

Subject:
Bank Supervision and
Enforcement and Compliance Division

Section

Formal and Informal
Administrative Actions

Senior Deputy Comptroller for Bank Supervision and
decision by the Comptroller. The Comptroller will
authorize Regional modification or termination of these
Agreements or Orders.
VII. Effective Date
These policies and procedures are effective immediately.
Inquiries concerning the applicability of this document to
particular fact situations should be referred to the
Directors of SP, E&C, Trust and EDP, as appropriate.

skd&k-

JOHN G. HEIMANN
COMPTROLLER OF THE CURRENCY

Attachment A - 1 page
Attachment B - 1 page




43
EXHIBIT A
EVALUATION Of C O M P L I A N C E WITH FORMAL OR INFORMAL
'ACTION"

ADMINISTRATIVE

(1)

Name of B a n k :

(Z)

Nature of A d m i n i s t r a t i v e Action (ex. Cease and Desist O r d e r ,
Formal A g r e e m e n t , "Memorandum of U n d e r s t a n d i n g , " e t c . ) :

(3)

Date of A d m i n i s t r a t i v e

(4)

Has the bank complied with^the provisions of each article of
the a d m i n i s t r a t i v e action:

(5)

If n o n c o m p l i a n c e e x i s t s , which Articles are involved, and
what is the nature and extent of the noncompliance?

(6)

If n o n c o m p l i a n c e e x M s t s , what action has been taken to ensure
compliance?

(7)

What s i g n i f i c a n t matters requiring attention are not presently
covered by the administrative action?

(8)

Discuss the e f f e c t i v e n e s s of the administrative action and
comment
as to w h e t h e r additional administrative action
should be taken or whether the outstanding administrative
action should be terminated.

97-830

0-82




Action:

44
Appendix D
SUMMARY OF FORMAL AGREEMENT
DATED SEPTEMBER 9, 1980'
Correct all violations of law and adopt procedures
to prevent them from occurring in the future.

Develop and implement specific plans to ensure
that the equity capital of the bank would

be

increased and maintained at a minimum of 7.5% of
average daily assets.

Obtain

and

credit

maintain

information

current
and

and

satisfactory

eliminate

collateral

exceptions.

Not grant additional

loans unless current and

satisfactory credit information were available and
the loans were supported by appropriate collateral
documentation.

Establish

a

program

for

the

elimination

of

criticized

assets and preclude the extension of

additional credit to borrowers whose extensions of
credit had been criticized.

Revise the lending policy and establish procedures
to monitor and enforce adherence to the lending
policy.

The revisions were to include:




45
guidelines

for

the

purchase

and

sale

of

participations;

procedures for identifying problem loans;

identification of the categories of loans
where

concentrations

of

credit

would

be

permitted and the limits thereto;

procedures

to limit, control, and

document

contingent liabilities.

Reviev* and revise the investment policy of the
bank.

Establish a committee of the board of directors to
perform a management study to evaluate the current
management and make appropriate

adjustments

for

the future.

Review the bank's allowance for possible loan
losses

and

establish

an

adequate

level

commensurate with the risks and potential for
losses inherent in the bank's loan portfolio.




46
Develop and adopt a written liquidity, asset, and
liability management policy to maintain the bank's
liquidity at a level commensurate with prudent
banking practices and the bank's needs.

File

monthly

reports

Office.




with

the

Comptroller's

47
Appendix E
SUMMARY OF NOTICE OF CHARGES
DATED JUNE 30, 1982
The bank, in violation of the Agreement and in
violation of 12 U.S.C. §84, had extended credit to
borrowers in excess of the bank's legal limit.

The

bank,

in

violation

of

the

Agreement

and

contrary to safe and sound banking practices,
failed

to

maintain

and

obtain

current

and

satisfactory credit information and granted loans
which were not fully supported by the necessary
collateral documentation.

The bank, in violation of the Agreement, extended
additional credit to borrowers whose loans had
been previously criticized.

The bank, in violation of the Agreement, failed to
ensure that the bank's Allowance for Possible Loan
Losses was maintained at a level commensurate with
the risks for loss inherent in the loan portfolio.

The bank was in an unsafe and unsound condition
having accumulated

criticized

assets aggregating

in excess of $81 million which amounted to more
than 200% of the bank's gross capital funds.




48
The bank, in violation of certain statutes and in
an unsafe and unsound manner, sold participations
in loans originated by the bank without disclosing
to

the

material,

purchasers
non-public

of

those

participations

information

known

to

the

bank.

The

bank

permitted

officers

without

lending

authority to extend credit on behalf of the bank.

The bank, contrary to safe and sound practices,
had paid interest to participating institutions on
participations
participating

sold

without

institution

that

advising
the

the

source

of

payment was not from the borrower.

The bank, contrary to the Agreement and contrary
to safe and sound banking practices, had failed to
implement

and

adhere

to

procedures

to

limit,

control, and document its contingent liability.

The bank, in violation of 12 U.S.C. §§375a and
375b had extended credit to insiders of the bank.




- 2 -

49
SUMMARY OF TEMPORARY ORDER TO CEASE AND DESIST
ISSUED JUNE 30, 1982
Immediately undertake actions to provide the bank,
by no later than July 9, 1982, with $30 million in
new equity capital.

Comply with the lending limit statute, 12 U.S.C.
§84.

Correct collateral and documentation deficiencies
with respect to all loans including participation
loans.

Not extend additional credit to any borrowers
whose

loans

or

extensions

of

credit

were

criticized.

Make no loans or loan commitments without first
obtaining

full

collateral

documentation

and

current and satisfactory credit information.

Not make any commitments to extend credit whether
for a fee or otherwise without first arranging
firm sources with which to fund it.

Engage independent qualified auditors to reconcile
various asset accounts of the bank.




- 3 -

50
Not s e l l any p a r t i c i p a t i o n in any e x t e n s i o n of
credit

unless

the

loan

and

collateral

documentation was in conformity with the terms of
the

participation

agreement

p a r t i c i p a n t was f i r s t

and

the

informed of a l l

potential
material

f a c t s with respect to the borrower and the c r e d i t .

Not permit o f f i c e r s

without lending a u t h o r i t y

to

extend c r e d i t or make commitments on behalf of the
bank.
The CHAIRMAN. We will be asking a few questions, I am sure.
However, we first would like to hear from Mr. Isaac, Chairman of
the FDIC, so we can then ask questions of either of you.
Mr. Isaac, we will put your entire statement in the record. You
may proceed.
STATEMENT OF HON. WILLIAM M. ISAAC, CHAIRMAN, FEDERAL
DEPOSIT INSURANCE CORPORATION
Mr. ISAAC. Thank you, Mr. Chairman.
Mr. Chairman, Mr. Stanton, members of the committee, I am
pleased to be here and have this opportunity to discuss the role of
the FDIC as receiver for the failed Penn Square Bank of Oklahoma
City.
I thought it might be useful in view of the complexity of this situation to review the background of the matter and the options
available to us.
Then I will discuss generally the implications of this bank's failure.
On Wednesday morning, June 30, the Comptroller's staff called
me to set up an urgent meeting at which they described the seriousness of the situation at the Penn Square Bank and indicated
that the bank was in danger of failing.
We immediately dispatched about 10 FDIC examination and liquidation personnel to the scene to gather information.
They were instructed to operate out of our Oklahoma City field
office, rather than the bank to the extent possible.
On Thursday, the American Banker ran a story on the bank and
on Friday, both the American Banker and the Wall Street Journal
ran articles.
The story also received local media coverage in Oklahoma City.
In view of the increasing media attention and the possibility of
widespread depositor concern, on Thursday, we dispatched about 50
FDIC personnel. They were to begin preparations for handling the



51
possible failure of the bank through either a purchase-and-assumption transaction or a deposit payoff.
Deposit outflows were modest on Friday, but on Saturday, conditions deteriorated substantially. In fact, the bank did not have sufficient cash on hand to meet depositor demands and issued $1.8
million in cashiers' checks.
Local TV stations broadcast reports from the bank on Saturday.
If the bank had opened for business as usual on the following Tuesday, we and bank officials anticipated extraordinary deposit withdrawals.
Approximately 30 FDIC personnel in Washington and 60 in Oklahoma City worked virtually nonstop through the holiday weekend
to prepare for every contingency.
We had essentially three alternatives to consider. One, to arrange a purchase-and-assumption transaction or merger with another institution.
Two, to do a deposit payoff.
Or three, to create a deposit insurance national bank to handle
the funds of insured depositors.
Our preferred method of handling the bank failure is to merge it
into another institution with FDIC assistance. Very occasionally we
are not able to do this.
Either because we have no acceptable acquirers or because the
bank has a potentially large amount of contingent or unknown
claims which makes it impossible to estimate the cost of a merger.
We cannot under our statute enter into a merger or a purchaseand-assumption transaction unless our board can make a finding
that the P. & A. will likely be no more costly than a deposit payoff.
We estimate that our maximum cost under deposit payoff could
be as high as $240 million in this situation, but would likely be
very substantially less, depending on the recoveries from the receivership.
In a purchase-and-assumption transaction, the corporation indemnifies the acquiring bank against contingent liabilities or unknown losses caused by the actions of the failed bank.
In providing this indemnification, we must estimate the losses
arising from the known contingent claims and satisfy ourselves
that other contingencies that might lead to large losses do not
exist.
In the case of Penn Square, we were aware of contingent claims,
including loan participations, loan commitments, and standby letters of credit ranging between $2.5 and $2.9 billion.
In addition, we had reason to believe that there might be irregularities that could give rise to other claims. It was virtually impossible, particularly in view of the time limitations, to estimate the
potential losses that could stem from this vast source of contingent
claims.
Given our inability to accurately assess and quantify these potential losses, and our statutory limitations, we simply could not arrange a purchase-and-assumption transaction.
Our second alternative was simply to pay off insured depositors
up to the $100,000 maximum limit. This process involves proof of
deposit accounts, the determination of the amount held by each de


52
positor in his or her separate right and capacity, and the preparation of checks.
Uninsured depositors and general creditors would receive receiver's certificates with payments to follow as the assets of the bank
were liquidated.
The process of paying off insured depositors is time consuming
and disruptive. Our Division of Liquidation estimated that the payment of insured deposits could not have commenced before the
week of July 12.
Furthermore, if this alternative was selected, any checks drawn
on deposit accounts in the Penn Square Bank would have been returned.
Given the anticipated press coverage of the transaction, the size
of the bank, and the possible adverse effect on public confidence,
we were most anxious to reopen the bank's doors on Tuesday.
Our third option was to create a Deposit Insurance National
Bank.
We call it a DINB. All insured deposits would be transferred to
the DINB, which would continue to honor checks drawn on the
Penn Square Bank up to the insurance limit and permit an orderly
payoff of insured accounts.
Uninsured depositors would be issued receiver's certificates for
the excess of their accounts over $100,000. It was decided that this
was the most desirable course of action.
We decided to pay interest on interest-bearing accounts, transferred to the DINB for 90 days as an assurance to depositors that
there was no need to rush immediately to the bank to withdraw
funds.
However, it is hoped that the 90-day limit will encourage an orderly transfer of funds to other banks within that time-frame.
We were greatly handicapped in our preparations over the weekend due to the fact that decision to close the bank was not made
until 7 p.m. on Monday.
Nevertheless, the DINB opened its doors at the usual hours on
Tuesday morning. There were depositor lines throughout the day
on Tuesday, but they were much shorter than anticipated for a
bank of this size with nearly 28,000 customers.
We announced that we would keep the bank open 24 hours a day
if necessary to meet the demands of the depositors.
People remained very calm, and by 7 p.m. on Tuesday, the depositor lines had disappeared and we closed the doors for the evening. Each day since, the bank has operated normally without lines
of any note. I would be remiss if I didn't take this opportunity to
salute the bank, and FDIC employees who worked around the clock
for days in order to provide uninterrupted service to the bank's depositors.
In addition to the activities at the DINB, we have a large
number of FDIC personnel involved in the receivership activities
relating to the bank.
Their first priority is to assist creditworthy borrowers in locating
alternative funding sources. They are also taking an inventory of
all of the bank's assets and attempting to determine their value.



53
We will endeavor to promptly dispose of the assets in an orderly
fashion so that we may return funds to uninsured depositors and
other creditors as soon as possible.
Our people are also conducting, in conjunction with the FBI, a
thorough investigation of the events and activities which led to the
bank's demise. Extensive legal proceedings are highly probable.
Many people are asking, how could this have happened? Why did
this bank fail? How did so many other financial instititions get involved?
Is this failure evidence of other problems in the financial
system?
The first point I should emphasize is that we do not yet know
precisely what happened. The FDIC has only just begun to conduct
its investigation.
However, we have at this stage a rough outline of the practices
and problems which led to the bank's demise.
The short answer is that at best, this bank engaged in shoddy,
speculative banking practices. Its problems were not due principally to the economy or even the decline in energy prices.
Its problems were the result of loans which should never have
been made at the values placed on them. The bank's growth rate
was excessive, causing extensive reliance on volatile and expensive
funds borrowed in national money markets.
There was a complete lack of diversification in the loan portfolio.
In a word, the problems of this institution were unique, and the
bank's collapse is an aberration.
Fortunately, the great majority of insured banks adhere to prudent and rational lending and funding policies. With nearly 15,000
banks in this country, we will occasionally encounter situations
like Penn Square. But they will be few and far between.
Much has been said and written about the impact of the Penn
Square failure on other financial institutions that either participated in loans originated by Penn Square Bank or provided funding to
the bank in amounts in excess of the insurance limit.
Simply stated, a number of financial institutions regrettably
have learned an expensive but important lesson, these financial institutions were attracted by the opportunity to obtain high yields
on their investments, but failed to take into account the degree of
risk being undertaken.
As a result, some institutions will sustain losses.
It is indeed fortunate that these institutions have the ability to
withstand these losses. If one can identify a silver lining behind the
dark cloud of the Penn Square affair, we should expect that all financial institutions will be more prudent in the future.
We realize that there will be a great temptation to rush through
legislation to address the specific practices that led to the Penn
Square failure.
This, in our judgment, would be a mistake.
The regulatory agencies have sufficient supervisory and enforcement tools to carry out their responsibilities. As I stated earlier,
the problems of the Penn Square Bank were unique. The failure
was an aberration, and similar pervasive problems within the financial industry simply do not exist.



54
Nevertheless, I think this experience should prompt us to reevaluate our financial institutions' regulatory structure.
In conducting a review of the regulatory structure, we should
carefully consider the following questions.
First, is there a need for five regulatory agencies to supervise the
activities of the Nation's depositor institutions and does our current system function properly?
Second, is there a need for three separate deposit insurance
funds?
Third, would it be appropriate to base deposit insurance premiums on the risk posed by the insured entity, rather than to
continue the present flat-rate system for all institutions?
Fourth, can and should we revise our deposit insurance system
and procedures to provide perhaps even greater protection for
smaller depositors while at the same time introducing a greater
degree of discipline with respect to the larger creditors?
Fifth, is it possible and desirable to provide more public disclosure regarding the condition and business practices of insured depository institutions?
These are all matters that I have addressed in the past, both
before the committee and in other public forums. I firmly believe
that significant reforms in our regulatory apparatus are needed.
It is my sincere hope that the experiences of the last 2 weeks will
provide the impetus to move forward on these issues.
The worse mistake we could make is to look for a quick fix or to
enact punitive measures that would further burden an entire industry to correct the abuses of the few.
We urge you to undertake a dispassionate review of the Penn
Square system from a broadly based, long-range perspective.
We appreciate this opportunity to appear before you today and
offer our complete cooperation in your future efforts in connection
with this matter.
I thank you, Mr. Chairman.
[The prepared statement of Mr. Isaac follows:]




55
STATEMENT ON
FAILURE OF THE PENN SQUARE BANK
OKLAHOMA CITY, OKLAHOMA
PRESENTED TO

COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES

BY

WILLIAM M. ISAAC
CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION

2:00 P.M.
THURSDAY, JULY 15, 1982
ROOM 2128 RAYBURN HOUSE OFFICE BUILDING
WASHINGTON, D.C.




56
Mr. Chairman:
I am pleased to have the opportunity to discuss the
role of the FDIC as the Receiver for the failed Penn Square
Bank of Oklahoma City.

I thought it might be useful, in

view of the complexity of this situation, to review the
background of the matter and the options available to us.
Then I will discuss generally the implications of this
bank's failure.

I.

BACKGROUND OF FDIC ACTIVITIES

On Wednesday morning, June 30, the Comptroller's staff
called me to set up an urgent meeting at which they described
the seriousness of the situation at the Penn Square Bank and
indicated that the bank was in danger of failing. We
immediately dispatched about 10 FDIC examination and liquidation personnel to the scene to gather information. They
were instructed to operate out of our Oklahoma City field
office, rather than the bank, to the extent possible.

On Thursday the American Banker ran a story on the
bank, and on Friday both the American Banker and the Wall
Street Journal ran articles. The story also received local
media coverage in Oklahoma City.

In view of the increasing media attention and the
possibility of widespread depositor concern, on Thursday we
dispatched another 50 or so FDIC personnel to the scene.




57
They were to begin preparations for handling the possible
failure of the bank through either a purchase and assumption
transaction or a deposit payoff.

Deposit outflows were modest on Friday but on Saturday
conditions deteriorated substantially.

In fact, the bank

did not have sufficient cash on hand to meet depositor
demands and issued $1.8 million in cashiers' checks. Local
T.V. stations broadcast reports from the bank on Saturday.
If the bank had opened for business as usual on the following Tuesday, we and bank officials anticipated extraordinary
deposit withdrawals.

Approximately 30 FDIC personnel in Washington and 60 in
Oklahoma City worked virtually nonstop through the holiday
weekend to prepare for every contingency. We had essentially
three alternatives to consider:

1.

to arrange a purchase and assumption transaction,

2.

to do a deposit payoff, or

3.

to create a Deposit Insurance National Bank
(DINB) to handle the funds of insured depositors.

P&A Transaction

Our preferred method of handling a bank failure is to
merge it into another institution with FDIC assistance.




58
Very occasionally we are not able to do this either because
we have no acceptable acquirers or because the bank has a
potentially large amount of contingent or unknown claims
which makes it impossible to estimate the cost of a merger.

We cannot, under our statute, enter into a merger or
purchase and assumption transaction unless our Board can
make a finding that the P&A will likely be no more costly
than a deposit payoff. We estimated that our maximum cost
under a deposit payoff could be as high as $240 million but'
would likely be very substantially less depending on recoveries from the receivership.

In a purchase and assumption transaction, the Corporation
indemnifies the acquiring bank against contingent liabilities
or unknown losses caused by actions of the failed bank. In
providing this indemnification, we must estimate the losses
arising from the known contingent claims and satisfy ourselves
that other contingencies that might lead to large losses do
not exist.

In the case of Penn Square, we were aware of contingent
claims -- including loan participations, loan commitments
and standby letters of credit -- ranging between $2.5 and
$2.9 billion.

In addition, we had reason to believe there

might be irregularities that could give rise to other claims.
It was virtually impossible, particularly in view of the




59
time limitations, to estimate the potential losses that
could stem from this vast source of contingent claims.
Given our inability to accurately assess and quantify these
potential losses, and our statutory limitations, we simply
could not arrange a purchase and assumption transaction.

Deposit Payoff

Our second alternative was simply to pay off insured
depositors up to the $100,000 maximum.

This process involves

proof of deposit accounts, the determination of the amount
held by each depositor in his or her separate right and
capacity, and the preparation of checks.

Uninsured depositors

and general creditors would receive receiver's certificates
with payments to follow as the assets of the bank were
liquidated.

The process of paying off insured deposits is time
consuming and disruptive.

Our Division of Liquidation

estimated that the payment of insured deposits could not
have commenced until the week of July 12.

Furthermore, if

this alternative was selected, any checks drawn on deposit
accounts in the Penn Square Bank would have been returned.
Given the anticipated press coverage of the transaction, the
size of the bank, and the possible adverse effect on public
confidence, we were most anxious to reopen the bank's doors
on Tuesday.



97-830 0 - 8 2 - 5

60
DINB

Our third option was to create a Deposit Insurance
National Bank. All insured deposits w6uld be transferred to
the DINB, which would continue to honor checks drawn on the
Penn Square Bank up to the insured limit and permit an
orderly pay off of insured accounts. Uninsured depositors
would be issued receiver's certificates for the excess of
their accounts over $100,000.

It was decided that this was the most desirable course
of action. We decided to pay interest on interest-bearing
accounts transferred to the DINB for 90 days as an assurance
to depositors that there was no need to rush immediately to
the bank to withdraw funds. However, it is hoped the 90-day
limit will encourage an orderly transfer of funds to other
banks within that time.

We were greatly handicapped in our preparations over
the weekend due to the fact that the decision to close the
bank was not made until 7:00 p.m. on Monday. Nevertheless,
the DINB opened its doors at normal hours on Tuesday morning.

There were depositor lines throughout the day on
Tuesday, but they were much shorter than anticipated for a
bank of this size with nearly 28,000 customers. We announced
that we would keep the bank open 24 hours a day if necessary
to meet the demands of depositors.




61
People remained very calm and by 7:00 p.m. on Tuesday
the depositor lines had disappeared and we closed the doors
for the evening.

Each day since, the bank has operated

normally without lines of any note.

I would be remiss if I did not take this opportunity to
salute the bank and FDIC employees who worked around the
clock for days in order to provide uninterrupted service to
the bank's depositors.

In addition to the activities at the DINB, we have a
large number of FDIC personnel involved in the receivership
activities relating to the bank.

Their first priority is to

assist credit-worthy borrowers in locating alternative
funding sources.

They are also taking an inventory of all of the bank's
assets and attempting to determine their value.

We will

endeavor to promptly dispose of the assets in an orderly
fashion so that we may return funds to uninsured depositors
and other creditors as soon as possible.

Our people are also conducting, in conjunction with the
F.B.I., a thorough investigation of the events and activities
which led to the bank's demise.
are highly probable.




Extensive legal proceedings

62
II.

WHAT WENT WRONG?

Many people are asking:

"How could this have happened?

Why did this bank fail and how did so many other financial
institutions get involved?

Is this failure evidence of

other problems in the financial system?"

The first point I should emphasize is that we do not
yet know precisely what happened.

The FDIC has only just

begun to conduct its investigation.

However, we have at this stage a rough outline of the
practices and problems which led to the bank's demise.

The

short answer is that, at best, this bank engaged in shoddy,
speculative banking practices.

Its problems were not due

principally to the economy in general or even the decline in
energy prices.

Its problems were the result of loans which

should never have been made at the values placed on them.
The bank's growth rate was excessive, causing extensive
reliance on volatile and expensive funds borrowed in national
money markets.

There was a complete lack of diversification

in the loan portfolio.

In a word, the problems of this institution were unique
and the bank's collapse is an aberration. %Fortunately, the
great majority of insured banks adhere to prudent and




63
rational lending and funding policies.

With nearly 15,000

banks in the country, we will occasionally encounter situations
like Penn Square.

But they will be few and far between.

III. RIPPLE EFFECTS

Much has been said and written about the impact of the
Penn Square failure on other financial institutions that
either participated in loans originated by Penn Square Bank
or provided funding to the bank in amounts in excess of the"
insurance limit.

Simply stated, a number of financial institutions
regrettably have learned an expensive but important lesson.
These financial institutions were attracted by the opportunity
to obtain high yields on their investments but failed to take
into account the degree of risk being undertaken.

As a result

some institutions will sustain losses.

It is indeed fortunate that these institutions have the
ability to withstand these losses.

If one can identify a

silver lining behind the dark cloud of the Penn Square
affair, we should expect that all financial institutions
will be more prudent in the future.




64
IV. LEGISLATIVE RESPONSE

We realize that there will be a great temptation to
rush through legislation to address specific practices that
led to the Penn Square failure. This, in our judgment,
would be a mistake.

The regulatory agencies have sufficient supervisory and
enforcement tools to carry out their responsibilities. As I
stated earlier, the problems of the Penn Square Bank we're
unique, the failure was an aberration and similar pervasive
problems within the financial industry simply do not exist.

Nevertheless, I think this experience should prompt us
to reevaluate our financial institutions regulatory structure.
In conducting a review of the regulatory structure, we
should carefully consider the following questions:

1.

Is there a need for five regulatory agencies
to supervise the activities of the nation's
depository institutions and does our current
system function properly?

2.

Is there a need for three separate deposit
insurance funds?




65
3.

Would it be appropriate to base deposit
insurance premiums on the risk posed by the
insured entity rather than to continue the
present flat rate system for all institutions?

4.

Can and should we revise our deposit insurance
system and procedures to provide perhaps even
greater protection for smaller depositors
while at the same time introducing a greater
degree of discipline with respect to larger
creditors?

5.

Is it possible and desirable to provide more
public disclosure regarding the condition and
business practices of insured depository
institutions?

These are all matters that I have addressed in the past
both before Congress and in other public forums.

I firmly

believe that significant reforms in our regulatory apparatus
are needed.

It is my sincere hope that the experiences of

the last two weeks will provide the impetus to move forward
on these issues.

The worst mistake we could make is to look for a "quick
fix" or to enact punitive measures that would further




66
burden an entire industry to correct the abuses of a few.
We urge you to undertake a dispassionate review of the Penn
Square situation from a broadly-based, long-range perspective.

We appreciate this opportunity to appear today and
offer our complete cooperation in your future efforts in
this matter.

The CHAIRMAN. Thank you and I would like to reassure you, Mr.
Isaac, that the reason for the briefing today, the reason that hearings will begin on August 11 and not yesterday or the day before, is
that indeed, we are looking at this dispassionately and some of the
items that you have suggested in your laundry list at the conclusion of your statement, I think you are aware, have been looked
into and discussed by this committee and by this chairman in the
past.
As a matter of fact, some of them contain the recommendation of
the FINE study in 1975 and 1976.
It is just that some of them, unfortunately, have a long gestation
period. But we will get to them.
There is no intent to take any punitive action. We want to know
what the causes were other than those which you cited. I think
there are a few others that have not as yet been cited that will
come out as the factfinding process continues.
At this point in time, I would ask the staff to start the 5-minute
clock on the go-around for both sides so that the members can ask
questions of either Mr. Conover or Mr. Isaac.
Mr. Conover, obviously you had, or your office, rather, had information about the problems at this bank.
Your examiners were aware of the fact for a long period of time
that various institutions were carrying on very extensive participation with Penn Square.
As a matter of fact, it's been cited and we have not been able to
determine the exact numbers as yet, one institution, Continental Illinois, may have had as much as $1 billion in participation with
Penn Square.
Now, I ask you, was the information that was gleaned from examinations of Penn Square forwarded to your Chicago office so
that the examiners at Continental would have knowledge of the
fact that some of those participations and some of those loans in
which they had purchased from Penn Square were, as you describe
it in your statement, not too well-collateralized?
And was information given to the NCUA and to the Federal
Home Loan Bank Board in view of the fact that many of their insured institutions were very heavy investors in jumbo CD's at Penn
Square?
So we have a two-pronged question?
Mr. CONOVER. I think I would like to answer the second part of
that first, Mr. Chairman, and then ask Mr. Homan if he would



67
deal with the first part involving the transmittal of information to
Chicago.
We learned, Mr. Chairman, late in the week prior to the bank's
closing, that there were significant uninsured deposits by a number
of credit unions and savings and loan associations in the Penn
Square Bank.
I believe late in that week, Thursday or Friday, both Mr. Callahan, the chairman of the NCUA and Mr. Pratt, the Chairman of
the Federal Home Loan Bank Board, were advised about the total
number of institutions and the approximate number of dollars of
insured deposits that they had outstanding at that time.
Over the weekend, I believe it was Saturday or Sunday, I am not
sure, I personally talked with Mr. Callahan and with Tom Vartanian, the General Counsel of the Federal Home Loan Bank Board,
and told him that we had a precise list of the names of each of
their institutions and the estimated dollar amount of uninsured deposits.
That information was provided to them, I believe, Sunday or
Monday, July 4 or 5.
The CHAIRMAN. Are you telling the committee that it was not
until the first week of July that this information was shared? Was
there not evidence of the fact that many of these institutions had
jumbo CD's over the insured amount?
Wasn't that knowledge available to the Comptroller's Office as a
result of at least the April examination, if not the January examination?
Mr. CONOVER. Well, we knew that there were a number of uninsured deposits in the bank, but we were not focusing on that as
part of our examination because we were busy looking at the loan
side of the balance sheet.
So the answer is that we knew that information, that there were
uninsured deposits, but we didn't focus on it until it became evident that the bank was in severe difficulty.
The CHAIRMAN. Let me ask you this question, in reading your
statement, looking at the memorandum, the cease-and-desist order
and your chronology, at no point do you mention anything about
problems with insider loans. Is that because there were no insider
loan problems, or because you would rather not go into that at this
point in time?
Mr. CONOVER. It is for the latter reason, Mr. Chairman, that we
would rather not discuss any potential violations of law at this
time.
The CHAIRMAN. NOW, at a given point in time, you asked that additional personnel, more sophisticated personnel, be brought in for
reviewing the loans.
Is there any truth to the allegation that, indeed, some were
brought in, but that, as a matter of fact, they were told, "You can
review a lot of these loans, you new men onboard, but not the
energy-related loans?"
Mr. CONOVER. I am not sure.
The CHAIRMAN. Mr. Homan?
Mr. HOMAN. NO; when the examiners in the Penn Square Bank
became aware that they had a large, large problem in the energyrelated loans, we, in fact, brought in some of our examiners from



68
Houston, Dallas, and other places in the Southwest t h a t were experts in energy credits to aid our Oklahoma crew in the analysis of
the credits.
The CHAIRMAN. My question is, Did you insist, as part of t h a t
cease-and-desist order t h a t the board of directors bring in new,
more experienced personnel to work for the bank, not for the
Comptrollers Office? To review the loans?
Mr. HOMAN. No; not as part of our cease-and-desist agreement.
We did ask the board to undertake a management study because
we were concerned t h a t the bank's growth, t h a t the systems in the
bank and the bank's internal management were not keeping pace
with the growth of the bank's assets and the type of lending it was
undertaking. Both during 1980 and 1981.
So we did ask for that management study. In fact, during 1981,
the bank did shore up its management team by bringing in several
new managers.
The CHAIRMAN. But not specifically loan officers?
Mr. H O M A N . Yes; I believe there were some loan officers added to
the energy division of the bank. The bank also
The CHAIRMAN. They were allowed to review the energy loans?
Mr. HOMAN. In the summer of 1981.

The CHAIRMAN. They were allowed to review the energy loans,
there were no restrictions?
Mr. H O M A N .

Yes.

The CHAIRMAN. N O restrictions placed on them by management?
Mr. HOMAN. That is correct. They were actual loan officers. We,
however, understand the bank's own Internal Loan Review Division was restricted in reviewing energy loans, in self-identifying
the problems in t h a t portfolio.
That was told to me.
The CHAIRMAN. Let's get back to the first part of my question,
Mr. Homan, t h a t Mr. Conover said he would defer to you on, t h a t
was whether or not your Chicago office was made aware of the fact
t h a t there were problems with some of these energy-related loans
in view of the fact t h a t such a large amount had been purchased
by Continental?
Mr. H O M A N . During the course of the examination, as soon as
the losses and poor quality loans, both in the bank and t h a t portion
t h a t was participated to other banks, became apparent, we did
notify all of our offices affected and particularly our larger regional offices t h a t directly supervise Continental Illinois, Chase Manh a t t a n Bank, and Seattle First, and a number of other participants.
We also sent an energy examiner, one of the experts from Oklahoma, to Continental to aid our examiners in the assessment of
their portfolio. We have a team working with all of those banks at
the present time. They are all presently under examination.
So, yes, information was widely shared between the examiners in
all of our affected supervisory units nationwide.
The CHAIRMAN. Thank you.
Mr. Stanton.
Mr. STANTON. Thank you, Mr. Chairman.
Mr. Conover, in colloquy with the chairman, you intimated t h a t
you had in the course of conversation, turned over to the Federal



69
Home Loan Bank Board and to the National Credit Union Administration the names of those institutions that were affected by the
failure of this institution.
Is there any information you could give the committee at this
time which you would consider nonconfidential regarding the
impact of Penn Square's failure upon other commerical banks, savings and loan associations, or the 150 credit unions that were involved?
Put another way, Are you sure they are doing all that they can
within their authority to assure there is no ripple effect?
Mr. CONOVER. The purpose of providing the information to them
in the first place was so that they would be aware of the potential
difficulty that institutions under their supervision were going to be
faced with upon demise of the bank.
I think you would have to ask representatives of the Bank Board
or the NCUA specifically how serious they think the institutions
under their supervision would be impacted by all this.
Mr. STANTON. HOW about your own?
Mr. CONOVER. We looked at both national banks and at State
banks who also had deposits in the Penn Square Bank. We made
sure that that information was available to the FDIC. In the case
of the national banks, there were very few institutions who had deposits in the Penn Square Bank, and so we concluded that no national bank under our supervision was likely to find itself in any
difficulty as a result of its having uninsured deposits with the Penn
Square Bank.
Mr. STANTON. One last question, Chairman Isaac. You alluded to
the fact that your preference, of your organization, would have
been to arrange a merger, of course.
The House of Representatives, as you well know, has passed legislation giving you additional authorities and powers under the regulators bill.
Had this legislation been enacted into law, would that have given
you any additional authority or help in this particular situation?
Mr. ISAAC. It is possible that if we had had the regulators' bill we
could have arranged an interstate takeover transaction, particularly one involving some of the large banks that already were involved in this situation and knew it so well. I am speculating a bit
there.
One of our big problems here was simply lack of time and information about just what had occurred in the bank and having to
work feverishly over a weekend to gain this knowledge.
But because those banks as I said did know so much more, in
effect, as to what the nature of the loan portfolio was and any contingent claims that might exist, it is conceivable that with that authority we could have arranged a takeover.
Mr. STANTON. I do not want to take up the time of the
committee, but what bothers the chairman and the rest of us is
that someone really knew about this condition in September of
1980, I think from that point on, or in February of 1981 you came
to the conclusion that you had a very, very serious problem, and
yet you waited until July of 1982 to take action.
Mr. CONOVER. Are you addressing the question to me or



70
Mr. STANTON. Well, it is hard to get into that in a hearing, but
those are some things we want to get to the bottom of.
I thank you, Mr. Chairman.
The CHAIRMAN. Mr. Gonzalez.
Mr. GONZALEZ. Thank you, Mr. Chairman.
Actually I look upon this proceeding as sort of a postmortem, and
just about as useful as a postmortem, except in cases where it
would be helpful to establish pathological causes hitherto unknown. Mr. Minish chairs a Subcommittee on General Oversight
and Renegotiation on which I am the ranking member, and we
have had the regulators, and I spoke out 1 year ago and asked
questions that were pertinent to what is happening now. You all
would not answer them. Always as I notice even in the news reports today if anybody raises a question, that may trigger off this
avalanche such as is happening now in the case of Penn Square
where depositors are lining up and demanding their funds.
Now, I fully realize, Mr. Conover, because I have been here 20
years on this committee, and predecessors of yours have made it
clear they are not obedient or responsive to the Congress because
you are independent, you take shelter or shield behind the fact
that you do not use appropriated funds. You are amenable to the
banks because it is the bank fees that pay for the upkeep of your
office. But I think it is tragic at this point, and a postmortem in
this particular case I think is kind of a wasted exercise; you need
not worry about quick legislation unless it is approved by the
American Bankers Association coming out of the Congress.
The only questions I have are, I think, what will be pertinent in
a postmortem proceeding such as this, that sooner or later something would break open—as a result of this Penn Bank business we
are now seeing reports of heavy sale of bank stocks. Now, is this or
is this not a relatively new development, and what is its significance? I will address that to all three members of the panel.
Mr. CONOVER. I will try to respond first.
The recent decline in the value of stocks of certain banks is no
doubt linked to their connection with the Penn Square Bank. Obviously some of them have incurred, as has been reported in the
press, some very significant operating losses. Their bond ratings
have been reduced. Their stock prices, as you have indicated, have
declined, and their reputations are tarnished as a result of their
connection with this situation. I am sorry to say this but I think
that that is the way it should be in this particular case. Bank
stocks are selling at very low price-to-earnings ratios, at very low
ratios of market price to book value, and that is no doubt reflective
of the market's judgment about the future earnings potential of the
banking industry. The banking industry, although healthy today, is
in for a difficult time over the next several years for a variety of
reasons. I think that the marketplace is recognizing that, and that
is the reason why bank stocks have been depressed of late. Certainly the Penn Square affair has contributed to such declines in the
stock of banks with certain characteristics and those who have participated in this matter.
Mr. GONZALEZ. Well, Mr. Isaac, do you see such an optimistic—
rather affirmative or happy note as Mr. Conover in what I consider
to be a very dire development? Is that your interpretation? Do you



71
agree with that? Is there anything that should cause us apprehension? If so, should not the Congress know the extent of the weakness and the forecasted weakness of these financial institutions?
What is your capacity to assist?
There is an ancillary question I was going to ask later, and I can
delay it to give you an opportunity to answer the first one, and
that is, Why did you not all follow the same procedures that you
have in other bank cases in making an arrangement to salvage
Penn Square and keep it from completely going under?
Mr. ISAAC. I will tackle the second question first, because the
answer to it leads into the first question.
Mr. GONZALEZ. Fine.
Mr. ISAAC. We did not handle this transaction the way we almost
always do, which is to merge the institution into another one, because when we do that kind of transaction we are required to step
in and make the acquiring institution whole with respect to any
contingent or unknown claims.
In this case we had massive contingent claims and evidence that
other claims might well exist.
Under our statute we must make a finding before we can do a
merger involving FDIC assistance that the merger would be less
expensive than a deposit payoff would be. We could not make that
finding here because of the very large potential exposure for contingent claims.
Now that leads me to respond to your first question by saying
that this situation was unique. It is not symptomatic of conditions
in the banking industry. This bank did not fail due to problems in
the economy. This bank did not fail due to problems in the energy
industry.
This bank failed because it was very poorly managed. It made
speculative loans. It grew at excessive rates. It borrowed excessively in national money markets to fund its activities. It concentrated
its loans in one industry, instead of having a diversified loan portfolio.
This is not a problem that exists in the banking industry. This is
a problem that existed in this bank.
Mr. GONZALEZ. Mr. Isaac, then why this continued impact and
forecasted impact on the most precious ingredients, the capital
stocks of these banks?
Mr. ISAAC. The banks that have been most affected in the stock
market these days are the ones that had deposits in the Penn
Square Bank or that had purchased loan participations from the
Penn Square Bank. I think Mr. Conover was referring to the fact
that for several years the market for bank stocks has been somewhat depressed in terms of price-to-earnings ratios and he was, I
gather, forecasting that it might continue to be somewhat depressed. I do not make those kinds of forecasts.
The CHAIRMAN. The time of the gentleman has expired.
The Chair on a point of personal privilege will take a moment at
this point to state that the American Bankers Association does not
dictate to the Chair whether legislation will be written, introduced,
or brought before the committee. I take issue with that statement.
I wanted it clear on the record on that immediately and not let it
go.



72
Mr. ISAAC. Mr. Chairman, if I might just say a word related to
t h a t I think it would be very unfortunate if this committee did not
look at the Penn Square situation for what it is, an aberration. It is
not typical of what is going on in the banking industry, and it
would be very unfair for this committee to consider some kind of
sweeping punitive legislation which would further overburden the
already overregulated industry.
The CHAIRMAN. I said t h a t already.
Mr. Isaac.
Mr. ANNUNZIO. Would the chairman yield for a moment?
Mr. Chairman—that is what you say about every bank t h a t goes
under, it is an aberration. When are you going to change the tune,
every time a bank goes under it is a one-shot deal.
The CHAIRMAN. Mr. Wylie.
Mr. ANNUNZIO. We have had too many one-shot deals.
Mr. WYLIE. I think I will let that go, but I am glad to hear you
say this is an aberration from my standpoint. But can you tell me
what is the present situation, and I say t h a t because Chairman
St Germain mentioned the uninsured depositors or investors; Mr.
Stanton referred to the fact t h a t there are a lot of credit unions
involved here, and I am not going to ask how they got into t h a t
mess, but I am referring now to an article in the Wall Street
Journal which says there are other ripple repercussions, worries
among big investors about the safety of uninsured deposits in financial institutions; for the first time in the failure of a bank a
large number of uninsured depositors and creditors are likely to
lose money. Can you tell me about that, will uninsured depositors
lose money? What is the present situation?
Mr. ISAAC. Yes; we believe uninsured depositors will lose some
portion of their uninsured deposits. At this stage we really cannot
say exactly how much. We are going to have a better evaluation of
the assets of the failed bank in the receivership now, and we are
also going to have to have an opportunity to work through any contingent claims that may be asserted against the receivership. We
would expect and hope to give the uninsured depositors a substantial recovery as soon as possible, but I think t h a t it would be terribly overoptimistic for me to say that they are going to get all their
money back.
Mr. WYLIE. I am quoting now from The American Banker,
wherein you say t h a t basically what you have here is a very small
shopping center bank 5 years ago that was probably $40 million in
size, maybe $50 million. It went out and tried to make a lot of highrisk loans in the oil business and energy related and grew faster
t h a n it should have. This bank would not have remained a shopping center bank, which probably is what it should have done, Mr.
Isaac said.
At the time of the failure it was somewhere in the neighborhood
of $500 million; is that correct?
Mr. ISAAC. That is correct.
Mr. WYLIE. NOW, it is my belief t h a t there was a failure here,
apparently due to what was characterized by you as excessive and
uncontrollable growth. Did you have the authority to preclude
that? In other words, could you have gone into the back office and
said, "We think t h a t you are making loans which you should not



73
be making, and making investments which you should not be
making'' and stop the bank from doing that? Or are you merely
limited to giving advice?
Mr. ISAAC. The FDIC had no regulatory jurisdiction with respect
to this bank except for one power, and that is if we had thought
that the bank was a threat to our insurance fund, we could have
initiated a proceeding to terminate insurance. Unfortunately t h a t
is a proceeding t h a t generally takes a year or two to complete and
it is not a terribly effective instrument. Aside from that, however,
we had no power in this circumstance.
Mr. WYLIE. HOW about you?
Mr. CONOVER. Mr. Wylie, if I may, as I think I indicated in my
prepared statement, we in the Comptroller's office did recognize
the explosive growth of this bank and did point out to the bank, to
its management and to its directors, t h a t we felt that its growth
was too rapid, t h a t it lacked controls, t h a t its loan portfolio was
poor quality, and that it ought to do something about it. We pointed that out to them on several occasions, including bringing the
board of directors of the bank from Oklahoma City to Dallas, and
in at least one of those cases we actually got 17 of the 19 directors
to get on an airplane to go to Dallas and talked to them about their
situation in their bank.
Those warnings, those requirements on our part in the formal
agreement t h a t we put on the bank, which was signed individually
by those directors, went unheeded. They did not pay any attention
to it.
Mr. WYLIE. NOW it is my understanding—and I know this is not
really a very good analogy—but if the SEC finds t h a t one of its regulated brokerage houses is expanding too rapidly or is doing something that the SEC does not think they should, they are making
investments in new business which the SEC feels t h a t they do not
have the ability to perform, t h a t they do have the authority to stop
them from making those imprudent investments.
You do not have t h a t kind of authority under the present statute
as I understand it?
Mr. HOMAN. No. There is nothing wrong with growth per se. It is
growth in poor-quality assets t h a t usually gets—as in the instant
case—a bank in trouble. If t h a t is deemed to be a large problem, as
it was in this case, we do have the authority to curtail it. We attempted to do t h a t in a controlled way in our September of 1980
formal agreement.
But the bank, after having made progress in controlling its contingent liabilities, its unfunded liabilities, as well as the growth of
the loans on its own books, nevertheless chose to ignore t h a t in the
end, and during the last 6 or 8 months of its life originated another
$800 million in loans participated out. This was after our examination of September of 1981.
Mr. WYLIE. YOU were pointing out t h a t Penn Square was investing in activities which you regarded as perhaps being unwise. And
there were some promises extracted t h a t those practices would be
corrected, am I right about that? Is t h a t what you said?
Mr. HOMAN. That is absolutely correct. In fact during 1981 they
did show significant progress in overcoming some of their problems.



74
Mr. WYLIE. But you have no authority other than to extract a
promise from them that they will correct their mistakes?
Mr. HOMAN. We could require it, but they ignored the requirements of the legal contract we had with the bank's board, which is
a formal agreement under our cease-and-desist power.
Mr. WYLIE. My time is expired.
Mr. HOMAN. They violated it in numerous ways.
The CHAIRMAN. Mr. Minish.
Mr. GONZALEZ. Mr. Chairman, will the gentleman yield just to
follow up on a question here t h a t I think we should ask, because
there is a great deal of concern here on the Hill.
Will the gentleman yield?
Mr. MINISH. All right.
Mr. GONZALEZ. At least for the record, and maybe you can
answer later. Since you indicated it would be a dim hope to expect
reimbursement of the noninsured depositors, the Wright P a t m a n
Credit Union here has, I understand, about $1 million there. What
do you think would be the chances for institutions of t h a t nature to
have some kind of priority, creditors or depositors' priority? What
portion of t h a t $1 million will be covered. Could you give us an
idea?
Mr. ISAAC. I hope I didn't imply t h a t the uninsured depositors
would not receive funds back. We certainly hope to return a substantial portion of the funds as soon as possible from the liquidation of the assets. I can't give you a percentage.
As far as giving these institutions preferred status, I think t h a t
would be the worst mistake the Congress could make. Then whatever discipline there would be left in the financial system would be
gone.
The CHAIRMAN. Amen.
Mr. ISAAC. These are the very institutions that need to discipline
banks t h a t are engaged in these kinds of practices.
The CHAIRMAN. Amen.
Mr. M I N I S H . Mr. Conover, on the bottom of page 1 of the statements it says the Comptroller's Office devoted special supervisory
attention to Penn Square since early 1980 when problems were
first identified. While I realize you were not serving the agency at
the time in your present capacity, I must ask what went wrong?
Why did it take them so long to wake up?
Mr. CONOVER. I think first of all I would like to clarify what special supervisory attention means, if I may.
There are probably 300 national banks at the moment t h a t we
have under what we call special supervisory attention. I took a
look at the number t h a t were rated 3, 4 and 5 under t h a t rating
system back at that time to see what had happened to them since
then. The vast majority of them, I recall the number as 65 percent,
had returned to health and were now rated 1 and 2 under this
system.
I forget the disposition of the remaining 35 percent but I think
the point is that special supervisory attention is something t h a t we
have a number of banks in at any given time and for the most part
it works.
This was obviously a case in which it did not. It did not, not because our efforts were not sufficient, I think, but because the



75
people t h a t we were trying to get to save their bank weren't going
to go along with us.
I really think it is t h a t simple.
Mr. MINISH. Let me ask you this; you were concerned early on
and you asked the board of directors or trustees or the appropriate
officers of the bank to appear at a meeting in Dallas where I
assume you dressed them down and they ignored the recommendations your people made.
Don't you have any alternative in dealing with a situation like
this?
Mr. CONOVER. Well, in t h a t particular case what we got was recognition of problems and assurances t h a t they would correct that
situation. In fact, we received periodic, progress reports, on a
monthly or sometimes even more frequent basis, on certain aspects
of the things t h a t we asked them to do. In late 1981, we actually
found that some modest improvement had taken place.
From about September 1981 to J u n e of 1982, obviously t h a t bank
got totally out of control.
Mr. MINISH. Well, the meeting in Dallas was held when?
Mr. HOMAN. I think the last meeting in Dallas was on J a n u a r y
12, 1982.
I believe there was a meeting in August. It is in the chronology.
Mr. MINISH. Mr. Isaac.
Mr. HOMAN. July 29, 1981.
Mr. MINISH. YOU used the figure of $240 million as a possible cost
to the insurance fund. That is the top figure, did I understand you
correctly when you said that?
Mr. ISAAC. That is what we believe would be our maximum exposure in this case. We did not expect to lose anywhere near that.
Mr. MINISH. Let me ask you this; is it possible t h a t some of the
banks t h a t got involved with Penn Square may find themselves in
difficulty because of their association with Penn Square which
would have a further impact on the insurance fund?
Mr. ISAAC. We do not expect any significant additional problems
resulting from this affair.
Mr. MINISH. Thank you. That is all, Mr. Chairman.
The CHAIRMAN. Mr. McKinney?

Mr. M C K I N N E Y . Gentlemen, this is just so reflective of a whole
system t h a t quite frankly to me is horrible.
Mr. Conover, I certainly won't make insinuations about your
office, but you are supervising the banking system; a bank goes
under and you say to Mr. Isaac: "Pay for it."
To me the system just doesn't make sense, Mr. Chairman. I think
we better do something about it.
The CHAIRMAN. We are being told over and over, during the
Drysdale security disaster; Oh, don't worry about it, Chase looks at
their performance. We look at this, they are a couple hundred million into this one.
Mr. Conover, are your people looking at these banks t h a t seem to
be financing go-go stock brokers, go-go money market changes, gogo commodities markets and everything else? What are these
banks doing with their depositors' money?

97-830
http://fraser.stlouisfed.org/ 0 - 8 2 - 6
Federal Reserve Bank of St. Louis

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It is fine to sit here and say this is, as Mr. Isaac said, an aberration, but 1 month it is Drysdale; next month it is Penn Square;
next month it is something else.
What is happening?
Mr. CONOVER. Well, in this case and obviously in the Drysdale
case, it is quite obvious that some banks engaged in some practices
they shouldn't have without any decent controls or carrying out of
prudent banking practices.
That, unfortunately, is going to happen from time to time. The
only way I know of to absolutely keep it from happening is to have
a very, very different kind of banking system in which the degree
of regulation and supervision is a quantum jump over what it is
today and, in effect, Government examiners or regulators are present in banks, watching virtually every decision being made as it is
being made. I don't think that is appropriate.
Mr. MCKINNEY. Don't you think it's about time we start making
a survey to find to what extent these nonprudent banking practices
are occurring?
Mr. CONOVER. That's certainly true and we do so as a matter of
course through the off-site surveillance system by which we track
banks with different characteristics all the time. As I said, we have
300 or so banks under special supervisory attention at this time.
Mr. MCKINNEY. We already live under the biggest imaginary
farce in the world. We look at an asset portfolio and say it's worth
such and such. What is a loan worth to Zaire? What is a loan
worth to a lot of these third world countries? What is the worth of
a tax-free bond that pays 5XA percent?
There is something else that bothers me. You were not there, but
you made an agreement with the directors of this bank; your
Department gave them a cease-and-desist order but they kept right
on going. Can't you go in and run that bank right, then and there,
instead of telling them they had better straighten up and go on
down the nice narrow road we told them to go down?
Mr. CONOVER. AS a matter of fact, the answer is no because in
order to do that, we end up closing the bank and turning it over to
the FDIC which is exactly what we did.
Mr. MCKINNEY. I would think it would have been better to turn
it over to the FDIC in July 1981 rather than July 1982.
Mr. CONOVER. I suppose you can always have a debate as to what
is precisely the appropriate time to close the bank.
I am sure that we will be criticized both for closing it too early
and for closing it too late.
Mr. MCKINNEY. I am not in the business of criticizing you but a
victim in the business of trying to find out how we try to stop this.
Here is a little shopping center bank that went from $50 million to
$500 million to $2 billion worth of contingent liabilities. Isn't there
a bell that rings somewhere; red lights go on and warns you that
banks don't double in size in a year and don't have $2 billion worth
of liabilities? Isn't there something that tells you there has to be a
crook or there has got to be something drastically wrong here?
Mr. CONOVER. There obviously was something drastically wrong.
Mr. MCKINNEY. I'll
Mr. CONOVER. But

authority.



say.

to answer your question, we don't have this

77
Mr. MCKINNEY. We better give them the authority they need,
Mr. Chairman. Because somehow or other, we are going to run out
of FDIC funds if this kind of thing keeps going. There has to be
some kind of early warning system. There has to be some broader
communication. I just hope now that you are the new man on the
block and I know you will work hard but you are going to have to
take a hard, long look at quote, unquote prudent banking practices
by money market banks.
You know, some of us on this committee are beginning to wonder
when the next shot is going to come. We are finding out that practices which theoretically are thought to be prudent banking practices are far from that. Our money market banks have probably
more examiners than the Federal Government has in some of
them, but it doesn't really matter how many examiners there are.
The energy people are over here and the commodity people are
over there—there is just no communication. What good is any portfolio that is a combination of worthless accounts.
The CHAIRMAN. Mr. Annunzio?
Mr. ANNUNZIO. I don't have any questions.
Mr. MCKINNEY. I would like to ask one last question if my chairman will give me 2 seconds. What would you tell us to do, Mr. Conover, or Mr. Isaac, to anticipate this and stop it before it goes to
the next full year, so we don't get insolvency July 5 at 7:05 p.m.?
Mr. ISAAC. AS I mentioned in my opening remarks, I think we
need to make some changes in our regulatory system. I don't think
the regulatory agencies need more power to take specific kinds of
actions. I think we have plenty of authority in that area. I think
we need to look at the overall system under which we are operating.
But I would also point out that you mentioned Drysdale and then
this affair and then you said how do we stop that from happening?
I don't think you can stop that from happening. Humans are fallible. We make mistakes every day. What you hope is that you
have spread out your risks far enough—diversified far enough—
and that you have adequate controls in place so that when the occasional mistake occurs, it doesn't do serious harm to your institution or to your personal financial situation if you are an individual.
We can't expect that the financial system, if it is going to perform the kind of service we want it to perform, is never going to
experience a problem. You wouldn't want that kind of system, one
where banks were not taking any risk and thus not suffering any
losses.
The CHAIRMAN. Tell you what, we will go through the 5-minute
rule, we are trying to adhere to that; and I am sure that by the
time all of these erudite people have asked their questions you will
have had an opportunity to make all of your points. If not, we will
hear you at the end.
Mr. Annunzio?
Mr. ANNUNZIO. Thank you, Mr. Chairman.
I want to remind my colleague from Connecticut that the bell
went off but nobody heard the bell. That is our problem.
Mr. Isaac, you state that there are some 260 banks on the FDIC
problem list. My information is that there are some banks that are
in critical shape. In fact, I have been informed that Penn Square is



78
just a tip of the iceberg. There is talk t h a t a bank in the size range
of Penn Square is on the verge of collapse and might have even collapsed this week had it not been for assistance from the Federal
Reserve in the form of injected money.
Can you tell this committee, with the weekend approaching, are
there any bank failures t h a t are likely to occur over this weekend?
J u s t don't keep it a damn secret. You have got an opportunity to
tell us now.
Mr. ISAAC. First of all, there are 268 banks on our problem list,
That is somewhat higher t h a n average, but not a whole lot. It is
certainly lower t h a n it was in 1976.
Mr. ANNUNZIO. We got through 1976 and we are all the way to
1982. We are talking about now. The American people are not concerned about 1976. Now, tell me about these banks. Tell me, is
there another one going down?
Mr. ISAAC. We got through 1976, Mr. Congressman, and we are
going to get through this period quite nicely.
Mr. ANNUNZIO. I hope so.
Mr. ISAAC. For your information, I plan to be in Ohio, visiting
family this weekend.
I do not agree with the characterization t h a t this is the tip of the
iceberg or t h a t a number of institutions are affected by it.
Mr. ANNUNZIO. I don't expect you to agree. You are appointed to
your jobs, we have to go out and get elected.
Mr. Conover, a columnist in the Washington Post this morning
indicated t h a t one of the reasons Penn Square was attracting so
many depositors was t h a t it was paying 2 percent premium for uninsured deposits.
I have made preliminary checks this morning and found t h a t
this 2-percent bonus did not exist to all such uninsured deposits.
Does your office have information t h a t the 2-percent bonus was
paid for all uninsured deposits or t h a t it might have been paid in
only some of the cases?
The impression of the columnist this morning was that everyone
who put money in Penn Square was doing it because of greed in
order to make the other 2 percent.
Do you subscribe to t h a t theory?
Mr. CONOVER. We have no evidence t h a t the Penn Square Bank
was paying 2 percent premium for its deposits.
The number t h a t I am aware of is closer to 25 to 50 basis points.
In addition, it would not be unusual for this bank or any other
bank to pay different rates for different amounts of money in a
different time period, so you would have a number of uninsured depositors who at any given time might be earning different yields on
their deposits.
Mr. ANNUNZIO. I am particularly disturbed about the failure of
your office to monitor or control the use of brokers by national
banks. The money you talk about the brokers received.
Federally insured financial institutions are prohibited from
paying a premium to an individual depositor which costs more
t h a n $20. That means t h a t if a housewife makes a deposit, she can
get a set of pots and pans, a toaster, but the premium cannot be
more t h a n $20.



79
I have even been told that financial institutions that exceed the
$20 limit have been threatened with substantial fines by the regulators. I know, my small banks tell me this.
Now, my question is this, If it is wrong for a bank to pay an individual depositor more than $20 in a premium in order to obtain
money, why is it right for the same financial institution to pay a
broker thousands upon thousands of dollars to bring money into
the financial institution?
Mr. HOMAN. Congressman, I am aware of no law which prohibits
a bank from paying a money broker a fee for money over $100,000,
which, in this case, was the type of money market funds gathered.
That may apply to certain small depositors under regulation Q.
But it was—does definitely not apply to
Mr. ANNUNZIO. I say federally insured financial institutions are
prohibited from paying a premium to an individual depositor which
costs more than $20. That is exactly what I am saying.
They are prohibited from paying $20 to the average American
housewife that goes in, but if you are a money broker, you can collect thousands and thousands of dollars, like what happened in
Penn Square and some of the other banks that are going to go
down with it.
When is that going to stop?
Mr. HOMAN. That is common practice among the money markets.
They have to attract money and fund themselves.
The CHAIRMAN. The time of the gentleman has expired.
Mr. ANNUNZIO. Thanks, Mr. Chairman.
The CHAIRMAN. Mr. Leach.
Mr. LEACH. In reading the two statements, I am frankly more
impressed with the operations of the FDIC than I am with the
Comptroller's Office in this situation.
Mr. Isaac properly rejected the purchase-and-assumption option.
You, sir, Mr. Conover, laughingly say some will criticize you for
acting too soon, others for acting too late. The fact of the matter is
I know of nobody who will criticize you for acting too soon. I think
the previous speaker is exactly right. The warning system worked;
you simply didn't act.
Let me give a couple of examples. In your testimony, you cited
an examination 2V2 years ago, from February to April of 1980,
which concluded not only that there were problems with the bank,
but that there were violations of U.S. banking laws. One and onehalf years ago, based on an examination, you concluded that there
were numerous violations of U.S. banking laws. A violation of
banking law is illegal behavior. In view of this, where was the FBI
2V2 years ago and IY2 years ago?
You cited uncontrolled growth, yet you did very little to moderate that uncontrolled growth. One reason for such phenomenal
growth was the willingness of larger banks to participate in loans.
My question, then, is what did the larger banks know and when
did they know it? For example, what did you tell Continental and
Chase and when did you tell them?
Mr. CONOVER. I think I would like to comment first on your
statement in regard to violations of law.
It is very common in the examination of a bank to find violations
of law. It happens every day to many, many banks.



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For the most part, those violations are pointed out by the examiners during the examination or in the examination report and
they are corrected by the management because most bank managers and boards of directors are law-abiding citizens and want to
abide by the law.
Mr. LEACH. Let me interrupt you there. I follow banking in my
State of Iowa very closely, and I guarantee that there are not numerous violations of banking law in Iowa.
As the Banking Committee of the U.S. Congress, as Members of
Congress, we write laws, and we take the laws we write very seriously. When you cite numerous violations of banking laws, what do
you do about it? Is the president of the bank removed? Do you
demand a change of top personnel?
Mr. CONOVER. What we do is point out the violation of the law
and discuss the circumstances.
Mr. LEACH. DO you bring charges against the bank?
Mr. CONOVER. We point out the violation of the law and understand the circumstances behind it and depending on its seriousness,
we may very well take such action.
In many cases, the violations of law are inadvertent, for example, and they get corrected rather quickly.
Mr. LEACH. In the case of Penn Square, were the violations corrected between 2% years and IV2 years ago?
Mr. CONOVER. In many cases, they were, yes.
Mr. LEACH. The first examination turned up violations, the next
examination numerous violations of banking laws.
Getting away from this for a second, can you tell me when Continental and Chase were informed of problems in Penn Square and
what they were told?
Mr. HOMAN. We informed Continental of the problems during
the week before the bank failed. Chase was informed, I believe, 2
days later.
Mr. LEACH. When you see massive problems in a bank, when you
see that the engine of growth is other banks' willingness to participate in the problem bank's loans, don't you feel a responsibility to
inform the other banks that are involved?
Mr. HOMAN. We do, but the backbone of the correspondent banking system is loans participated between upstream and downstream
correspondent banks. They typically take out overlines or lines
that are larger than a small bank's lending limit throughout the
Middle West.
Mr. LEACH. YOU are referring to the whole banking system of the
United States, not to a single bank. If one bank is affected by problems at another bank, isn't it proper to inform the affected bank?
Mr. HOMAN. It is if we think there is a significant problem that
it creates for the other bank. In this case—
Mr. LEACH. Based on your examination, didn't you ever think it
important to inform Chase or Continental?
Mr. HOMAN. Previous to this last examination, there were not
significant problems in the portion of the loan portfolios sold to the
other banks that we had identified.
Mr. LEACH. Let me ask one other question. It appears in this instance there was extraordinary use of letters of credit. It also
seems that this extraordinary use of letters of credit is becoming a



81
national phenomenon. Is there any thought in the banking community that this phenomenon deserves far greater scrutiny than it
has received in the past?
Mr. HOMAN. The letters of credit in this particular bank played
no part in the failure of the bank. Not at all. As a matter of fact,
out of $138-odd million in letters of credit, less than $400,000 were
criticized.
So we do not consider that to be a contributory cause of the
bank's failure.
Mr. LEACH. My final question is whether there is something from
a regulatory standpoint to be learned from the Penn Square experience. When problems of this nature develop, perhaps you should
inform the very banks that are partly responsible for the situation.
To say that the correspondent banks are not partly responsible
would be very foolish because it never would have occurred without
them. May I ask you, are you going to reexamine your practices in
this area?
Mr. CONOVER. We are certainly going to reexamine our practices
regarding looking at loans that are participated in by a number of
banks.
Mr. LEACH. IS that an admission that past practices perhaps were
inadequate?
Mr. CONOVER. NO, sir; it is not.

Mr. LEACH. Thank you, Mr. Chairman.
The CHAIRMAN. I must observe, because of your initial questions,
Jim, that in my opening statement, I stated that the first agreement had all the sting of a flogging with a wet noodle.
I am very serious about that.
As I listen to our witnesses, it occurs to me that the restraint
that was exercised by the Comptroller's Office was just unbelieveable.
When I went to school, grammar school, if you were a naughty
boy, the teacher just whacked you. Now we try to talk to them,
talk children into being nice and obedient.
It seems as though the Comptroller's Office has gone that way,
too. I agree with Jim. I don't think you would be criticized if you
rang the bell earlier, rather than too late. Keep that in mind.
Not only you, Mr. Conover, but those people in the Comptroller's
Office who were there 10 years and will be there another 20 years.
Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
Mr. Conover, I noted with interest your comments in the last instance where you said that violations of the law go on every day. I
look at the top of the page 2 in the series of charges, summary of
notice of charges given to us as of June 30, 1982, the bank permitted officers without lending authority to extend credit on behalf of
the bank; the bank, in violation of certain statutes, in a unsafe and
unsound manner sold participations in loans originated by the
bank without disclosing to the purchasers of those participations
material, nonpublic information known to be public to the bank.
These charges are not the type of violations, I hope, that go on
every day in my State and across this country. This sounds like
fraud to me.



82
I understand your reluctance to talk about criminal charges,
about a variety of other things. I sure hope that this is an aberration but the amazing thing to me and I think to other members, is
that over a period of time, this went on with no action on the part
of the Comptroller of the Currency in terms of your regulatory supervision, and one wonders with the type of hindsight I suppose it
is easy to criticize, I mean, why not?
Are these the charges you are talking about that this just developed in the last year? Or is this a culmination of charges that have
been repeated over the last 4 or 5 years by this particular bank?
Mr. HOMAN. The civil violations contained in the notice of
charges which you are reading from, Mr. Vento, were significantly
different from the types of violations that went on in the past.
They were the basis for our temporary cease-and-desist order requiring correction. Many of the violations which occurred in the
December 31, 1980, report and subsequent reports, while numerous,
were technical in nature and subsequently corrected in the following months.
We monitored that closely through progress reports and through
five examinations that were conducted over the period. None of the
violations were in the nature of a criminal or fraudulent violation.
We deal with that separately by the referral process.
Mr. VENTO. It also appears that this time between that that
things became worse. In other words, you came in and started putting pressure on it looks like that the situation went from bad to
worse in terms of violations.
These do not sound like civil violations to me.
Mr. HOMAN. Between the September 1981 examination and the
final examination, they did go from bad to worse. And there were
significant violations of the law.
We are not trying to
Mr. VENTO. Sounds like as a regulator, you are trying to regulate
in good faith and you are bending over backward to keep this bank
open and it sounds like they took you to the cleaners, in terms of
participation, that is what it sounds like, in terms of their reaction
to your regulation.
That does not speak well for your role in terms of disciplining
and that does not bode too well in terms of the future with regards
to how you regulate banks.
Mr. HOMAN. With the benefit of hindsight, that may be true, but
you can lead a horse to water, you can't make him drink.
Mr. VENTO. Doesn't look to me like you got him to do anything
except run the other direction. Sounds to me like you went back to
the range, did not even have him in the corral the way this looks
to me.
The fact is you notified the Federal Reserve Board and you notified the FDIC in 1980, did you not? What was the purpose of that
particular notification?
Mr. CONOVER. That is a very standard notification. Whenever a
bank is rated three as a result of an examination and is put under
special supervisory surveillance, we normally, as a matter of
policy
Mr. VENTO. What are we telling the FDIC, protect your turf, we
are protecting ours?



83
Mr. HOMAN. We provided the FDIC with copies of our pertinent
correspondence and supervisory actions taken in respect to all
three-, four- or five-rated banks, together with reports of examination.
They independently review those examination reports to determine their own insurance risk.
Mr. VENTO. TO determine their own insurance risk. What did
that mean to you, Mr. Isaac, that standard notification that came
in in 1980 that concerned Penn Square?
Mr. ISAAC. It did not mean anything to me personally because I
did not receive it, but
Mr. VENTO. YOU are speaking for your institution, that is one of
the things that goes with that appointment.
Mr. ISAAC. I understand. But what it would mean to our people is
that there is a bank that is under increased surveillance; I doubt
very much, in fact I know, they would not have been alarmed by it.
A three-rated bank is not considered a problem bank.
Mr. VENTO. DO you think you ought to have received additional
communication beyond that considering the chronology that we
have before us today, together with the discussion that has gone on
here today?
Mr. ISAAC. I would like to finish that one thought. A three-rated
bank is not considered a problem bank. It has to be a four or five to
be considered a problem bank.
A three-rated bank is simply one that is requiring closer-thanusual scrutiny.
Mr. VENTO. This was never reclassified, was it?
Mr. CONOVER. No; this was a three-rated bank until the time of
its failure.
Mr. ISAAC. We would have liked to have known about the seriousness of the problem sooner, of course. It would have facilitated
the handling of the failure if we could have been in there earlier.
Mr. VENTO. Why weren't they notified earlier, Mr. Conover,
based on the disposition? As you say, things went from bad to
worse.
Why wasn't this bank classified as a four or five, based on where
it was going?
Mr. CONOVER. Well, it would have been in the current examination. However, at the time we started this examination in April, we
recall that the bank had shown progress through September 1981's
examination and they were providing us with periodic reports indicating they were making progress.
What we actually expected to find when this examination began
in April was a significantly improved situation for this bank.
Obviously we were very surprised. As soon as the nature of the
problem became obvious to us, we did inform the FDIC.
Mr. VENTO. June 30, 1982. In other words, in April when you
completed the work, it took you 3 months to notify the FDIC and
the Federal Reserve Board.
That is when they were notified again according to your chronology. Is there some communication going on that the members of
the committee should know or do I misunderstand what I have?
Mr. CONOVER. Mr. Vento, the examination began in late April.
As of the date of March 31.



84
We began to recognize the seriousness of the problems in the
loan portfolio approximately 4 weeks into the examination. So it
would have been mid- to late-May when the nature of the problem
in the loan portfolio became obvious to us and that it was evident
that it was
Mr. VENTO. Did the FDIC get its notification?
Mr. CONOVER. No, they did not.
Mr. VENTO. The point is you waited another 6 weeks to notify
them. If you wanted them to do their job in protecting these funds,
it would seem that the 6 weeks was insufficient.
Mr. HOMAN. I think we notified them on June 23 in the regional
office. On June 30, we notified the Washington office.
You have to recall that during this examination, we were
midway through this examination when the bank failed.
We had not had an opportunity to go through the loan portfolio
in full. In fact, our examiners are still trying to complete that examination.
But midway through, we determined that the losses eventually
might exceed the net worth of the bank. We worked continuously
through the last weekend analyzing the credits and eventually that
did happen.
What triggered the failure earlier than we had expected, in a
sense, and denied us an opportunity to make a more orderly arrangement with the FDIC, was the liquidity crisis that occurred.
That essentially was triggered in the final week.
Mr. VENTO. My time is up, I have to cut you off. The same question goes to the Federal Reserve and I know Mr. Isaac's answer,
but he may want to say it for the record in terms of whether he
would like to have been notified earlier.
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Parris.
Mr. PARRIS. Thank you, Mr. Chairman. I think all of us on this
committee accept the fundamental premise that this was a case of
a small shopping center bank whose board of directors adopted an
aggressive loan and deposit policy.
They wanted to play in the big league and they were bush
league. Let's accept that.
Let me reduce the discussion if I might, in amplification with
one of my previous colleagues comments to a provincial matter.
The name of this room is the Wright Patman room. They have a
Wright Patman Credit Union in this building serving congressional
employees.
This is a provincial case, but it is perfectly typical in this whole
situation. That credit union was just one of 150 credit unions nationwide who had $106 million in deposits in this institution.
This credit union is estimated to lose about $200,000, or 20 percent of its deposits. A District of Columbia credit union with $1
million in an Oklahoma bank and it is only 1 out of 150. The real
problem is, only $100,000 is insured.
It gets receivership certificates for the remaining or $900,000, but
even after all of that, it earns no income on the $900,000.
Federal policy, as I understand it, allows the credit union to
borrow up to 80 percent of the face value of the receivership certifi


85
cates from the Federal credit window and then reinvest t h a t to
earn additional interest.
So, we have come full circle. After a very long history of questionable operations by a nationally regulated bank t h a t fails, it
takes with it a substantial deposit of a nationally regulated credit
union, the credit union gets receivership certificates issued by national regulators and then because of the loss of the income, it can
borrow 80 percent of that paper in the national financial market.
All the money there is in all of t h a t is the initial $100,000 t h a t
Mr. Isaac has got in the FDIC insurance fund.
I have heard a lot of instances of creative bookkeeping, but t h a t
is a con game and there are many of us in this committee, I think,
who wonder about the blind subservience to the concern for earnings per share or return on deposit or whatever it is t h a t brings all
of that about.
My question really is, it is bad enough for one bank, Continental
Illinois, to have more than $1 billion in participation or correspondent relationship loans in this institution.
It had bought $1 billion worth of loans. Is there no procedure or
should there not be one, for the Comptroller of the Currency to
monitor this?
Is there not a procedure by some appropriate regulatory agency
to recognize t h a t there is massive shifting of deposits of other institutional assets around the Nation over a period of over 2Vfe years?
Is there not a process or shouldn't there be one? If there is, why
did it not work in this instance?
Mr. H O M A N . I think that is the way t h a t most large banks raise
their money. It has been a principle of the money and capital markets for as long as I can remember. It is advantageous to have a
free flow of funds between institutions and this occurs every day in
the correspondent banking networks and the payment systems
through the Federal Reserve and elsewhere.
It also occurs through various sweep accounts and invested fund
accounts used by pension funds and other large money market participants in terms of distributing money nationwide, short and long
term, on a daily basis.
To interrupt t h a t flow with rules and regulations just seems to
be almost an impossible task to even approach.
Mr. PARRIS. I am not suggesting, Mr. Homan, that it be necessarily interrupted. The thrust of my question, I apologize if it was not
clear to you, but the thrust of my question is should there not be
some smoke t h a t is going to set off the bell t h a t we have heard
about earlier here today t h a t you gentlemen will know there is a
fire or at least recognize as smoke?
There has got to be a reason why the gentleman who runs the
credit union in this building wants to deposit his money in Oklahoma. Now, if there is 150 of those, there has to be some evidence,
some information on the street t h a t would lead you to the suggestion t h a t there is a problem in a bank in Oklahoma t h a t needs to
be a matter of concern to the regulators. Isn't there?
Mr. CONOVER. Apparently not.
Mr. PARRIS. Shouldn't there be?
Mr. CONOVER. When the manager of a credit union or a savings
and loan association makes a decision to make a deposit in another



86
financial institution, or a bank that we are responsible for does
that, he needs to follow some prudent guidelines regarding concentration.
We often criticize banks for undue concentrations of assets.
On the surface, it seems ridiculous to me that we have had 150
credit unions, some number of savings and loans and a number of
banks from all over the country that ended up making deposits in
this particular bank without seemingly doing a very good job of
doing their homework.
If anything, what we need to do is have some kind of a system
whereby people have sufficient information to analyze the affairs
of institutions in which they are making deposits.
Mr. PARRIS. My time has expired, but I would simply make the
observation to you that it seems to me this is very much like leeching a patient who is bleeding to death. We are too late with the
wrong medicine. Certainly we were this time.
Thank you.
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Mr. Conover, how often does the Office of the
Comptroller examine banks?
Mr. CONOVER. That depends on the size of the bank, sir.
Mr. BARNARD. Give me an example.
Mr. CONOVER. The large multinational banks are examined on an
annual basis. In fact, we have almost continuous contact with
them.
Mr. BARNARD. Large what?
Mr. CONOVER. The large multinational banks. Bank of America,
Chase and Manhattan, Citibank, and so forth.
Mr. BARNARD. Smaller banks?
Mr. CONOVER. Smaller banks tend to be examined less
frequently.
Mr. BARNARD. On this particular bank, what would the frequency be?
Mr. CONOVER. A normal frequency for a bank of this size would
have been what, 18 months?
Mr. HOMAN. Would have been in this period of time 18 months.
But Penn Square was an identified bank requiring special supervisory attention. For such banks, we do, as a matter of policy, one
full examination each year, together with a short visit.
Mr. BARNARD. Short visit.
Mr. HOMAN. Yes.

Mr. Barnard. Just one short visit?
Mr. HOMAN. Each year, yes, We do a full comprehensive examination once a year and a second visitation or limited-purpose type
examination during that year.
Mr. BARNARD. Mr. Isaac, do you get copies of his examination reports?
Mr. ISAAC. Yes.
Mr. BARNARD. What do you do with
Mr. ISAAC. We review them in our

them?
Division of Bank Supervision
and if the bank is accorded problem status, a memorandum is prepared and distributed to various people throughout the corporation,
including myself, that, as I said in this case, that wouldn't have occured because it was not considered a problem bank.



87
Mr. BARNARD. Even with the unfavorable reports that Mr.
Homan has just talked about, it would not be regarded as a problem bank by FDIC?
Mr. ISAAC. It was rated a three bank.
Mr. BARNARD. IS that bad?
Mr. ISAAC. That is a bank that requires closer-than-usual scrutiny, but is not a problem.
Mr. BARNARD. It is not customary for FDIC to pay any particular
attention to that bank?
Mr. ISAAC. NO.
Mr. BARNARD. When do you become alarmed?
Mr. ISAAC. We, obviously, would become more

concerned when a
bank is rated four, which is a problem status, and even more
alarmed or concerned when it is rated five, which is a bank in
danger of failing.
I get a weekly list of any banks that are in that condition.
Mr. BARNARD. If you had received a copy of the examination
report, and you saw some very obvious things in it which might require classification by the Comptroller as three, yet in your judgment or that of the FDIC, would be worse than a three—such as a
bank selling 80 percent of its loans, is that unusual?
Mr. ISAAC. For a bank this size to sell that volume of loan participations is very unusual.
Mr. BARNARD. I take a little issue with you
Mr. ISAAC. I am not sure that would have shown up in the examination report. It might, I don't know.
Mr. HOMAN. Yes, it does. Congressman Barnard, the FDIC reviews each of our ratings and we have an interagency dispute procedure in the case where they would disagree with a rating of ours
on a national bank.
In this case, they reviewed it and did not dispute it.
Mr. BARNARD. I am trying to support the present system, which
is difficult to do. If I thought the FDIC was backing up the Comptroller's Office or a State supervisor—you do examine State banks,
right, on your own?
Mr. ISAAC. That is correct.
Mr. BARNARD. YOU don't take a State supervisor's bank examination on face value, do you?
Mr. ISAAC. In most States, we alternate.
Mr. BARNARD. At least you are in there pitching.
Mr. ISAAC. We will go in and do another report at a later date.
Mr. BARNARD. But you take the examination of the OCC and the
Federal Reserve at face value.
Mr. ISAAC. That is correct.
Mr. BARNARD. DO you think that is right? On reflection, do you
think that is right?
Mr. ISAAC. I don't think that the present regulatory system at
the Federal level
Mr. BARNARD. Under the present system, don't you think it is a
responsibility of the FDIC to be a little more careful in looking at
these examinations?
Mr. ISAAC. We have not been assigned regulatory responsibility
for national banks or for State banks that are members of the
Federal Reserve System and we don't exercise that authority.



88
Mr. BARNARD. You are the one that will have to close it out.
Mr. ISAAC. That is correct.
Mr. BARNARD. YOU are the one that has that ultimate responsibility.
Mr. ISAAC. We have no regulatory authority.
Mr. BARNARD. Mr. Conover, one of the recent press accounts of
this bank indicates that in evaluating the collateral of a loan,
which so often in this bank was oil reserves, the reserves used as
collateral were only determined after the loan was made.
Are you familiar with that?
Mr. CONOVER. I am not aware personally whether that is true or
not. I think I am aware that the lending practices in the oil and
gas division of this bank were unusual, to say the least, compared
to those of other banks who are experienced in making oil and gas
loans.
Mr. HOMAN. Congressman, our examiners have indicated to us
that many of the engineering reports estimating the values of the
reserves were in their words "made as instructed/'
That is that they could have been falsified or very optimistic and
generous in terms of evaluation on these particular types of loans.
Mr. BARNARD. Well, you know, I don't know how much more I
could develop from my questioning, but I just want to take friendly
issue, with Mr. Isaac.
I don't think this is an aberration at all. It would be an aberration if Penn Square was a good, solid, sound, properly run bank
that went broke under your capable supervision and examination,
but in this case, all the flags were here for a failure 2Vz years ago.
So it is not an aberration at all. It was a foregone conclusion
which direction this bank was going and it went that way and it
failed.
This one bank is going to call for a very thorough reappraisal of
what our bank supervising practices are. We may need to get back
to one agency with all the responsibility.
Thank you.
The CHAIRMAN. I have got to observe something.
Mr. Conover and Mr. Isaac, did I hear you say this was classified
as a number three up until the date of the failure, when the bank
failed?
Mr. CONOVER. The bank was rated number three up to this examination. Obviously had the examination been completed, and the
bank survived the examination, it would have received a lower
rating.
But up until the time of the examination, it was a three-rated
bank, yes, sir.
The CHAIRMAN. SO there was no deterioration from April 1980
until the conclusion of the examination and the failure in 1982?
Mr. CONOVER. I think, as I ihdip&tect earlier, we saw some improvement in the bank in Septerpber 1981 and fully expected at the
start of the April 1982 examination to find that they were in a
much improved position.
The CHAIRMAN. Mr. Weber.
Mr. WEBER. Thank you, Mr. Chairman.



89
I would like to have the panel clarify what in your opinion was
the reason that the supervision turned out to be ineffective to prevent the failure of this bank.
Mr. CONOVER. When all is said and done, I think the reason that
the supervision was ineffective in this bank was that it was not
heeded by the supervised.
Mr. WEBER. Mr. Homan, do you agree?
Mr. HOMAN. I agree. I think you can only do so much in a bank
in terms of guiding it, in terms of advising it, in terms of suggesting to it the proper recipe to solve its problems. We do not run
banks; we do not manage banks. We are there once a year, or in
this case, twice a year.
We do not make the loans in a bank. To do so would be to nationalize the institution.
We do not think that the Congress or anyone else in the United
States wishes the Federal Government to nationalize its banking
institutions and have the Government run them. So we followed
our proper procedures in this respect.
The bank chose to ignore it, chose to ignore the law, if you will.
It chose to ignore the common recipies that we gave it to solve its
problems, and there is very little more that one can do in that type
of a circumstance.
The CHAIRMAN. Would you yield, Mr. Weber?
Mr. WEBER. I would be happy to yield.
The CHAIRMAN. What restrictions are there on the Comptroller
from doing more? Other than those you have self-imposed upon
yourself and the fact you have used cease-and-desist orders like
pabulum?
Mr. HOMAN. We are not in the habit of managing banks, Mr.
Chairman. In this case, we had no power to remove the management because we had no evidence of any dishonest acts, which is a
requirement in the law.
The CHAIRMAN. YOU cite illegalities throughout in your report.
Mr. HOMAN. This was a bank that was mismanaged.
Those were civil violations of law. There is no statute which
gives us the power to remove a manager for civil violation of the
law, a violation of the lending limits, a violation of the insider
laws. So long as they are civil.
There has to be evidence or act of dishonesty.
The CHAIRMAN. I apologize, my blood pressure was going up
there.
Mr. WEBER. I was glad to have the chairman follow that line of
questioning. Did you have any different opinion, Mr. Isaac, about
the reason for ineffective supervision which prevented failure in
this case?
Mr. ISAAC. At this stage I would not be prepared to express an
opinion on that. We have been very busy over the past 2 weeks, as
you might imagine, trying to make sure that depositors are taken
care of and that we get the receivership activities under way so
that the loan customers of the bank are taken care of properly. We
are just beginning our investigation, in conjunction with the FBI,
into what went wrong.
If you were to give us another month or two, I think we would be
more knowledgeable on that subject.



90
Mr. WEBER. I know we will be looking forward to that.
To come back to the question you had an agreement with them
called a cease-and-desist agreement t h a t the officers and directors,
of the bank signed on September 9, 1980, according to your testimony.
You chose, apparently, not to enforce the provisions of t h a t
agreement. I think the chairman has characterized it beautifully as
a slap with a wet noodle.
What powers do you have to enforce t h a t type of agreement? If
the agreement means nothing, why did you take the trouble to
have them sign it.
Mr. HOMAN. We had numerous meetings with the management
of the bank and the board of directors after t h a t particular agreement. We had evidence to suggest t h a t they were complying in certain respects.
They gave us assurances throughout t h a t period t h a t they were
trying to come into compliance with the terms and conditions of
the agreement.
Mr. WEBER. DO you not have power to go to court and enforce
t h a t agreement if necessary?
Mr. HOMAN. Yes.
Mr. WEBER. What
Mr. H O M A N . We

other powers do you have.
could have filed a notice of charges, yes, and
had them stipulate to a final cease-and-desist order. After review
by the courts, after opportunity for hearing it would be enforceable
in court.
Mr. WEBER. And you are saying in the exercise of your discretion, you chose to give the bank the benefit of the doubt?
Mr. H O M A N . In this case, yes.
Mr. WEBER. YOU also said it was up to the investors in these
jumbo CD's to exercise better protection for themselves, reviewing,
and so forth. There is an article in the Wall Street Journal of July
8, 1982 in which there is a quotation from one of these asset managers is t h a t Penn Square's latest financial statement certificated
by Peat, Marwick & Mitchell gave them a complete bill of health.
Is t h a t true? Were the auditors at fault for not footnoting the
statement in some way? Why didn't they know the same things
t h a t you knew as to the condition of this bank?
Mr. CONOVER. I think it would be inappropriate for us to comment about the auditors' role and the audit report at this time.
Mr. WEBER. I can understand that. But is t h a t correct? Did you
communicate the information to Peat, Marwick? Would they have
known of this?
Mr. CONOVER. Peat, Marwick would have known about the existence of the formal agreement, yes, and they did know.
Mr. WEBER. YOU are not expressing an opinion as to whether
Peat, Marwick, under their standards of good accounting practice
and the law, would require them to footnote the statement to point
out t h a t cease-and-desist agreement t h a t had been signed?
Mr. CONOVER. NO; I am not.
Mr. WEBER. What self-protection

are you referring to then on the
part of the investors t h a t was lacking?
Mr. CONOVER. Well, it seems to me t h a t the potential depositor
who is going to make a $1 million deposit in an institution of



91
any kind, ought to first of all choose an institution that it has some
confidence in and will be a safe resting place for that deposit, as
opposed to simply seeking the highest return it can find.
Mr. WEBER. In relation to this bank, what would have led a depositor to believe that it was not a safe and secure resting place for
that amount of money?
Mr. CONOVER. I know of no information that would have been
available to investors that would have helped them make that decision.
Mr. WEBER. SO, Mr. Conover, it is improper to fault the investor
or place the responsibility on the investor or to cast them in the
light of persons who did not know how to make a sophisticated
investment of $1 million.
Mr. CONOVER. Not necessarily. They might very well have chosen
a larger, stronger institution on which information was available to
them.
The CHAIRMAN. Like Franklin National; and the U.S. National
Bank of San Diego.
Mr. WEBER. My time is expired.
Thank you, Mr. Chairman.
Mr. ISAAC. Can I interject at this point in response to that, because I would take issue with saying that there was nothing to
alert an investor here to this situation. I think there was information available that should have alerted an investor.
Mr. Parris was asking earlier why the Wright Patman Credit
Union and 150 other credit unions place their money in this bank
in Oklahoma? They did so because the bank was paying above
market rates for that money.
Why was that? If I had been an investor I would have wanted to
ask that question. I would have wanted to know more about that
institution.
I think that there was information out on the street about this
institution that could have been uncovered through closer scrutiny.
I hope other financial institutions, will be more diligent in doing
that in the future as a result of Penn Square—that they will have
learned some lessons and make that kind of inquiry. I hope they
will invest in an institution based not just on rate, but on quality—
whether it is a small or large bank and wherever it is loacted.
Mr. WEBER. I am still at a loss as to what this information on the
street is when the audited financial statements don't show it.
The CHAIRMAN. They tell me that there is a footnote in the Peat,
Marwick, Mitchell audit report, very cryptic and you would have to
have the wisdom of Solomon and be prophetic in wisdom to understand that perhaps they should have—the investors should have
recognized this as a caveat.
But you know I have to observe, if the fact that this deposit was
paying that high a rate, obviously that is what attracted the deposits from around the country, shouldn't that have said to the Comptroller, hey, there is something wrong here, and to the FDIC, that
there is something wrong here?
Why did it just—why should it just say that to sophisticated investors?
Mr. HOMAN. It is very common to see in the money markets
every day certain tiering between classes of institutions that
97-830

0 - 8 2 - 7




92
exceed 20 to 25 basis points, which, for the most part, this institution was paying.
The CHAIRMAN. In a shopping center bank?
Mr. HOMAN.

Yes.

The CHAIRMAN. With the brokers' fees being paid on top of that?
Mr. HOMAN. Smaller banks generally pay higher in the national
money markets than the top AAA- and AA-rated institutions.
The CHAIRMAN. My expert here, who used to be a small banker,
is wincing at that. That is Mr. Barnard.
Mr. Patman.
Mr. BARNARD. I don't know if I want to be classified as a banker
now.
The CHAIRMAN. Excuse me, Mr. Schumer.
Mr. SCHUMER. Thank you, Mr. Chairman.
I am really appalled by this testimony today. I am most appalled
by this statement, made by either Mr. Homan or Mr. Conover.
What went wrong, we were unheeded by the supervised.
That is like saying we have crime in this country because the
criminals don't obey the laws. It is unbelievable. We also have a
great deal of contradiction.
Mr. Isaac is saying we need no new laws to protect ourselves. Of
course, he wants the FDIC or other single agency to take charge of
all regulatory functions, including those performed by the Comptroller of the Currency and maybe even those handled by the
Federal Reserve.
But Mr. Conover and Mr. Homan are saying we have no laws
that allow us unless there is a criminal violation which, of course,
is very, very difficult to prove.
That is a direct contradiction. We either need new laws, which
means that we have to act and Mr. Isaac is wrong; or we don't
need new laws and it means that you, Mr. Conover, and you, Mr.
Homan, were negligent in performing your duties.
I would like a direct answer to that statement by Mr. Conover
and Mr. Isaac.
Mr. CONOVER. It seems to me that it is important to insure that
the regulators have adequate powers to do their jobs.
Mr. SCHUMER. YOU feel you don't, correct?
Mr. CONOVER. I didn't say that; no.
Mr. SCHUMER. Then what went wrong here?
Mr. CONOVER. I think I have already answered the question.
Mr. SCHUMER. Well, what you have answered and what I heard
was that the superviser didn't listen to us. That, to me, says that
you think happened here, you don't have the power to do more.
Mr. CONOVER. I think it is essential that in regulating banks that
the banks we are trying to regulate do listen to us, obviously.
Mr. SCHUMER. What happens when they don't? This one didn't.
Mr. CONOVER. The vast majority of banks on which we uncover
violations of law, unsafe or unsound banking practices, and so
forth, do listen and do correct.
Mr. SCHUMER. What happens when one doesn't? The vast majority of banks didn't prompt this hearing.
Mr. CONOVER. When one doesn't and the bank deteriorates significantly, it probably fails. And I frankly think that the price we
pay for having a private-sector, competitive financial services in


93
dustry is that with the right to succeed and prosper goes the right
to fail.
Mr. SCHUMER. I understand that point.
Basically you are saying the role of the Comptroller in all but
the most criminal violations is to be advisory and if advice is not
heeded, that's too bad; not only too bad for the Penn Square board
but too bad for Chase Manhattan and other banks that bought participations and too bad for other investors that happened to put
more than $100,000 into this bank.
That is what you are saying?
Mr. Isaac, do you stand by the statement that there are no further laws needed to give the Comptroller or whatever other agency
might assume jurisdiction for the Comptroller's responsibilities in
the future to get these few negligent banks to heed advice from the
regulators?
The CHAIRMAN. Would the gentleman yield to me?
Mr. SCHUMER. I sure will.
The CHAIRMAN. Let me ask Mr. Homan because he is the professional here, are you familiar with the excerpt from Public Law 95630, dated November 30, 1978, that refers to removal from office,
notice of intent?
Mr. HOMAN. Yes; I am.

[The excerpt from Public Law 95-630 referred to by Chairman St
Germain follows:]
PUBLIC LAW 95-630—NOV. 10, 1978

92 STAT. 3657

"(c) (1) Whenever, in the opinion of the appropriate Federal hank- Removal from
ing agency, any director or officer of an insured hank has committed office, notice of
any violation of law, rule, or regulation or of a cease-and-desist order intent,
which has become final, or has engaged or participated in any unsafe
or unsound practice in connection with the hank, or lias committed
or engaged in any act, omission, or practice which constitutes a breach
of his fiduciary duty as such director or officer, and the agency deter-'
mines that the bank has suffered or will probably suffer substantial
financial loss or other damage or that the interests of its depositors'
could be seriously prejudiced by reason of such violation or practice or5
breach of fiduciary duty or that the director or office has received
financial gain by reason of such violation or practice or breach of
fiduciary duty, and that such violation or practice or breach of fiduciary
duty is one involving personal dishonesty on the part of such director
or officer, or one which demonstrates a willful or continuing disregard
for the safety or soundness of the bank, the agency may serve upon
such director or officer a written notice of its intention to remove him
from office.

The CHAIRMAN. We thought we gave some pretty good checks
and powers. That is what Mr. Isaac meant.
We gave them the powers. They didn't use them.
Thank you for yielding.
Mr. SCHUMER. Yes.
Mr. HOMAN. I am familiar

with that, as I said earlier. We have
applied that statute. You read a lot of "or's" there, but it has to be
one from each part of that law with the operative language "and
that such violation or practice or breach of fiduciary duty is one
involving personal dishonesty/' and that has to be present in order
for us to remove any bank officer.



94
The CHAIRMAN. Or willful.
Mr. HOMAN. No; it is "and." Our interpretation is, I am advised
by counsel, is t h a t that has to be present.
Mr. SCHUMER. Do you think t h a t ought to be changed?
Mr. H O M A N . I do,
Mr. SCHUMER. I

yes.

think the astute questioning of the chairman
and everybody else today has brought out, I think, at least in the
preliminary opinion t h a t this committee has of the Comptroller of
the Currency's role, that we knew the problem existed for a long
time, it was ignored, it was understated and no positive action was
taken.
I would like to t u r n to Mr. Isaac once more. Once the bank
failed, there were, of course, two alternatives—liquidation and
merger.
The newspapers reported t h a t Chairman Volcker was in favor of
a merger and t h a t you were opposed. You prevailed.
Can you tell me his reasoning? If everything is so good in the
banking community and this is a complete aberration not to be repeated, and you are going to go visit your family in Kentucky this
weekend
The CHAIRMAN. Ohio.
Mr. SCHUMER. Excuse me, Ohio, across the river. Why was Mr.
Volcker so eager to spend Federal Government money to cover the
extra, whatever it is, $190 million-some of uninsured deposits?
Mr. ISAAC. I will be happy to respond to that. Before I do, I would
like to respond to another point you made earlier—that I was here
testifying that we should have a single agency
Mr. SCHUMER. I was tweeking you. You know I respect your ability so tremendously, it might not be a terrible thing.
Mr. ISAAC. I have long been of the opinion t h a t five Federal regulatory agencies is either three or four too many.
Mr. SCHUMER. Right.
Mr. ISAAC. I don't know whether the FDIC or some other agency
will survive that process. However it comes out, it ought to be
done.
As far as myself being the chairman, as quickly as I can get this
term over with, I intend to find an easier lifestyle.
Mr. SCHUMER. A weak tweek.
Mr. ISAAC. I am going to find a cornfield in Ohio and I am going
to plow it.
Turning to your question, I read that in the New York Times
t h a t Paul Volcker and I had a disagreement about this matter.
That is incorrect.
There were really two policy issues involved here. One was t h a t
if you paid off the deposits in this bank and some large depositors,
including other financial institutions, took some losses, you would
have a lot of media attention and congressional hearings. That
would be disruptive.
The easiest way to handle this situation would be to merge Penn
Square into another institution at whatever costs and not make
waves.
Mr. SCHUMER. Probably shortsighted.
Mr. ISAAC. A merger was very tempting.



95
It was difficult to arrive at the conclusion we did in this situation.
On the other hand, if we had taken the merger route, with as
much mismanagement and possible other irregularities as seemed
to be involved in this situation, how would we ever achieve any
marketplace discipline in the financial system?
How would we get credit unions like the Wright P a t m a n Credit
Union to start making intelligent investment judgments about the
institutions with whom they do business?
So on the one hand, there was a natural concern about not creating a lot of waves, and on the other hand, there were concerns
about where the system was headed if we didn't impose some discipline on it.
Furthermore, we have an FDIC statute which very clearly sets
out a cost test, and we couldn't make t h a t cost test finding here
because of the contingent liabilities.
So even if we had decided to go the other direction and smooth it
out, we didn't feel we could legally do t h a t under the laws you
have provided for us.
I am frankly not here to ask t h a t the laws be changed.
I don't think Paul Volcker was on one side of the issues, and Bill
Isaac on another side. I think we both recognized the same issues.
We had a lot of discussions about them and in the end, we were all
in agreement—including Mr. Conover—on how this situation
should be handled.
Mr. SCHUMER. One of the few victories against socialism for the
rich in this administration.
The CHAIRMAN. Would you repeat for me, Mr. Isaac, your description of the management and what was wrong, the irregularities?
Mr. ISAAC. I stated t h a t it was mismanaged.
The CHAIRMAN. That it was mismanaged.
Mr. ISAAC. And other possible irregularities.
The CHAIRMAN. I want to insert an excerpt from the committee
report pertaining to the section of Public Law 95-630 that was
cited to Mr. Homan a moment ago. This is under section "C, Removal and Suspension of Insiders."
[The excerpt from the committee report referred to by Chairman
St Germain follows:]




96
O. Removal and Suspension of Insiders
The agencies have also forcefully stated that present law authorizing removal of an insider from his position is unduly restrictive upon
the agencies in their performance of their duties to insure that thenation has a safe and sound banking system. Presently, an individual
may be. removed only on a showing that the individual is engaging in
unsafe and unsound practices which 'have an adverse effect on the
institution and that the individual's activities involve personal dishonesty. This standard has hampered the agencies in their efforts to take
timely action to make certain that individuals whose actions are seriously damaging the institution may be removed from their positions.
Your committee has provided statutory language which will give
the regulatory agencies a less burdensome test under which they may
institute removal proceedings. The provisions would authorize removal when an individual has evidenced personal dishonesty (current
standard) or has demonstrated willful or continuing disregard for
the safety and soundness of the financial institutions.
This new standard will allow the agencies the opportunity to move
against individuals who may not be acting in a fraudulent manner but
who are nonetheless acting in a manner which threatens the soundness
of their institution. As with the other powers given the agencies, requirements for due process are built into the removal statute.
The lanjjugc in the bill also corrects existing law with respect to removal and suspension of individuals indicted or convicted of specified
crimes. In the Feinberg v. FDIC case, the court held that the suspension and removal statute was deficient since it did not provide opportunity^ for hearing and review of an agency's action. Under the
proivsions of IT.R. 13471 an individual will now'have that opportunity.
Mr. HOMAN. Mr. Chairman, I—
The CHAIRMAN. Have any of these been brought to court? Has
t h e r e been a removal or intent to remove in a court case, in suit?
In other words, has there been a court interpretation of t h e revised
statute or would the court ignore the committee report?
Mr. H O M A N . I am not sure I know the answer to that. I do not
know the answer to t h a t question. There have been very few removal proceedings.
The CHAIRMAN. YOU don't know if any have gone to court?
Mr. H O M A N . I think each one has been settled prior to t h a t determination by a court. I a m not sure. We can research t h a t question.
The CHAIRMAN. I hope you would. We will be revisiting this.
Mr. H O M A N . We will be glad to provide our legal interpretation
of t h a t statute and how we as an agency interpret that.
[In response to the information requested by Chairman St Germain, the following letter was received from Mr. Homan for inclusion in the record:]




97

O
Comptroller of the Currency
Administrator of National Banks
Washington, D.C. 20219

J u l y 29, 1982

Dear Mr. Chairman:
The purpose of this letter is to clarify the testimony before
your Subcommittee on July 15, 1982, regarding removal powers
under 12 U.S.C. §1818(e). That statute permits each of the
Federal financial institutions regulators to institute removal
proceedings against an officer or director of an insured
financial institution under certain specified conditions. In
order to justify removal under the statute, the regulator must
establish at a formal hearing before an administrative law judge
that the following criteria have been satisfied:
I.

That the officer or director of the insured bank has
committed:
A.
B.

has engaged or participated in any unsafe or unsound
practice in connection with the bank; or

C.

II.

any violation of law, rule, or regulation or of a cease
and desist order which has become final; or

has committed or engaged in any act, omission, or
practice which constitutes a breach of his fiduciary
duty as such director or officer; and

The agency determines that the bank has:
A.

suffered or will probably suffer substantial financial
loss or other damage; or

B.

that the interests of its depositors could be seriously
prejudiced by reason of such violation or practice or
breach of fiduciary duty; or

C.

that the director or officer has received financial
gain by reason of such violation or practice or a
breach of fiduciary duty; and




98
III. That such violation or practice or breach of fiduciary duty:
A.

is one involving personal dishonesty on the part of
such officer or director; or

B.

one which demonstrates a willful or continuing
disregard for the safety or soundness of the bank.

The removal provisions of the Financial Institutions Supervisory
Act of 1966 (FISA) as amended by the Financial Institutions
Regulatory and Interest Rate Control Act of 1978 (FIRA), as
described above, may be invoked only under the combination of
special circumstances delineated in the statute. 12 U.S.C.
§1818(e) has not been subjected to direct judicial review;
nevertheless, Congress made it clear when it gave the agencies
the removal power that it was .an extraordinary power and was not
to be used by the agencies to remove an officer or director from
a bank on simple grounds of incompetence or poor judgment.
The removal power is an extraordinary remedy which this agency
has used on only a few occasions. The reason the agency has not
needed to utilize the power is that, ordinarily, when management
problems are brought to the attention of the directorate, the
directorate takes action to correct them. It is a principal
responsibility of the board of directors to ensure that the
institution is properly managed. Thus, in the normal course,
where problems are identified the board of directors will resolve
the difficulties through management changes. If the board of
directors does not take action to change management and there is
a statutory basis to remove the individual from the bank this
Office would not hesitate to consider the need to use the removal
statute.
In the instant case, while problems existed in the bank prior to
the April 1982 examination, in our opinion, based on the
information known at the time, these problems did not then rise
to a level satisfying the strict three-criteria removal standards
of 12 U.S.C. §1818(e). The problems as identified in prior
examinations indicated that the management team needed
strengthening. The formal cease and desist Agreement required,
among other things, that the board of directors evaluate and make
adjustments to the current management team both in quality and
depth. Because of that Agreement, the bank responded by
augmenting its management through the hiring of personnel from
other financial institutions. This was viewed as a positive




99
response to the previously identified management problems. Under
the circumstances, removal was viewed as neither appropriate
under the statute nor necessary to effect management changes.
Sincerely,

Paul M. Homan
Senior Deputy Comptroller
for Bank Supervision
The Honorable Fernand J. St Germain, Chairman
Committee on Banking, Finance and Urban Affairs
2129 Rayburn House Office Building
Washington, D. C. 20515

The CHAIRMAN. Our intent—remember this was in response to a
complaint that we received prior to 1978 when we adopted this
statute. Our intent was to give you the power that you needed
without a finding of fraud or illegality. If t h a t wasn't enough
maybe we ought to revisit it. I think you ought to have t h a t power.
I think you have it.
Mr. HOMAN. We would be glad to give you our internal analysis.
I do know that is how our agency applies it. That there must be a
personal act of dishonesty present before we start a removal.
The CHAIRMAN. In other words, you ignore the statute.
Mr. HOMAN. NO; t h a t is the advice t h a t our general counsel gives
us, that we must have t h a t factor present before we are able to go
forward.
That may be a fallacious interpretation, but it is the agency's
legal opinion.
The CHAIRMAN. HOW does the FDIC interpret that?
Mr. ISAAC. I think we have different legal interpretations.
The CHAIRMAN. You agree with me?
Mr. ISAAC. That is what my lawyer tells me.
The CHAIRMAN. Good. Excellent counsel.
Mr. Patman?
Mr. PATMAN. Mr. Conover, was First Penn the parent company
of Penn Square?
Mr. CONOVER. Yes; it was.
Mr. PATMAN. HOW many banks did First Penn own?
Mr. CONOVER. It is a one bank holding company.
Mr. PATMAN. Did it perchance drain off any assets

of Penn
Square?
Mr. CONOVER. I don't think it did, no.
Mr. PATMAN. Were there any unusual or excessive charges made
of Penn Square by First Penn?
Mr. CONOVER. Not t h a t I am aware of.
Mr. PATMAN.
Mr. HOMAN.

OK.

There were some intercompany transactions which
we moved to abate during the final few days of the examination.
We had no evidence of any particular abuse between the bank and
the holding company in previous examinations.




100
Mr. PATMAN. First Penn didn't own interest in any other banks
or financial institutions?
Mr. HOMAN. I don't believe it did.
Mr. PATMAN. Was it the characteristics of the loans or transactions of this bank that the bank, its directors, its parent company,
any of its subsidiaries, officers, or employees would take a proprietary interest in business deals brought to the bank?
In other words, did they try to take a piece of the action?
Mr. HOMAN. Yes; there were substantial insider transactions between the bank and certain directors, officers, employees, and
shareholders.
Mr. PATMAN. They would try to take a part of a drilling deal or
something like t h a t and gain some interest in it?
Mr. HOMAN. Generally, yes.
Mr. PATMAN. Has your office been contacted by any person in political office or associated in any way with a particular governmental office during your examination of Penn Square?
Mr. CONOVER. No; not that I am aware of.
Mr. PATMAN. IS that true of all three of you?
Mr. ISAAC. I don't know t h a t I understand the question.
Mr. PATMAN. Has your office been contacted by anyone in political office during your examination?
Mr. ISAAC. We didn't examine Penn Square, so, no. The answer is
no.
Mr. HOMAN. Other than the people in the Federal Government?
We were in contact with a good many people in the Federal Government in counterpart agencies, with the U.S. Treasury and the
like.
Mr. PATMAN. Any elected officials contact you?
Mr. CONOVER. N O .
Mr. PATMAN. YOU are each saying no?
Mr. ISAAC. Contacting about Penn Square?
Mr. PATMAN. Yes, that is right.
Mr. ISAAC. N O .
Mr. PATMAN. Why didn't you have a person

in the bank on the
job at all times during this difficult—especially in the last few
months?
Mr. CONOVER. Since the examination started in late April we
would have had examiners on the scene in the bank, I believe, virtually every working day. We had a presence in the bank certainly
during the week prior to its failure and every day over t h a t weekend.
Mr. PATMAN. NOW, Mr. Isaac, you say that there are no similar
pervasive problems within the financial institutions in the industry. Are there similar problems in the industry t h a t do not exist?
When you say pervasive, do you mean throughout the financial industry or aside from the 365 banks t h a t you have identified as
having problems?
Mr. ISAAC. First of all, the number is not 365 that we have on
our problem bank list; it is approximately 268. Those institutions
do not have the characteristics of Penn Square, because Penn
Square was a unique case.
There are always going to be some problems in the system. You
have 15,000 institutions and occasionally one of them will get into



101
trouble, and occasionally one of them is going to fail. Right now
our problem bank list is somewhat higher than average. Not as
high as you would think it might be in light of the high interest
rates and economic turmoil we have experienced.
But I think it might be a serious mistake to say that what happened in Penn Square exists elsewhere. This is not evidence of any
widespread problems at all.
Mr. PATMAN. YOU are not saying that problems similar to those
found in Penn Square do not exist elsewhere in the banking
system?
Mr. ISAAC. That there are not banks somewhere that have made
bad loans sufficient to threaten the institution? No, I wouldn't say
that.
Mr. PATMAN. Those are the only problems you see in common?
Those are the only problems you see in common between Penn
Square and any other banking institution?
Mr. ISAAC. Right. Earlier, Mr. Annunzio said each time you have
a bank failure you say it is unique. He asked, how can you keep on
saying that these are unique? Isn't there a pattern?
The answer is no. If you stop and think about the number of institutions in the country and the number that fail, I think it is
very easy to come to the conclusion that the problems of those institutions that have failed are unique. In some cases you have outright fraud involved. In other cases you have gross mismanagement.
Mr. PATMAN. This insider dealing Mr. Conover described, you
didn't see any insider dealing that Mr. Conover described?
Mr. ISAAC. I am not ruling out there may have been insider dealing in Penn Square.
Mr. PATMAN. I am asking did you see any of it?
Mr. ISAAC. We did not examine the bank. We are starting to examine it now.
Mr. PATMAN. SO you don't know if it is there or not.
Mr. ISAAC. We do not know yet.
Mr. PATMAN. Really you can't testify about how unique this situation is then, can you?
Mr. ISAAC. I know enough about it to know that the banking
practices in which this bank engaged are not generally practiced
throughout the industry.
Mr. PATMAN. But you have not examined the bank, so you really
don't know a great deal about it; is that true?
Mr. ISAAC. We don't know as much as we should know, but we do
know generally what caused the problems.
Mr. PATMAN. Thank you very much. My time has expired.
The CHAIRMAN. Mr. Homan, were you with the Comptroller's
Office when Franklin National failed?
Mr. HOMAN. Yes; I was.

The CHAIRMAN. YOU know it occurs to me—correct me if I am
wrong in my memory. I am trying to refresh my memory by partisan staff work. As I recall it, one of the principal reasons for failure of Franklin was they were speculating in foreign currencies.
They had a little cellar where they were speculating in foreign currencies. During the examination process, the examiners had examined that particular facet of it and gone on to others, and while the



102
examiners were still in there Franklin National failed. Is that correct? Is my memory correct?
Mr. HOMAN. Congressman, I was an examiner in California at
the time, and I just cannot—I do not know the answer to that question. I do know
The CHAIRMAN. The further point is
Mr. HOMAN. YOU are right, the foreign exchange losses in the
bank were a contributing factor to Franklin's failure. I don't know
whether our examiners were there continuously.
The CHAIRMAN. My recollection is that the examiners had been
through that phase of the bank and gone on to others, and were
still there examining. That points out two things: first, it was admitted by the Comptroller at the time that one problem was the
examiners who went through that phase of it didn't know enough
about it to really evaluate it; second, the enormity of some of these
examinations really imposes a tremendous burden. It is a great responsibility for the Comptroller's Office.
I want to cite the fact that I appreciate that. I agree to it.
Mr. Homan, you said to the members here while it is wonderful
hindsight, you know, having been here through Sharpstown, the
Rent-A-Bank thing in Cariso Springs, Franklin, USNB, those are
just the ones where we really looked into them thoroughly. When
do you cease talkng about hindsight and start talking about foresight? That is why we gave these additional powers in 1978.
I didn't even mention the Calhoun Bank in Georgia. As you
recall, that one we looked into as well.
I had a question of Mr. Isaac, which you probably answered, but
I would still like to ask it. How come 150 credit unions, a number
of S. & L.'s and a number of other jumbo depositors put money into
a shopping center bank in Oklahoma City, Okla. How did it get
there?
Anybody care to respond to that?
Mr. CONOVER. I think it got there in two ways. Much of it got
there through money brokers who attracted funds from all over the
country, because there certainly were financial institutions from a
good number of States with no particular geographic concentration
as I recall.
Second, I believe that the bank did some direct advertising on a
nationwide basis, also, to attract funds.
The CHAIRMAN. Was the advertising saying they were paying
more than other institutions?
Mr. CONOVER. I am not sure that it was, Mr. Chairman, but I
would presume it probably did.
The CHAIRMAN. What fee does a money broker get for placing a
$1 million deposit? Do you know what the average fee is?
Mr. HOMAN. I have heard it may be up to 25 basis points.
Mr. CONOVER. I don't know.
The CHAIRMAN. IS there any way for us to find out at future
hearings?
Mr. HOMAN. We can find that out.
Mr. CONOVER. We can find that out.
The CHAIRMAN. Before you go back too far, FDIC has a credit
union.
Mr. ISAAC. Yes; it does.



103
The CHAIRMAN. DO you know whether or not?
Mr. ISAAC. I don't know, but I am told by one of your staff people
that it does not have any investments in Penn Square.
The CHAIRMAN. Am I correctly informed t h a t these receivership
certificates can be taken to the discount window at the Fed at this
point?
Mr. CONOVER. Yes; t h a t is correct.
The CHAIRMAN. DO you know what they are paying?
Mr. ISAAC. The receivership certificates held by depository institutions?
The CHAIRMAN. That was my next question.
Mr. CONOVER. A S I understand it, they are lending 90 percent of
the face value of the receiver's certificate at the discount rate.
The CHAIRMAN. Ninety percent.
Does that indicate to Mr. Isaac t h a t
Mr. ISAAC. They are lending 90 percent of the 80 percent.
The CHAIRMAN. Ninety of the eighty.
Mr. ISAAC. In other words, they lend 72 percent against the face
amount.
The CHAIRMAN. That is the number t h a t I had here.
My next question was to whom?
Mr. ISAAC. TO depository institutions—credit unions, S. & L.'s
and commercial banks.
The CHAIRMAN. SO t h a t little old widow who worked hard all her
life can't use the discount window if she had $1 million dollars in
there.
Mr. ISAAC. YOU would have to talk to the Federal Reserve about
that, but it is my understanding—because this is an issue we discussed over the course of the weekend when we were trying to resolve this situation—that the Federal Reserve does not have authority to make t h a t available in these circumstances to the individuals as much as it might like to.
The CHAIRMAN. Continental was informed of the fact there were
problems at this bank 6 days before?
Mr. CONOVER. I don't know if t h a t is the precise number, but it
was during the previous week. Yes.
The CHAIRMAN. And 2 days later Chase Manhattan was informed.
Mr. HOMAN. I believe that is correct.
The CHAIRMAN. They were told what?
Mr. HOMAN. We advised them t h a t they had significant problems
in their portfolio as a result of loans they had purchased from
Penn Square and t h a t we were placing them under examination in
terms of our trying to come to grips and having their internal
people come to grips with the loss exposure in those particular
loans.
The CHAIRMAN. SO t h a t would indicate to them they should not
have any further dealings with Penn Square?
Mr. HOMAN. That was a business judgment that they had to
The CHAIRMAN. Well, you hope they are sophisticated enough.
Mr. HOMAN. Right, absolutely.
The CHAIRMAN. All right. This bothers me. Again my bipartisan
staff informs me t h a t some moneys in credit unions were deposited
as late as Thursday before the closure, which would be subsequent



104
to the time or the date which Continental and Chase were informed of the problems, and put on notice, so to speak.
Is t h a t accurate? Do you know if there were large deposits
Mr. HOMAN. I am unable to verify that.
The CHAIRMAN. We will be able to get that information later,
though, won't we?
Mr. HOMAN.

Yes.

The CHAIRMAN. Those are things t h a t are bothersome, and Mr.
Isaac brought t h a t up in his formal statement about notice. When
do you let people know t h a t there is a big problem? We have been
wrestling with t h a t for a long time.
On that point, we all have a concern t h a t the fate of Penn
Square centers on adequacy of information available to investors
and depositors on the bank s financial condition. Many statements
have been made t h a t the information on this bank was either inadequate or misleading whereas others think t h a t someone who was
very sophisticated should have—could have known.
I have a few questions. One, what information is now publicly
available on our banks?
Mr. CONOVER. Well, obviously their own published financial
statements would be and their call reports are available to anybody
who would like to get them. I think more recently there is something called the Uniform Bank Performance Report, which is also
available to the public through the Examination Council, t h a t has
a multipage, approximately 10-page document that has a 5-year
history, financial ratios and comparisons with peer groups.
The CHAIRMAN. Is there a $25 fee for that?
Mr. CONOVER. I believe t h a t is correct.
The CHAIRMAN. SO you feel therefore t h a t t h a t information you
just cited is easily accessible particularly to people who invest over
$100,000.
Mr. H O M A N . It is, and a good many of the private firms use the
same public call report information on tapes and provide
investment advisory services to market participants.
The CHAIRMAN. NOW, Mr. Isaac, as well as Mr. Conover, is this
information sufficient to make an informed judgment about the advisability of depositing or investing in given banks?
Mr. ISAAC. In addition to that, if the holding company is publicly
held or the bank is publicly held, you have a significant amount of
information through filings required under securities laws.
I believe I said earlier t h a t there was probably enough information out about this institution so that a sophisticated investor could
have been—perhaps with the use of some investment advice which
many of these credit unions were buying—alerted to some greater
t h a n usual risk in this situation. But while I
The CHAIRMAN. If a money broker is running an investment
service for a group of institutions, wouldn't it seem t h a t broker has
a fiduciary responsibility since t h a t broker is earning a fee to make
these investments?
Mr. ISAAC. If I were in t h a t situation, I would certainly want to
make sure I knew everything I could know about that bank, particularly when I was handling t h a t volume of money. I probably
would have visited the bank personally and talked to other people
in the town if I were pumping in tens of millions of dollars which



105
apparently was being done here. While I believe there was enough
disclosure that a sophisticated investor could have been placed on
alert, I would not argue that there should not be more disclosure. I
think we ought to search for ways to get more meaningful information about institutions out in a more timely fashion.
The CHAIRMAN. The Examination Council has recommended that
we pull back or make some changes; to wit, in one area in particular where we have available in the regional offices reports on insider lending and correspondent lending. That was put into the act of
1978.
Mr. CONOVER. Right.
The CHAIRMAN. In view of what is happening here and what I
anticipate we will be receiving as the story unfolds, since both of
you are on the Examination Council, and I spoke with Preston
Martin from the Fed this morning, I would hope you review that
Examination Council recommendation because even if—remember,
you just said you are in favor of disclosure, Mr. Isaac.
Mr. ISAAC. Yes. I am in favor of meaningful disclosure and my
problem with those particular reports is that they are not meaningful. I think FIRA has accomplished a lot of good, and there are certainly parts of FIRA that have had positive effects. But the disclosures under title VIII and IX are not useful to our people or to
people outside the agency.
I would hate to see more institutions file more paperwork with
Government agencies if the paperwork is not useful.
The CHAIRMAN. I bet when we finish this you will see credit
unions and S & L's looking to see those reports in the future. Let's
wait and see.
Mr. Conover, there was an article when there were hearings earlier by another subcommittee wherein it was stated that you would
like to streamline your agency, reduce the number of regional offices and the number of examiners.
Are you still embarked on that effort?
Mr. CONOVER. Well, I think there are several different issues
there. We are looking and do intend to restructure our field organization. That does not necessarily mean that we are going to reduce
the number of offices in the field or the number of examiners.
The CHAIRMAN. Or the number of examinations?
Mr. CONOVER. That is correct. To be sure that you have all the
facts, we have also said that we want to look at the examination
process to see if there is a way to streamline it because we find
that we have something like 70 percent of our examiner hours and
the cost of examinations spent on banks with approximately 20
percent of the assets, if I recall the numbers correctly.
When I first saw that information that seemed to me to be a misallocation of the agency's resources, so I suggested that what we
ought to do is take a look at that and see if there is some way to
modify it. What we have proposed to do is to change the frequency
of examinations for small first- and second-rated banks—that is to
say healthy financial institutions—to reduce the frequency of a
general examination and supplement that with abbreviated examinations in between and greater off-site surveillance. We are in the
process of reviewing how we would go about doing that and doing
some testing on it to see if we think it would be effective.



106
The CHAIRMAN. A continuation of what Jim Smith started right
after USNB.
Mr. CONOVER. I am not sure.
The CHAIRMAN. Oh, I am.

Mr. Parris?
Mr. PATMAN. Thank you, Mr. Chairman. I just have a couple
brief observations, and then one or two brief questions.
Throughout the great portion of this hearing I have been sitting
here just incredulous, frankly, because those of us who have had
the opportunity to have experiences as members of boards of directors of a bank or other financial institution—and I happen to be
one of those—when the Comptroller of the Currency's office
classified a loan at my bank we went bananas and between Tuesday and Friday afternoon we increased the compensating balance
or curtailed the loan or pledged additional collateral or we did
something. I simply fail to understand why there was total noncompliance, apparently, in this situation.
I am not being personally critical of any of you gentlemen or of
your agency. I just don't understand this to be honest. Because in
my banking experience it can't happen. This is not possible to
happen in the real world. But it happened. I think that is really
why we are all sitting here in a kind of a state of shock.
Mr. BARNARD. Will you yield?
Mr. PATMAN. I would be delighted to yield to my banker friend
from Georgia.
Mr. BARNARD. I have the same observation. I worked in a small
country bank and it threw us into a trauma if we got criticized by
an examining agency, whether it was Federal or State supervisory
authority. I hope this meeting can be kept secret, because if the
banks of this country find out that you don't mean business, Lord
help us what the banking business will come to.
But all the banks I have ever known just stayed in fear of being
criticized by an investigation. Especially if they came back the
second year and you still had that bad loan or it was not properly
collateralized, and he rolled that card out and said, "Now last year
when we were here you had a loan to ABC 0)."—man that puts
you in shock.
So let's keep this a secret because you are going to have trouble
if this story ever gets out.
Mr. PATMAN. TO follow up on what the chairman alluded to earlier, the reason why the institutions deposited money there was because it maximized their profits, made the management look good,
and I submit to you that if they are not preferential creditors they
have de facto preferential treatment because the point I was
making in my earlier question is they can take receivership certificates and get 80 percent of the total deposits which they have already gotten 10 percent in cash, and they can roll those back with
taxpayers' money again and do the same thing in another lousy institution in a different town.
That is the system under which we live. There is a problem with
that. I submit there is a problem with that.
Just one other brief observation concerning Mr. Isaac's comments. Things that might tend to prohibit recurrence of this, and I
submit to you that in the five regulatory institutions everybody's



107
business is nobody's business, and maybe that is what we found
here. But on the question of uniform insurance fees, the point I
was trying to make earlier, if the institution is getting in trouble
and they pay an exorbitant or extraordinary or above competitive
rates, what you would do if you classified t h a t as a troubled institution presumably would increase its fees. Then they just have to
raise their prices again to cover their costs through the increased
fees. It seems to me at least that the question of uniform insurance
fees is one of those kinds of things that, an issue whose time has
come but you have a long way to go to prove to this member t h a t it
is true.
Mr. ISAAC. If an institution is on the verge of failure, increasing
its fees is certainly not going to do much except hasten its demise.
I would hope that institutions sliding from a class 1 bank to class 2
would get a fee increase, and going from class 2 to 3 would initiate
another fee increase. So you catch the problems before the bank
gets to the brink. But t h a t is not the whole solution to the problem.
That is just one suggestion that might help us. Also, it would be
more equitable t h a n the present system.
Mr. PATMAN. I understand what you are saying and there may
be some merit to that, but I now have an advanced case of terminal
cancer so you want to give me whooping cough so I can hurry. That
is just one point.
Mr. Conover says in his original statement that this bank was
rated 3 pursuant to the uniform financial institutions rating
system. And the last sentence of that in the composite 3 category
says, overall strength and financial capacity, however, are still
such as to make failure only a remote possibility.
My question is, when did somebody, whoever it was, determine
that there was more than a remote possibility of failure of this
bank?
Mr. CONOVER. The answer to t h a t is, during the examination
that began in April 1982.
Mr. PATMAN. SO from the beginning of the classification of two
and a half years ago it was rated 3 throughout the entire process?
Mr. CONOVER. That is correct.
Mr. PATMAN. Or something in the vicinity of 2Vz years?
Mr. CONOVER. Early 1980 to early 1982.
Mr. PATMAN. The question of pending insolvency and failure was
not changed to category 4 or 5 during t h a t entire period? Was it in
fact seriously considered?
Mr. CONOVER. I don't know if it was.
Mr. HOMAN. No, it was not until the final examination. As a
matter of fact, during the September 1981 examination we felt and
the examiner reported t h a t the bank was making progress, t h a t its
condition was improving. We continued to believe t h a t until we
commenced the final examination and we discovered t h a t the problems had grown significantly worse.
Mr. PATMAN. HOW many of the 268 rated banks are number 3,
Mr. Isaac?
Mr. ISAAC. None. They are all category 4 and 5. Only category 4's
and 5's are problem banks.

97-830
http://fraser.stlouisfed.org/ 0 - 8 2 - 8
Federal Reserve Bank of St. Louis

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Mr. PATMAN. SO it is possible t h a t in addition to your 268 trouble
banks you can have a whole batch of number 3's t h a t might have
modest problems?
Mr. ISAAC. There are not a whole batch, but there are other
banks in the category 3 which require closer than usual scrutiny.
Mr. PATMAN. Could you furnish the committee information as to
the number or do you have the number of banks t h a t might be
rated as 3?
Mr. CONOVER. I don't know the numbers precisely, but of the national banks there are approximately 260 3-rated banks; approximately, I believe, 30 4-rated; and about 10 5-rated banks. That is
out of 4,500 total banks. I have the numbers here. Would you like
the precise numbers?
Mr. PATMAN. I would be very much interested.
Mr. CONOVER. This is as of J u n e 30, 1982.
The number of banks rated 3, 260.
Number of banks at 4, 32. Number of banks rated 5 is 9, for a
total of 301.
Mr. HOMAN. Those are only national banks.
Mr. PATMAN. Are these in addition to or included in or different
t h a n the 268 banks?
Mr. ISAAC. They are included in our list.
Mr. CONOVER. The 4's and 5's would be in Mr. Isaac's list.
Mr. PATMAN. But not the 3's?
Mr. CONOVER. Not the 3's.
The CHAIRMAN. Mr. Barnard?
Mr. BARNARD. Mr. Conover, I

am interested in the banks t h a t
were so willing to participate in these loans. How many banks are
there involved? Is it primarily just two?
Mr. CONOVER. There are approximately 60 banks who were purchasing participations from the Penn Square Bank.
Mr. BARNARD. HOW do they feel? Are they adequately covered?
Mr. CONOVER. If by "covered" you mean as a result of this will
they lose money, that is hard to say on all of them. There have
been several of the major ones who have already reported t h a t
they will incur significant losses for either the first half year or
perhaps for the total year of 1982.
Mr. BARNARD. Sixty banks are going to be involved plus all the
other financial institutions t h a t have got deposits there. This is
spreading like wild fire; right?
Mr. HOMAN. I think for most of the 60 the participations were
just relatively insignificant.
Mr. BARNARD. TWO or three were rather significant. Five or six
had significant numbers. One as much as $1 billion.
Mr. H O M A N . That is right.
Mr. BARNARD. NOW in case of the participating banks, especially
those having a billion dollars in them, will you followup to see
what kind of documentation they have for those loans? If the collateral is there, and so forth?
Mr. CONOVER. We are in the process of doing that.
Mr. BARNARD. All right. That would concern me.
Mr. Conover, I noticed in some publication, that as the Comptroller you are making some organizational changes. Is t h a t true?
Mr. CONOVER. That is correct.



109
Mr. BARNARD. Are any of those changes coming about because of
this incident?
Mr. CONOVER. No; they are not because we have not had a
chance to even assess whether there is a need for an organizational
adjustment as a result of this incident.
Mr. BARNARD. I see. Thank you very much.
The CHAIRMAN. I want to assure you, Mr. Barnard that hopefully
if you don't leave the committee that we are going to be asking a
lot of questions of a lot of people on this.
Mr. BARNARD. I have another question, Mr. Chairman.
Mr. Conover, inasmuch as the chairman has an interpretation of
the law, and Mr. Isaac agrees or he says he thinks he agrees with
his interpretation of the law, what are you going to do about your
interpretation of the law?
Mr. CONOVER. I can assure you I am going to check on our interpretation of the law.
The CHAIRMAN. If it is a BU graduate, you are in good shape. BU
is a good law school. Probably Harvard, though.
Mr. BARNARD. Thank you very much.
The CHAIRMAN. Mr. Patman.
Mr. PATMAN. I just have a short question for all three of you gentlemen, I guess, Mr. Isaac and Mr. Conover and Mr. Homan. Did
any elected official, State or Federal, put any pressure on you or
your offices in regard to the Penn Square Bank after the problems
became evident in 1980?
Mr. HOMAN. Not to my knowledge.
Mr. PATMAN. What do you say, Mr. Conover?
Mr. CONOVER. Not to my knowledge.
Mr. PATMAN. Same with you, Mr. Isaac?
Mr. ISAAC. The same with me.
Mr. PATMAN. That is all I have. Thank you very much.
The CHAIRMAN. Mr. Conover, I would ask you since taking office
have you had any discussions with the eminent Mr. Heimann, your
predecessor, about Penn Square either previous to the failure or
since the failure?
Mr. CONOVER. I have talked with him once on the phone since
the Penn Square failure, yes.
The CHAIRMAN. Did he have anything significant to contribute?
Mr. CONOVER. My conversation with him was limited to asking
him to please give me some information about what his assessment
was of what was going on in the financial markets, and he did that.
The CHAIRMAN. Well, the Chair is going to mull over in his mind
whether we should ask the eminent Mr. Heimann to join us at
some point in these proceedings. That might help you out.
Gentlemen, I want to express the deep appreciation of the
committee for all three of you for your participation today. We all
have a great deal, great many more questions but this is only a
briefing session, so though I would be prepared to stay to 8 o'clock
or 9 o'clock, it is not unusual for this committee to sit that way
when we are engaged in interesting dialog. It is my understanding
that you have to be up bright and early in the morning for another
round on this. You have answered a great many of the questions
that are predominant at this point and would really appreciate



110
your attendance and assistance, and as Bill Stanton said, your willigness to come yourselves, the principals, along with Mr. Homan.
It has been very, very helpful, and we look forward to your continuing cooperation with our staffs as we proceed on this matter.
Thank you.
Mr. HOMAN. Thank you.
Mr. CONOVER. Thank you.
Mr. ISAAC. Thank you.
The CHAIRMAN. We are adjourned.
[Whereupon, at 5:08 p.m., the committee was adjourned, to reconvene subject to the call of the Chair.]




PENN SQUARE BANK FAILURE
MONDAY, AUGUST 16, 1982
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,

Oklahoma City, Okla.
The committee met, pursuant to notice, at 9:30 a.m., Congress
Room, Lincoln Plaza Convention Center, 4345 Lincoln Boulevard,
Oklahoma City, Okla., Hon. Fernand J. St Germain (chairman of
the committee) presiding.
Present: Representatives St Germain, Evans of Indiana, Barnard,
Leach, Weber, and Wortley.
The CHAIRMAN. The committee will come to order.
This morning we start phase one of this committee's effort to
find out why Penn Square Bank failed and what can be done to
minimize the possibilities for a rerun of this episode.
A failed bank causes severe economic Shockwaves in any community. This time the ripples have been felt in the boardrooms from
Seattle to New York as bankers have scrambled to find out just
what they brought home from the Penn Square supermarket in
Oklahoma City. In fact, not even my State of Rhode Island has escaped the repercussions.
The failure of Penn Square Bank comes at an unfortunate time.
Our economy is filled with doubts and uncertainties and the prolonged period of high interest rates has produced more concern
about our financial system than at any time since the Great Depression.
While our banking system remains unquestionably strong, Penn
Square does not help. Nor do the revelations to date inspire confidence that our Federal bank supervisory network has the vigor and
the imagination to deal with unusual situations in the financial
community. In the case of Penn Square, the creativity of some of
the bank's high-powered salesmen may have outstripped the imagination of our regulators.
If bankers are going to drive supercharged, souped-up vehicles,
the policemen on the beat are going to have to get out of their
slow-moving jalopies lest they be left behind in this economy.
The failure of Penn Square has not been easy on the State of
Oklahoma. We realize that the community would prefer to avoid
the glare of this type of publicity.
At the same time, I know it is understood t h a t the U.S. House of
Representatives has assigned this committee the responsibility and
jurisdiction to deal with legislative issues bearing on the Nation's
depository institutions. The committee also is assigned the over-




all)

112
sight function concerning the various Federal financial, regulatory,
and supervisory agencies.
Knowing what happened to Penn Square and why it happened is
essential to the mandate of this committee. The failure of Penn
Square is bad enough. The only thing that could make the fallout
worse would be for the agencies and branches of Government
which have responsibility for these institutions to sweep the facts
under the rug and make no effort to determine whether there is
preventive medicine to immunize the banking system against an
epidemic of Penn Squares.
We have come to Oklahoma City to make this process as easy as
possible for the local people to testify, minimize disruption, and to
assure that the committee have input from the people most directly involved and who can help us understand what happened.
For the most part, our efforts have been responded to with fine
cooperation. I know that much of this is painful for many of you.
But you are to be commended for accepting your responsibility to
help establish the facts and to place the tragedy of Penn Square in
perspective. Voluntary cooperation of this sort is part of the
strength of our economic system. Our American free enterprise
system may not be perfect. But when mistakes are made we correct
them in the open in keeping with the spirit of an open society that
insists on having the information necessary to make its own decisions. In too much of the world, mistakes are hidden and papered
over and denied and the interests of the public ignored. In America, thank God, we do it differently.
Six weeks after its death, Penn Square remains a mystery in
many respects.
It is true that the bank had massive problems cited in its 1980
examinations by the Office of the Comptroller of the Currency.
These were important enough that the Comptroller felt it necessary that a full fledged written agreement be signed. By the spring
of 1981, however, the bank had come up with new management,
and by the end of that year both the bank's independent auditor,
Peat, Marwick & Mitchell, and the Comptroller's examiners tell us
they had found at least "modest improvement," yet the bank remained with serious problems.
Six months later, the patient lay dead, despite its yearend medical report of improvement.
Were the "improvements" simply cosmetic and the underlying
illness never treated? Or did something drastic happen during the
early months of 1982 to completely change the picture?
Despite all the bank's troubles, through all the ups and downs of
the 1980-82 period, Penn Square's paper pipelines between Oklahoma and Seattle, Chicago, Michigan, New York and virtually all the
points in between continued to flow with both loan sales and purchases of high-priced money.
Was Penn Square caught in the middle of some high-stakes
poker game, unable to fold its cards for fear that it would lose everything? As the ante was raised, was it forced to take back some
of its least attractive participations for fear the big banks would
shut off the pipeline for future participations? And did the frenzy
to find money at whatever cost result from the need to keep
making massive interest and principal payments on nonperforming



113
loans participated out to the big banks but serviced by Penn
Square?
Was the sudden downturn in the fortunes of the oil and gas industry the final tilt that brought this delicately balanced game
crashing down?
And through all this, was anyone really in total control? Or were
lines of authority actually split among ownership and management
factions in a manner that made any overall control an impossibility?
And did the Office of the Comptroller of the Currency, despite
wearing a rut in the road between Dallas and Oklahoma City, ever
really understand the dynamics of the inner workings of the Penn
Square management and ownership team and its high flying portable energy supermarket? Or did the OCC simply go from A to B to
C to D through its manuals without grasping the big picture?
The final cease and desist order issued by the Comptroller comes
down hard on insider lending. But this was entered only in the last
hours of the bank's life. Did the OCC spot insider problems in time
and did they make any effort to track the insiders upstream
through the participation loans and the possibility some of this
paper found its way back to Penn Square from time to time?
In Penn Square, has a new device been found for that age-old
nemesis of sound banking, insider self-dealing? How much self-dealing is buried in the mounds of participations generated in the Penn
Square shopping center? We thought Bert Lance had defined insider lending for all times, but Penn Square may have invented a new
mail-order variety of an old banking game.
I remain deeply concerned and troubled by the fact that so many
investors were caught short in the Penn Square debacle. Certainly,
there is strong evidence to suggest that investors should have been
more prudent and that they should have engaged in a greater
degree of original research before sending their funds off to Oklahoma City for an extra quarter or half a point.
But, the fact remains that a few knew a great deal and that
many knew very little about Penn Square. It is difficult for me to
reconcile the fact that Government agencies, the Comptroller, the
FDIC, and the Federal Reserve, had intimate knowledge of the deteriorating conditions of Penn Square, but allowed the bank to
continue to reach out with offers of high yields to investors within
hours of the institution's demise. Something is very wrong about
this.
The regulators were filling every corner of Penn Square on
Friday afternoon, July 2. They knew everything that was happening and everything that was about to happen. Yet, I know that
credit unions were allowed to invest hundreds of thousands of dollars that very day in an institution literally clinging on the edge
with only the cash infusion from the Federal Reserve to maintain
any semblance of solvency.
This committee has looked at more problems and failed banks
than all the rest of the congressional committees combined, and
never have we seen so many questions funneled into the operations
of a single institution.
We intend to continue these hearings and our factfinding mission
until we find the answers to all of these questions.



114
At this time I would like to note the presence of my colleagues.
To my right, on the majority side, Congressman Annunzio of Illinois, who is also chairman of the Subcommittee on Consumer Affairs and Coinage; Congressman David Evans of the great State of
Indiana; and Congressman Doug Barnard of the great State of
Georgia. To my left, we have the Honorable Jim Leach, our ranking minority member here; Congressman Weber of Ohio; Congressman Wortley of New York.
I would also like at this point in time to take this opportunity on
behalf of the committee, both the majority and the minority, because we have had our staffs working together on this, to compliment and thank our staffs for the long hours they have been
spending on this. Many of you out here and out there in the public
who could not be here this morning are probably saying to yourselves, well by now they should have all the answers. That is not
the case because indeed and in truth, the entire situation is very
complex and complicated and involves reams and reams and crates
and crates of records.
For that reason I want to compliment our staffs, both majority
and minority, for the many, many hours they have been spending
on this, weekends and right through the night, and the many hours
they will be spending on this in the weeks and months ahead.
And at this time I would like to recognize our colleague Mr.
Leach for an opening statement on behalf of the minority.
Mr. LEACH. Thank you, Mr. Chairman.
I am sure I speak for the committee in stressing we have no
desire to participate in a witch hunt for individuals called upon to
testify, but rather it is our obligation to unearth just what has
transpired in this extraordinary banking situation.
The scandal we are dealing with here is not just how a particular
bank operated. It may be and probably is an aberration. The real
scandal is how large money center banks greedily participated in
poor lending practices; how credit unions risked their deposits; how
a major accounting firm failed to register public concern in its
audit; and perhaps most of all, how Federal regulators came to understand the problem but failed to act before it was too late.
The Penn Square scandal, in short, is not of men and their foibles; it is of a system and its failures. There are several startling
ironies in this breakdown in prudential banking practices. In this
banking huckstering, those that were duped were the biggest and
most powerful. Continental Illinois, our sixth largest bank; Chase
Manhattan, our third largest, both have to write off enormous financial losses.
But losses in the final measure are the public's. The failure of
Penn Square involves the largest number of unsecured depositors
in recent history. It reflects the greed of money managers across
the country who have bid interest rates up to unsustainable levels.
My own State of Iowa, for instance, has been swept of funds by
money market mutual funds and these in turn have been deposited
in money center banks where lending practices were assumed—
falsely in this instance—to be prudent.
Oklahoma has been a short-term beneficiary of several billion
dollars in loan participation authored by Penn Square. But it is
very likely their imprudent lending practices will prove to the



115
long-term disadvantage of the State and the oil and gas industry.
Because of the problems of Penn Square, money center banks may
well shy away from lending to the oil industry and cut back on risk
loans in general. The flight to quality of government securities that
is going on today may help reduce the interest rates of Uncle Sam,
but it bodes poorly for those Americans who want to borrow to
take risks in a competitive economy—which is what a free enterprise society is all about.
The question that remains now is whether the liquidity crisis in
the petroleum industry will not only jeopardize the viability of particular companies but also endanger a significant segment of the
U.S. banking system. For the public, the ultimate, catch-22 involved in Penn Square-style banking is that not only did the bank's
capacity to package and sell oil and gas loans at a premium push
interest rates higher in good times for the petroleum industry, but
it keeps them higher during bad. As the cost of money is coming
down, money center banks are not allowing the prime rate to fall
proportionately. They are in effect asking the public to help them
recoup losses sustained through their own imprudence.
I think this is something of concern to the national economy and
not simply to the Oklahoma situation we are facing.
Thank you, Mr. Chairman.
The CHAIRMAN. At this time the Chair would note that in compliance with House and committee rules, copies of those rules are
available at the witness table. In addition, each witness has been
furnished in advance by mail with a copy of the rules.
Since I understand that a number of the witnesses here today
will be accompanied by counsel, I want to clarify at the outset
what the role of counsel will be. Under clause 2(k)(3) of rule 11 of
the House rules and clause (g)(3) of rule 7 of the committee rules,
witnesses at investigatory hearings may be accompanied by counsel
for the purpose of advising them concerning their constitutional
rights and their rights under the House and committee rules, and
the relevant statutes of the United States. Counsel will not be allowed to address the committee unless the Chair grants permission
to do so. Any inquiries about the treatment of a witness before this
committee must be addressed to the Chair by the witness, not by
counsel. The Chair will do all within his power to protect the rights
of witnesses under the rules and the Constitution.
The Chair will note for the record that there are seven members
present, a quorum under the rules for the taking of testimony.
Our first witness this morning is Mr. Eldon Beller, president of
the Penn Square, N.A., at the time of its closing.
Mr. Beller, would you be good enough to approach the witness
table?
Now, if you would, I would like to swear you in under our rules,
Mr. Beller.
If you would raise your right hand.
[Witness sworn.]
The CHAIRMAN. Please be seated.
Now, would you please identify yourself.



116
TESTIMONY OF ELDON BELLER, PRESIDENT, PENN SQUARE
BANK, N.A.
Mr. BELLER. I am Eldon Beller, previously the president of the
Penn Square Bank.
The CHAIRMAN. Mr. Beller, if you have a prepared opening statement or a written one, we are prepared to receive it. Otherwise, do
you have any opening remarks? If you have any opening remarks,
we would be happy to hear them. Otherwise we will go to a question and answer period.
Mr. BELLER. Yes, I have some written comments relative to the
time that I became associated with Penn Square Bank, and if you
think it is appropriate, I will read those.
The CHAIRMAN. If you would.
Mr. BELLER. When I came to the bank it was under criticism by
the Comptroller's office. This was in the spring of last year. It had
been placed under a letter of agreement the previous year. The
agreement had 10 points, and the bank was out of compliance with
10 of 10.
In July the board was asked to attend a meeting in Dallas, Tex.,
at the Comptroller's Office. Mr. Clifford Poole, the regional administrator, chaired the meeting. Mr. Poole advised the board that he
had called the meeting to place the bank under a cease and desist
order. However, because of some new faces he was not going to do
so at that time, but that the bank would be examined again in
about 90 days.
Mr. Jennings, the chairman and CEO, addressed the group and
pledged more effort, and I stated that as the new president, I would
use the criticisms of the last examination and the letter agreement
as my blueprint for corrective action.
My first observations of Penn Square Bank as the new president
was that it was understaffed in all areas and some departments
that would have been normal did not exist. For example, there was
no overall loan administration, there was no loan review
department, there was no collateral department, there was no loan
closing department, there was no in-house legal department, there
was no financial services department, there was no chief financial
officer. The credit department, such as it was, was in chaos. The
accounting department was understaffed and behind in workload.
The energy department was understaffed, with the head of the
energy department controlling the credit department, and he also
held letters of credit under his control, and there was no way to
determine what contingency the bank had under the letters of
credit or loan commitments, either written or verbal.
The need, then, as I perceived it, was to bring together a management team to form management committees, establish departments that didn't exist, hire people to head the departments, and
hire staff for the departments.
During the year I was there I hired and developed a management team, formed management committees, executive management committee, asset and liability committee, corrections
committee, examination and correction committee, loan review
committee, credit policy committee, benefits committee, et cetera,
and established all the departments that I referred to earlier that



117
were necessary, and staffed them with personnel and increased the
personnel from 180 people to 400.
In October of 1981 the Comptroller's Office sent a team of examiners to the bank to perform an examination. The written report of
that examination was to commend us for the significant progress
made in all areas.
At our January 1982 board meeting, Mr. Preston Morrow of the
Comptroller's Office addressed the board and repeated the findings
of the examination, and commended us for our progress. I asked
Mr. Morrow if he agreed that at this time that now, instead of
being out of compliance with 10 out of 10 of the articles of the
agreement, that we were in compliance or substantial compliance
with 10 of 10? He agreed with this.
I further asked him if we could expect to be removed from the
letter agreement, and he implied that this might occur in April.
All this gave me comfort that the task I had assumed was being
accomplished.
In the fourth quarter of 1981, we engaged the firm of Peat, Marwick, Mitchell & Co. to do our yearend audit. The reason for choosing this firm was that they had the staff and expertise necessary,
as they do more bank audits in Oklahoma City than any other accounting firm, and I felt they were the best available, and I certainly felt that the bank at this point needed the best.
The result of their yearend audit was to have essentially some of
the same findings as the previous Comptroller's examination and
to commend the new management for the restructuring and progress that had been made in such a short period of time.
Again, this gave me additional comfort that proper progress was
being made.
In April of 1982 the Comptroller again sent a team of examiners
to examine the bank. This team consisted of 20 to 30 examiners at
different times and continued for almost 3 months, with the final
result that they charged off more loans than the capital of the
bank and the bank became insolvent.
Only time will tell how many of the charged off loans will be collected.
That gives you a brief history of the year that I spent at the
Penn Square Bank, what I found when I got there, and some of the
things that I did about it, and the final results.
The CHAIRMAN. Mr. Beller, do you feel today, as you sit before
the committee, despite the recitation of that which you were able
to do, improving management, internal controls, that you had full
cooperation from Mr. Jennings in order to correct all of the areas
that needed correction in Penn Square Bank?
Mr. BELLER. I never had complete control or control over Bill
Patterson; or the energy department as such. At the time that I assumed the job of president of the bank, I advised Mr. Jennings that
even though I had banking background, certain expertise in certain
areas, that I was not an energy lender. He concurred that he knew
that, that he was an energy lender, and that he would be responsible for Bill Patterson and the energy department.
So the answer to your specific question, sir, is that no, I never
did have that complete control.



118
The CHAIRMAN. Well, we know that Mr. Jennings was an energy
borrower, as was Mr. Patterson, is that not correct?
Mr. BELLER. Yes.

The CHAIRMAN. And quite a few of their loans not only from
Penn Square but from other banks are also in default.
Do you suppose you could be an expert energy lender if you are
not too good an energy borrower? Should you not be good on both
sides of that spectrum or coin?
Mr. BELLER. YOU would think so, wouldn't you?
The CHAIRMAN. AS to Mr. Patterson, had you worked with him
previous to working with him at Penn Square Bank?
Mr. BELLER. Yes, sir. The previous bank that I was employed by
within my supervision fell several departments, and several years
ago, roughly 5 years ago, Mr. Patterson was employed in one of
those departments that came under my supervision. He was employed in the capacity of more of a PR person.
The CHAIRMAN. PR, that is public relations?
Mr. BELLER. Public relations, making calls on existing accounts
and relationships to make them aware that we were knowledgeable
they had accounts in the bank, depository relationships, thanking
them for the business, things of that nature, and to solicit business,
but his primary responsibility at that point was good will calls.
The CHAIRMAN. Therefore, did he have any real—any authority
over loan making or loan processing?
Mr. BELLER. He did not have lending authority. He had requested
that from me previously and I declined to give it to him.
The CHAIRMAN. TO your knowledge, did Mr. Patterson undergo a
training program or any formal education of any type, shape,
manner, or informal education that would have increased his capacity and ability as an expert in energy loans between the time
that you knew him and his departure from his previous employment and the time that you met him in his new capacity at Penn
Square Bank when you went to Penn Square Bank?
Mr. BELLER. Certainly this was a question that I had on my
mind, and in conversation with the chairman of the board, Mr.
Jennings, at the inception, I raised this issue and he said well, you
know, when he worked for you or at least under your supervision,
that was 4 to 5 years ago, and since that time he has been well
trained and in my opinion is an expert in the energy lending business, and I had no reason to doubt that in its entirety because certainly the bank had a reputation of doing a lot of energy business,
and they were doing it with sophisticated upstream banks who are
supposed to be the authorities in that area with expertise and staff
and know what they are doing. And so certainly it was considered
by me that he had learned a lot from them.
The CHAIRMAN. Whereas, as a matter of fact, in retrospect at
this point in time, would you agree that those sophisticated upstream banks thought that Mr. Patterson was the expert and they
were relying on him, so that here you were saying to yourself, well,
I guess he has learned a great deal because these big, important
institutions in those big cities up north are relying on him.
Mr. BELLER. If they had considered him the expert and they in
fact had the reputation of being the experts, certainly it wouldn't
have taken many questions from them to him to determine that.



119
The CHAIRMAN. But as we see from the results, they obviously
did not ask many questions, did they?
Mr. BELLER. I don't know.
The CHAIRMAN. What would your opinion be? Do you think they
asked many questions when we look at what has occurred?
Mr. BELLER. I still don't know. I was not with them, so I don't
know what they asked him or did not ask him, or what they neglected to ask him.
The CHAIRMAN. Well, if the point of the matter is there are quite
a few of these participations that they purchased t h a t are nonproductive, nonproducing that there are going to be some rather adequate losses inuring to these upstream banks, is t h a t not a fact?
Mr. BELLER. I don't know t h a t as a fact, but I will accept that, to
tell you the truth.
The CHAIRMAN. Some of these banks have already written down
those loans to a substantial degree.
Mr. BELLER. Yes, sir, you are correct.

The CHAIRMAN. And did they not have loans on which the interest was being paid by Penn Square Bank, even though the borrowers were not paying either interest or principal to Penn Square
Bank?
Mr. BELLER. That is correct.
The CHAIRMAN. By the way, were you aware of the fact that t h a t
situation existed?
Mr. BELLER. N O , sir, I was not aware of it until my chief financial
officer made me aware of it. I directed him and with his people to
pursue it, to identify and find out what was being paid upstream to
whom, how much, get a list, and we developed the list and immediately started work on it and shared t h a t information with the
Comptroller's office as soon as we had it.
The CHAIRMAN. When did you receive that or develop t h a t list,
Mr. Beller, do you recall?
Mr. BELLER. Near year end.
The CHAIRMAN. That would be year end 1981?
Mr. BELLER. Yes, sir, which I came there in the spring of 1981.
The CHAIRMAN. And you would have provided t h a t information
to the Comptroller's office approximately when, J a n u a r y of 1982 or
December 81?
Mr. BELLER. I don't recall when. I just know t h a t we did.
The CHAIRMAN. Would it be possible for you to look at your records and determine when you did indeed provide t h a t information?
Mr. BELLER. Well, sir, I do not have any records.
The CHAIRMAN. Who was it who did this for you, Mr. Beller?
Mr. BELLER. Who?
The CHAIRMAN. Yes.
Mr. BELLER. My chief financial officer, who was Jim Gunter.
The CHAIRMAN. IS this one of the gentlemen you brought to Penn

Square with you?
Mr. BELLER. Yes,

sir.

The CHAIRMAN. IS Mr. Gunter here this morning?
Mr. BELLER. I don't think so. He was not a director.
The CHAIRMAN. I would like to ask you maybe one or two more
questions; then t u r n it over to my colleagues.



120
Did you tell us t h a t you made the decision to change from
A r t h u r Young to Peat, Marwick, Mitchell & Co. as auditors and accountants?
Mr. BELLER. Did I make t h a t decision?
The CHAIRMAN. Yes, was that decision made by you?
Mr. BELLER. Yes, sir, basically it was made by me. It was also
made by me based upon my knowledge of the firm, as I said before,
our need, and also on the recommendation of our chief financial officer who said he needed their expertise and abilities and their responsiveness which we did not have with the other firms.
The CHAIRMAN. NOW, again, this chief financial officer was Mr.
Gunter?
Mr. BELLER. Yes,

sir.

The CHAIRMAN. Who made this recommendation to you.
Mr. BELLER. It was also my decision.
The CHAIRMAN. Did Peat, Marwick & Mitchell do the work at the
institution t h a t you were previously employed at?
Mr. BELLER. Yes, sir.
The CHAIRMAN. SO as

a matter of fact, you had worked with
them before and had a knowledge of their procedures and their
personnel.
Mr. BELLER. And their abilities, yes, sir.
The CHAIRMAN. And their abilities as far as you were concerned.
Did you have cause to feel t h a t the Arthur Young firm was not
performing their functions in a proper manner, or was it merely
the fact t h a t you were more familiar with the Peat, Marwick &
Mitchell t h a n the Arthur Young firm?
Mr. BELLER. Well, the facts are t h a t the chief financial officer
complained to me that the AY people would not return his telephone calls.
The CHAIRMAN. They would not return his phone calls?
Mr. BELLER. Right. So how are you going to work with them?
The CHAIRMAN. Our information is that Arthur Young's firm,
the gentleman who heads t h a t firm up here in Oklahoma City,
indeed, has written quite a few books and manuals on procedures
for examination and auditing banks.
Are you familiar with that?
Mr. BELLER. I am not familiar with that. I never met the gentleman.
The CHAIRMAN. YOU never met the gentleman.
Mr. Leach?
Mr. LEACH. Thank you, Mr. Chairman.
Mr. Beller, it is quite clear you were brought in to tighten things
up, and you took some steps in the right direction. It would appear,
however, t h a t you were more president in name t h a n in power because this is an energy bank and you obviously have limited jurisidiction regarding energy loans.
I would like to ask a couple of questions. In terms of Penn
Square's loan committee, there have been indications t h a t loans
were made outside the scope of the loan committee. Were you
aware of loans being made without loan committee approval?
Mr. BELLER. Yes,
Mr. LEACH. Was



sir.

t h a t normal banking practice?

121
Mr. BELLER. NO, but then on the other hand, you have to—I
think, at least I rather perceived that the tremendous volume of
loans that was going through the bank being participated in
through the upstreams, that there were commitments of many
kinds, written and verbal, in place that I had no way of knowing
anything about on the verbal ones. The pipeline, so to speak, was
full but no one knew how much was in it, and I and my management people in our attempts to identify that were very frustrated
by it because we could never identify the commitments outstanding, either in the lending or the letters of credit area until such
time as we finally were able to get the letters of credit under control and get a punch list on those through the computer.
Mr. LEACH. In any industry there are ups and downs. For example, in the oil industry there have been some strong ups, and it appears now that the industry is in a bit of a down.
Did the bank ever reconsider its bullishness on oil and gas lending based upon the downturn in the oil industry? I ask this in a
general sense and in terms of the rules which banks set up regarding how much will be lent in relationship to proven reserves. Did
your bank have any rules in that regard, and were those rules
kept?
Mr. BELLER. There was an engineering department, petroleum
engineers, that reported to and are under the supervision of the
head of the energy department. They did the engineering evaluation of reserves, and they discounted those reserves, and that
became the basis under which you could make a loan, the amount
of the loan, and the discount on the reserves that the engineers determined were there, and with relation to that, not only our own
engineers but in the upstream correspondents with their engineering staffs obviously must have concurred with the appropriateness
of the amount of reserves and the discounted values.
Mr. LEACH. I have just one further question.
One of the unusual features of your bank, as I understand it, is
that you sometimes had bank officers from other banks present. Is
that accurate? I mean, for example, did Continental Illinois have a
desk in your bank?
Mr. BELLER. Not in that sense of the word. There were almost
always bank officers from the other upstream banks in our bank
building, but they did not have offices or desks as such. They were
there doing due diligence on their part, visiting with the customers
in which loans were participated to them through our bank, working with Mr. Jennings, Mr. Patterson and other lending officers in
the energy area. So the answer to your question, Mr. Leach, is that
yes, constantly they were there, but they did not have offices and
desks assigned to them.
Mr. LEACH. HOW frequently was a Continental or a Chase officer
present in your bank?
Mr. BELLER. It would be a guess on my part. I would say weekly.
Mr. LEACH. Once a week.
Mr. BELLER. Certainly, not all weeks.
Mr. LEACH. But there was no desk or place where they would
hang their hats?



122
Mr. BELLER. NO they had no assigned desk or office and I did not
consider them as a person that was on retainer for the bank, if you
will.
Mr. LEACH. Several weeks before the bank failure, was the situation different? Were there many representatives of large banks
present?
Mr. BELLER. Yes, and at that time, certainly, there were representatives of all the major upstream banks there constantly for
probably a number of weeks. They would be there, 5 from this
bank, 11 from that bank. They were in checking the documentations on the various loans that were made, obviously trying to find
out where they were in the documentation of the loans that had
been participated to them, doing their diligence with their counsel
and so on.
Mr. LEACH. I yield to the chairman.
The CHAIRMAN. Could you be a little more specific timewise, Mr.
Beller? I would assume that frankly there would have been a great
presence for a week, a week and a half prior to the Fourth of July
weekend because we have been told
Mr. BELLER. I agree with that.
The CHAIRMAN. We have been told that within that period of
time, the regional offices of the Comptroller of the Currency in Chicago and for New York as well as that for Seattle, Wash., informed
the larger participants upstream that they had better take a good
look at those loans. In other words, a bit of a red flag went out at
that point.
Mr. BELLER. I agree.
The CHAIRMAN. I am wondering, I would be very surprised if
they had not been there for 1 week to 10 days prior because that is
about the timing of the information given to those upstream banks.
But you, a few seconds ago in answer to Mr. Leach's question,
said that there was a larger presence for a few weeks.
Can you be more specific as to when this larger, more continued
presence began?
Mr. BELLER. I will try.
As I had said earlier in my statement, in my opening statement,
that in the final examination that there was 20 to 30 representatives of the Comptroller's Office there for a period of about 3
months when they finally charged off enough loans and made the
bank insolvent. From my memory and my best guess on the timing
basis—and now I am answering your questions at this point as specific as I know how—about 30 days prior to the closing of the bank,
the examination took a different turn. It was declared to be that
more of a national share examination which means that the findings of the Comptroller's Office would then be encumbered upon
the upstream banks, so to speak. At that point is when the upstreams started coming in with a lot of people to check out where
they were.
If I have answered your question
The CHAIRMAN. If the gentleman would yield further.
Mr. LEACH. Of course.

The CHAIRMAN. YOU are aware of the fact that within a few days
of the closing that Fourth of July weekend, there was some rather




123
substantial withdrawals of funds by some of the customers of Penn
Square.
Could you tell us what you know about the withdrawals and how
they came to your attention and when you learned of them?
Mr. BELLER. The only withdrawal of significance t h a t came to my
attention in a specific fashion was when the so-called Hefner withdrawal was made, and that was conveyed to me by my chief financial officer the day it occurred, and t h a t is all I know about it.
The CHAIRMAN. That appeared on which day?
Mr. BELLER. It seems to me that it was probably on the Tuesday
before the bank was closed on a Monday, about 1 week before, 5
days, something like that.
The CHAIRMAN. NOW, the amount of t h a t withdrawal was
Mr. BELLER. It has been reported to be $21 million and $25 million, and I honestly don't know what the number is now.
The CHAIRMAN. YOU mean your financial officer at t h a t time
Mr. BELLER. Well, he knew the number and I knew the number
at that time, exactly the amount, but today maybe I have read too
many newspapers.
The CHAIRMAN. Well, having read—we have both been reading a
great number of newspapers, I am sure, as well as members of the
entire committee who are here present. One of the reports we had
is t h a t this withdrawal came about as a result of advice from a financial consultant, anonymous, in New York City.
Mr. BELLER. I read the same article, and t h a t is as much as I
know about that.
The CHAIRMAN. YOU would not have any indication as to what
might have prompted this withdrawal.
Do you have any opinion, personal opinion as to what might
have prompted this withdrawal?
Mr. BELLER. I have no knowledge of what prompted it other than
what I read in the newspaper. Other t h a n that, it was common
knowledge in Oklahoma City that the bank examiners had been
there 3 months.
The CHAIRMAN. But t h a t wasn't unusual. Bank examiners had
been there previously for 3 months when previous letters of criticism had been issued, and board of directors meetings held in
Dallas. Was that not the case? That is what brought about your
taking over the bank.
Mr. BELLER. I don't know how long they were there t h a t time. I
wasn't there.
The CHAIRMAN. And if the gentleman would yield further, in addition to that, now we find out that there was a presence, an increased presence of people from the upstream banks, right?
Mr. BELLER. Yes, sir.
CHAIRMAN. Chase Manhattan,
Mr. BELLER. Yes, sir.
The CHAIRMAN. DO you think t h a t

The

Continental, et cetera.

might have come to the attention of some people, some of the more sophisticated people in Oklahoma City dealing with Penn Square Bank?
Mr. BELLER. Well it was difficult to get in and out of the bank
because of the number of people t h a t were in there. [General
laughter.]
 - 8 2 - 9
97-830 0


124
The CHAIRMAN. NOW, Mr. Jennings would have known t h a t all of
those people were there, right?
Mr. BELLER. I don't know anyone t h a t wouldn't have known they
were there.
The CHAIRMAN. And if the gentleman would yield 1 more second,
I would like to ask a question now and I will have a followup on it
a little later on.
I would like to read this one very carefully. It is a rather important question, and the next one will be as well. We are almost
ready with it.
Do you know of any loans from Penn Square Bank to any officers
or directors or high level employees of any of the money center
banks with which Penn Square was dealing on these rather substantial participation loans?
Mr. BELLER. The only loan that I am aware of in t h a t category
was a home loan that was made to Mr. Lytle by Mr. Patterson.
The CHAIRMAN. Mr. who? Mr. Lytle?
Mr. BELLER. Mr. Lytle.
The CHAIRMAN. And he was with which institution?
Mr. BELLER. Continental Chicago.
The CHAIRMAN. DO you know what the amount of t h a t loan was?
Mr. BELLER. I do not recall the amount.
The CHAIRMAN. Did you look at t h a t particular loan?
Mr. BELLER. I saw it after the fact.
The CHAIRMAN. YOU are aware of the requirements of FIRA legislation with regard to a few years ago, and t h a t also asked t h a t we
look at loans to officers of correspondent banks as well, correct?
Mr. BELLER.

Yes.

The CHAIRMAN. That being the case, when you looked at t h a t
loan, did you look at it rather carefully to see if the loan terms
were the same as they would be for anyone else?
Mr. BELLER. I don't recall the details of the loan. I just remember
t h a t the loan was made.
The CHAIRMAN. Again, any idea as to what the amount of the
loan was?
Mr. BELLER. N O , sir. The only thing I can recall about it is t h a t it
was a real estate residential loan, as I remember.
The CHAIRMAN. Would the number $500,000 be within the ball
park?
Mr. BELLER. That would be an awful big residential loan. I doubt
that, but if I knew the answer, I would give it to you.
The CHAIRMAN. I am sure you would. Believe me, we are most
appreciative of the assistance you are giving us here this morning.
Mr. Leach, t h a n k you for yielding.
Mr. LEACH. I have one final question, which does not relate particularly to your jurisdiction but to the committee's. In the last
month, there were major numbers of bank representatives present
at your bank, but were there any representatives of credit unions
present? I raise this because there are those who believe t h a t some
banks were tipped off to the problems in Penn Square but credit
unions were not. For the record, can you tell us whether there
were any credit union representatives present?
Mr. BELLER. TO my knowledge, none.



125
Mr. LEACH. This is important because there are a large number
of uninsured depositors and the nature of bank deposits shifted
toward those belonging to depositors who lacked insider knowledge
and insider protection.
Mr. BELLER. I understand the significance of the impact of that.
To my knowledge, none.
Mr. LEACH. Thank you very much, Mr. Chairman.
The CHAIRMAN. Mr. Annunzio?

Mr. ANNUNZIO. Thank you, Mr. Chairman.
Now, Mr. Beller, in your testimony you painted a picture when
you became president of Penn Square, you found a situation where
there was no loan committee.
Mr. BELLER. There was a loan committee, sir.
Mr. ANNUNZIO. Would you repeat the conditions that you found
in the bank? In other words, you came in about 1 year ago?
Mr. BELLER. Yes, sir.
Mr. ANNUNZIO. A S you

were reading that, the thought occurred
to me, here was a large financial institution doing business with
other institutions throughout the entire country.
Mr. BELLER. Well, sir, I guess the point t h a t you are probably
after, and maybe I can help you reach t h a t point, is t h a t the
growth of the bank had been so dynamic t h a t it had literally outstripped its management, its people, its personnel, its physical
plant. That growth had been so rapid t h a t t h e personnel had not
been hired to cope with it.
For example, I would say t h a t a bank with a couple of billion in
loans, of gross loans t h a t it was servicing, would need more than
180 people, and certainly t h a t bank needed them, but they had not
organized it to the point where they could keep up with their own
growth. That is the point, and t h a t is when I came in and tried to
do something about it.
Mr. ANNUNZIO. And what did you do about it? You are the president of the bank?
Mr. BELLER. The very things that I read to you in my opening
statement.
Mr. ANNUNZIO. And what was that?
Mr. BELLER. That I formed these various committees, hired
people, set up departments, staffed departments in order to get a
control and get a hold of that growth.
Mr. ANNUNZIO. NOW, you did all of this to bring about improvement in the internal running and operation of the bank?
Mr. BELLER. Correct.

Mr. ANNUNZIO. However, the
Mr. BELLER. Yes.
Mr. ANNUNZIO. IS t h a t right?

bank still failed.

Mr. BELLER. Correct.

Mr. ANNUNZIO. NOW, can you tell me what the Comptroller of
the Currency did to correct some of t h e situations t h a t you found,
that you were trying to correct?
Mr. BELLER, The Comptroller of the Currency was aware of these
situations. They were aware t h a t I came to the bank because of
those problems. They were aware on a weekly reporting basis t h a t
we sent to their office of the progress being made in the different
areas.



126
Mr. ANNUNZIO. NOW, could you put your finger on whose fault
we can attribute this failure to, poor management to the Comptroller of the Currency?
Somebody has been at fault.
Mr. BELLER. That's true, but I can't give you that answer. I'm not
that smart.
Mr. ANNUNZIO. YOU know, I find it hard to believe every time
you are asked a question, you can't give an answer. I mean, who
was running the bank? Were you running the bank? You are the
president? Was Patterson running the bank?
We've got to find out who was running this institution if we are
going to correct the situation that existed so that it will not happen
again.
Mr. BELLER. I understand that and I am trying to cooperate with
you, sir.
Mr. ANNUNZIO. I know you are, but I want some answers.
Mr. BELLER. My answer is that I was not the chairman of the
board and I was not the chief executive officer. I was the president
and chief administrative officer.
The CHAIRMAN. If the gentleman would yield to the Chair, the
Chair would like to state that to date Mr. Beller has been most
helpful to the staff. Unfortunately, a lot of the records he would
like to have he is not in possession of because they were taken by
the regulatory agencies when they swept in. But indeed, we find
that Mr. Beller has been cooperative. Unfortunately, again, No. 1,
the records are not available to him, but second, the other problem
that Mr. Beller faces is that, as he states, he was brought in and
given partial authority but not total authority.
Mr. BELLER. That is correct.
The CHAIRMAN. I thank the gentleman for yielding.
Mr. ANNUNZIO. Mr. Beller, I am aware of the fact that I have
listened to your testimony and I know that you are a very cooperative witness, but on the other hand, you know, it is difficult for me
to conceive—and you have answered the question that you were
the chief operating officer—you were not the chairman of the
board, and other people had and knew more about the inner workings of the bank than you did, but can you tell the committee if
there are any customers of the bank who are not officers?
Mr. BELLER. Could you repeat the question?
Mr. ANNUNZIO. Were there any customers of the bank who are
not officers?
Mr. BELLER. I give up. I don't understand the question.
Mr. ANNUNZIO. Did anybody borrow money at your bank that
was not an officer?
Mr. BELLER. Yes.
Mr. ANNUNZIO. Well,

I'm glad to hear that.
You know, as you keep with your testimony, I do not know how
often it snows in Oklahoma, but somebody was doing a snow job in
portraying this situation at Penn Square.
I have no further questions except that I want to say that for
your sake I hope that if the situation arises again, that you will
become more cautious about these snow jobs. That is exactly what
happened, and this reminds me of a picture of a lot of con artists
you see that were conning each other, and they conned some of the



127
biggest institutions of this country, including some of our own
Federal credit unions and thrift institutions. It was like a confidence game. You know, we would all be up in arms if a confidence
man had taken some of these very reputable institutions to the
woodshed.
Here it was, the Penn Square in little Oklahoma City, took a lot
of these big city bankers to the woodshed. Somebody is at fault,
and we are trying to find out where that fault lies. It is in either
the Comptroller's Office or in the management end of Penn
Square, and most important, we want to find out, if we can, if
there is any violation of Federal law that occurred so we can pinpoint where these Federal violations were made.
Thank you.
Mr. BELLER. I have some material here that I will read a short
paragraph which will help answer one of the questions you asked
me a while ago.
Mr. ANNUNZIO. I would be deeply grateful.
Mr. BELLER. Or would more better define the answer, if you will.
Mr. ANNUNZIO. Would you read it, please?
Mr. BELLER. I will read you the first paragraph of the job description of the president of the bank. Under the overall direction of the
chief executive officer, "manages all of the bank's activities except
the energy division." I will now read you the executive vice president of the energy department's job description, first paragraph.
"Directs, coordinates and controls departmental activities concerning the extension of commercial credit to oil and gas customers in
accordance with established policies and procedures; reports to the
chairman and chief executive officer." The job description of the
chairman of the board and chief executive officer, "organizational
relationships, reports to the board of director and supervises the
president and the executive vice president in the energy division."
The CHAIRMAN. Mr. Beller, let me ask you this.
Mr. ANNUNZIO. I am familiar with job descriptions.
Did you read these job descriptions before you accepted the job as
president of the Penn Square Bank?
Mr. BELLER. Yes.
Mr. ANNUNZIO. YOU

did, and you accepted the job that would
give you absolutely no authority? After all, you were brought in—
you were brought in when this bank was in this situation because
the Comptroller of the Currency, as I understand it, had issued a
cease-and-desist order back in 1980.
Now, when did you come in as president?
Mr. BELLER. 1981.
Mr. ANNUNZIO. And

the cease-and-desist order did exist, and did
you know that?
Mr. BELLER. NO, sir, there was not an order to cease and desist at
that time.
Mr. ANNUNZIO. What was it?
Mr. BELLER. It was a letter agreement.
Mr. ANNUNZIO. Well, a letter agreement is practically the same
thing, is it not?
Mr. BELLER. NO, sir.
Mr. ANNUNZIO. Where



you agree to do

128 x
Mr. BELLER. YOU agree to do certain things, but it is different
from a cease-and-desist order.
Mr. ANNUNZIO. They did not tell you what not to do, just not to
do certain things, but the letter was there, but you knew that the
bank was in trouble, is that right?
Mr. BELLER. That is why I was hired, to try to help straighten it
out, yes, sir.
Mr. ANNUNZIO. Well, they did a hell of a good job. They hired
you to straighten it out and gave you no authority. That is the only
conclusion I can figure.
The CHAIRMAN. Thank you, Mr. Annunzio.
At this point, was the Office of the Comptroller of the Currency
aware of the fact that these job descriptions were in place when
you were retained and brought on board?
Mr. BELLER. I don't know.
The CHAIRMAN. Was this job description available to the Office of
the Comptroller of the Currency in the documents at Penn Square
Bank?
Mr. BELLER. The job descriptions were retained in the personnel
department files.
The CHAIRMAN. Those personnel department files were available
to and open to the OCC, the Office of the Comptroller of the Currency?
Mr. BELLER. Yes, sir, as everything in the bank is.
The CHAIRMAN. Well, I am in agreement with what Mr. Annunzio has just said, that the curious thing here is that the Comptroller of the Currency was elated about the fact that you were
brought in, new management, new personnel being brought in, but
it seems a little peculiar that they were not concerned about the
fact that you as president did not have the authority you should
have had; to wit, as far as energy loans were concerned you were
told, hey, that is sacred territory, do not transgress, stay away.
That in essence was what it was, was it not?
Now, you may have been willing to buy this, but the thing that
bothers me is the auditing firms and the Comptroller's Office gave
these reports saying oh, how wonderful, how things have improved.
Mr. Beller is there, and he brought in other personnel. You would
think that they might know of the limitations placed upon you by
these job descriptions.
Mr. Weber?
Mr. WEBER. Thank you, Mr. Chairman.
Mr. Beller, I want to express my appreciation to you the same as
the committee chairman for your cooperation and your candor in
this testimony today.
Just to set the record straight, is it not true that there was no
order to cease and desist until June 30, 1982, as a matter of fact?
Mr. BELLER. That is correct.
Mr. WEBER. And that order was amended then on July 2, 1982,
all of which was only a few days before the bank failed on July 5,
1982?
Mr. BELLER. Yes, sir.
Mr. WEBER. And one

of the problems, it seems to me, is we did
not have an order to cease and desist anywhere nearly soon enough
to remedy some of the problems that were existent at the bank.



129
Mr. Beller, were you ever approached to become the chief executive officer of this bank?
Mr. BELLER. NO, sir.
Mr. WEBER. Your duties

were to be administrative and limited to
the commercial real estate lending department of the bank?
Mr. BELLER. No, sir, that statement you just made is not correct.
You said commercial real estate department; did I understand you
correctly?
Mr. WEBER. Yes, I did. In other words, what lending functions
did you oversee, if you did not oversee the energy lending of the
bank?
Mr. BELLER. I was chairman of the credit policy committee,
which was formed when I got there, that I put members of the staff
in place on, and we reviewed all of the loans that were going
through the bank.
Mr. WEBER. Did you also review the energy loans?
Mr. BELLER. The loan review department, which did not exist at
the time I got there, which I had to find people to staff it with, it
reviewed loans that were classified by the Comptroller's Office and
charged off loans, in order to attack those things that we knew
were wrong. And those that were classified in the energy
department, we reviewed those that were classified.
The department had not been put together long enough to get
into the review of the loans in the energy department. It took time
to form the department, to find people, hire them, staff them, organize them to get the review started.
Mr. WEBER. Well, did you at any time, Mr. Beller, have the
power to deny a loan that had been recommended by Mr. Patterson?
Mr. BELLER. That power was circumvented.
Mr. WEBER. You're saying you did not have that power to deny
the loans that were recommended from his energy department?
Mr. BELLER. That is correct.
Mr. WEBER, Not at any time?
Mr. BELLER. The loans were committed ahead of time.
Mr. WEBER. What lending powers did you have, the power either
to approve or to disapprove?
Mr. BELLER. Outside the energy area, there was no problem.
Mr. WEBER. There was no problem?
Mr. BELLER. Outside of the energy area.
Mr. WEBER. When you came to the bank—and what was the date
that you became the administrative officer?
Mr. BELLER. I came to the bank April 24, 1981.
Mr. WEBER. Were there particular kinds of loans at that time
that were causing the bank difficulty?
Mr. BELLER. A tremendous amount of loans that were causing
the bank problems, in the form of past due loans that had been
made by a previous loan officer at the bank who had resigned the
week before I got there, that had created a lot of problems in the
bank at that time, and that is where I devoted my efforts in trying
to review those loans and determine what the problems were and
restructure the loans and file suits in some cases against people
who were not paying.
That was the thrust that I gave.



130
Mr. WEBER. The type of those loans, were those energy related or
were they commercial?
Mr. BELLER. NO, sir.

Mr. WEBER. They were not energy-related loans at that time?
Mr. BELLER. NO, sir.
Mr. WEBER. What was the category for those loans?
Mr. BELLER. The majority of them were horse loans.
Mr. WEBER. I beg your pardon?
Mr. BELLER. Horse loans.
Mr. WEBER. When you became president, I assume

that you
made some judgment or assessment about the financial health of
Penn Square, right?
Mr. BELLER. Correct.
Mr. WEBER. Did you have any feeling that this bank could not be
saved at that time?
Mr. BELLER. NO, sir, I did not have that feeling.
Mr. WEBER. Did you have any guess as to what the odds would be
that the bank would fail within a year?
Mr. BELLER. I had no such feeling.
Mr. WEBER. YOU had no inclination at all?
Mr. BELLER. I did not expect it to fail.
Mr. WEBER. In retrospect—as Mr. Annunzio has very carefully
pointed out, nevertheless the bank did fail—what corrective actions
in your judgment should have been taken to have saved Penn
Square which were not taken? What could have been done to save
this bank?
Mr. BELLER. Stop making so many loans, stop the growth, which
is what I was attempting to do.
Mr. WEBER. TO operate the bank more conservatively?
Mr. BELLER. Stop the growth, slow it down.
Mr. WEBER. At any time would you have welcomed a more forceful regulation by the Comptroller of the Currency?
Mr. BELLER. I don't know. That would be dependent upon what
the situation was, and what that was, I don't know how to answer
that.
Mr. WEBER. At any time did you seek a more forceful regulatory
policy? Did you have any policies that you wanted to see enforced
or brought about that you were unable to bring about, that you
would have welcomed the assistance of the OCC with?
Mr. BELLER. I can think of none.
Mr. WEBER. What corrections were taken relative to the Arthur
Young qualification? They were the auditors that did the year-end
statement for 1980 and they qualified their report with the statement:
We were unable to satisfy ourselves as to the adequacy of the reserve for possible
loan losses at December 31, 1980, due to the lack of supporting documentation of
collateral values on certain loans.

What corrective action was taken to your knowledge?
Mr. BELLER. AS you are aware, that was prior to my coming to
the bank. But my opening statement and the various things I itemized to you that were not in place at the bank were the things that
were put in place that corrected those situations.
Mr. WEBER. Are you telling us



131
Mr. BELLER. The loan closing department, the collateral
department, the loan review department; trying to upgrade the
credit filings, the functions of the credit department, et cetera.
Does t h a t answer your question?
Mr. WEBER. You're telling us t h a t t h a t had nothing to do with
the fact t h a t you changed auditors, their qualification
Mr. BELLER. N O , it had nothing whatsoever to do with it.
Mr. WEBER. Mr. Chairman, I have other questions, but I think I
should probably surrender to the other members of the committee.
The CHAIRMAN. Thank you, Ed.
At this time the Chair would like to ask two additional gentlemen to join Mr. Beller. They're colleagues of his or were colleagues
of his at the bank, Mr. John Preston and Mr. Richard Dunn. Are
they here?
[Witnesses sworn.]
The CHAIRMAN. Please be seated. Mr. Preston, if you would briefly identify yourself, I will ask Mr. Dunn to do the same and then
we can continue to pursue the questioning.
I would say to the members of the committee that both these
gentlemen came in as part of the management team, the new management team with Mr. Beller. The Chair felt t h a t at this point,
rather than have them go separately later on, it might be wise to
have them join Mr. Beller.
Mr. Preston, if you would just identify yourself to the committee.
TESTIMONY OF JOHN PRESTON AND RICHARD DUNN
Mr. PRESTON. My name is John Preston. I am former general
counsel of Penn Square.
The CHAIRMAN. Prior to t h a t you were affiliated with?
Mr. PRESTON. Prior to t h a t time I was senior vice president and
general counsel and secretary of the First Oklahoma Bancorporation and vice president, general counsel and secretary of its subsidiary, the First National Bank & Trust Co. of Oklahoma City.
The CHAIRMAN. Which is the institution t h a t Mr. Beller was with
prior to coming with Penn Square?
Mr. PRESTON. That is correct, Mr. Chairman.
The CHAIRMAN. Mr. Dunn?
Mr. D U N N . My name is Richard Dunn. I was an executive vice
president of the Penn Square Bank. Prior to t h a t I was with First
National Bank as senior vice president of the loan administration
division.
The CHAIRMAN. At Penn Square you were executive vice president. In what area were you functioning?
Mr. D U N N . A S of April 1, I took over the commercial nonenergy,
non-real-estate-loan division, and I was hired in to head up and
form the loan administration division.
The CHAIRMAN. Thank you.
Mr. Evans?
Mr. EVANS of Indiana. Thank you, Mr. Chairman.
Mr. Beller, did you ever discuss Bill Patterson with Bill Jennings?
Mr. BELLER. Yes, on numerous occasions.
Mr. EVANS of Indiana. Could you elaborate on that?



132
Mr. BELLER. Well, to the extent t h a t I was seeking Mr. Jennings'
assistance in controlling Mr. Patterson from some of his activities
insofar as continuing this fast growth in the lending area t h a t I referred to earlier.
Mr. EVANS of Indiana. Could you describe the Patterson-Jennings
relationship, please?
Mr. BELLER. Well, Jennings hired Patterson probably 4 to 5 years
ago. I'm not sure how long he was there, about 5 years. During
t h a t period of time it was my observation after I came to work
there t h a t they had become very close friends and worked together
as business associates in the energy area with the energy customers, and t h a t they had become extremely close, more like father
and son.
Mr. EVANS of Indiana. Could you tell us what happened when
you tried to control Patterson's energy department?
Mr. BELLER. Well, the thing that would happen is t h a t you would
become circumvented in whatever you were attempting to control,
and if then, when you pursued that, Mr. Patterson would secretly
inform Mr. Jennings in t h a t regard.
The CHAIRMAN. Would the gentleman yield at that point?
Mr. EVANS of Indiana. Yes.

The CHAIRMAN. Let me ask this. You certainly were interviewed
by members of the OCC examining team, the Comptroller of the
Currency's examining team, subsequent to your arrival in April, is
that correct?
Mr. BELLER. Say that again, Mr. Chairman?
The CHAIRMAN. When OCC, the Office of the Comptroller of the
Currency, came—when did they first come into the Penn Square
Bank subsequent to your arrival upon the scene in April of 1981?
Mr. BELLER. The first time I met with them after becoming affiliated with the bank is when they called the directors to Dallas for a
meeting in July.
The CHAIRMAN. In July. Subsequent to t h a t what was the next
instance?
Mr. BELLER. We had an examination in the fall of t h a t year.
The CHAIRMAN. That was in September, correct?
Mr. BELLER. September or October, yes, sir.
The CHAIRMAN. When those personnel were in there during the
exam, did they stop into your office and discuss the problems of the
bank with you on a 1 to 1 basis?
Mr. BELLER. Yes,

sir.

The CHAIRMAN. Either in the meeting in Dallas or in September,
did you communicate to the Office of the Comptroller of the Currency, again getting somewhat akin to the job description situation,
the problems you were having in controlling the activities of Mr.
Patterson and the circumvention of your authority by the team of
Patterson and Jennings?
Mr. BELLER. N O , sir, I did not have conversations with them in
t h a t specific regard. Fm sure they were aware of all of those
things.
The CHAIRMAN. Well, how would they be aware of it unless you
told them?
Mr. BELLER. They had been examining the bank.
The CHAIRMAN. Pardon?



133
Mr. BELLER. Through their examination of the bank. Well, I
don't know.
The CHAIRMAN. YOU assumed that they would know t h a t control
and authority over energy loans and energy-related loans was
being retained by Mr. Jennings and Mr. Patterson, and even
though this is one of the big problem areas, this continued quick
growth in motivation by Mr. Patterson, you didn't mention this to
the regulatory agency representatives in the bank when they came
to the bank or the board of directors' meeting?
IVIr SELLER N O sir
The CHAIRMAN/You felt t h a t they had ESP?
Mr. BELLER. N O , sir. I certainly knew t h a t they knew t h a t Mr.
Patterson was the executive vice president in charge of the energy
lending.
The CHAIRMAN. And that you had no control or authority over
him?
Mr. BELLER. I don't know that.
The CHAIRMAN. I thank the gentleman for yielding.
Mr. EVANS of Indiana. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Wortley?
Mr. WORTLEY. Thank you, Mr. Chairman.
Mr. Beller, what percentage of Penn Square's loans is in the area
of energy?
Mr. SELLER. In the neighborhood of 80 percent.
Mr. WORTLEY. Eighty percent?
Mr. BELLER. Yes,

sir.

Mr. WORTLEY. The remaining 20?

Mr. BELLER. The remaining 20 were the remaining commercial
loans, industrial loans, real estate loans, consumer loans.
Mr. WORTLEY. YOU mentioned horse loans previously. Are horse
loans a special category of loans?
Mr. BELLER. Well, when I said horse loans, t h a t means that the
loans were made, the collateral for the loan being horses.
Mr. WORTLEY. Were many of those written off?
Mr. BELLER. Substantial.
Mr. WORTLEY. Were many of those loans made to insiders of the
bank?
Mr. BELLER. Not to my knowledge.
Mr. WORTLEY. There were no insiders to whom these loans were
written off?
Mr. BELLER. Not to my knowledge, no.
Mr. ANNUNZIO. Would the gentleman yield?
Mr. WORTLEY. Yes, I will, to Mr. Annunzio.
Mr. ANNUNZIO. In answering the question of the gentleman from
New York, you again made the statement t h a t 80 percent of the
loans were energy related, which means t h a t when you became
president you had nothing to say about 80 percent of the bank's
business, is that correct?
Mr. BELLER. YOU could draw that conclusion, I guess.
Mr. ANNUNZIO. Then will you please tell the committee how you
could have stopped this growth if you had nothing to say about 80
percent, the energy-related loans?
Mr. BELLER. The facts are I didn't, did I?
Mr. ANNUNZIO. The bank failed.



134
Mr. BELLER. Yes, sir.
Mr. ANNUNZIO. Thank you.
Mr. WORTLEY. If I could reclaim
The CHAIRMAN. You're on.
Mr. WORTLEY. Mr. Beller, who

my time.

was responsible in the bank for
either selling off or obtaining participation of upstream banks in
the loans?
Mr. BELLER. That was Mr. Patterson's responsibility and the area
that's known as the correspondent department, who worked under
Mr. Patterson's supervision.
Mr. WORTLEY. SO the correspondent department was under his
jurisdiction as well as the energy loans, is that correct?
Mr. BELLER. That's correct.
Mr. WORTLEY. IS that standard operating procedure in most
banks?
Mr. BELLER. Not to have the correspondent department under
the energy department, no. But this bank was certainly unique in
that area.
Mr. WORTLEY. Did you make any effort to revise that relationship when you came aboard?
Mr. BELLER. TO revise it in what regard, sir?
Mr. WORTLEY. Since this was not the procedure in other banks,
as the principal administrative officer, did you make a recommendation about changes in that relationship?
Mr. BELLER. The difference between having a correspondent
department under the energy department in that bank as opposed
to other banks is that we did not have the downstream relationships that you normally use a correspondent department for. So in
effect the correspondent department in Penn Square Bank under
the supervision of the head of the energy department was more of
a syndication department, working with the upstream and downstream banks on loan participations.
Mr. WORTLEY. Was there a limit on the amount a loan officer
could make on his own?
Mr. BELLER. Different loan officers had different lending authority, different amounts.
Mr. WORTLEY. What was the maximum of any one officer?
Mr. BELLER. One officer was the legal lending limit of the bank,
the legal lending limit of the bank, which was $3 million.
Mr. WORTLEY. YOU mean one officer could make a decision of
that magnitude?
Mr. BELLER. Yes.
Mr. WORTLEY. Did

you make any recommendations about
changes in this particular area?
Mr. BELLER. Yes, I made recommendations at different times
about different things pertaining to lending authority, yes.
Mr. WORTLEY. Were any of your recommendations adopted in
that particular area?
Mr. BELLER. The lending authority of the energy department was
separate from the rest of the bank.
Mr. WORTLEY. In other words, none of your recommendations
was adopted if it affected the energy department?
Mr. BELLER. Correct.



135
Mr. WORTLEY. During the first week of December 1981, a choice
was made to go to Peat, Marwick, Mitchell & Co. Did you make
that decision unilaterally or was that made in conjunction with
other officers or the chairman of the board?
Mr. BELLER. TO change from one accounting firm to the other?
Mr. WORTLEY. Yes.
Mr. BELLER. That change

was made based on the combined judgment of my chief financial officer, myself, the chairman of the
board, and others.
Mr. WORTLEY. Had you had any previous experience with Peat,
Marwick?
Mr. BELLER. Yes, sir.
Mr. WORTLEY. Would
Mr. BELLER. Yes, sir.

you care to elaborate on that?
I must say that I worked with the different
people of Peat, Marwick, Mitchell & Co. at the place of my previous employment and I considered them to be—to have the expertise that I needed in that bank to give us assistance.
Mr. WORTLEY. Was Peat, Marwick, Mitchell & Co. hired to audit
the bank in December? Had any other audit been initiated by another firm prior to Peat, Marwick, Mitchell & Co.'s engagement? In
other words, would there have been any duplication?
Mr. BELLER. Not to my knowledge, no.
Mr. WORTLEY. Thank you, Mr. Beller.
I yield back the balance of my time.
The CHAIRMAN. Thank you.
May I ask a few questions before I get to you, Mr. Barnard?
Mr. Beller, the funds that were brought into Penn Square came
from around the country, and basically a lot of the funds that were
brought in, deposits made, came in as a result of the activities of
money brokers around the country; is that a fair evaluation?
Mr. BELLER. Yes.
The CHAIRMAN. NOW,

do you know when the money brokers were
contacted by Penn Square and who at Penn Square was responsible
for contacting the money brokers and saying, hey, we need some
money and we're going to pay maybe a quarter point over, and
what have you?
Mr. BELLER. Well, part of the question was when, and the bank
was using brokers for funds at the time I went to work there.
The CHAIRMAN. Prior to your arrival?
Mr. BELLER. Which was normal, for banks to use broker funds.
Later, after I had had a chief financial officer and he had hired a
man under him as our money manager, then I guess for the second
part of your question, as to who contacted them, our money manager is the one that ended up working with them in the time frame
that you're referring to.
The CHAIRMAN. NOW, do money brokers get a fee from the institution into which the deposit is made, rather than from the depositor? In other words, money brokers don't work for nothing?
Mr. BELLER. Yes, the answer is yes.
The CHAIRMAN. Would you sort of describe what the process is to
the committee?
Mr. BELLER. Well, the brokers put funds into the institution and
you paid them agreed-on, negotiated rates for those funds, depending on what market conditions are, with a fee which is also a nego


136
tiated rate depending upon what market conditions are with t h e
other people who are bidding for the same funds.
The CHAIRMAN. SO those rates, those fees, would vary from time
to time?
Mr. BELLER. Daily.
The CHAIRMAN. On a daily basis?
Mr. BELLER. They could, yes.
The CHAIRMAN. DO you know where we might find a record of
what those fees were? Where in the bank's records would we find
those?
Mr. BELLER. Yes, sir. The financial services department of the
bank.
The CHAIRMAN. That was headed up by whom?
Mr. BELLER. That was headed up by Mr. J i m Gunter, chief financial officer, and Mr. Bert Davis, who was the money manager. And
they would have those exact records of the funds, where they came
from, what day, how much, and what rate.
The CHAIRMAN. Thank you.
Prior to coming to Penn Square, you were with—refresh my
memory.
Mr. BELLER. First National Bank of Oklahoma City.
The CHAIRMAN. And had been there for about 10 years?
Mr. BELLER. Twelve.

The CHAIRMAN. Twelve years. At the time you left First National
Bank of Oklahoma City, your salary and bonuses, et cetera,
amounted to what approximately?
Mr. BELLER. In the neighborhood of $80,000.
The CHAIRMAN. Then you came to Penn Square National Bank.
Is it accurate to state t h a t you came to Penn Square, t h a t they
gave you an agreement to employ you for a 5-year period?
Mr. BELLER. That is correct.
The CHAIRMAN. And t h a t was a 5-year period and t h e agreement
included salary plus bonuses?
Mr. BELLER. Yes, sir.

The CHAIRMAN. And could you tell the committee what the
salary, basic salary, was?
Mr. BELLER. The beginning salary was, the basic salary, was
$125,000 a year, with a guaranteed bonus of $30,000.
The CHAIRMAN. SO t h a t would amount to a guarantee of $155,000
per year for the first 5 years.
Mr. BELLER. It was on a sliding scale. That was the first year,
yes, sir.
The CHAIRMAN. Would you give us the scale, please?
Mr. BELLER. A S I can recall it, I will. The second year t h e bonus
would become $50,000 or a percentage of the profits of t h e bank not
to exceed 1 percent, and the salary would be $140,000. And t h e
third year, as I recall, $150,000, and so on.
The CHAIRMAN. SO in the fifth year you would be up about t h e
$250,000 category, is t h a t accurate?
Mr. BELLER. Correct.

The CHAIRMAN. Mr. Barnard, our real expert here a t the hearing
on the nitty-gritty.
Mr. BARNARD, Mr. Beller, did you make application for t h e job as
president of the Penn Square Bank?



137
Mr. BELLER. NO, sir.
Mr. BARNARD. HOW was this association established?
Mr. BELLER. Mr. Jennings solicited me for the job.
Mr. BARNARD. And what was his reason for picking

you out for
this job?
Mr. BELLER. I don't know his reasons. I know as far as picking
me out the reasons he gave me for needing someone was that the
growth of the bank was so accelerated that he needed additional
help, and that the then-president of the bank's health was not
good, and that for those purposes he needed additional help.
Mr. BARNARD. Were you comfortable being president of the bank,
being hired under these circumstances, and still not being given
the position of chief executive officer?
Mr. BELLER. That was the condition.
Mr. BARNARD. In other words, you agreed to come into this bank
as president and yet you were not the chief executive officer and
you really had only administrative responsibilities?
Mr. BELLER. That is correct, that I came in not as the chief executive officer, yes, sir. And the chief executive officer was the
chairman of the board.
Mr. BARNARD. On the other hand, though, you were chairman of
the loan policy committee.
Mr. BELLER. That is correct.
Mr. BARNARD. And what responsibilities were assigned to you as
chairman of that committee?
Mr. BELLER. TO staff that committee and to look at loans on their
submittal basis, to review the loans, to approve or disapprove the
loans, and to do other different jobs, as the committee minutes reflected.
Mr. BARNARD. SO you might have been chairman, but it was
more of an administrative chairman as opposed to a decisionmaking chairman?
Mr. BELLER. The attempt was to do the other, but we didn't get it
done, you might say.
Mr. BARNARD. Mr. Beller, you came into office, I believe, in April
of 1981, right?
Mr. BELLER. Correct, sir.
Mr. BARNARD. April of 1981. Do you feel that you were successful
in bringing in your experience and expertise and changing the direction of the bank?
Mr. BELLER. Successful to a degree that I felt was—during the
period of time accomplishments that were made were more than I
had hoped to make in that time frame, yes, sir.
Mr. BARNARD. In other words, between April and December the
31st of 1981, you were pleasantly satisfied with your results?
Mr. BELLER. I was satisfied with the results that I had obtained
at that time in being able to attract enough people, to set up
enough departments, to do the job that needed to be done to try to
control the growth of the organization and monitor things through
the departments and through the people that were established.
And with the examination of the Comptroller's Office in the fall of
that year, with their commendation that there had been significant
progress in all areas, the answer to your question is, Yes, sir.
Mr. BARNARD. YOU were satisfied with that result?



138
Mr. BELLER. I was not satisfied. I was pleased with the accomplishments to date.
Mr. BARNARD. HOW long did you think it was going to take you
to get the policies of the bank developed so you would be satisfied?
Mr. BELLER. My stated target was 3 years. I was there 1.
Mr. BARNARD. Well, in the Peat, Marwick, Mitchell & Co. report
of their findings as of December 31, which I'm sure you are familiar with
Mr. BELLER. Yes,
Mr. BARNARD. It

sir.

is just replete with criticism on criticism stating
t h a t the policies were not working; and went on to talk about the
inadequate asset-liability management, the poor liquidity, the no
monitoring of credit and collections. From the basis of the statement which was made as a result of the December 31 audit, it appears the practices t h a t you were putting into place didn't have
much of an effect on the overall operation of the bank.
Mr. BELLER. They had not had time yet to become effective to the
degree that they needed to be.
Mr. BARNARD. But you were satisfied, though, t h a t in spite of all
t h a t you were trying to do, without your supervision and control
over the energy loans, t h a t you would never be successful in bringing this bank back into compliance, right?
Mr. BELLER. Well, at the end of the year, 1981—I came to work
there in the spring of 1981. At the end of 1981 the record shows
t h a t bringing it into compliance under this letter agreement had
been accomplished almost in its entirety.
Mr. BARNARD. Well, I think we are going to have to determine
that. It was determined by the Comptroller of the Currency at one
point, to some degree, but they surely did an about-face in April.
Mr. BELLER. I agree.
Mr. BARNARD. DO you think the Comptroller of the Currency was
too harsh on your bank?
Mr. BELLER. I don't know how to answer t h a t question, sir. But I
will say t h a t the amount of recoveries of the loans t h a t were
charged off, that created the insolvency of the bank, may answer
part of t h a t question, depending upon the recovery of those loans.
And I don't know what t h a t is going to be.
The CHAIRMAN. Would the gentleman yield?
Mr. BARNARD.

Yes.

The CHAIRMAN. On the letter t h a t you were reading from, the
harsh criticism, I think it should be made clear in the record and
to the public at this point t h a t t h a t was a private letter. It is
known as a management letter, to the management alone from
Peat, Marwick, Mitchell & Co., unfortunately not available to the
public, because, had it been, certainly some of those large depositors over $100,000 might have thought twice, correct?
Mr. BARNARD. Mr. Beller, what was the bank endeavoring to accomplish? What was really the goal of the Penn Square Bank, in
view of the fact t h a t you said 80 percent of the loans were in
energy, and that it was acting as a brokerage house for three of the
large national banks in the country? What actually were you
trying to accomplish?
Mr. BELLER. Let me try to answer you this way. At the time I
joined the bank, I think it was well known t h a t the stated philos


139
ophy of the chairman of the board of the bank was that he wanted
this bank to be an energy bank. It was located in a geographical
energy area. He had strong relationships with large customers who
were energy customers; and that his stated position was that this
should be a concept of a merchant bank, which is to say that this
bank would put together loans with their customers and participate those loans to other banks who had need for additional loans.
This was the philosophy of the bank.
Mr. BARNARD. Well, Mr. Beller, didn't that violate every principle of banking that you had known of before, because of the element of concentration? I'm sure the First National Bank of Oklahoma City would not have recommended concentration, even in
Government bonds, to the tune of 80 percent.
Mr. BELLER. The answer to that, sir, is that when I got there and
when I had time to do so and hire people to do so, I established
another type of lending known as industrial lending, and staffed it
with people that I knew, expanded the real estate area, established
a leasing company within the operation, all for the purpose of
giving diversification to the portfolio as you related.
Mr. BARNARD. The information we have before us is that even
with that there was an unusual and a continuing large volume of
energy loans being made and sold. I think the information I've got
here is that $150 million worth of participations went to the First
Seattle Bank from November 1, 1980, until the first week of January 1982, which means to me that you were continuing to develop
that concentration.
Mr. BELLER. Yes, sir, that is true. That was all previous commitments of things that were being funded at the time.
Mr. BARNARD. DO you think that that is contrary to good banking practices, to concentrate in one area to that degree?
Mr. BELLER. Well, normally that is considered to be true, yes, sir.
I would only answer that if you are in a geographical area that is
energy you can concentrate in energy pretty significantly, whatever bank you are. If you are in an area that is lumber, well, you
would concentrate in that.
It all depends upon how you diversify within the credits, within
the industry within which you are concentrating.
Mr. BARNARD. Did you feel like you had that diversity?
Mr. BELLER. It would appear that we did have, yes.
Mr. BARNARD. I have no further questions, Mr. Chairman.
The CHAIRMAN. Mr. Beller, it becomes increasingly clear—and
this can be addressed to Mr. Preston and Mr. Dunn as well—that
the bank was operating its loan sale program in an unsafe and unsound manner. The bank was attempting to be a merchant bank.
However, the procedures for correctly implementing such a program were lacking.
In a memo dated—and I think you referred to this earlier—December 8, 1981, the bank staff outlined the major problems in current operations at that point in time. In particular the memo outlined the problems of interest advances by Penn Square to participating banks on commercial loans.
The memo states:
Correspondent banking is making verbal agreements with the participating banks
contrary to the standard participation certificates, such as paid monthly interest

97-830
http://fraser.stlouisfed.org/0 - 8 2 - 1 0
Federal Reserve Bank of St. Louis

140
when interest payments terms to the customer are much longer, paid interest to
date of extension when extensions are granted, repurchased or recalled participating principal, and recouped interest on granted extensions. The correspondent banks
are setting the terms that PSB, Penn Square Bank, must agree with to keep the
relationships and maintain reputation of Penn Square Bank.

The memo further states that: "As of November 30, 1981, there
was $2,177,969 of interest alone advanced to participating banks on
the loans that were reviewed," only those reviewed.
Now, those are the numbers that you didn't have earlier right,
when I questioned you about this?
Mr. BELLER. Right.
The CHAIRMAN. These advances cost the bank approximately
$46,319 in opportunity cost for the funds advanced, because they
couldn't lend those out to anyone else, is that correct?
Mr. BELLER. That's correct.
The CHAIRMAN. Given the severity of this problem, what steps
were taken to correct these problems, both from operational and an
accounting sense, as well as from a legal sense?
Mr. BELLER. When it was learned that this was occurring
The CHAIRMAN. This is that rather lengthy memo and the pages
are numbered here, exhibit A, exhibit B, etc. And this is a memo to
James Gunter, executive vice president, financial planning, from
Arlyn C. Hill, vice president, dated December 8, 1981. Do you have
that memo at this point, a copy of it?
[A copy of the memorandum is inserted in the record at this
point.]




141
TO:

James J .

Gunter,

FROM:

A r l y n C. H i l l ,

DATE:

December 8,

SUBJECT:

Interest

Executive Vice P r e s i d e n t ,

Vice

Financial

Planning

President

1981

Advances to P a r t i c i p a t i n g

B a n k s on CommerciaT

' >-ins

Requested:

Review procedures and determine amount of interest advanced to
participating banks on commercial loans that is included in
Interest Earned, Not Collected account (IENC).
Review large loans and determine cause for increases on those
loans.
Identify large customers and participating banks.
Compare extensions ro participation certificate agreements.
.
Review reconcilements of general ledger to trial balance.
Recommend improvements to (1) internal accounting records and
controls and (2) operating procedures.
Scope of Review:
Our review included discussing procedures with Commercial
Discount and Correspondent Banking Department personnel,
tracing accounting entries to supporting records on a test
basis, reviewing general ledger account reconcilements, and
reviewing each loan, $500,000 or more, as of November 30, 1981
that was partially or wholly participated in by other banks.
Findings:
Our findings can be classified as (a) causes for advanced
interest (b) amount of advanced interest and (c) condition of
accounting records and controls.
CAUSES FOR ADVANCED INTEREST:
Correspondent. Banking is making verbal agreements with the
participating banks contrary to the standard participation
certificates, such as:
a.

Pay monthly interest when interest payment terms
with customer are much longer.

b.

Pay interest to date of extension when extensions are granted.

c.

Repurchase or recall participated principal
and accrued interest on granted extensions.




142
Accrued interest is not being collected to date of note
extension. Extension agreements call for payment of
interest "at maturity" of the extension in nearly all
cases.
The correspondent banks are setting the terms that PSB
must agree with to keep the relationships and maintain
reputation of PSB.
Some notes have had as many as 10 extensions without a
principal collection and interest is to be collected
"at maturity."
AMOUNT OF ADVANCED INTEREST:
As of November 30, 1981, there was $2,17 7,969 of interest
advanced to participating banks on the loans reviewed.
Exhibit A.
The amount of available funds lost during 1981 was
$112,708,796 on the loans outstanding and reviewed as of
November 30, 1981. (Amount X number of days of an advance.)
This amount does not include paid out, renewed or recalled
participation loans and minor adjustments on interest
received and forwarded. Exhibit B.
Using a Federal Funds rate of 15%, this operating procedure cost PSB $46,319 in 1981 on the loans reviewed. (Available funds lost + 365 days x 15%).
CONDITION OF ACCOUNTING RECORDS & CONTROLS
Reconcilement of general ledger accounts was about one
month late for both principal and IENC. The "Other AssetAdvances of Interest on Participations" account started
November 3, had not been rconciled. The number and gross
amount of reconciling items as of October 27, to Commercial
Loans, not including Real Estate and Construction to both
computer system and general ledger was 135 items totaling
$52,528,381. As of November 30, 1981, the net reconciling
amount was $2,656,629 on loans outstanding and $88,751 on
IENC. Exhibit C,
Prior to November 16th, daily transactions input to the
system were not being reconciled to computer output which
caused most of the reconciling problems.
Entries to the general ledger are not segregated as to new
loans, payments received, interest collected, interest
advanced, and other adjustments, etc.




143

The note transactions by participating bank and PSB
(in the note jackets) do not balance to total note on a
number of loans.
Recommendations:

*
Review and revise operating procedures to collect accrued
interest from loan customers before forwarding to participating bank. Exceptions to procedures should require the
Chairman1s or President's written approval.
Review and revise operating procedure to limit number of extensions and require a percentage principal reduction before
additional extensions may be granted.
Revise or develop accounting records in the Commercial
Discount Department to:
1. Provide totals that can be traced to computer system
reports for new loans, payments received, and other
adjustments, etc.
2. Provide detail entry totals by transaction type for
general ledger posting.
3. Insure loan jacket histories balance to total note and
trial balance. (May require revision in payment schedule format.)
4. Provide information on interest advanced on participated
notes until current operating procedure is corrected.
Reconcile the general ledger accounts daily to computer system
reports for daily transactions. When the reconciling backlog
is current, the transaction and balances should be reconciled
daily for all accounts. The reconciliation function should be
independent from those making the initial entries.




144

Exhibit A
Penn S q u a r e Bank NA
Advance of I n t e r e s t t o P a r t i c i p a t i n g Bwnks
a s of November 3 0 , 1981

Customer Name

Note No.

Participating,
Bank

Prepaid

B F & B Drilling

26837

Chase

Richard Buck, J r .

26467

Mich. Nat'l.

Executive Airways, ILc.

27267

Chase

J. P. Exploration

26232

Cont'l. Chgo.

4,173.44
1,047.95

$ 28,568.15
22,542.46
114,727.77

Robert Hefner I I I

(1)

28123

Nat'l. McAlester

Robert Hefner I I I

(11)

27383

Chase

R o b e r t Hefner I I I

(1)

23174

Nat'l. McAlester

12,120.05

E. P e t e r Hoffman

(2)

28312

Chase

58,577.26

J e n k i n s 1980 D r i l l i n g P r g .

25502

Cont'l. Chgo.

19,282.79

Robert P . Lamraerts

28322

Chase
Cont'l. Chgo.

12,928.04
60,655.37

24399

Mich. Nat'l.
Hibernia

16,273.97
92,027.40

(12)

27622

Utica Nat'l.
Mich. Nat'l.

1?.C, 027.^0
38,509.59

(A)

27478

Chase

15,404.79

Mahan-Rowsey, I n c .

27333

Mich. Nat'l.

82,849.31

Maximo-Mooring, I n c .

26650

Chase

Mikes D o z e r s , I n c .

29059

North Trust
H.bernia

15,801.37
1,809.59

(3)

William L o c k r i d g e

Lor.ghorn O i l & Gas

Magnet D r i l l i n g

469,463.63

178,859.59

V. D. Newsom & A s s o c .

(5)

26965

Mich. Nat'.l.
Chase

59,188.77
29,803.93

W. D. Newsom

(5)

26959

Sea First
Chase

43,996.93
15,797.71

W. D. Newsom & Assoc. (6)

25162

Oilfield-California Ltd.
(Newsom)
(7)

26964




Chase

Cont'l. Chgo.

6,398.63

11,161.78

145
E x h i b i t A-2
Participating
Bank

Customer Name
Oklahoma-Hughes,

Prepaid

Ltd.
26961

Cont'l. Chgo.

24319

north Trust

25771

Cont'l. Chgo.

8,375.02

27451

Cont'l. Chgo.

70,170.02

28740

Chase

27423

Chase
Mich. Nat'l.

52,150.68
5,794.52

Second Geostratic

27135

Mich. Nat'l.

8,687.39

0. L. Scott, Jr.

27188

Chase

52,459.51

22625

Cont'l. Chgo.

11,749.38

Texas Upsetting & Finish.(10) 29195
29012

Cont'l. Chgo.
Cont'l. Chgc.

12,779.45
24,575.34

Texoma Resources, Inc.

27485

Mich. Nat'l.

12,438.22

Daniel R. Urscheil

28646

Bk. of Red Oak

Western Wells Company

21852

Mich. Nat'l.
North Trust
1st Wagoner

(Newsom)

15,164.87

(5)

Otex Energy, I n c .

(8)

331,714.60

David Palm
Robinson Bros., Drilling
5,885.48

Ramco Well Service
Samantha Petroleum Corp.

Swan Petroleum

(9)

4,824.66
39,202.40

$2,177,969.21

(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)

Interest paid monthly
Interest payment due 9/13/81 extended to 1/18/82
Principal and interest extended from 9/18/81 to 4/17/82
Principal and interest extended from 10/5/81 to 4/5/82
Principal and interest extended twice from 7/31/81 to 12/8/81
Principal and interest extended twice from 6/10/81 to 12/8/81
Principal and interest extended 7/31/81 to 12/8/81
Principal and interest extended 9/30/81 to 12/16/81
Collected $165,375 11/24; Forwarded $177,125; Extended 5/5/81 to 5/5/82
Principal and interest extended 10/31/81 to 12/15/81
Principal and interest extended 7/20/81 to 12/20/81
Changed interest quarterly to "at maturity"




146
Exhibit B
Penn S q u a r e Bank, N.A.
L o s t A v a i l a b l e Funds by Customer
11 Months Ended November 3 0 , 1981
Amount of
Advance

Note No.

Customer
B F & B Drilling

26837

R i c h a r d Buck,

$

26467

Jr.

28,568.15(2)
{
I

87

1,243.84

28
47*

{
< 22,542.26
Greg L. Cook

25770

Cromling D r i l l i n g Co.

28756

R o b e r t Hefner

28123

Lost
Available
Funds

"No„ of
1Days (1)

(2)

$

2,485,429.05
34,827.52
1,059,495.62
1,094,323.14

20,938.72

175

3,664,276.00

(
(

104,506.85
102,698.63

40
8

4,180,274.00
821,589.04
5,001,863.04

(
(
(
(

54,340.27
1,956.16
2,058.09
1,047.95(2)
469,463.63(2)
3,294.04
2,033.50(2)
5,905.86(2)
4,180.69(2)

1
35
8
27
10
4
81
60
29

54,340.27
. 68,465.60
16,464.72
28,294.65
4,694,636.30
13,176.16
164,713.50
354,351.60
121,240.01
5,515,682.81

28312

58,577.26(2;

52

3,046,017.52

Executive Airways,Inc.

27267

114,727.77(2)

51

4,703,838.57

J e n k i n s Berkey J t . V .

22793

105

3,629,191.65

R o b e r t P. Lammerts

26706
28322
26707
19328
26708
19341
19385

21
35
20
7
14
6
2
6
6

2,372,165.67
2,575,419.35
2,159,569.60
39,757.13
360,760.96
65,063.04
15,217.80
50,424.66
184,095.60
7,822,473.81

III

27383
23174

E. P e t e r

Hoffman




20783

(
(
(
(

34,563.73
112,960.27
7 3 , 5 8 3 . 4 1 (2)
107,979.48
5,679.59
25,768.64
10,843.84
(
7,608.90
C 8,404.11
30,682.60

147

Customer Name

Note No.

Amount of
Advance

No. of
Davs (1)

Exhibit B^2
Lost
Available
Funds

William Lockridge

24399

(16,273.97(2)
(92,027.40(2)

45
89

732,328.65
8,190,438.60
8,922,767.25

Longhorn Oil & Gas

27623
25805

(110,027.40(2)
( 38,509.59(2)
29,534.25

59
31
123

27333
26650

82,849.31(2)
178,859.59(2)

6,491,616.60
1,193,797.29
3,632,712.75
11,318,126.64
3,893,917.57
5,902,366.47

Mahan-Rowsey, Inc.
Max imo-Moor ing, Inc.

W. D. Newsom:
W. D. Newsom & Assoc. 26965
W. D. Newsom

27,759.78(2)
61,232.92(2)
4,166.14(2)
55,628.50<2)
6,398.63(2)
11,161.78(2)
15,164.87(2)

26959

W. D. Newsom & A s s o c .
Oilfield-Calif. Ltd.
Oklahoma HXghes

47
33

25162
26964
26961

(
(
(

94
33
101
33
33
33
26

2,609,419.32
2,020,686.36
420,780.14
1,835,740.50
211,154.79
368,338.74
394,286.62
7,860,406.47

16,972.27
14,578.43
4,173.44(2)

1
104
95

16,972.27
1,516,156.72
396,476.80
1,929,605.79-

J. P. Exploration

26232

Otex Energy

28247
24319

13,715.75
331,714.60(2)

38
20

David Palm

25771

8,375.02(2)

305

521,198.50
6,634,292.00
7,155,490.50
2,554,381.10

Samantha Petroleum

27423

57,945.20(2)

74

4,287,944.80

Joseph Sanson

25093
25109

24,302.93
24,532.77

115
116

2,794,836.95
2,845,801.32
5,640,638.27

0. L. Scott, Jr.

22261
27188

10,399.90
52,459.51(2)

2
47

Texoma Resources

27485

( 72,123.29
U 12,438.22(2)

18
14

20,799.80
2,465,596.97
2^486,396.77
1,298,219.22
174,135.08
1,472,354.30

Western Wells Co.

21852

( 16,688.01
( 105,944.56
( 47,880.21
( 39,202.40

Subtotal
Others, less than $1 million in Lost Available Funds

. 1
14
30
14

16,688.01
1,483,223.84
1,436,406.30
548,833.60
$3,<485,.
151. 75
,872 ,643 .27
$103,
8 ,836 ,153 .04
$112 ,708 ,796 .31

(1) The number of days outstanding is through November 30, 1981 and does not
include transactions in December.
(2) Outstanding advances as of November 30, 1981




148
Exhibit C
Penn Square Bank, N.A.
General Ledger/Trial Balance Comparison
November 30, 1981
General
Ledger

Computer
Trial Balance

Differenca

$2,656,629

November 30, 1981
Commercial, Real Estate & Construction loans outstanding
--PSB- portion

$236,549,125

$-233,892,496

IENC - Commercial, Real Estate &
Construction

$ 16,977,505

$ 18,270,678

Other Assets-Advances of Interest
on Participations

1,381,924
$ 18,359,429

Commercial, Real Estate & Construction
loan income and fees—11 months

$ 37,654,454

% IENC to loans outstanding

7.76%

%IENC (ending) to income, annualized

44.69%

Becember 30, 1980
Commercial, Real Estate, & Construction loans outstanding—PSB
portion

$ 1 7 9 ,, 7 6 5 , 5 7 4

lENC-Commercial, Real Estate, &
Construction

S

Commercial, Real Estate & Construction loans income and fees

$ 2 2 .,7 0 8 , 8 9 2 "

% IENC to loans outstanding
% IENC (ending) to income




6,, 4 8 3 , 4 0 0

3.61%
28.55%

$ 18,270,678-

$

88,751

149
Exhibit D

Penn Square Bank, N.A.
Advances of Interest to Participating Banks
as of November 30, 1981

Chase

$1,041,025.17

Michigan National

246,284.23

McAlester
Hibernia

13,168.00
. .

93,836.99

Utica

110,027.40

Northern Trust

347,515.97

Seattle First

43,996.93

Continental (Chicago)

238,087.46

Bank of Red Oak ,
1 (Northern Trust
(First Wagoner
(Michigan National

(1)

4,824.66
_
39.202.40
$2,177,969.21

Could not distinguish prepaid by bank.




150
Mr. BELLER. Which part are you referring to now, Mr. Chairman?
The CHAIRMAN. I just gave you the question based upon the
entire memo from Arlyn Hill to Mr. Gunter, that was then forwarded to you, that you discussed earlier. This is about the fact
that Penn Square Bank was paying interest to the upstream banks
when the borrowers were not paying the interest to the Penn
Square.
Mr. BELLER. Yes, sir, that is what we discussed earlier, where I
think that I said that as we found this had occurred that I asked
the chief financial officer to identify in detail and to have his
people work on it so that we could correct that and also stop it
from occurring in the future, and we did collect the interest from
the customers and notified the upstream correspondents what had
occurred and tried to put monitoring into place to make sure that
it wouldn't happen on an accidental basis again, and advised all
the people not to pay interest upstream.
The CHAIRMAN. And so once this was brought to your attention
in this December 8 memo—was that Pearl Harbor Day?
Mr. BELLER. Close.
The CHAIRMAN. That was the end; you stopped it?
Mr. BELLER. That is when it was brought to my attention, is
when we went to work on stopping it, yes, sir.
The CHAIRMAN. NOW, we have been told that you didn't have
much authority over energy-related loans and that portion of the
bank's business. Did your cease and desist order in this area apply
to participations in energy loans as well, controlled by Patterson
and Jennings?
Mr. BELLER. I don't understand the last question. Could you say
that again, please?
The CHAIRMAN. Earlier this morning you told us that your authority did not exist over energy-related loans and participations, is
that not correct?
Mr. BELLER. That is correct to a degree, yes, sir.
The CHAIRMAN. NOW, the problems related in this memo of December 8 were primarily problems on energy-related loans that had
been sold upstream, correct?
Mr. BELLER. Yes,

sir.

The CHAIRMAN. Did you have therefore the authority to stop that
practice, since you didn't have authority over energy-related loans?
Mr. BELLER. By working through the chief financial officer and
his personnel, through the accounting department, yes, sir.
The CHAIRMAN. YOU were able to stop it?
Mr. BELLER. We got it stopped, yes, sir.
The CHAIRMAN. And was this, a copy of this memo, forwarded to
the Office of the Comptroller of the Currency as well at the time
this occurred?
Mr. BELLER. I don't recall.
The CHAIRMAN. But it was available to them when they came to
the bank?
Mr. BELLER. Yes,

sir.

The CHAIRMAN. YOU were sending them periodic reports on a
voluntary basis, were you not?
Mr. BELLER. That is correct, sir.



151
The CHAIRMAN. YOU didn't feel that this was the type of memorandum and practice that they should be made aware of?
Mr. BELLER. The reports that were being sent were the reports
that were required to be sent under the letter agreement.
The CHAIRMAN. But as an individual brought in to straighten out
this institution, you didn't think that this was a rather unique
practice, an erroneous practice that should be stopped, and therefore wouldn't you have fared well with the Comptroller's Office by
saying, hey, look at what we found here that was being done, that
was certainly improper, we're going to put a stop to it? You didn't
feel that was a good report to send forward?
Mr. BELLER. I don't know.
The CHAIRMAN. But you didn't?
Mr. BELLER. TO my knowledege, no.
The CHAIRMAN. Mr. Beller, with all due respect, they brought
you in because the Comptroller's Office had swooped down and
said, hey, unless you make changes you've got bad days ahead. So
they brought you in, but they tied one and a half arms behind your
back and put you in a wheelchair. Yet they increased your salary
to I think what is a rather adequate amount, as a matter of fact a
very adequate amount for an institution of this size.
Did you ever go to bed at night and lie down in bed—because
that's when I do a lot of thinking and reflection—and say to yourself, am I being used by Mr. Jennings and Mr. Patterson?
Mr. BELLER. NO, I did not consider I was being used. I considered
that I certainly wanted to accomplish more faster than I was accomplishing it. But on the other hand, some of the things that were
being done, I felt that was making great strides.
The CHAIRMAN. I didn't mean that as being disrespectful, Mr.
Beller, because I say, these fellows conned Chase Manhattan, they
conned Continental Illinois. They conned the best.
Mr. ANNUNZIO. YOU were in good company. [Laughter.]
The CHAIRMAN. SO if they conned you, you shouldn't feel badly,
really. I think they conned the Comptroller, too. In fact, I'm becoming more and more convinced of the fact that they conned the
Comptroller of the Currency's Office—the past Comptroller, the
acting Comptroller, and the new Comptroller. So that they are exceptionally adept at it, and that is why I say, don't feel badly.
But boy, as I sit here and analyze this situation, I have my
doubts.
Mr. Beller, in those final days, that last week when not only the
temperatures in Oklahoma City got very high, but the temperatures within Penn Square Bank, the shopping center bank, got
very high and the tempers got very short, at any point did you consider just giving it up and saying, hey, here are the keys, I'm
taking off, I've had it?
Mr. BELLER. NO, sir, I did not, because I never thought the bank
would close. And I didn't undertake a very, very difficult job just to
quit in the middle of it.
Mr. BARNARD. Mr. Chairman, would you yield for a question?
The CHAIRMAN. Why, of course.
Mr. BARNARD. Mr. Beller, in your opinion—and I want to ask
this question again—do you think the Comptroller of the Currency



152
acted hastily in their decision to demand $30 million of you to replenish your capital and then close the bank?
Mr. BELLER. Well, that was their decision to make and it was not
something that we could negotiate.
Mr. BARNARD. But you have an opinion on it, don't you, sir?
Mr. BELLER. Sir?
Mr. BARNARD. YOU have an opinion? Here you are telling us that
you thought everything was going well and that they were implementing the policies that you brought to the bank and things were
just going just fine, except that the market price of energy sort of
hit the bottom, which I bring up in conjunction with this matter of
concentration.
But still, things were going so well. Didn't the Comptroller act a
little impulsively, impetuously?
Mr. BELLER. I am not in a position to call that shot. But I think
before this hearing is over with it will probably be more apparent
than it is today to a lot of people.
Mr. BARNARD. When did you think the bank was doomed?
Mr. BELLER. The day after it was closed. [Laughter.]
Mr. BARNARD. YOU didn't have that feeling the first day you
went to work, though, did you, sir?
Mr. BELLER. NO, sir. I never thought the bank would be closed.
Mr. BARNARD. Did you think the FDIC was going to come up
with all of that money they have got and bail you out and let you
make a good financial merger or an acquisition and then you
would be scot-free?
Mr. BELLER. Well, as I've read in the newspapers, I think maybe
it's the third time that a bank has been closed that way in about 50
years. What is normal is hundreds of banks are reorganized every
year. That is normal.
Mr. BARNARD. That is normal. But on the other hand, if that is
what people are looking for as the salvation of their depositors
while they run rampant with loose banking policies, that ain't
going to happen no more.
The CHAIRMAN. I would like to associate myself with the gentleman's remarks. It's unfortunate for a lot of people. We wish that it
wouldn't have happened. But people have got to learn. They have
to go a little further, you know.
In reading material since arriving here that the staff has
gleaned—did you have any connection with the holding company,
Mr. Beller?
Mr. BELLER. Yes, I was vice president of the holding company.
The CHAIRMAN. Were you with the holding company when they
were looking for—when they made a private placement to sell
some stock in the holding company?
Mr. BELLER. They sold some
The CHAIRMAN. I'm trying to look for the staff to give me the
date of that.
Mr. BELLER. That is what I was going to ask.
The CHAIRMAN. That was May 18, 1981. The reason I asked that
is that when I looked at that particular
Mr. BELLER. May of 1981. No, sir, I would not have been a director—I mean, a vice president—of the holding company.
The CHAIRMAN. They had not put you on board there yet?



153
Mr. BELLER. NO, sir.

The CHAIRMAN. The reason I asked that is that, very frankly, if
anyone had seen that private placement letter they would be
amazed at the fact that that particular letter did indeed cite many
of the problems that existed at Penn Square Bank.
Do you have a question, Mr. Annunzio?
Mr. ANNUNZIO. Thank you, Mr. Chairman.
The CHAIRMAN. Why don't you ask that while I try to find this
letter.
Mr. ANNUNZIO. Mr. Beller, for the record I would like to have
answered: Who ran the bank?
Mr. BELLER. Who ran the bank?
Mr. ANNUNZIO. Yes.

Mr. BELLER. In all banks, the chairman of the board and chief
executive officer run banks on a daily basis, and the board of directors run it overall.
Mr. ANNUNZIO. SO that—I want you to tell me, what was the
man's name who ran the bank? Who was the chairman of the
board and the chief executive officer?
Mr. BELLER. Mr. Jennings.
Mr. ANNUNZIO. Mr. Jennings.
Mr. BARNARD. Mr. Chairman, while you're looking, could I ask
another question?
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. I would like to ask Mr. Dunn a question, if I
might. Mr. Dunn, as loan administration officer during this time,
as oil prices, energy prices, declined how did the bank adjust its reserves to support the loans that had been made? How was that
done?
Mr. DUNN. The engineers in the department, as a matter of
normal practice—and I think this is prevalent throughout the industry—would take the discounted cash flow of the proven reserves
and come up with a figure. Then they would discount that figure
by 50 percent, in essence, to give you a 50 percent cushion.
This is a rather complicated formula, but the annual discount
figure could be adjusted upward or downward. It was adjusted
upward as inflation and the interest rates continued to remain
high. It was adjusted from 12 to 15 percent, as I recall. On the
other side, these escalating oil prices that had been prevalent
throughout 1979, 1980, and so forth, there was I think an 8 percent
factor that was used.
We followed the lead of—I believe I was told we followed the lead
of Continental Illinois in this regard and their standards exactly.
The normal 8 percent factor applied to oil prices was deleted and
through the formula used in coming up with the engineering reserve values the prices were held to be flat for 2 years. This practice was begun I believe in the first quarter of 1982, around January or February.
Mr. BARNARD. NOW, you were relying on the estimates of your
own engineers, right? They were not outside engineers offering you
an unbiased opinion?
Mr. DUNN. In most cases I believe outside engineering was put
together and reviewed by our in-house engineers, and also by the
participating bank's engineering division.



154
Mr. BARNARD. Well, was there some type of certification or documentation by outside engineers?
Mr. DUNN. Yes, sir, there were reports put together that were
very lengthy and very technical. Our in house engineers had a way
of going through the same technical gyrations and coming up with
a very simple loan analysis, a page or two which would give you
the amount of the loan that you could lend against the reserves
based upon the report.
Mr. BARNARD. And your participating banks very agreeably accepted your engineers' reports and estimates?
Mr. DUNN. I wasn't present when any representative—and it was
my belief and is my belief that they had their own engineering
department in most cases, in the large cases, Continental and some
of the others.
Mr. BARNARD. Did their analysts or engineers ever come to Penn
Square and make an onsite inspection of your loan portfolio?
Mr. DUNN. Engineers? I don't think I ever met any engineers.
However, it would not surprise me if they had. Some of the loan
officers with those banks had a petroleum geology degree in their
background, or experience with oil companies, before they had
gone to work for the banks.
Mr. BARNARD. The staff of your department, the loan administration department as far as the engineers and those administering
these loans, did they have prior bank experience?
Mr. DUNN. In some cases. The engineers were not under my
jurisdiction.
Mr. BARNARD. Under whose jurisdiction did they work?
Mr. DUNN. Bill Patterson.
I'm not aware of any of them who had prior banking backgrounds. However, they had experience with oil companies. They
were very technical, analytical type individuals.
Mr. BARNARD. Thank you, s r
i.
The CHAIRMAN. Mr. Leach?
Mr. LEACH. Mr. Beller, I think it has been well established that
you're not responsible for the bank practices. There is some question however, as to whether you were entirely blind to what was
happening. I stress this because some of the losers in this bank failure are local people who bought commercial paper from the bank.
In offering commercial paper for sale, the bank presumably was
acting in good faith. On the other hand, there wasn't a lot of disclosure about the bank's problems. Can you tell us the mechanisms by
which commercial paper was sold to customers, how much of it was
sold, and how much was disclosed at the time of its sale?
Mr. BELLER. Well, it was normal for commercial paper to be sold
to some of the major companies that would purchase the paper on
different time schedules. I don't know really what I can tell you
about that.
Mr. LEACH. The bank holding company sold commercial paper?
Mr. BELLER. Yes.
Mr. LEACH. YOU

were not responsible for that, is that what
you're saying?
Mr. BELLER. Well, sir, to my knowledge everything was—commercial paper that was being sold at the bank had been sold there



155
for a long time, and everything was done in accordance with the
manner in which it should have been done.
The CHAIRMAN. Would the gentleman yield?
Mr. LEACH. Of course.
The CHAIRMAN. Well, I just read here that "At present the company invests"—that is, the holding company—"the proceeds of
sales of commercial paper in deposits in the bank. Interest paid by
the bank by the company is less than interest paid by the company
on its commercial paper."
[Chairman St Germain read an excerpt from "Confidential Offering Circular" which appears in the appendix to the hearing as appendix A.]
The CHAIRMAN. In other words, they were selling commercial
paper, taking that money, putting it in Penn Square Bank, and getting less from Penn Square Bank for the commercial paper than
they were paying to the purchasers of that commercial paper.
Do you think that that is standard order or procedure?
Mr. BELLER. What is the date of that?
The CHAIRMAN. May 1981.
Mr. BELLER. May 1981. What

you have read was correct at that
time, but I think you will find that later on that we recognized that
and we made some changes with it, and that that situation was reversed.
Mr. LEACH. Let me ask about one aspect of your commercial
paper sales that alarms me a great deal. In referring to the oil and
gas division, you mentioned that some commitments were made in
writing and some verbally and that you had a very difficult time
understanding them. Is the making of verbal commitments a standard operating procedure of any bank? And, if there were verbal
commitments that could not be understood, how could you as president of a bank in good faith sell commercial paper to the people in
your community? After all, such an investment is not protected by
the Federal Deposit Insurance Corporation.
Mr. BELLER. Well, I do not know how to answer that.
Mr. LEACH. Thank you very much.
The CHAIRMAN. Mr. Annunzio?
Mr. ANNUNZIO. One last question, again, Mr. Beller. I would like
to, as you reflect back on being president of the bank, can you give
us an opinion? Do you feel that the Comptroller of the Currency
knew what he was doing?
Mr. BELLER. Well, I hope he did. My opinion at the time was
that, yes, he knew what he was doing.
Mr. ANNUNZIO. But the bank failed. You agree with the decision?
Mr. BELLER. DO I agree with what, sir?
Mr. ANNUNZIO. The decision they made to shut down.
Mr. BELLER. Well, of course, the bank failed because it was rendered insolvent, because they charged off so many loans, and I do
not know what those loans are as of this day. I have not seen a list
of those loans that were charged off, and the collectability of those
loans. How good it is, I have no way of knowing, because I still do
not even know what loans were charged off.
Mr. ANNUNZIO. We have been through this before. In other
words, you were selling this commercial paper and paying x
number of dollars of interest, and actually paying out more than
97-830

0 - 8 2 - 1 1




156
you were buying for the paper. It reminds me of the deficit t h a t
the Federal Government has got. We spend more t h a n we take in.
Mr. BELLER. I became aware of that shortly after I got to the
bank, and was very disturbed about it. I did not agree with it,
either.
Mr. ANNUNZIO. SO what did you do about it?
Mr. BELLER. Well, certainly, we changed it to the point where, as
I recall, t h a t t h a t was not the case later.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Wortley?
Mr. WORTLEY. Thank you, Mr. Chairman.
One last question, Mr. Beller. Why did Penn Square continue to
lend heavily in the face of the oil and gas slump t h a t the industry
was going through?
Mr. BELLER. Well, as I said before, trying to relate to what was
referred to as the loans within the pipeline, the loans t h a t were
previously committed to by Penn Square Bank and their participating banks, those loans were ongoing, and committed to many,
many months before the actual funding of those loans. So, as the
energy continued to build, the loans and the base t h a t the loans
were based off of continued to pyramid itself.
Mr. WORTLEY. In other words, the only loans t h a t were made
during the slump were those t h a t previously had been committed?
Mr. BELLER. N O , sir. I did not say that. No. There were other
loans. None t h a t I can specifically relate to you but certainly it was
not all that.
Mr. WORTLEY. And is not prudence the trademark of a good
banker?
Mr. BELLER. It should be. Yes, sir.
Mr. WORTLEY. Why wasn't the board of directors—and I am not
trying to lay this specifically at your doorstep, because I realize
t h a t you had little to do with the loans in the energy area, but why
would the board of directors ever tolerate some imprudent action?
Mr. BELLER. I do not think I can answer for them.
Mr. WORTLEY. Were they part of the group that was borrowing?
Mr. BELLER. Well, I think there were some of them, yes, t h a t had
loans from the bank, which was normal.
Mr. WORTLEY. Thank you.
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Evans?
Mr. EVANS of Indiana. Thank you, Mr. Chairman.
Mr. Dunn and Mr. Preston, as you know, the Comptroller's
Office continually criticized Penn Square for its failure to institute
proper asset-liability management systems. In fact, the last examination states that the bank had continued this practice to the end,
and had huge volumes of lending commitments and letters of credit
outstanding. As major officials of this bank, what steps did you
take to address these concerns of the Comptrollers' Office?
Mr. PRESTON. DO you have a preference as to who goes first?
Mr. EVANS of Indiana. No, whatever.
Mr. PRESTON. In the fall of 1981, I was asked by the president to
look into letter of credit matters from a legal viewpoint, and at
t h a t point I made a recommendation in regard to how letters of
credit should be prepared, how they should be booked, t h a t the is-




157
suance of letters of credit should be removed from the energy division and set up under the loan administration division.
Subsequent to making those recommendations, those steps were
put in place, as I recall, in the first month of 1982. In terms of the
commitments t h a t were in place, many of those commitments, as I
understood them, I did not participate in the lending side of the
bank, and was not on those committees, but as I understood them,
existed at the time that I joined the bank, because I recall that the
Comptroller's Office referred to the large number of commitments
at the July 29 board meeting in Dallas. Those commitments were
not going to go away, and they would have had to have been
funded or they would have had to have been denied by the bank to
be funded with the resultant litigation t h a t would arise over them.
Mr. EVANS of Indiana. Mr. Dunn?
Mr. D U N N . I think the first step in the process would be to identify commitments and continue these so t h a t you did not know it
existed. As John pointed out, around year end, we sought to put
together a new and well staffed letter of credit function, and of
course letters of credit are only one part of the whole area of contingent liabilities, but this was one area in which we made some
attempts to staff t h a t area, identify the letters of credit t h a t were
already on our books as commitments, and to put in place procedures to control future letters of credit in terms of the operational
matters involved, what were their terms, their maturity, collateralized or uncollateralized, as well as the legal aspects of the form
and substance within the letter itself.
Mr. EVANS of Indiana. And so policies were instituted then to
assure that loan commitments and letters of credit could be funded
when they were called?
Mr. DUNN. Yes, sir. Could be funded. If the letter is called, you
have no choice other than to fund it, so t h a t was not really what
we were after. We were trying to gain insight into what already
existed within the bank, what had already been committed to,
what the bank was liable for.
Mr. EVANS of Indiana. So controls were placed on lending officers?
Mr. D U N N . From an operational standpoint. Yes, sir. In other
words, certain procedures were to go into effect before a letter was
to be issued. The form had to be approved by not only the lending
committee supposedly but the general counsel, and steps were provided from an operational standpoint, was where we made the best
gains to identify the portfolio with a minicomputer we put in place
in another area outside of letters of credit. The overall contingent
liabilities and unfunded loan commitments, for example.
If a loan for $10 million is committed and initially or at any
point the total $10 million, say, is not funded, the balance remains
as a contingent liability of the bank. That had not been identified,
and it was a very difficult process with the computer systems and
the operations in place to do so, but after months of attempts that
was done and provided to the Comptroller when they came to the
bank at their normal examination,
Mr. PRESTON. A S a member of the asset and liability committee,
and as a director, my recollection was t h a t in, I believe, the early
part of 1982, there was a policy put in place, if it had not been put



158
in place before that, that was confirmed, as I recall, to the board
and to that committee, that in fact no additional commitments
were being made or could be made—that would be policy—without
that commitment having been what the bank referred to as presold
or in fact a participation in place with a corresponding bank relating to that commitment prior to the time that that commitment
was passed on to the borrower.
Mr. EVANS of Indiana. Thank you, Mr. Chairman.
Mr. LEACH. Mr. Chairman?
The CHAIRMAN. Mr. Leach.
Mr. LEACH. It is my understanding that the Comptroller's Office
was informed by you at their September 30 supervisory examination that you had placed a $50,000 limit on Mr. Patterson and his
operation. Is that an accurate statement?
Mr. BELLER. I had placed a $50,000 limit on any funding going
out of the bank without it being reviewed before it went to the discount department for funding, because the bank was in a tight situation in regard to loans to deposit ratio, and we were concerned
about liquidity. Yes, sir.
Mr. LEACH. YOU had informed the Comptroller's Office that you
had a $50,000 limit?
Mr. BELLER. Yes, sir.
Mr. LEACH. And yet

you have told us that you had no control
over Mr. Patterson. Which is the accurate description of the situation?
Mr. BELLER. The accurate description is that I was attempting to
control, but was unable to do so.
Mr. LEACH. Was the Comptroller's Office subsequently informed
that you were unable to exercise control?
Mr. BELLER. In a formal fashion, I do not know.
Mr. LEACH. I would like to make one final observation relating to
Mr. Dunn's comments on the letters of credit. The letter of credit
issue should be examined both as a banking problem and an investor problem. As we look at the problems of this bank, which also
reflect problems in the oil and gas industry, it is fair to raise some
red flags to the American public about highly leveraged letters of
credit type operations. They are not as safe as many of us had once
thought they might be. While a bank may prudently seek letters of
credit to protect itself, the American investing public should be
very, very concerned about any leveraged investment involving
substantial letters of credit which while they might appear unlikely to be called upon might well have to be called upon.
Would you agree with that, Mr. Dunn?
Mr. DUNN. AS general investment advice to the general public,
yes, sir.
Mr. LEACH. Thank you very much.
The CHAIRMAN. Mr. Preston. Wait. First, Mr. Dunn, on letters of
credit you gave us a nice description of the policy, et cetera, but did
that apply to letters of credit as far as Mr. Patterson and his
machinations were concerned? Maybe you thought it might apply,
but did it indeed in fact apply?
Mr. DUNN. Not totally. No, sir.



159
The CHAIRMAN. NO, because we are aware of the fact that there
are some lawsuits pending, are there not, with respect to some of
those machinations?
Mr. DUNN. I have read of those. I do not know if those were committed 3 years ago or 1 year ago. I do not think they are recent
letters of credit that are involved in those lawsuits. I want to distinguish here between the operational aspects of controlling the
portfolio versus the actual lending decisions made. The systems
that we were attempting to put in place was step 1, which was to
find out what you have so that you can take a look at it and
manage it, and see if it is laced with efficiencies and so forth, and
set about to correct those, and efforts were made in that area.
The CHAIRMAN. Mr. Preston, as chief legal officer of Penn
Square, or general counsel, is that title correct?
Mr. PRESTON. That is correct, sir.
The CHAIRMAN. Did you ever advise the officers of the bank concerning the memorandum that I discussed with Mr. Beller, that is,
the payment of interest and principle on nonperforming participation loans to those people who purchased these participation loans
without informing the purchasers of the participation loans that
interest was being paid by Penn Square on behalf of the borrower?
Mr. PRESTON. TO answer your question, first, I have not seen this
memorandum to my knowledge until today. I did become aware of
the problem of paying upstream correspondents interest when the
bank had not collected it from its customer, I believe in May or
June of this year, during an examination, and at that time I had
been asked by the president to look into the issue. I did, and referred the issue to our outside regulatory counsel. I do not recall
whether I wrote a memorandum or not of a general nature or a
specific nature dealing with that issue.
The CHAIRMAN. YOU, I believe, were here when Mr. Beller read
us the limitations on his authority as president of Penn Square.
Mr. PRESTON. I was here when he read those, yes, sir.
The CHAIRMAN. Were you aware of those limitations prior to this
morning?
Mr. PRESTON. Not until he read them, sir.
The CHAIRMAN. Not until he read them. Did they have intercom
telephones in the Penn Square Bank?
Mr. PRESTON. I am sorry, I do not know what you mean.
The CHAIRMAN. Well, I mean, could you call Mr. Beller's office or
Mr. Dunn's office on a telephone? Was your office in the Penn
Square Bank?
Mr. PRESTON. Yes, sir.
The CHAIRMAN. In the shopping center?
Mr. PRESTON. It was originally removed

from where Mr. Better's
was. It was ultimately next to Mr. Beliefs.
The CHAIRMAN. OK, but you had communication facilities?
Mr. PRESTON. Yes,

sir.

The CHAIRMAN. And there were Xerox machines in the bank?
Mr. PRESTON. Yes,

sir.

The CHAIRMAN. And there were secretaries who could type and
take shorthand?
Mr. PRESTON. Yes,



sir.

160
The CHAIRMAN. It seems to me there was a lot of lack of communication here. Would you think so, Mr. Preston?
Mr. PRESTON. I do not know how you mean that question.
The CHAIRMAN. Well, you were not aware of this memo that I
just referred to until May or June, yet it was a December 8, 1981,
memo. You were not aware of the limitations placed upon the gentleman who asked you to come along to Penn Square from your
previous employment. Wouldn't that have given you cause to
wonder? In other words, I am going over there with a president of
an institution, but he is limited jurisdictionwise to about 20 percent
of the activities of that institution. Do you not think you should
have known about that?
Mr. PRESTON. I believe I should have known about it, but I did
not know about it.
The CHAIRMAN. But in all truth, you should have known about
it, should you not, so you would be better able to analyze what you
were stepping into?
Mr. PRESTON. Yes,

sir.

The CHAIRMAN. IS this a promotion or demotion or what? Correct?
Mr. PRESTON. It would have been helpful to know that.
The CHAIRMAN. Well, I would certainly like to know those things
if somebody asks me to go along with them.
Let me ask you this. There is a suspicion of the fact, and this is
sort of being corroborated because of the facts that are being
brought out, to wit, that we are finding participation loans that
were sold to upstream banks that were not performing too well,
and the next thing you know, they are back in Penn Square,
almost to a point, and as I say, I want to make this clear, we do not
have it capped yet, we do not have it signed, sealed, and delivered,
but it looks very much as though there is a possibility on these
loans that there was a tacit agreement, A, you buy this loan, if it
ends up being a nonperforming loan, we, Penn Square, will take it
back.
Did that come to your attention at any point, any suspicion of
that practice?
Mr. PRESTON. It did in, I believe, May or June of this year.
The CHAIRMAN. Did that come to your attention, Mr. Beller?
Mr. BELLER. Not that there were any agreements to buy them
back.
The CHAIRMAN. I said tacit agreement. Sometimes you may not
see it in writing, but by crackey, the facts as we in the law know,
the facts speak for themselves.
Mr. BELLER. I do not know.
The CHAIRMAN. My colleague, the eminent banker from Georgia,
tells me res ipsa loquitur. I have just been handed a letter by staff,
January 28, 1981, Mr. Patterson, from John R. Lytle—L-y-t-1-e. Is
that the fellow that got the loan?
Mr. BELLER. That is correct.
The CHAIRMAN. We are checking that a little further. By the
way, homes in the Chicago area, Mr. Annunzio informs me, if you
live in the right area of Chicago, $500,000 is not a lot for a house. It
is a lot in Woonsocket, R.I., I will tell you.
[The letter, in part, follows:]



161
DEAR BILL: Just want you to know that Caroline Janda had her meeting with
Arnold Middeldorf and his people at Michigan National determined that they are
pleased with the package of credits we put together last November. I feel they are
grateful both to you and to us for the help. It looks like they are growing both in
confidence and understanding of oil-related lending. Bill Patterson and Bill Dell
were given these people's reference, but as we did previously, I reassured them that
we would take the credits out at maturity or whenever they felt unconfident.

[The letter in its entirety follows:]
CONTINENTAL BANK
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO • 231 SOUTH LA SALLE STREET. CHICAGO. ILLINOIS 606S
*»-..,,,— 0 Q
January 28,

JOHN It LYTL
VICE PRES.DEM

1QA1

1981

312/823-434

Mr. Milliam Patterson
Executive Vice President
Perm Square Bank
1919 Penn Square
Oklahoma City, Oklahoma 73126
Dear Bill:

Just want you to know that Caroline Janda and her crew had
a meeting with Arnold Middeldorf and h i s people at Michigan
National and determined that they are pleased with the
package of credits that we put together l a s t November. I
f e e l they are grateful both to you and to us for the help.
I t looks l i k e they are growing both in confidence and
understanding of o i l related lending, but as we did previously, I reassured them that we_would_take_the credits out
at maturity or whenever they f e l t unconfident.
Thanks again for your help. I think that t h i s i s a s e r v i c e ,
that working together, we can provide to others.
Sincerely,,

JS

Ufrefovx/.




**"/?/

0 8 1 7 3 ;> - ^

SUBSIDIARY OF CONTINENTAL ILLINOIS CORPORATION

£^_

~\

162
The CHAIRMAN. Mr. Preston, does that not sound to you like an
agreement to take it back, to repurchase? And this one is not too
tacit, is it?
Mr. PRESTON. Well, I do not have that document in front of me.
The CHAIRMAN. DO we have a copy to give to the gentleman?
Mr. PRESTON. I do not recall seeing it, but I agree with your
statement.
The CHAIRMAN. The date of this is January 28, 1981, an informal
takeout agreement to purchase by Continental, and who signed
this? This is from Peat, Marwick, Mitchell, & Co. Oh, Arthur
Young, 1981; 1981. In January of 1981. Did you retain Peat, Marwick, after April of 1981?
Mr. BELLER. Yes.

The CHAIRMAN. SO they had that informal agreement. We will
send it down and let you take a look at it.
Mr. BARNARD. Mr. Chairman, didn't our legal counsel tell us that
maybe against the law?
The CHAIRMAN. Well, we discussed it with our counsel last night,
in our late hour briefing, and it seems to us that it should be
looked at very thoroughly to see about its legality or illegality, but
I think we are going to find that illegal things in this institution
were not out of the ordinary.
Mr. BARNARD. Well, of course, this is locking the door after the
horse's loan has gone.
[General laughter.]
Mr. BARNARD. But it looks to me, though, that the Comptroller's
Office or the FDIC would classify a participation loan with a buyback provision as a deposit against which reserves are supposed to
be made. Is that not true?
The CHAIRMAN. Well, I would have to agree with the gentleman.
Mr. BARNARD. Mr. Beller, would that not be true?
Mr. BELLER. I believe that you would look at it that way, yes, sir.
Mr. BARNARD. Thank you.
The CHAIRMAN. Mr. Beller, you were on the board of directors of
Penn Square in 1982?
Mr. BELLER. Correct.
The CHAIRMAN. NOW, I have here a series of minutes of meetings
of the board of directors, January 12, 1982. At that meeting, the
secretary noted "that loans associated with Bill Patterson in the
amount of $650,000, board approval required", and he did indeed
get it, and then later on Mr. Patterson again—where are we—
March 16, 1982, "Bill Patterson totaling $2,800,000." That was the
March 16, 1982, meeting.
Then there is another meeting on April 2, 1982. The total
amount of the loan to Bill Patterson was $3 million. "Extension of
any loans previously made to Bill by said officers is hereby specifically ratified and approved." Were you at these meetings with the
escalation of loans to Mr. Patterson, where it was occurring?
[A copy of meeting minutes from April 14, 1981 through June 15,
1982, appear in the appendix section as appendix B]
Mr. BELLER. In those directors' meetings?
The CHAIRMAN. Yes, sir.
Mr. BELLER. Yes, sir.



163
The CHAIRMAN. DO you recall what the purpose of those loans
was?
Mr. BELLER. Not in the specific amounts. I can recall conditions.
There was one loan that was to Mahan-Rowsey, an affiliated loan
for Mr. Patterson and a couple of other gentlemen, where they borrowed money to purchase—it was not Mahan-Rowsey. Let me think
about that a little bit and try to figure out which loan it was.
Maximo, that is what it was. It was where he and a couple of other
gentlemen borrowed funds to acquire the Maximo-Mooring for the
ultimate sale, as I recall, to the Heller Co.
The CHAIRMAN. At this point in time, I would like unanimous
consent for the committee to put in the memorandum dated December 8, 1981, which I have been quoting from, with respect to
the payment of interest on participation loans, and then there is
the private placement letter that was quoted from earlier, from
May of 1981. That is the one, the placement letter from the holding
company offering in May of 1981, and then I think we have another memorandum we want to put in. I have got the private placement and the December 8, 1981, and the letter to Mr. Patterson
that I just showed Mr. Preston from Mr. Lytle of Continental Illinois. Without objection, those will all be placed in the record.
The CHAIRMAN. Mr. Beller, one of the very prominent members
of the Oklahoma City community who was, I think, a director of
the bank and a rather substantial borrower or business customer of
the bank was a gentleman named Carl Swan.
Mr. BELLER. Yes.

The CHAIRMAN. Did you meet Mr. Swan?
Mr. BELLER. Yes,
The CHAIRMAN.

sir.

Would you say he was rather influential as a
member of the board of directors of that institution? Did he participate in the board of directors meetings?
Mr. BELLER. Yes, sir. He was at the board meetings, and he was a
substantial borrower through the bank, with his loans being
funded by the upstream correspondents. Yes, sir.
The CHAIRMAN. Tell me, do you feel he was, and I do not mean
this in a derogatory fashion in any way, but from what I have read,
he is a rather influential, rather substantial individual. As a
member of the board of directors, was he what you would call on
the boards of directors you have, people who go to the meeting, and
they sit back and they listen, and you have those who go to the
meeting and are real, actual, active participants, because they have
knowledge of the background and what have you.
Mr. BELLER. Yes.

The CHAIRMAN. HOW would you classify Mr. Swan?
Mr. BELLER. I would classify him as a director who fell in between the two extremes.
The CHAIRMAN. But did you feel that he gave helpful input?
Mr. BELLER. He would make comments in the directors' meetings
relative to what he anticipated was going to happen to drilling rigs
in the future, what he thought was going to occur as far as pricing
in the energy field in the future, oil prices, gas prices, things of
that nature, which would give input.
The CHAIRMAN. And this was his area of expertise, I am told.



164
Mr. BELLER. Yes, which would, I am sure, gave some comfort to
not only me but other directors, that his input was assisting in us
trying to evaluate what was happening in the industry in which we
were concentrating efforts.
The CHAIRMAN. However, he did not attempt to evaluate individual loans?
Mr. BELLER. N O , sir.
The CHAIRMAN. Or collateral for individual loans?
Mr. BELLER. N O , sir.
The CHAIRMAN. NOW, we just read about Mr. Patterson's

line of
credit with the bank. Mr. Swan also was a substantial borrower
from Penn Square.
Mr. BELLER. Yes, sir.
The CHAIRMAN. DO you

feel as though as far as his borrowings
and those of his affiliated companies were concerned, t h a t there
was no—at any time did they exceed the limits that are placed on
insiders, such as members of the board of directors or major stockholders?
Mr. BELLER. It certainly never occurred in a deliberate fashion. It
was never intended. We had systems and procedures set up to try
to cope with that. We had lines of credit established for the directors ahead of the fact, and if there was such occurrence, I am not
aware of it.
The CHAIRMAN. YOU say there were loans that were bought by
some of the upstream banks and institutions. Were any of those
sent back as we were told might happen in the letter I just read to
Mr. Preston? Were any of those participations t h a t went upstream
in which Mr. Swan was involved as a borrower? Were any of those
returned to Penn Square or repurchased by Penn Square?
Mr. BELLER. I do not know. I would not be surprised if some were
for the purposes of the loan was being reworked, redone, and was
becoming a different type of loan, and was moving out of one category and into another category, and maybe into a production loan
for a term out, and things of t h a t nature t h a t would seem to be
normal in that type of lending.
The CHAIRMAN. Lastly on this issue, to the best of your knowledge, at the time Penn Square was shut down on the 5th or the
6th, did Mr. Swan or any of his affiliated companies have any loans
with Penn Square t h a t were classified loans or problem loans?
Mr. BELLER. Yes,
The CHAIRMAN.

sir.

There were some of those loans t h a t were
classified by the Comptroller's Office?
Mr. BELLER. Yes,
The CHAIRMAN.

sir.

Does anyone else have any further questions at

this point?
[No response.]
The CHAIRMAN. If not, the Chair would like to express its deep
appreciation to the panel. Despite the fact t h a t some might think it
is warm in here, when you go outside, it is cooler in here t h a n it is
outdoors. Mr. Beller in particular. I do not know if you are employed at the moment or not. If you are not, we would certainly be
most grateful to you if you could be with us a little longer, in case
something comes up through further witnesses t h a t might evoke a
situation where we could need your assistance and guidance.



165
Mr. BELLER. I will stay available.
The CHAIRMAN. If you are able to.
Mr. BELLER. I will.
The CHAIRMAN. It is common practice with the committee, I
know, but I would like to ask if we could look for cooperation from
you gentlemen in this instance as well. Oftentimes questions come
to mind that did not occur to us at the time of the hearing, and we
have a practice of sending questions in writing. If this should
occur, we would either do t h a t or have staff contact you. Would
that be acceptable?
Mr. BELLER. Yes,

sir.

Mr, PRESTON. Yes. Mr. Chairman.
Mr. D U N N . Yes,

sir.

The CHAIRMAN. Well, under the circumstances again, on behalf
of the committee and myself, I want to express our deep appreciation to you for all of your assistance this morning.
Mr. BELLER. Thank you, Mr. Chairman.
Mr. PRESTON. Mr. Chairman, I have been reemployed, so if I
could be excused.
The CHAIRMAN. Yes. Thank you, Mr, Preston, and congratulations. [General laughter.]
The CHAIRMAN. NOW, we will call our panel composed of Mr.
Richard Haugland, Mr. James Randolph, Mr. Gary Cook, Ms. Elizabeth Merrick Coe, W. A. Ross, J e r r y Richardson, and Gene
Smelser. So, if you would all be kind enough to come up to the witness table, we will go through the process of swearing you in.
[Witnesses sworn.]
TESTIMONY OF RICHARD HAUGLAND, JAMES G. RANDOLPH,
GARY COOK, ELIZABETH MERRICK COE, W. A. ROSS, JERRY
RICHARDSON, AND GENE SMELSER
The CHAIRMAN. A S I think you all know, we did not, because of
the circumstances, we do not look upon you as professional witnesses, as we do the high-powered, highly paid lobbyists t h a t usually come before us in Washington, so we did not require any written
or prepared statements, but I understand from staff t h a t Mr. Randolph would like to make an oral statement, and you are all public
directors, outside directors of Penn Square, correct?
Mr. Ross. Yes, t h a t is correct.
The CHAIRMAN. Mr. Randolph, we would be happy to hear from
you at this point.
Mr. RANDOLPH. Thank you. I would like to speak on behalf of the
seven outside directors. Is this on?
The CHAIRMAN. Unfortunately, you have to almost swallow it.
Pretend you are eating an ice cream cone, and you have not had
any ice cream in a month.
Mr. RANDOLPH. Well, perhaps some background just to show the
diversity of the board.
I am a graduate of the University of Michigan in engineering. I
have a master's degree from George Washington University, and I
attended the advanced management program of the Harvard Business School. I am also a graduate of the Army Command General
Staff College and the National War College, so you might ask me



166
why I am a banker. Well, I spent almost 28 years' active service
with the Air Force, and left the Air Force as a major general in
1976, and immediately joined, as president, a new company that
had been formed to develop coal reserves and to market those coal
reserves headquartered here in Oklahoma. We have built two
mines and have started a third one. Last year our production
ranked about 12th or 13th in the Nation in terms of volume.
I met Bill Jennings while I was still in the Air Force here at the
local base, and he asked me to join the board shortly after I left the
Air Force. I declined at the time, but after a number of additional
requests, I did join the board in the summer of 1979. As I mentioned, I had no prior experience in banking nor as a bank director,
although I had a limited period of service as a director of a halfbillion-dollar savings and loan association.
Bill's reason for wanting me on the board was to get my help in
assisting him in guiding the board and developing the bank organization and management team, and he felt that my experience in
managing rather large organizations would be of value to the
board, particularly since most of the other board members' primary
experience was in small businesses.
My first impressions after joining the board were: It was
different from a savings and loan, the bank was operated somewhat as a proprietorship, as opposed to a public company. There
was no formal monthly plan or budget. The management depth
was thin. Bill at that time, was really running the bank, and he
had no heir apparent at that time to take over in case something
should happen to him. And more importantly, there was no automated management information system.
And so, some of my first contributions or suggestion to him was
that the bank certainly needed to develop a budget plan, because
that gave you a tool to measure where you had been and to explain
the differences and see what was happening.
The CHAIRMAN. What was the date of this again?
Mr. RANDOLPH. This was in the fall of 1979, early 1980. And I felt
we needed a longer range plan to define the manpower and capital
requirements for the organization, and certainly we needed to get
away from the manual management information flow and to use
computers to improve the quality of the management information,
and we certainly needed additional senior management personnel.
I don't think we—first of all, being the new man on the block
and the young guy on the board, you do not come in and make a
lot of waves initially, because you feel your way in, but I had expressed these points to Bill, and I think he recognized that these
needed to be done, but he had not had a chance to react to them.
The CHAIRMAN. Could I say something to you, Mr. Randolph? I
do not think the outside members of the board get paid very much
compared to auditors like Peat, Marwick, or Arthur Young, but I
must say that you know, you tell Mr. Jennings what the bank had
to pay big numbers for through these accounting firms, so I congratulate you, because you were telling them exactly what they
were told. You gave it to them practically free, and they paid a lot.
Subsequently, I assume, you saw these management letters where
that which you are stating now was recommended, so that is fantastic.



167
Mr. RANDOLPH. Well, of course, I had been on the board only a
few months when we got the first examination, and being from a
military background, I characterized this as an IG inspection, of
which I had had a few. Before the examination the board had already been discussing with Mr. Jennings the need for additional
capital. We recognized that we needed to place additional capital in
the bank.
But the points of the examination that stood out in my mind
were the need for additional capital and the need for an additional
or stronger management team, because most of the conditions they
cited were really because of a lack of adequate management staff,
and the lack of procedures and controls, there was also a need to
better manage the liquidity either by increasing the deposits in the
bank or by restraining the lending actions. All other points that I
remember from that first examination, in which we went to Dallas
in August of 1980, were primarily what I would call technical discrepancies, more of form rather than substance.
When we went to Dallas in August of 1980, Mr. Poole briefed us
of his findings, and his briefing basically reinforced my initial impression that there was definitely a need for greater management
control and planning, a need for additional quality people to
manage the growth and change. And as far as I am concerned, the
meeting was very instructive to me, because it kind of reinforced
and lent credence to some of the points that I had initially.
As a result of that meeting, the board did see that additional capital was put into the bank, additional shares of stock were sold in
the holding company, and we brought our capital reserves up to
our peer group, and we tried to maintain it at about 7% percent
throughout the remainder of the life of the bank.
We then put additional pressure on Bill to hire additional experienced bank managers, and Mr. Beller has been testifying, that he
was hired as a result of that search, which took longer than we had
hoped. But it is difficult to find experienced, qualified people. We
also during the same period of time added additional technical
people in the oil and gas department, and we were told that we had
developed—that the bank had developed—the largest and the most
qualified oil and gas technical staff in the State.
At the same time there was a considerable effort to develop additional procedures and systems and training programs, and certainly manuals were written which were forwarded to Dallas, and some
of us reviewed and looked at them, and I thought personally they
were quite good. In summary, during this period of time, after that
first examination, a new president was hired, a new general counsel, chief loan officer, financial officer, a new vice president in
charge of the real estate department, plus other additional experienced bank officers were added to the staff. As Mr. Beller said, the
bank more than doubled in size during this period of time.
The second examination, which occurred in the spring and
summer of 1981, started really before these new people were barely
in position. They had no real opportunity to correct any of these
fundamental problems of management, and more importantly, the
time of the absolute top staff was consumed in trying to resolve
loan problems in real estate and agriculture which Mr. Beller char


168
acterized as horse loans which had been caused by the lending actions of a dismissed senior loan official.
So, it was not a surprise to the board to receive the report in the
summer of 1981 that there had been little improvement in the
bank's management practices, because we realized that the new
management team had not really had time to correct these particular problems.
So, when we went to Dallas for the second trip in July of last
year, and met with Mr. Poole and his team when they reported the
conditions, we were not terribly surprised. That meeting was quite
lengthy, and Mr. Poole dwelt at considerable lengths, which I considered almost like a lecture that you would expect in a university,
on how to manage to achieve liquidity goals, he used several
graphs, and went into some more details of his views on how a
bank could manage to insure that they maintained appropriate
spread between what they were paying for money and what they
were charging for money.
At the end of the meeting, the examiners at Dallas wrere very
complimentary about the quality and the reputation and the experience of the new people that had been recruited by the bank, and
so that the overall flavor of that meeting was not one of a great
deal of criticism, but one we thought was helpful and hopeful, because we felt, as outsiders, the bank were moving in the proper direction.
After the meeting, the board expressed concern about an alleged
lending limit violation mentioned at that meeting, and it was explained to us that it was a technical violation in the sense that the
combination of the value of a loan, a letter of credit, and perhaps
an honored overdraft caused the bank to have a technical lending
violation. This explanation at a subsequent board meeting was further expanded to include that it was an administrative error in not
insuring that the terms of a loan from Penn Square corresponded
to the dates of coverage for the loan from the upstream corresponding banks.
As a result of this latter, second examination and trip to Dallas,
the management reported to us very serious efforts to correct all of
the deficiencies, and to obtain release from the letter of agreement
perhaps as early as 1982, and certainly by the spring of 1983, since
this relief was essential in order for the bank to receive authority
or permission from the Office of the Comptroller of the Currency to
move into new bank premises that were being constructed.
During the fall of 1981 at the board meetings the bank management reported and displayed results of numerous actions to establish appropriate checks and balances: The formalization of the
asset and liability management committee, detailed procedures,
loan policy committee, additional people, and further elaboration
and sophistication of the data system for the oil and gas
department,
The Comptroller of the Currency reported to us in our January
1982 board meeting that the bank had made extensive progress,
and they were very complimentary on work that had been done,
and I believe it was reported to us that the bank had accomplished
a great deal more than they expected to find.



169
Mr. BARNARD. May I interrupt at this point? Who made this observation?
Mr. RANDOLPH. I believe it was Mr. Morrow who was the spokesman at the time.
Mr. BARNARD. For whom, the Office of the Comptroller?
Mr. RANDOLPH. That is right.
Mr. BARNARD. In J a n u a r y ?

Mr. RANDOLPH. In the J a n u a r y 1982 board meeting.
Mr. BARNARD. Thank you.
Mr. RANDOLPH. And there was some discussion, and I do not
recall whether it was at t h a t time concerning the letter of compliance, and they said, well, that they expected t h a t we would be able
to lift that letter after the next regular examination, which was
scheduled to commence in March, but actually commenced in the
latter part of April.
In April, then, we received a report from the outside auditor. He
confirmed that there were a number of problems in the bank, but
that for all of the problems t h a t they had identified, management
was aware of them and were working on solutions. They were complimentary t h a t significant improvement was evident, which had
taken place since the previous independent audit, and since the
last examination by the Office of the Comptroller of the Currency.
So we felt t h a t finally things were moving in a very positive direction. The final examination started shortly after t h a t particular
board meeting.
In the May board meeting, management, I believe Mr. Beller reported that the examiners were still here, t h a t they were looking
deep, and at all areas. At our J u n e 1982 meeting, he reported t h a t
the examiners were still here, and in response to one of the directors about the amount and extent of chargeoffs, he said he really
did not know, and someone said, well, about $5 million, and he
said, yes, make it t h a t or perhaps a little more. And so t h a t was
the last word we as a group learned until probably Tuesday or
Wednesday at the end of June, when we were notified t h a t there
would be a special meeting at the bank on Thursday morning—
July 1.
Several members at this table continued to make sizable uninsured deposits in the bank up until the end. So, even after the 2day meeting t h a t ended on the 2d of July, the board left there on
Friday night expecting t h a t the board would have until the 9th of
July, under the terms of the proposed or proffered cease-and-desist
order, to raise additional capital to keep the bank open.
In response to the relationship with upstream banks, the board
did discuss this matter at considerable length at different times. It
was characterized to us, and we agreed with t h a t characterization,
t h a t placing of loans with the upstream correspondent banks were
really considered to be a strength for us rather t h a n weakness for
several reasons. One, t h a t this area is a capital-poor region, and
the oil and gas industry is capital-deficient persistently, and they
needed the additional capital.
It was also an additional source of earnings for the bank, but
more importantly from of our perspective is t h a t we felt we were
getting an independent backup evaluation of reserves. One could
agree easily on the assumptions on what is going to happen to oil



170
and gas prices, the inflation rate, and perhaps what will be the
trend of gross production, but to go in and agree upon the amount
of oil gas reserves in rock—several thousand feet below the surface
is a matter that not many people would agree on, by dealing with
major banks experienced in oil and gas lending, we were getting an
independent valuations.
By verifing the evaluation of the independent engineering firms
that were being provided by the loan applicants, coupled with the
evaluation by the bank staff, and then further confirmed by these
very experienced energy lenders we felt gave the bank, at least us,
greater assurance that we were acting in a more prudent fashion.
The CHAIRMAN. Mr. Randolph, I am constrained to—and hopefully you will not lose your train of thought, but I am constrained at
this point and on that point to ask you to halt.
Mr. RANDOLPH. I could go for about one more minute, and I
would be finished.
The CHAIRMAN. Well, indeed and in fact, are you and your colleagues satisfied that that which you just described did really and
truly occur, that Continental and Seattle First and Chase sent engineers in and had these participation loans thoroughly reviewed
by their experts in energy, or, as has been described to us, the impression we are getting is that that did not happen, that they sort
of took carte blanche, face value, in most instances, what was being
sent to them by Penn Square.
Mr. RANDOLPH. All I am trying to do is to present to you the impression that we as board members gained from the management
that these banks were in fact independently evaluating these credits, and these were nonrecourse loans.
The CHAIRMAN. Wait a second. Are any of the outside directors
present at this table, can any of you say that of your own personal
knowledge, that what Mr. Randolph just described gave you comfort and gave you confidence? The management said, oh, we are
selling these participations to the big city banks, and they are
bringing their "hifalutin" experts in, and their highly educated engineers in. You were told that, but of your own knowledge, did you
discuss this? Are you aware of any energy loan experts in these
large banks that looked at these loans and said, these are great,
these participations we are buying are great? Are you aware of any
engineers coming in and setting up shop and examining and getting their own independent appraisals of reserves in that rock, as
you were just describing it? Are any of you aware of that to your
personal knowledge? Mr. Smelser?
Mr. SMELSER. NO, sir, we were not aware of it.
The CHAIRMAN. YOU took management's statements?
Mr. SMELSER. Well, we also felt that we were assured by the fact
that certainly the upstream banks who supposedly had the expertise and the knowledge and the staffs to evaluate these loans before
they took them.
The CHAIRMAN. But why don't you have one other word, and you
probably relied upon the fact that they were prudent business
people, and would evaluate these very carefully before purchasing
them, right?
Mr. SMELSER. We felt that would be true, yes, sir.
The CHAIRMAN. But that is as far as you went, Mr. Richardson?



171
Mr. RICHARDSON. I was not aware that any of them were coming
into town. However, based on the fact that Continental Illinois is
one of the largest oil lending banks in the country, and they were
buying the loans, I would assume that.
The CHAIRMAN. That made you feel comfortable?
Mr. RICHARDSON. I felt they knew what they were doing.
The CHAIRMAN. Mr. Ross?
Mr. Ross. That is the same for me.
The CHAIRMAN. NO personal knowledge?
Mr. Ross. No personal knowledge.
The CHAIRMAN. MS. Coe?
Ms. COE. I felt the same way.
The CHAIRMAN. Mr. Cook?
Mr. COOK. I felt even more strongly, because the loans were
being sold without recourse, which was clear to me, that those upstream banks had all of the obligation and the potential liability,
and therefore they should have the strongest possible interest in
evaluating those loans to the degree that they felt was appropriate.
The CHAIRMAN. At any point were you made aware of the fact
that indeed what was happening on some of these loans, that Penn
Square was paying interest to the upstream banks on these loans,
even though they were not getting the interest from the borrowers?
Were you aware of that?
Mr. COOK. Mr. Chairman, I was made aware of that, and I think
the other members here, the other directors were made aware of
that fact in the June board meeting, but at that time we were
all
The CHAIRMAN. When you sat down with the Comptroller?
Mr. COOK. NO, not on the July 1981 meeting with the Comptroller, but the June 1982 meeting of the board, we were told by management of some $10 million in potential moneys that had been
paid upstream without having—without us being paid at the bank
level, that in fact only about $200,000 was outstanding, and the
practice had been ended, as Mr. Beller pointed out.
The CHAIRMAN. And were you aware of the fact that there was a
possibility that in some instances, that indeed though they appeared to be nonrecourse participations, that there was a tacit
agreement, as I think you were here earlier when I read from the
letter to Mr. Patterson from Mr. Lytle, or whatever his name was.
Mr. COOK. Mr. Chairman, in the spring of this year, I remember
asking the president, and for that matter the other members of
management, whether or not nonrecourse in their terms meant the
same as it did my terms, which was to say that those loans were
sold without any recourse whatsoever, and I was assured that in
fact that was the case.
The CHAIRMAN. Mr. Randolph, I would like you to answer the
same question I have asked of your colleagues.
Mr. RANDOLPH. I concur with everything he said.
The CHAIRMAN. Mr. Haugland? And would you please pronounce
your name for me?
Mr. HAUGLAND. Haugland.
The CHAIRMAN. Thank you.
Mr. HAUGLAND. I believe that the energy departments and representatives from Chase and Continental and Seafirst in Seattle were

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in fact coming down here, and I also was led to believe by our management that some of the people that we staffed the Penn Square
energy division, some of the technical people, petroleum engineers,
actually came in part from some of those banks.
The CHAIRMAN. But my question, sir, you have not answered.
You say you believed this. Did you have personal knowledge?
Mr. HAUGLAND. Did I have personal knowledge?
The CHAIRMAN. Did you have personal knowledge that these reserves were being independently evaluated by engineers from these
upstream banks?
Mr. HAUGLAND. N O , I just assumed they were.
The CHAIRMAN. YOU assumed it, and you were given sort of to
understand that from management, but you do not have personal
knowledge of the fact?
Mr. HAUGLAND. N O .
CHAIRMAN. It was just like,
Mr. HAUGLAND. N O , sir.
The CHAIRMAN. Neither have I. I

The

have you ever been to China?

have read t h a t it is there, but I
do not really know it is there. That is the manner in which I ask
this question.
Mr. Randolph, you have another minute and a half, I believe, sir.
Mr. RANDOLPH. I would just like to say t h a t in the last year,
when it was quite apparent t h a t the drilling business was getting
soft, and that people were curtailing their plans for additional
drilling, we asked what happens, what is the exposure, how secure
are our loans, and we were assured t h a t they felt the loans were
being made with strong collateral. They were against reserves in
the ground, and at the very worst, t h a t the period of payout would
be extended, but t h a t the loans were still on a sound basis.
You asked a question at the beginning this morning as to why
the bank closed. I do not know, and I do not think anyone else here
at this table does. And we would like to learn the reason. And so
therefore we pledge our cooperation in many ways and in all ways.
We are very much victims of this debacle. We have some questions
t h a t we hope that you will be able to answer, or find the answers
to: such as, were objective criteria used to classify the loans, or
were they highly subjective? As the district director [of the OCC]
has been reported as saying, in one of our local newspapers.
And a second question, if the bank management was so weak as
reported by the OCC in your July 15 hearing, why didn't the Office
of the Comptroller of the Currency approach us the outside Directors some time in May or some time after the start of the examination and say, you have got to get rid of all of these clowns and let
us try to do something to stave off this disaster? Although we represented a very small minority in terms of stock ownership of the
bank, I believe t h a t we would have been able to bring about some
management changes to hopefully avoid the ultimate consequences.
The CHAIRMAN. I think t h a t the confidence in the institution
would have been shaken had all of you as a group said, well, wait a
minute, now, unless you do this, we as a body and as a group are
resigning. Certainly a report of t h a t in the press would give rise to
a great deal of apprehension.



173
Let me ask you this. Were the bulk of you recruited by Mr. Jennings to join the board of directors in Penn Square? Is there
anyone here who was not approached by Mr. Jennings?
Mr. SMELSER. I.

The CHAIRMAN. Mr. Smelser, how did you come to join?
Mr. SMELSER. I was approached by Mr. Cravens. I had been on
the board since 1965.
The CHAIRMAN. 1965, a period of time when Mr. Jennings was
not at the institution?
Mr. SMELSER. That is correct.
The CHAIRMAN. Mr. Richardson?
Mr. RICHARDSON. My company has had a long association with
the bank, and they have owned stock in the bank since the inception at the time the bank was sold to Mr. Jennings.
The CHAIRMAN. TO the holding company?
Mr. RICHARDSON. N O , the stock from the previous owners. We
had a number of shares of stock, and my father basically had the
stock, and he requested at the time the previous owners sold out to
sell his stock, too. That was not done. He asked Mr. Jennings if he
would be interested in buying his stock, and he said no, since had
already bought this amount of stock, he would not be interested in
buying any more at this time, and so my father said, well, why
don't you put my son on the board to give him some banking experience? [General laughter.]
And basically, t h a t is how I got on the board, and I got the banking experience. [General laughter.]
The CHAIRMAN. YOU sure have. Well, ladies and gentlemen, you
were here this morning, and I would like to ask you a few questions. You heard Mr. Beller state t h a t though he was brought in as
president, t h a t nonetheless his duties, or rather not his duties but
his actual authority was rather limited by the memoranda t h a t he
read to us, in that he was subservient to Jennings and Mr. Patterson in certain areas. Were you as members of the board of directors aware of those limitations t h a t had been placed on Mr. Beller's
authority at the Penn Square Bank?
Mr. Ross. No.
Mr. RICHARDSON. N O .
The CHAIRMAN. All in

ated with a
Square?

financial

the negative? Mr. Haugland, you are affiliinstitution in the area other t h a n Penn

Mr. HAUGLAND. Yes.
The CHAIRMAN. HOW

large an institution is it? How would it
compare with Penn Square in size?
Mr. HAUGLAND. It is $80 million in total assets, much smaller.
The CHAIRMAN. It is much smaller. Were you aware of the employment contract t h a t was given to Mr. Beiler when he was
brought in to Penn Square National Bank as the members of the
board of directors?
Mr. HAUGLAND. Yes, sir.
The CHAIRMAN. Mr. Randolph

stated that, and this is with all
due respect to Mr. Beller, but he stated t h a t it was difficult to find
somebody to come in and take over as president of Penn Square.
Am I quoting y o u —



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Mr. RANDOLPH. I am not so sure how difficult it was because we
were not involved directly in the search, but Mr. Jennings reported
that it was taking a while to find what he was looking for, a real
strong man, and it was difficult to find a real strong man.
The CHAIRMAN. NOW, you heard Mr. Beller testify or inform the
committee of the fact that his strong point, his forte is not energy,
oil and gas related loans, did you not?
Mr. RANDOLPH. Yes,

sir.

The CHAIRMAN. And Penn Square's principal involvement was in
this area. I think you stated that in your opening statement to us.
Mr. RANDOLPH. Yes.

The CHAIRMAN. Were you people aware of the fact that Mr. Jennings' strong points were not in that field, but in the other commercial lending and leasing and things like that? I mean, Mr.
Seller's strong points.
Mr. RANDOLPH. I personally was not aware of the actual experience.
The CHAIRMAN. Of the limitations that he was under at Penn
Square?
Mr. RANDOLPH. NO, I was not. He came from a bank that does do
quite a bit of energy lending.
The CHAIRMAN. But in fact he did not do it. Did you think it a
little curious that Mr. Jennings probably spent a lot of time trying
to find a man with good experience who would be looked upon as a
strong president, but who admittedly had not the experience in the
energy related loans. Did that not seem a little strange? I know it
is Monday morning quarterbacking.
Mr. COOK. Mr. Chairman, I thought considerably about that question when Mr. Jennings was talking about hiring Mr. Beller, and
frankly, I considered it a plus that Mr. Beller had administrative
and operational experience in a significantly larger bank than
Penn Square. It was also clear to me that Mr. Jennings owned a
significant chunk of Penn Square Bank, and that it was important
to find an individual who had the kind of operating and administrative experience but who could nonetheless work with Mr. Jennings. As you know, and Mr. Randolph said, in some respects the
bank was almost a proprietorship when we first came on the board.
The CHAIRMAN. A one-man show?
Mr. COOK. Exactly, so it was important to find someone who in
effect could take over the reins, and it was clear that there were
administrative problems that had to be solved, so I felt that it was
a strong plus that we be able to attract a man from a larger bank
which had a stong reputation, who himself had a good reputation,
to whom we had basically given a no-cut 5-year contract, so he
should not be reluctant to make comments to us as directors about
the situation at the bank.
I viewed all of those as very strong positives.
The CHAIRMAN. Mr. Cook, let me make an observation.
Mr. BARNARD. Mr. Chairman, may I follow that up?
The CHAIRMAN. Yes, but I want to follow up on that also.
Mr. BARNARD. Mr. Cook, because of that, did you ever feel that
Mr. Beller was not getting the responsibilities which you thought
he should have in this role?



175
Mr. COOK. Mr. Barnard, over the course of the last year, at least
two or three times after board meetings I went in to talk to Mr.
Beller and to ask him how things were going, because I was very
much concerned that again Mr. Jennings owned a substantial
chunk of the bank, and I knew that he had a very close relationship with Mr. Patterson, and it was clear that the salvation of our
bank in terms of taking the corrective measures that we had been
asked by the Comptroller to take lay with Mr. Better's ability to
make those measures stick. Mr. Beliefs comments to me typically
were that no, he felt he did not need any more support from the
board of directors, that we still had a long way to go, and he said
that on several occasions, but he would repeatedly say that he
thought he was making significant progress.
The CHAIRMAN. He never complained to you about what he
enunciated this morning?
Mr. COOK. NO, he did

not.

The CHAIRMAN. The fact of that lack of control over Mr. Patterson?
Mr. COOK. NO, sir, he did not, and frankly, I hoped that I had
given him that opportunity, because I was concerned that that
might be a possibility.
The CHAIRMAN. Well, he did not tell the Comptroller about that
either.
Mr. BARNARD. Thank you.
The CHAIRMAN. One word of caution about one-man bands in the
banking business. This committee went to Carrizo Springs a few
years ago, where there was a bank failure that affected a substantial area in Texas, a one-man show. Then there was C. Arnholt
Smith, who controlled USNB of San Diego. He had two entire
crews, loan officers, everything. The fellow worked two shifts. Of
course, one shift did not know what the other shift was doing.
When that thing came down and came tumbling down, there was
the largest bank failure in the Nation. Of course, that was followed
by Sindona and Franklin National Bank.
So, in the future, always be cautious of a one-man show, the oneman band, because again, here it appears to me that the last thing
Mr. Jennings wanted was someone to come in strong enough to
take over the overall operation. He wanted somebody to sort of placate the Comptroller's Office, keep the Comptroller's examiners
happy, but he still wanted to share with Mr. Patterson control of
that lucrative area, those energy loans.
Mr. Cook, you mentioned Bill Patterson. Did you privately and
on your own do any checking into Mr. Patterson's activities in the
oil and gas lending division generally?
Mr. COOK. The only thing I did, Mr. Chairman, was that in the
early part of this year, several people had said to me on the street
that they had heard that Penn Square was being more aggressive
in its lending policies than some other energy banks. At that time,
I was serving on the board of a company that wanted to purchase
oil and gas properties in Texas, and it had received a preliminary
indication from a bank in Denver that that bank would supply approximately, if I remember the number, $3.2 million on the collateral of that reservoir.



176
I decided to take t h a t property to Penn Square Bank to see what
kind of collateral value they would give to t h a t property, and I did
it frankly in part because I thought it was appropriate from the
standpoint of my interest in this other company, but also I was
very curious to see if these comments t h a t I had heard were accurate. The reservoir engineer I talked to, whose name at the
moment I do not remember, but I think I have it in my notes somewhere, came back to me
The CHAIRMAN. This engineer where, sir?
Mr. COOK. At Penn Square Bank, came back to me and said t h a t
based upon what he had seen, t h a t Penn Square would loan $2.8
million on that property, and I quizzed him at some length as to
how he got to the $2.8 million, and he reflected to me precisely the
loan criteria, which we had spent a great deal of time in various
board meetings talking about as being appropriate given the decline in oil and gas prices. So, frankly, sir, t h a t gave me a warmer
feeling t h a t in fact the loan practices in which we were actually
engaging were commensurate with the ones that we thought we
were engaging in, and t h a t they were appropriate. They were not
unusually aggressive.
The CHAIRMAN. Mr. Haugiand, you, I understand, did spend
some time with the Comptroller's Office?
Mr. HAUGLAND, Yes, sir, 1 year.
The CHAIRMAN. In what capacity?
Mr. HAUGLAND. I was an assistant national bank examiner at, I
guess, the first level.
The CHAIRMAN. NOW, you were present at the meeting in Dallas
in the summer of 1981, but not in 1980, Is t h a i correct?
Mr. HAUGLAND. Yes,

sir.

The CHAIRMAN. Let me ask you, what was your impression of
those meetings?
Mr. HAUGLAND. Well, of course, I was not in attendance at the
first one.
The CHAIRMAN. On the second one?
Mr. HAUGLAND. Because I was not on the board at t h a t time. I
joined the board in April of 1981, and after the third meeting t h a t I
attended, we were invited to Dallas for the meeting t h a t was held
on July 29, I believe. My impression at t h a t time was t h a t the representatives of the Comptroller's Office were still very concerned
about the lack of compliance t h a t the bank was in relative to the
administrative letter t h a t was in effect. Also, t h a t they were very
pleased with the people who had just recently been hired by the
bank, namely Mr. Beller, Mr. Preston, and Mr. Dunn, and an additional number of other senior officers.
At t h a t point, the bank was just beginning to draft the various
committees and restructure its entire lending function and its administrative function, and I got the feeling from t h a t July 29 meeting t h a t the Comptroller's Office was not letting up in their pressure on the bank to continue to move toward greater compliance,
but t h a t they were very pleased with the staff that we had brought
on board, and they so stated t h a t the members of the staff were
well known to them through their association and examination
process with the other banks before they came to us.



177
The CHAIRMAN. Did you get the impression that the Comptroller
felt that Mr. Beller, the new president, had experience in energy
lending? Do you think the Comptroller's Office was aware of the
fact that Mr. Beller was not brought in for his expertise in the
energy area, but in other areas? In other words, 20 percent rather
than 100 percent of the operation?
Mr. HAUGLAND. I really did not feel that that was a critical problem with bringing in a man of Mr. Beller's ability, because he was
an administrative lending officer at a very high level at his previous employer, and I do not think that his speciality in energy lending or lack of specialty in energy lending was critical to his position for what he was supposed to do at Penn Square.
The CHAIRMAN. But the primary problems of Penn Square were
related to the energy lending area, were they not, the criticism by
the Comptroller's Office in 1980?
Mr. HAUGLAND. I think they were the concentration of lending in
the energy area, but not as specific credits at that point in time.
The CHAIRMAN. HOW about the loans that were criticized? In
which area were they primarily located? Were they not in the
energy and oil related areas?
Mr. HAUGLAND. Not specifically, no, sir.
The CHAIRMAN. YOU say no. I will have to have my staff check it
out again, because I have been misinformed then.
Mr. HAUGLAND. Well, naturally, I think you could say that if you
had 80 percent of the loans in the energy field, there would be a
larger percentage as a rule of classified loans coming from the
energy area, but I do not believe that the energy lending at the
point we were aware of through examinations had produced any
sizable classification of energy loans as opposed to horse loans.
The CHAIRMAN. Let me ask you, Mr. Haugland, did you sign the
August 1980, agreement after joining the board?
Mr. HAUGLAND. NO, sir.
The CHAIRMAN. And then

I would ask, other than Mr. Cook, I
think all of you were at the July 1981, meeting in Dallas with the
Office of the Comptroller of the Currency. I am wondering about
the impression you got of that meeting with Mr. Poole and his
staff. Now, did Mr. Poole—am I quoting correctly—comment that
the Washington office of the Comptroller of the Currency had reviewed the association's funds management and found the same
unacceptable on a national standard? He noted that he had gone to
bat with the Washington office to keep from having a cease and
desist order issued. Is that an accurate report of what Mr. Poole
said to you at that meeting?
Mr. Ross. I think so.
Ms. COE. Yes.
The CHAIRMAN. I see everybody nodding in agreement.
Mr. RANDOLPH. I do not remember specifically whether those
words were stated.
The CHAIRMAN. NOW, subsequent to that July 1981, meeting, and
my reading of the minutes of that meeting is that he really harrangued the entire board and management, what steps did you people
on the board take when you returned to Oklahoma City at your
next meeting with management, after Mr. Poole's harranguing of
you, of the entire board? Do you recall?



178
Mr. RANDOLPH. I think I summarized. What I think we did was
basically get everyone in high gear in the management team. We
had this new group that had just joined the bank, and there were a
number of things that had to be addressed, and as I recall, they
were spending a great deal of extra time to in fact get these things
accomplished that had been promised to be done the year before.
And I believe the results—at least we felt that the results
showed that the management was taking these actions we had
promised in the fall of 1981 and further confirmed then by the
Comptroller's report to us in January, and further reinforced then
by the independent auditor's report in April, and every meeting
that we had, Mr. Dunn and the financial officer would report on
the status of these promises that we had made to the Comptroller.
The CHAIRMAN. Let me ask you this. Were you people shown the
management letter from Peat, Marwick, Mitchell & Co., that was
referred to earlier this morning, the rather lengthy letter that was
rather caustic in its criticism of things that had not been done?
Mr. RANDOLPH. A summary of that report was discussed at our
June, 1982, meeting.
The CHAIRMAN. But you did not see the entire letter?
Mr. RANDOLPH. I do not think so. The highlights only.
The CHAIRMAN. Well, the beginning of that letter is rather complimentary, but as you get into the last three or four pages, it is
rather caustic and critical.
Mr. COOK. Mr. Chairman, we did have some discussion about
that, because several of us on the board asked what the status was
of the various criticisms that had been made, and the gentlemen
from Peat, Marwick, Mitchell & Co. said there were a number of
criticisms they had made, but that—the word was "most" or
"many," but I think the word was "most"—most of those were in
the process of being addressed by management, and indeed we had
a summary which also had management's analysis of what they
were doing to analyze those questions.
I asked the Peat, Marwick, Mitchell & Co. auditors specifically if
there was any material problem that they had uncovered that they
thought was of such significance that it should be drawn to the attention of the board, to which we were told no, that there was no
such problem. There were a number of other problems, again, as
related in the management letter, but that management was in the
process of correcting those problems.
The CHAIRMAN. Mr. Haugland, the minutes of the board meetings show your criticism of the high amounts of overdrafts and the
monitoring of overdrafts. On April 14, 1981, you abstained from
voting on the overdraft report, and in that instance the overdraft
report showed that it was in the amount of $2,833,731. Was that
because you had just arrived on the board, or because you thought
that it was excessive?
Mr. HAUGLAND. NO, I thought it was excessive for the size of the
bank at the time, and in fact I continued to discuss the level of
overdraft in subsequent meetings.
The CHAIRMAN. In September, you discussed it again when Mr.
Patterson gave his report, correct?
Mr. HAUGLAND. I discussed it for several months, and I was finally—it was suggested that I not beat a dead horse any more, that I



179
was talking too much about overdrafts, and using up too much
time.
The CHAIRMAN. Again, you do have experience being involved
with another financial institution, and having spent time at the
Comptroller's Office, yet you were told you were beating a dead
horse. It seems as though that horse was a lot livelier than you
were told. So that it is obvious that the overdraft situation did not
improve. How about the large overdrafts reported by MahanRowsey and Instapipe Co.? Do you recall those?
Mr. HAUGLAND. I recall one discussion we had at the board meeting on the Instapipe, which I believe was a classified line of credit
at one point, and subsequent to the classification of that line of
credit by the regulators, I recall that there was an instance when
that account was overdrawn. The checks issued by that company
were allowed to go into an overdraft status which would be an additional extension of credit.
The CHAIRMAN. Over and beyond the statutory limits?
Mr. HAUGLAND. Over what would have been ordinarily classified,
and my understanding is that the management was not to make an
additional extension of credit to this particular entity, and I raised
the question again about overdrafts.
The CHAIRMAN. Let me ask you, you say that, you will excuse the
expression, that you were told to knock it off, that you were beating a dead horse. Was it a fellow member of the board of directors,
the outside board, or was it somebody in management that asked
you to cease and desist?
Mr. HAUGLAND. Management.
The CHAIRMAN. Could you be more specific? Do you recall?
Mr. HAUGLAND. Mr. Jennings suggested that I did not need to
take quite so much time on the amount of overdrafts.
The CHAIRMAN. AS one, Mr. Haugland, who is well versed in the
profession of banking, could you tell us as far as the participations

were concerned, the loan participations at Penn Square in the sale
of the same to upstream banks, did you at any point compare that
with the manner in which you handled the participations at your
bank in Muskogee?
Mr. HAUGLAND. Well, we had participations from Penn Square in
our bank, and as we also had from about five or six other larger
institutions in the Southwest.
The CHAIRMAN. Did you rely upon the evaluations of the institutions from which you purchased the participations, or did you
make your own evaluations?
Mr. HAUGLAND. We made our own evaluations.
The CHAIRMAN. YOU made your own evaluations?
Mr. HAUGLAND. Of course, you always have to rely upon the
originating bank to some extent for some of the information.
The CHAIRMAN. Thank you.
Mr. Leach?
Mr. LEACH. For the record, during the 7-year period, did any director resign?
Mr. COOK. I do not think so.
Mr. LEACH. For the record, too, other than the stock that any of
you might have held, did any of you lose money in the bank closing?



180
Mr. Ross. Yes, sir, I did.
Mr, BARNARD. Jim, did you mean t h a t beyond t h a t being insured?
Mr. LEACH. Beyond t h a t being insured, of course.
Mr. Ross. Yes, sir.
Mr. LEACH. Mr. Smelser, you lost money?
Mr. SMELSER. Yes, around $75,000 in commercial paper.
Mr. LEACH. Mr. Richardson?
Mr. RICHARDSON. Around $56,000 in company and personal
money,
Mr. LEACH. Mr. Ross?
Mr. Ross. I lost a little over $2 million.
Mr. LEACH. WOW.
Mr. BARNARD. Was

t h a t in deposits or stock?
Mr, Ross. It was in CD's in the company and personal.
Mr. LEACH. I think it is worth noting t h a t at least with regard to
the directors, there were no inside dealings for self-protection.
The CHAIRMAN. Would the gentleman yield?
Mr. LEACH. Certainly.
The CHAIRMAN. I think one of the mysteries t h a t is going to
evolve in this entire situation is t h a t here are the members of the
board of directors, quite a few of whom lost very substantial
amounts of money as a result of this bank closing, and yet we look
at a prominent depositor who pulled $20 some odd million out. I
think he sent his secretary across the street to pull it out for him.
And t h a t is because some financial consultant told him to do so. I
think that is going to be, if any of you are of the Catholic religion,
we have the mystery of the Holy Trinity, and I think this one sort
of comes in that classification. [General laughter.]
Mr. ANNUNZIO. Mr. Chairman, t h a t is exactly right. I was going
to ask if any of you had the same opportunity to draw money out
before. I know you said you lost $50,000, and $2 million, but did
any of you? Mr. Haugland, did you have an opportunity to draw
money out in advance?
Mr. HAUGLAND. Well, No. 1, I had an opportunity. No. 2, I did
not have any money on deposit in t h a t institution.
Mr. ANNUNZIO. Mr. Randolph?

Mr. RANDOLPH. I had an opportunity, and I have on deposit a
grand sum of $112.93, which is still frozen.
Mr. COOK. I did have an opportunity, but I only had $500 in the
bank.
Mr. ANNUNZIO. M S . Coe?
Ms. COE. I had no opportunity. I lost under $200,000, but I had a
considerable amount of stock.
Mr. ANNUNZIO. Mr. Ross?
Mr. Ross. I had no opportunity.
Mr. ANNUNZIO. Mr. Richardson?
Mr. RICHARDSON. Well, I deposited $228,000 in the bank about 7
or 8 days before it went down.
Mr. ANNUNZIO. And you never withdrew anything out in
advance?
Mr. RICHARDSON. Of the $228,000, I drew out $60,000. About the
same time I put the $228,000 in, I drew $60,000 out. But I still had
about $150,000 in there when the bank was closed.



181
Mr. ANNUNZIO. Mr. Smelser?
Mr. SMELSER. I had an opportunity to draw it out, and I did not.
Mr. ANNUNZIO. Thank you.
Mr. HAUGLAND. Mr. Chairman, I just want to clarify t h a t when I
said I had an opportunity, I meant I was there on the Thursday
before the fatal weekend, so if I had had money, I was present at
the bank. That is what I meant.
The CHAIRMAN. I think if the gentleman would yield further, I
think that the question is not whether you had the opportunity,
but rather did you have knowledge t h a t would indicate to you t h a t
the ax was about to fall?
Mr. HAUGLAND. NO ? sir,

Mr. Ross. No.
Mr. COOK. N O .
Mr. RICHARDSON. N O .
The CHAIRMAN. That is Mr. Leach's
Mr. LEACH. In any institution, one

point.
must deal both with the abstraction and with people and their personalities. I would like to
address a question to you, General Randolph, because you have a
history of distinguished public service. As a former general, if you
had a wing commander or a company commander acting the way
Bill Patterson, Penn Square's vice president, did in terms of keeping figures and in terms of community activities, would you promote him, would you demote him, would you think t h a t his tenure
should come to an end? As his commander in chief, how would you
have reacted?
Mr. RANDOLPH. Obviously, in the stewardship role here, you
could not afford to have someone acting like that. I personally was
not aware of Bill Patterson's activities t h a t have been extensively
reported after the failure of the bank. I met Bill only at board
meetings, and had social dealings with him, and for instance I
heard no rumors of his extraordinary activities until after this happened,
The CHAIRMAN. YOU do not go to the Cowboy Club?
Mr. RANDOLPH. I have never been there. I know where it is. It is
on the way to the airport. But I have never stopped in. I do not
own any cowboy boots. [General laughter.]
Mr. LEACH. It strikes me that Mr. Jennings knew what he was
doing to bring someone with your respectability to the board.
Generally, boards of directors take final responsibility for loans,
and this is not simply a proforma approval in board meetings. Oil
to me is a very fast track, and racehorses are an even faster track.
How seriously and how deeply did you go into loans? How much
discussion was there at board meetings regarding loans, and how
much effect do you think your input had?
Mr. RANDOLPH. I think as a group the board was probably never
satisfied with the amount and the scope of information t h a t was
available to review the actions that had been taken by the bank,
and it became apparent to me later this spring, in April and May
and June, that the bank was probably not doing the kind of cash
flow analysis that they should have to assure t h a t they had a coverage ratio to meet the various interest payments, and I think you
will notice in some of the board meetings in either April or May,
while we raised and had extensive discussions on this whole ques


182
tion of evaluating the ability of a borrower to repay the money,
and I guess it is just regrettable that we did not get wise sooner.
Perhaps we would have been able to bring about some changes
enough so that this whole episode could have been avoided.
Mr. COOK. Mr. Leach, a number of us were speaking specifically
to one of the areas you mentioned. A number of us early last year
were concerned that there might be a downturn in the energy
economy, and we knew that oil rigs, oil service companies were the
first to be hit, so we actually requested of management an analysis
of our rig loan portfolio, how large it was, and to what extent was
that rig loan portfolio secured by underlying assets as such oil and
gas properties as opposed to just the collateral, the rigs themselves,
because we all knew that if the energy economy deteriorated, that
the rigs would be worth perhaps 15 cents on the dollar.
We had that kind of analysis presented to the board in the
summer of last year, and we were assured that we were changing
our lending policy so that we were not making rig loans except to
our ongoing customers, and that those rig loans were secured by
underlying oil and gas properties as opposed just to the rigs themselves. So, during this period of time I would say that we did not
spend a great deal of time talking about specific loans, but we did
spend a great deal of time talking about loan policies, about loan
loss reserve ratios.
I remember in January of this year we spent a lot of time talking with management about whether or not the loan loss provisions should be increased if oil and gas prices declined.
The CHAIRMAN. Could you please speak into the microphone?
Mr. COOK. I am sorry.
In January of this year, we spent considerable time talking about
loan loss provisions, because we could see obviously that oil and gas
prices were declining, and we were concerned about the value of
the collateral standing behind these various loans, and in fact management in February of this year raised loan loss reserves accordingly. So, a number of the. others of us here felt that the kinds of
concerns that we were raising in board meetings were having a
positive impact on the policies of the bank.
Mr. LEACH. Thank you very much. I would conclude with a comment, Mr. Chairman, that I think we have an example here of an
extremely intelligent outside director board that has been caught
up in the circumstances, and it is going to be a lesson, frankly, to
all boards of directors of all banks throughout the country. I appreciate your testimony.
The CHAIRMAN. I could not agree with the gentleman more. As I
stated to the previous witnesses, do not feel bad because some of
the sharpest people in the country were conned in this operation.
You can just react and act based on the facts and the knowledge
presented to you, but that which is not being presented to you or is
essentially hidden from you, gosh almighty, it is rather difficult for
you to react, and the mere fact that some of you lost such substantial sums—Ms. Coe, I understand some of your deposits went in
Ms. COE. On the 30th.
The CHAIRMAN [continuing]. On the 30th, so that certainly had
you been apprised of this picture as we see it now, and your background indicates that you are a very, very astute business lady,



183
certainly you would not have made that deposit. So, as Mr. Leach
just said, it is a lesson to bank directors around the country that
you really have to be—and I do not ascribe any lack on my own
part, any lack of efforts to exercise a fiduciary responsibility to any
of you. I think you did your utmost, and despite that you got
burned. So, it is a lesson to everybody who serves on bank boards
that it is a very, very heavy responsibility, and it is a very difficult
one.
Mr. Annunzio?
Mr. ANNUNZIO. Thank you, Mr. Chairman.
As the people on the board know, some of the larger institutions
received a 5-day notice that the bank was closing. So it is apparent—did anybody here have that same information, that the bank
was closing?
[No response.]
Mr. ANNUNZIO. When the Comptroller asked that $49 million be
written off as bad loans, Mr. Randolph, how much of this was discussed at the board meeting? How serious were the discussions?
Mr. RANDOLPH. AS I mentioned, we were never—in the regular
board meetings, we never had a discussion of any specific loans,
and at the time of our last board meeting in the middle of June of
this year, Mr. Beller
Mr. ANNUNZIO. YOU had no knowledge?
Mr. RANDOLPH. Mr. Beller said they were still there. We do not
know how many loans. And someone said, well, how much, $5 million, and he said, yes, perhaps more. That was the extent of it.
Now, when the meeting was held on the 1st of July, and I must say
I am speaking of what I have read and what these gentlemen tell
me, they were presented with a list of about $30 million.
Mr. ANNUNZIO. Does that apply to any person here?
Mr. HAUGLAND. The meeting that Mr. Randolph refers to on
Thursday morning, the July 1, the board was convened at 9 o'clock,
and a representative of the Comptroller's Office was present, and
at that time served each member of the board with a cease and
desist order.
Mr. ANNUNZIO. These loans, when the Comptroller of the Currency writes off, as you know, $49 million in bad loans, do you
mean these loans were not discussed weeks before, months before?
Mr. HAUGLAND. NO, sir. They may have been discussed with
management after the examination commenced the April 19, but
we have not ever heard anything officially or unofficially except
what you read in the newspaper.
Mr. ANNUNZIO. In your honest opinion, what kind of shape did
you think that the bank was in?
Mr. HAUGLAND. From my information that I got from management on the 15th of June in our regularly scheduled board meeting, and from what they had been able to find out from the ongoing examination, I suspected that we were going to have to raise
maybe $10 million or $15 million worth of new capital, but I did
not have any inclination that we were in that kind of shape.
Mr. ANNUNZIO. Mr. Randolph?
Mr. RANDOLPH. As I mentioned, we had no previous knowledge,
and did not have any specifics on the loans that were considered to
be bad, and the management guessed that it would be somewhere



184
around $5 million or perhaps greater, and I do know t h a t there
were a list of entities on the cease and desist order, and it is supposedly reputed to be about $30 million in bad loans, and I do know
t h a t at least in one or two instances, those loans have already been
fully satisfied and have been removed from the bank in the ensuing time since the bank was closed.
So, how many of those really and truly were bad and did not
have collateral and appropriate resources, it is hard for us to guess
at this time,
Mr. ANNUNZIO. Mr. Cook?
Mr. COOK. Mr. Annunzio, I assumed at the board meeting on the
15th t h a t we might have to raise somewhere between $5 million
and $10 million, but I never in my wildest dreams thought t h a t the
bank would close or that the charge-offs would be anywhere near
what they ended up being.
Mr. ANNUNZIO. M S . Coe?
Ms. COE. Well, needless to say, I was very surprised. I was certainly not prepared for the bank to close, obviously. I did not think
it was going to close, or I would not have put some money in the
bank. We were not given anything but the one list on July 1 by the
Comptroller, and you just heard Mr. Randolph say t h a t some of
those loans have already been paid off. The Comptroller really gave
us no information, or if they gave it to management, management
did not give it to us.
Mr. ANNUNZIO. Mr. Ross?
Mr. Ross. I would have to concur with my fellow directors 100
percent.
Mr. RICHARDSON. We had no indication. We knew the examiners
were in there, of course, for 3 or 4 months, 3 months or 2 months,
whatever it was. However, during the course of the examination,
the examiners left for about a period of 1 week or 2, I understand,
to go to some kind of a training seminar, and we felt t h a t if it was
t h a t bad, they should not have left.
The CHAIRMAN. DO you know where t h a t seminar was held?
Mr, RICHARDSON. I have no idea.
The CHAIRMAN. Does anyone on the board know?
[No response.]
Mr. RICHARDSON. But anyway, apparently, if it was in t h a t dire a
shape, I thought they would have stayed around. We were not notified until t h a t Thursday before it went down t h a t we were in t h a t
bad a shape.
Mr. ANNUNZIO. Mr. Smelser?
Mr. SMELSER. Mr. Annunzio, we met all day practically on Thursday and Friday prior to the 4th, the closure. When the board left
the bank Friday evening, we were under the impression we had
been getting constant information from the Comptroller and the
Federal Reserve, who was meeting with Mr. Jennings and Mr.
Beller. We had been getting information all day long, and when we
left the bank at 5 o'clock t h a t evening, we were under the impression and had been told t h a t the bank would reopen Tuesday morning. It would be necessary for Mr. Jennings to raise capital, which
he stated he had pledged at t h a t time, but t h a t the bank would be
open Tuesday morning.



185

We did not hear another word until late Monday, when we were
called in to an emergency meeting, and told t h a t the bank would
be closed as of t h a t time.
Mr. ANNUNZIO. All you heard from the Comptroller was open
your wallet and shut your mouth. [General laughter.]
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Weber?
Mr. WEBER. Thank you, Mr. Chairman.
Ladies and gentlemen, I am very troubled by the question about
the board's responsibility in this matter. I think you are in a situation where you were probably doing your best and it is very difficult to control a strong-willed management, a management t h a t I
think in many ways was devious, and as the chairman has said,
demonstrated a capacity to con some of the best banks in the country, or some of those t h a t we would normally think would be the
most sophisticated.
Nevertheless, let me just recount some of the factors in the situation to review what has taken place. First of all, each one of you—
let me do a little bit of preaching perhaps—took an oath of office
established by the United States Code that you would diligently
and honestly administer the affairs of the association, and will not
knowingly violate or willingly permit to be violated any of the provisions of the United States Code.
You, as a board, were informed on numerous occasions through
various reports, letters, and meetings, and I will refer to these in
just a moment, with the regional office of the Office of the Comptroller of the Currency about the condition of the bank. All of this
raises the very obvious question to me whether you did not breach
the fiduciary duty which you took in your oath of office by failing
to monitor and failing to restrain the officers of the bank.
Now, let me just refer to the staff report on J u n e 9, 1980. The
OCC forwarded its examination to the board of directors. Did you
receive that? I mean, was that mailed to you, or was it not mailed
to you?
Mr. Ross. It was not.
Mr. RANDOLPH. It was mailed to the bank.
Mr. COOK. I went into the bank and read the examination. There
was a copy in the bank. But we were not sent it individually.
Mr. WEBER. HOW many of you, if you would raise your hands, are
saying you did not receive t h a t examination which was forwarded
to the board of directors? Would you raise your hand if you are
saying you did not receive it?
Mr. Ross. We did not.
Mr. RICHARDSON. I did not,
Mr. SMELSER. I did not.
Mr. HAUGLAND. Mr. Weber,

they only mail one, and it goes to
the bank. They do not send them out to the directors.
Mr. WEBER. SO at that point it is up to the bank apparently to
disseminate the information, and I think t h a t is very helpful for us
to know. On August 14, 1980, a letter from the regional office to
the board of directors identifying weaknesses in the capital plan,
asking for submission of an acceptable one, how many of you received that letter?



186
Mr. RANDOLPH. Again, that was mailed to the bank. I am sure we
saw it at a board meeting, but not individual copies. We did not
receive it independently of the bank.
Mr. WEBER. On August 27, 1980, a full board of directors meeting
in Dallas at the regional office was held, at which time these matters were discussed. Now, how many of you did not attend that
meeting?
Mr. COOK. I did not attend.
Mr. HAUGLAND. I was not on the board at that time.
Mr. WEBER. The two of you? Well, Mr. Cook, were you subsequently given minutes of that meeting?
Mr. COOK. NO. That was the time that I read the examination. I
felt since I had not been at the meeting, I ought to go in and read
the examination, and I did, cover to cover.
Mr. WEBER. Were there not minutes that were taken?
Mr. Ross. I have never seen a copy of minutes, if there were, of
that particular meeting.
Mr. WEBER. Did you not customarily have minutes of your board
of directors meetings that were subsequently mailed to the directors?
Mr. RICHARDSON. NO.
Mr. RANDOLPH. They were not
Mr. COOK. We did have copies

mailed to the directors.
of minutes that were in our board
books at each subsequent meeting, which were reviewed.
Mr. WEBER. The minutes from the previous meeting were not
mailed? Instead, they were reviewed and approved at the subsequent meeting of the board of directors?
Mr. COOK. That is right.
Mr. HAUGLAND. Yes.

Mr. WEBER. I see. On September 9, 1980, the board of directors
individually signed and consented to an administrative agreement
and each of you then signed it, except perhaps Mr. Haugland. You,
I take it, were not a member of the board at that time.
Mr. HAUGLAND. That is correct.
Mr. WEBER. October 8, 1980, the OCC sent a visitation report to
the board of directors. Again, how many of you did not receive that
report?
Mr. RANDOLPH. I do not remember seeing it or having it even discussed.
Mr. WEBER. HOW many remember that they did receive it? That
was October 8, 1980, a visitation report from the OCC. Do any of
you remember receiving that?
Mr. RANDOLPH. NO.

Mr. Ross. No.
Mr. WEBER. On March 13, 1981, Arthur Young signed their certificate to the yearend report of the bank. Did all of you receive
copies of the yearend financial statement certified by your auditors?
Mr. RANDOLPH. I do not have a copy.
Mr. WEBER. IS there any person that did not review that statement, the yearend report?
[No response.]



187
Mr. WEBER. YOU are telling me as members of the board of directors that you did not review the financial statement for the yearend, 1980, prepared by your auditors?
Mr. COOK. I reviewed it.
Mr. WEBER. HOW many did not review that statement?
Mr. Ross. It was reviewed at a board meeting.
Mr. WEBER. At a board meeting?
Mr. SMELSER. Yes, sir.
Mr. WEBER. On July 1,

1981, a letter from the regional administrator to the board of directors identifying problems and demanding action. Again, did any of you receive that letter?
Mr. COOK. NO.
Mr. WEBER. A

full board of directors meeting was held again at
the Dallas regional office on July 29, 1981. Were there any of you
who were not present at that meeting?
Mr. COOK. I was not present.
Mr. WEBER. Did you inform yourself as to what went on?
Mr. COOK. Yes, I did.

Mr. WEBER. On December 1, 1981, the regional administrator forwarded the special supervisory examination to the board of directors. How many did not receive that report? Did anyone receive
that report?
Mr. Ross. No.
Mr. COOK. NO.

Mr. WEBER. Then on May 4, Peat, Marwick did their confidential
report on the management initiatives that they would recommend.
How many of you received and reviewed that? How many of you
received that report?
Mr. HAUGLAND. That was delivered in the board meeting of
June.
Mr. WEBER. That was not delivered to the directors until the
June board meeting?
Mr. COOK. Right.
Mr. HAUGLAND. Right.

Mr. WEBER. It seems to me that that may identify a failing of
procedure. If I wanted a communication out to the board of directors, I would have their names and addresses and mail directly.
The agreement that you personally executed on September 9, 1980,
I am informed by staff, was violated in a number of different areas:
Violations of section 84 on the lending limits, you failed to get sufficient credit information, the bank failed to get collateral documentation, additional credit, and criticized borrowers without prior
board approval, and notice to the regional administrator failed to
keep the APLL adequate—I am not sure even what that means—
failed to limit control of document contingent liabilities.
The examination of December 1980 identified substantial problems with the growth of the bank. You made commitments to the
regional office in the July 1981 meeting about the growth of the
bank. Mr. Beller previously testified this morning that if you had
one corrective action to make that would have saved this bank, it
would have been, stop making so many loans. Nevertheless, the
bank under your direction, your control, grew from $200 million of
loans in December 1980 to $380 million of loans at the time of closing. The loans that were declared lost in the preliminary report of
97-830

0-82-13




188
the bank as of July 5, 1982, totaled approximately $49 million, of
which $30 million appeared to have come into the bank subsequent
to September of 1981.
Also, approximately $1 billion of additional loans were made and
participated in during the period of September 1981 to the closing
of the bank. That does not sound to me as though you were doing
very much to slow down the growth of the bank.
Now, we obviously have something of a failure in communication
between the Office of the Comptroller of the Currency and the
members of this board of directors. I do not know whose responsibility that is. I am certainly not going to accuse any of you of doing
anything willful or deliberate in this situation. I believe if anything
my observation would be that this is an indictment of the regulatory system that places excessive reliance on outside directors such
as you good people, who are lay persons, each with your own activities, your own primary occupations and duties, to override a very
strong-willed management to whom many of you probably owe
some natural feeling of loyalty for having been serving on the
board of directors in the first place.
Those would be my observations about this whole situation, and I
would be happy to entertain any of your comments. It strikes me
as a situation in which an attempt was made on numerous occasions, almost a dozen times, to bring these matters to your attention, and rightly or wrongly, apparently, the Comptroller of the
Currency was placing a great deal of reliance on you people to
clean up the act, and it did not happen, and I am not saying that I
would have done any better if I had been in your shoes, but it did
not happen, and I guess what I am saying is that perhaps it is the
fault of the regulators for waiting for you to act in a situation
where they should have taken stronger action themselves. Am I
right or am I wrong?
Mr. COOK. Mr. Weber, the only comment I would make is that as
Mr. Randolph pointed out, we felt from sometime last fall through
the spring of this year that the combination of the new management team which we as outside directors had helped to put in place
coupled with the kinds of policies and procedures which that management team was putting into place and subsequent changes in
the bank's lending philosophy such as strengthening the loan loss
reserve, changing the policy on rig loans, et cetera, that those
changes were resulting in the elimination of the kinds of problems
that the Comptroller had indicated. In fact we further felt then
that in January of this year, by the Comptroller's own comments,
from his staffs comments to us, that a substantial number of those
problems that they had raised in 1980 had finally been solved, and
we felt that there was further confirmation of that in the Peat,
Marwick, Mitchell & Co. audit later this year.
So, in fact, we felt that, yes, there had been substantial problems,
but not only had we exercised a fair amount of diligence in trying
to change the situation, but there seemed to be some evidence, independent evidence that the situation was changing substantially
for the better.
Mr. WEBER. Well, I can sympathize with the situation that you
were in. Does anyone else care to make a comment?
[No response.]



189
Mr. WEBER. Mr. Chairman, I yield back my time.
The CHAIRMAN. I am trying to get to the bottom of something
here. As members of the board of directors, let me ask you this
question. Did you not get copies of the examiners' reports at the
conclusion of each examination for you to read and sign and
return?
Mr. Ross. No.
Ms. COE. No.
Mr. SMELSER. NO.

Mr. RANDOLPH. We received those in the course of the board
meetings, Mr. Chairman, and would review them there.
The CHAIRMAN. And is there any requirement that you initial
them or sign them once you have seen them?
Mr. RANDOLPH. I do not recall whether we had to or not.
Mr. SMELSER. We never had a report or a letter or a memo or
anything that was sent to us personally and that we could take
outside of the bank board room.
The CHAIRMAN. At any time when you were at meetings in
Dallas, and I will ask Ms. Coe and the ladies in the audience to
forgive me for using this term—and now I am reading from a news
clip—but at any time were you told at any of these meetings at the
Comptroller's Office that there were a lot of "crappy loans?" Was
that word used by anyone in the Comptroller's Office in meetings
with you, that there were a lot of crappy loans at Penn Square?
Ms. COE. NO.
Mr. Ross. No.
Mr. RANDOLPH. I do not recall that expression.
[The news article referred to follows:]
[From the Daily Oklahoman, Aug. 1, 1982]
P E N N BANK WARNED IN 1980 To GET HOUSE IN ORDER

(By Judy Fossett)
These were people who weren't used to being scolded. They called the shots in
their own businesses, and if there were ever any scoldings to be given, they would
be the givers. But on this late August day in 1980 sat an array of corporate executives being warned by a government official who told them "in no uncertain terms"
that Penn Square Bank would fail if they, the bank's directors, didn't make some
swift and sure changes in the way they were running their bank.
That was the government's position: If they failed, the bank would fail, and it
would be their fault. No one else's. Just under two years later, Penn Square Bank
did fail. Federal regulators, who for years kept the bank's troubles a secret as they
sought to save it, are saying publicly now that the bank collapsed because the
bank's directors didn't change the way the bank was run. They say instead of improving its conditions, the board allowed the institution's condition to grow progressively worse under free-wheeling and possibly, as several lawsuits claim, fraudulent
dealings.
The role the bank's directors played in the Penn Square Bank saga isn't being
told by the directors themselves. They are not talking. The story is instead being
told through the steps federal regulators say they took in the last two years.
Apparently not all of Penn Square Bank's directors attended that Aug. 27 meeting in Dallas. It isn't clear exactly who was there, but the entire board had been
summoned by Cliff Poole, the regional adminstrator of national banks, because the
bank was in trouble.
Ordered to assemble were bank directors Bill P. Jennings, the board chairman;
Frank L. Murphy, board president, and Ronald H. Burks, chairman of Burks Investments Inc.; Elizabeth Merrick Coe, president of the Merrick Foundation; Gary M.
Cook, then chairman of Trend Construction Corp., now of Tulsa; C. F. "Tag" Kimberling, then owner of Kimberling's Food Markets, now in investments and real



190
estate; Dr. Marvin K. Margo with McBride Clinic; L. F. Rooney, Tulsa, president of
Manhattan Construction Co.; Jerry Richardson, president of Dub Richardson Ford
Inc.; W. A. "Dub" Ross, president of Dub Ross Co.; Gene Smelser, president of Val
Gene's Food Service; Bill Stubbs, real estate; Carl W. Swan, independent oil producer, and James G. Randolph, president of Kerr-McGee Coal Corp. and former commander of the Oklahoma City Air Logistics Center at Tinker Air Force Base.
These well-known civic and business leaders listened as the chief examiner who
had scrutinized the bank's books listed the violations that had been found. There
should have been no surprises. Two months earlier, on June 9, the regional office
had requested the Dallas meeting because of problems found in an examination
dated Feb. 29, 1980, and completed that April.
Comptroller of the Currency C. T. Conover told the House Banking Committee recently it was after that examination that "the bank became a matter of supervisory
concern. This examination revealed, among other things, rapid growth of bank
loans, and assets, insufficient liquidity, inadequate capital, an increase in classified
assets and violation of banking laws."
The examination also noted that the bank's loans were concentrated in the oil
and gas industry.
On June 19, 1980, the regional administrator met with bank chairman Jennings
and the executive vice-president, who is identified by records as Tony W. Williams,
to discuss the bank's problems. Then on Aug. 27, it was the full board's turn for the
lecture. When the examiner concluded his presentation, the regional administrator
began comparing Penn Square Bank's operation to that of a "prudenf'bank.
He told them the responsibility for the Oklahoma City bank was theirs. He also
reminded them, as Poole said he always does when the officials of any bank are
brought in for a reprimand, that "they can't say they weren't warned in time. If the
bank is in crappy condition, the blame is at their feet."
For a regulator, there is a fine line to walk between making things too easy for
the directors and making them mad, Poole said. Just being ordered to Dallas is already enough of a reprimand for people of the stature of bank diretors, he said.
"They're usually sufficiently contrite or remorseful and find the situation distasteful and immediately want to correct the problems."
On Sept. 9, 1980, a week after the Dallas meeting, Penn Square Bank's directors
signed an agreement in which they promised to: Stop violating banking laws by exceeding lending limits; increase capital; stop loans without adequate collateral; stop
lending to poor quality borrowers; document loans they get other banks to participate in; make more accurate estimates and setasides for possible bad loss loans;
make monthly reports on the bank's progress under the agreement.
From Sept. 9 to 11, 1980, examiners reviewed the bank's books and discovered the
institution's liquidity was strained, its existing staff overtaxed by the volume of
business and its capital adequacy deteriorating, banking officials have testified.
Nonetheless, the required reports filed with the regional administrator by bank
officials showed progress and "repeatedly gave assurances that the required corrective actions had been or would be accomplished."
The examiners returned in January 1981 for another, longer look at the bank's
circumstances and reported "further deterioration of the bank's overall condition."
They said they also found "insider lending violations, and officers who borrowed
without the bank board's knowledge or approval."
Sometime in 1981, unknown then to the examiners, the bank would institute a
policy of forbidding its own internal loan review committee from scrutinizing the
millions of dollars in gas and oil loans being generated by its Energy Department,
congressional investigators have been told.
It was in the period between Dec. 31, 1980, and the bank's final April 1982 audit
that the Energy Department wrote $1.6 billion in oil-related loans and sold virtually
all of them to other banks.
How these loans were written, who they were written for and whether or not they
should have ever been written at all are the subjects of a federal grand jury probe
beginning Monday and two simultaneous congressional inquiries that began earlier
this month. Federal regulators are also sifting through the bank's documents for
clues about these loans and the participation of major banks such as Continental
Illinois, Chase Manhattan and Seattle First National.
For all their demands of the bank and its directors, the examiners failed to make
note of the large volume of energy loans when a limited examination was conducted
in the fall of 1981. Earlier, on July 1, 1981, the regional administrator had notified
the bank's directors that an examination conducted that spring showed that the
"board and management failed to supervise prudently the bank's activities."



191

In particular, the examination report said the lack of supervision showed up in
"numerous violations of banking laws, inordinate asset/liability management risk,
high levels of poor-quality assets, uncontrolled growth of bank resources, and noncompliance with the formal agreement" of the previous September. On July 29,
1981, the bank's board of directors was once more summoned to the Dallas regional
office. A new member of the board by this time was Bill Patterson, the man in
charge of generating Penn Square Bank's millions of dollars in energy loans.
As a follow-up, a special supervisory examination was conducted Oct. 8-30, 1981,
which revealed "modest improvement" although some concerns remained, Comptroller Conover told the House Banking Committee. "As late as January of 1982, we
believed the outlook to be favorable and that all substantive areas of concern were
being addressed and corrected," Conover testified.
Then came the April 1982 audit and the discovery of all those oil loans, about
$900 million of which had been written since the fall audit. None of the previous
$600 million-plus in loans had been checked because the examiner was directed to
review only previously criticized loans and those that had been generated by the
bank's loan review committee—and that committee (which includes bank directors
in its membership) wasn't seeing the oil loans.
Examiners who had been checking the books since April have found "proof of
falsified and altered documents, "insider loans throughout the examination,
throughout the entire period," and "massive violations of law," bank regulators
have testified.
Poole, whose office began altering Penn Square Bank's directors more than two
years ago of problems in the bank, commented: "Any board of directors has the full
responsibility laid at their feet. The board bears the ultimate responsibility. "We try
to get them to face facts if they've got crappy loans, poor documentation, all kinds
of violations of the law.
"Usually when we get them down here to talk to them, they think, 'We're getting
the hell beat out of us here.' They look over at their management and say, 'You told
us you could do it this way and you're fired.' "That's the way it ought to happen."
The CHAIRMAN. NOW, let me ask you this. There is a firm known
as Petro Industries. Does that ring a bell with anyone on the board
of directors?
Mr. RANDOLPH. Not me.
Mr. HAUGLAND. NO.
Mr. COOK. NO.
The CHAIRMAN. They did have some loans with—and I am read-

ing here from minutes of the meeting of the board of directors. Is
this all April 14, 1981? No, this is June 15, 1982. The chairman
commented he believed the loan to be sufficiently collateralized.
Mr. Patterson noted that it would be charged off per the examiner.
He further noted that on Petros Energy and Land, Nos. 25705,
26506, 26999, 27046, the loans had been paid off by the customer
selling off its production to another customer/' You do not recall
that one? This is a board of examiners—I am sorry, a board of directors, the minutes of a meeting of the board of directors. How
about a fellow named Creamer, a former vice president at Northern Trust. Does that ring a bell?
[No response.]
The CHAIRMAN. Mr. Beller, does that name ring a bell with you,
Creamer, Northern Trust?
Mr. BELLER. NO, sir.

The CHAIRMAN. HOW about the Petros, P-e-t-r-o-s Energy and
Land?
Mr. BELLER. Yes, sir.
The CHAIRMAN. Did they have a line of credit with Penn Square?
Mr. BELLER. They had loans with Penn Square, Mr. Chairman,

but I don't recall which bank had participated in the loan. But the
name Creamer, I don't remember.



192

The CHAIRMAN. But they had a loan with Penn Square t h a t was
participated out, or did Penn Square buy a participation from
someone else, do you recall?
Mr. BELLER. It was normal to participate them out.
The CHAIRMAN. Most of yours were participated out, right?
Mr. BELLER. I remember the name. I don't remember the details.
The CHAIRMAN. What we are trying to find out, you say you
recall a real estate loan to Mr. Lytle. Was it a direct loan, or did
t h a t come from another institution, or was it purchased?
Mr. BELLER. That was a loan from Penn Square Bank.
The CHAIRMAN. Direct to him?
Mr. BELLER. Yes.
The CHAIRMAN. For

a mortgage on real estate?

Mr. BELLER. Yes, as I recall.

The CHAIRMAN. Well, t h a t was just a 2-minute news flash. We
will get back to this on later on. We are going to track this one
down before the day is out.
Mr. Wortley?
Mr. WORTLEY. Thank you, Mr. Chairman.
Mr. Haugland, why did Bill Jennings ask you to come on the
board of the bank?
Mr. HAUGLAND. I represented a larger stockholder who owns
stock in Penn Square in the bank holding company organization.
Mr. WORTLEY. YOU did not come on until April of 1981.
Mr. HAUGLAND. Yes, sir. I replaced a man who was deceased
about 6 months prior to that, who also represented t h a t block of
stock.
Mr. WORTLEY. In other words, you did not come on the board because the Comptroller of the Currency was reviewing things and
said this board needs to be beefed up with people who understand
the banking process a little better? Would that have been a reason
why you came to the board?
Mr. HAUGLAND. NO, sir. It had nothing to do with the Comptroller.
Mr. WORTLEY. I know it was not because you were a large depositer.
Who did you replace?
Mr. HAUGLAND. Well, I didn't replace the man, but Mr. L. F.
Rooney was a board member of the bank until his death in October
of 1980. Then subsequent to that period of time I joined the board
to represent their family interest in the holding company.
Mr. WORTLEY. Were they a substantial stockholder in the bank?
Mr. HAUGLAND. They owned about 7 percent of the holding company stock as of the last day of the bank operation.
Mr. WORTLEY. I see they owned 6.7 percent of the stock.
I will address this to any of you out there.
When did you first begin to realize the commitments t h a t you
had given to the Comptroller of the Currency to clean up Penn
Square Bank, that those recommendations were not being followed
by the management?
Ms. Coe?
Ms. COE. Well Mr. Wortley, I think certainly that with the new
administrative officers, t h a t things were going very well. The
Comptroller's Office had said they were. They had told us t h a t in



193
January. Peat, Marwick had told us that. I had no reason to believe the bank was going down.
Mr. WORTLEY. Mr. Cook?
Mr. COOK. I concur 100 percent. As I just mentioned, we felt that
particularly in the last 9 months substantial improvements had
been made, and the Comptroller himself said that a substantial
number of the items which were in the compliance letter we had in
fact complied with, as Mr. Beller testified earlier today.
Mr. WORTLEY. In other words, none of you sitting out there as
directors of the bank realized until the Fourth of July weekend
that the bank was in serious trouble? Is that correct?
Mr. Ross. That's right.
Mr. COOK. That's correct.
Mr. HAUGLAND. Mr. Wortley, I think we recognized that the
bank was under an administrative letter of restraint and had problems. It is a semantics problem when you are talking about whether it was in trouble or whether it had problems. We all recognized
that there were problems.
Mr. WORTLEY. During the last several months did any of you ever
discuss the financial condition of the bank with outsiders, casual
cocktail party conversation or luncheon conversation?
Mr. COOK. Well, the condition of the bank was discussed with me
by a couple of outside people who would ask me what condition we
were in. It was well known that we were a substantial energy
lender, and obviously people then said, well if the energy business
is in trouble, perhaps Penn Square Bank is in trouble.
Mr. WORTLEY. Did you have any discussions with any major depositee of the bank who might have started a run on the bank earlier?
Mr. COOK. I certainly didn't.
Mr. RICHARDSON. NO.
Mr. SMELSER. NO.
Mr. WORTLEY. Did any

of you as directors ever receive special
privileges of overdraft in your accounts for any extended period of
time, not overnight, for example?
Mr. Ross. No.
Mr. SMELSER. NO.
Mr. COOK. NO.
Mr. WORTLEY. DO

you really feel that the management of this
bank was a good and prudent management, knowing full well that
the president himself was unaware of and was not highly knowledgeable of energy type loans, and you put a major concentration
of the bank's resources in the area of energy loans?
Now, Mr. Haugland, you are a banker. You are on there because
you are a prudent man. Did you ever bring up—you mentioned
overdrafts. You cited that in at least one or two board meetings,
that you were urged to cool it somewhat.
Did you ever raise the question about having concentration of
bank loans in the energy field?
Mr. HAUGLAND. I think we were all aware—at least I was aware
that we were an energy concentrated lender. We did not suffer in
the past, and I guess history would tell us what the actual losses
we did suffer, but we have not suffered significant losses from
energy lending.



194
Mr. WORTLEY. Where did you suffer significant losses if it was
not in the area of energy?
Mr. HAUGLAND. The significant losses that the bank apparently
suffered were in some of the loans that were on the books as a
result of some poor judgment by officers who are no longer there,
that is, some of the agricultural loans and some of the real estate
loans. It is my understanding we have not had significant losses up
until the most recent examination which apparently is still ongoing.
Mr. WORTLEY. What was the ratio of Penn Square's loan losses
compared to the industry's?
Mr. HAUGLAND. I can't recall it.
Mr. WORTLEY. Well, were your level of losses higher in the area
of energy loans than other competitive banks?
Mr. HAUGLAND. I don't have a way of making that comparison.
Mr. WORTLEY. I wonder if Mr. Beller could refresh our memory
on that.
Mr. BELLER. Could you state the question again, sir?
Mr. WORTLEY. The question was the level of loan loss, your loan
loss ratio. Was it higher at Penn Square in the area of energy
loans than it was at other banks in the area?
Mr. BELLER. I think not. My memory is that I came there with
the amount of chargeoffs of the bank, that it had incurred in the
previous examination before I arrived. The chargeoffs were practically all in areas other than energy.
Mr. WORTLEY. In other words, this bank was doing a fine job on
its energy loans, is that right?
Mr. BELLER. That is what the chargeoff records would show, yes,
sir.
Mr. WORTLEY. Well, what led to its demise?
Mr. BELLER. The chargeoffs of substantial energy loans by the
Comptroller's office that rendered the bank insolvent.
Mr. WORTLEY. SO it was really
Mr. BELLER. If you want the bottom line, that's what happened.
How many of those loans are bad, only time will tell.
Mr. HAUGLAND. Just because you charge a loan off doesn't mean
the borrower doesn't necessarily have to pay it. It doesn't necessarily mean it is a bad loan. That is the judgment that is subjective,
and you and I could both look at a loan and come up with a
different conclusion. Just the fact that the chargeoffs were of the
magnitude they were means that it rendered the bank insolvent,
but it is not inconceivable that they could all be collected.
Mr. WORTLEY. NO, but you did have a larger proportion than
normal of loans in which the interest was deficient, is that correct,
in the area of energy? Did Penn Square Bank have a larger ratio of
loans in which the interest and principal were not being reduced?
Mr. HAUGLAND. I don't know that.
Mr. WORTLEY. Well, why would the Comptroller of the Currency
single out Penn Square Bank from all the other banks that there
are in this country for making energy loans?
Mr. HAUGLAND. Are you addressing that to me?
Mr. WORTLEY. Well, you were responding. You are the banker sitting up there and are perhaps more knowledgeable than the rest.



195
Mr. HAUGLAND. As I say, I have not seen or heard anything official from the Comptrollers Office relative to the examination that
was started on April 19, so I really don't know.
Mr. WORTLEY. I would ask any of you, when did you first become
aware that the internal loan review program was precluded from
reviewing energy credits?
Mr. COOK. Well, I think I just heard that right now because I remember this spring there was a review of the internal loan review
program. Mr. Dunn reviewed that program, and energy credits
were included in the reviews that he had conducted to date, if I am
not mistaken. I also remember that he was asked if the profile of
loans of the bank that had not yet been reviewed would be in any
different distribution in terms of poor quality versus good quality
loans compared to the profile of the loans that had been reviewed,
and he said he had no way of knowing but he didn't believe that
was the case. So I assume the loan review program was in fact covering energy loans and that it was going along well. It wasn't going
as fast as we wanted it to, but he was working on a number of potential chargeoffs, and he had not been able to devote as much
time to it as I think many of us would have hoped he would have
been able to.
Mr. WORTLEY. But in fact, the energy loans were being precluded
from the overall review of the credit policy.
Mr. COOK. That is news to me.
Mr. RANDOLPH. I was going to confirm that that is news to us.
We were not aware that it was excluded, that he made restrictions
on reviewing energy loans.
Mr. WORTLEY. I wonder if the president could comment.
Mr. BELLER. Yes, sir. I don't know where you came by that information. The energy department was not precluded in my knowledge, and I would add to that that the loan review function, after
we were able to get it in place, started reviewing the loans, and we
attacked those loans that had been classified by the Comptroller's
Office first, and reviewed those loans and charged off the ones that
were classified substandard, doubtful, et cetera. That was the place
where obviously we reviewed them.
So as soon as we assembled the people to do it, that is what we
attacked, and there was, to my knowledge, we were never precluded in any way from reviewing energy loans. It was just that we
had not gotten to those reviews yet.
The CHAIRMAN. Mr. Barnard?
Mr. BARNARD. Thank you, Mr. Chairman.
Ladies and gentlemen, you have been most cooperative today, as
well as patient and enduring, and for that reason I will make my
questions as brief as possible.
Mr. Cook, did you know that the Penn Square Bank very frequently made venture capital loans for new oil ventures?
Mr. COOK. NO, I didn't.
Mr. BARNARD. Let me rephrase it.
Do you have any knowledge that they made that type of loan?
Mr. COOK. NO, I do not.
Mr. BARNARD. Mr. Haugland,

as a banker, and in Muskogee,
Okla., where I would imagine you would be confronted with the
same opportunities for business as the Penn Square Bank, is it a



196
customary practice for banks to involve themselves in venture capital for new wells and new drills, new rigs.
Mr. HAUGLAND. Sir, we have very little oil activity in that part
of Oklahoma. So our customer base is quite a bit different than the
banks that you would look at here in Oklahoma City.
Mr. BARNARD. Is it not customary for those larger banks who
have been in the oil business or energy business for many, many
years to specialize not in venture capital loans but in collateral of
wells and rigs and operations that are already in being and making
a profit?
Mr. HAUGLAND. I guess in response to that, I would say that a
venture capital oil loan would be like any other venture capital,
that if there were additional collateral forthcoming to justify the
credit advance, it would be done, but do you mean just by the venture itself?
Mr. BARNARD. Well, it was pretty widely known, at least suspected that Penn Square was making brandnew loans to brandnew
people in the business, which was contrary to what I understand to
be the practice in other banks who have had many, many years of
experience in the oil-lending business. That story was written up
rather at length in the American Banker of April 26, 1982, and
somewhat corroborated by Mr. Jennings. When the gentleman
writing the article asked him if he was actually providing venture
capital, Mr. Jennings said he would like to be, noting that he was
thinking about forming a venture capital subsidiary. It was reported that Penn Square was pretty much involved in new ventures,
which I understand is somewhat contrary to normal banking practice
Mr. HAUGLAND. If it was, sir, I was not aware of it.
Mr. BARNARD. Back in 1979, we passed a bill in Congress called
FIRA, and in that particular law it required that insider loans,
loans to members of the board of directors or to correspondents,
had to be reported to the board of directors.
Was any such report ever made to you all about a schedule of
loans made to your directors?
Mr. HAUGLAND. Yes, sir.
Mr. COOK. Yes, at every meeting.

Mr. Ross. Yes, sir.
Mr. BARNARD. At every meeting that was done?
One of the things that interests me is that all of you seemed to
be very, very surprised that the bank closed. You suspected that
additional capital had to be raised and possibly according to some
of you, $4 million or $5 million might be needed, and then all of a
sudden $40 million in loans were charged off.
Mr. RANDOLPH. Someone from your bench said that.
Mr. BARNARD. YOU had no forewarning, no indication at all from
the Comptroller of the Currency that this requirement was going
to be made on the bank?
Mr. RANDOLPH. NO, sir, not until the last weekend.
Mr. BARNARD. Not until the last week, and yet you had had how
many meetings with the Office of the Comptroller of the Currency?
Mr. RANDOLPH. We as a board did not meet with them at all
during the last examination.
Mr. BARNARD. But you had been to Dallas twice, right?



197
Mr. RANDOLPH. Well, in 1980 and 1981.
Mr. BARNARD. But in those discussions, the ultimate results of
what could happen if you did not turn the bank around was never
discussed?
Mr. RANDOLPH. I don't understand what you mean.
Mr. BARNARD. Well, general, it is like talking tough to a recruit.
They did not say something like if you do not turn that bank
around we are going to close you up? Nothing like that was ever
said?
Mr. RANDOLPH. They made those comments, but as we have told
you over and over again that based upon their examinations in the
fall of 1981 and their report to us in January 1982, that we were
making progress to clear up those deficiencies that they were concerned about, further collaborated by the auditor's report to us in
April.
Mr. BARNARD. SO you felt comfortable?
Mr. RANDOLPH. Yes, sir, we did. We felt that the bank was in fact
improving and the fact that they came in in April of this year and
started an examination and we had no contact with any members
of that examining group until the last week, on the first of July.
Mr. BARNARD. And they felt so comfortable about it in April that
the just took a little vacation.
Mr. RANDOLPH. Well, I read the testimony that they found after
2 or 3 weeks that it was so horrible they ran to Washington with it,
but we didn't have a chance to take a swing at the bat, so to speak.
Mr. BARNARD. Well, we are going to give them a swing at the bat
when they come before us.
Mr. Haugland, I believe that you have been very close to the
Rooney family, if I am not mistaken.
Mr. HAUGLAND. Yes,
Mr. BARNARD. And

sir.

my information is you replaced Mr. Rooney
on the board of Penn Square after his death in 1980.
I understand that there was a relationship between the Rooney
family of Muskogee and the Rowsey family of the Mahan-Rowsey
Co.
Do you know much about that relationship?
Mr. HAUGLAND. I know both families. Mr. Rooney, deceased,
Larry Rooney, happens to live next door to the Rowsey-that-youare-mentioning's father, but I don't think that outside of that, they
serve on different bank boards.
Mr. BARNARD. IS Mr. Rooney on your board? Is there a Rooney
on your board?
Mr. HAUGLAND. Yes, sir.
Mr. BARNARD. Which Rooney is it?
Mr. HAUGLAND. The son of Lawrence Rooney.
Mr. BARNARD. Can you tell us anything about

the Mahan-Rowsey
debt at Penn Square?
Mr. HAUGLAND. NO, sir, I don't know anything about it except
that we had an extremely large line of credit granted to them that
was a participation of credit with either Chase or Continental.
Mr. BARNARD. All right. Thank you, sir.
Mr. Chairman, I have no further questions.



198
The CHAIRMAN. I am going to ask each and every one of you to
answer this question. We have been trying to get to this, and perhaps we will try to twist the question around.
The Comptroller's Office was in Penn Square and indeed called
the FDIC in, alerted Chase Manhattan and Continental, finally admitted to the Federal Reserve Board, after they asked about it,
that there was trouble in the streets of Oklahoma City, particularly at Penn Square Bank.
There is a question about the fact that some customers of the institution withdrew substantial amounts of funds at the "advice of a
mystical financial consultant/'
You people are on the board, or were on the board of directors of
the Penn Square Bank.
Did you, Mr. Smelser, can you state to this committee that the
Comptroller's office and the representatives of the Comptroller's
Office alerted you and apprised you of the severity of the situation
at Penn Square Bank on Thursday and Friday of the week—that
was the last 2 days, the Thursday and Friday that that bank was
open?
Mr. SMELSER. Did they apprise us of the severity?
The CHAIRMAN. The severity of the situation and the impending
doom that laid ahead.
Mr. SMELSER. Well, they apprised us of the severity, but I don't
think they apprised us of the impending doom.
The CHAIRMAN. Well, let's put it this way. Did you feel as a
result of those meetings that at the next board meeting with the
management of Penn Square, that there was a whole lot that had
to be done that had not been done to date, despite those glowing
reports from Peat, Marwick & Mitchell and the Comptroller's Office
in January of 1982?
Mr. SMELSER. Yes.

The CHAIRMAN. Yes what?
Mr. SMELSER. Yes, I did feel there was a lot to be done.
The CHAIRMAN. There was a lot to be done as a result of meetings on Thursday and Friday?
Mr. SMELSER. That's correct.
The CHAIRMAN. But prior to that you were not aware of it?
Mr. SMELSER. NO, sir.

The CHAIRMAN. This was the first point at which you felt it was
that serious?
Mr. SMELSER. The severity of it, yes, sir.
The CHAIRMAN. And Mr. Richardson, I believe you had some
loans, rather substantial loans with Penn Square?
Mr. RICHARDSON. That's correct.
The CHAIRMAN. Would you pull the mike a little closer? That
had to be renegotiated once Penn Square was closed, correct?
Mr. RICHARDSON. NO, I just moved them out of the bank.
The CHAIRMAN. I am sorry, I used the wrong term. You had to go
someplace else to get those loans.
Mr. RICHARDSON. That is right.
The CHAIRMAN. I ask you, did the Comptroller's Office in your
opinion keep you properly apprised of the severity of the situation
at Penn Square Bank?



199
Mr. RICHARDSON. I would say on Thursday they apprised us
pretty heavily. They gave us 1 week to raise enough capital, until
the 9th, to more or less stay in business.
The CHAIRMAN. OK. Prior to that.
Mr. RICHARDSON. NO. That is the first meeting we had.
The CHAIRMAN. Was that the first inkling you got that things
were that severe and that serious?
Mr. RICHARDSON. Yes, that is correct.
The CHAIRMAN. Mr. Ross?

Mr. Ross. I was out of town on Thursday the 1st, and my first
knowing of the problem was on July 2, on Friday when I returned
back to town, but prior to that I had no knowledge or any expectations as has been testified here about its closing.
The CHAIRMAN. Well, I think you get the most—well, not the
most, but certainly very glowing testimony and testimony very difficult to contradict that in view of the loss you sustained.
Mr. Ross. Yes, sir.
The CHAIRMAN. SO it is fair to say that until that Friday, because
you could not be there Thursday, you were not aware of the fact
that Penn Square was as severe as it was?
Mr. Ross. That is correct.
The CHAIRMAN. SO either the Comptroller held it from you or hid
it from you, or the Comptroller did not know it either.
Mr. Ross. Yes, sir, I would say that is fair.
The CHAIRMAN. IS that a fair conclusion?
Mr. Ross. That is a fair statement.
The CHAIRMAN. M S . Coe?
Ms. COE. Yes.
The CHAIRMAN. DO you agree?

Ms. COE. I did not know anything until I attended the July 1
meeting.
The CHAIRMAN. SO either those facts were not made available to
you
Ms. COE. They were not.
The CHAIRMAN. Or/and were hidden from you, or the Comptroller's office did not know it either.
Is that a fair summation?
Ms. COE. I think that's fair.
The CHAIRMAN. Mr. Cook, do you agree with that summation?
Mr. COOK. I would concur with that.
The CHAIRMAN. Mr. Randolph?

Mr. RANDOLPH. Yes, sir, I knew nothing prior to the meeting. I
did not attend the meeting because I was out of the country. I did
learn about the need to raise capital in order to keep the bank
open from talking to Mr. Smelser by phone on Thursday evening,
and I later learned—I didn't learn the bank closed until the following Thursday. So I was somewhat out of touch.
The CHAIRMAN. But prior to the meetings of Thursday and
Friday, July 1 and 2, you as a rather—as a businessman, again,
whose I think business acumen is pretty good, were not aware of it.
You were not appraised of it.
Mr. RANDOLPH. NO.

The CHAIRMAN. SO the conclusion is either the Comptroller hid it
from you or the Comptroller did not know it either.



200
Mr. RANDOLPH. I guess I really don't know how to characterize
the facts.
The CHAIRMAN. NOW we get to our star here, Mr. Haugland, who
is also not only a member of the board of directors but is also a
member of the financial institutions industry, so to speak.
Were you aware of the severity of the situation prior to July 1
. and 2?
Mr. HAUGLAND. Only to the extent that in our June regularly
called board meeting that our management speculated from what
he had been able to determine in his meetings with the representatives of the Comptroller's Office that our losses were going to be
somewhere in the $5 million to $6 million area.
The CHAIRMAN. That was your management, right, your management telling you that?
Mr. HAUGLAND. Yes.

The CHAIRMAN. HOW about the Comptroller's Office?
Mr. HAUGLAND. Nothing. We knew they were in the bank and
had been there since April 19,1 believe.
The CHAIRMAN. YOU know, you were called to Dallas a few times,
and here is what I want to know before we hear from the regulators, and I am going to be straight out with it.
You went to Dallas, and we got the impression from the Comptroller's briefing that by cracky, you people on the board should
have known how bad things were because they laid it all out on
the table for you.
Do you think that is an accurate picture of the meetings that you
had in the Dallas office of the Comptroller on those two occasions?
Did anyone feel as though it was all laid out for you and made
clear to you that things were real bad?
Mr. RANDOLPH. I think with that meeting in Dallas they probably attempted to convey to us that there were some problems
there, and they gave us the scenario of what they wanted us to do.
But I guess I don't really know.
The CHAIRMAN. Did you come away from that meeting say, by
cracky, I am on this board of directors, I own stock.
Do you own stock or does your family own stock in the bank?
Mr. RANDOLPH. Yes, that is correct.
The CHAIRMAN. By cracky, I am going home to Oklahoma City
and I am going to talk to my fellow board members, and by golly,
we have got a lot of work to do to turn this thing around and we
have got to do it rather expeditiously.
Did you have that feeling when you came home from that meeting?
Mr. RICHARDSON. I think that to some extent, yes, but then
maybe that is wrong. However, from that day on in the board
meetings we were constantly questioning the fact that we had this
letter of agreement—and how we were getting along with it, and
felt that things were getting done to work towards its solution.
Mr. SMELSER. Mr. Chairman, we speak of the severity of the situation, were we aware of it. The Comptroller classified Penn Square
as a class 3 bank and not a 4 or 5 which makes a tremendous difference as to what the supposed severity of the situation is.
The CHAIRMAN. I just repeat that Mr. Richardson says he came
back feeling things ought to be done. You know, on a scale of 1 to



201
10, how excited were you about the fact that you had to come back
here, motivated, excited?
Mr. COOK. I remember talking to Eldon Beller and asking him
how serious the problem was, and he said it was damned serious.
He said the next step will be a cease and desist order—this was in
the summer of 1981. He said the next step was clearly going to be a
cease and desist order. But again, as I think all of us have said,
that was 1981. Then we get the examination in late 1981 and we
have got the Comptroller saying to us in January that we have
gone a long way toward solving the various items that were in the
compliance letter, No. 1, and No. 2, that there is a reasonable
chance—and that is in our minutes—I believe there is a reasonable
chance that we will get out from underneath that compliance letter
at our next audit, that things are in that good a shape.
The CHAIRMAN. SO at that point you were lulled into a sense of
security?
Mr. COOK. I wouldn't say we were lulled because we still felt—I
mean, after all, we didn't want to be a No. 3 bank. We wanted to
be a No. 1 bank. So there was still a long way to go.
The CHAIRMAN. But a number three bank in reality and in truth
is not all that bad.
Mr. COOK. At least it is not a four or a five. That is exactly right.
Mr. BARNARD. Mr. Chairman, I guess we cannot resolve until we
talk to the Comptroller, how they moved from $5 million or $6 million in capital needs to $40 million in capital needs overnight.
Maybe Mr. Beller could answer that.
Mr. BELLER. NO, sir, I can't. But based upon the anticipated chargeoffs that we had concluded in-house that our chargeoffs would
run in the neighborhood of $3 million to $4 million, we had identified that many problems ourselves. The first indication I had that
it would be more than that was when I was advised by the examiners that they looked like it was $6 million.
Mr. BARNARD. NOW, you charged off $4 million at the end of
1981, at your direction, I believe.
Mr. BELLER. At my direction, after I came to work for the bank.
Mr. BARNARD. But those were other than energy loans? Those
were real estate loans?
Mr. BELLER. Yes, other than energy, and those were loans that
we charged them off ourselves.
Mr. BARNARD. Did you feel that you had cleaned up the loan
portfolio at that time?
Mr. BELLER. Inasmuch as I had been able to find within those
few short weeks. The examination continued and the examiners
continued to come up with larger numbers of chargeoffs until they
finally got to $12 million, $20 million, and I understand it ended up
somewhere in the $40 millions. I have never seen the list of the
chargeoffs yet.
Mr. BARNARD. Mr. Chairman, I would like to ask the board members, were you being lulled into the dream of this bank in the next
2 or 3 years becoming a billion dollar bank?
Mr. RANDOLPH. NO. We were programming somewhere between
15 to 20 percent growth, which was in real terms probably 5 to 6
percent if you take account of inflation. We were basically basing



202
our growth on the ability to fund the capital needs from the earnings of the bank rather than the need for new capital infusions.
Mr. WEBER. Mr. Chairman?
The CHAIRMAN. Mr. Weber.
Mr. WEBER. It seems to me the situation is becoming a little
more clear. Based upon the testimony of the board of directors and
also Mr. Beliefs testimony that apparently—and also the earlier
testimony that we had from Mr. Conover and buttressed by the testimony that we will be getting from the regional Comptroller's
office later today, corrective actions apparently were in place or
were being put into place that were satisfactory to the OCC as of
the September 30, 1981 examination.
The question then is how were those corrective actions evaded so
easily between October of 1981 and the period or the time of the
next examination of the bank that the OCC made in I believe it
was April of 1982, completed—the preliminary I think was completed in early May of 1982, arousing their alarm.
I think the question is, What were the corrective actions that
were taken and how were they so easily evaded during that period
of time? And I do not know that any of you can answer that, but I
think that is really the question.
The OCC is saying that the bank had the corrective, was in the
process of taking corrective actions and did not follow through, and
I do not know who could answer that question. Apparently you
were placing your reliance on a management that did not make
good on the corrections that they had agreed, the corrective actions
that they had agreed to make, and I do not know if that was the
president, the chief executive officer, or the senior loan officer in
the department of energy?
The CHAIRMAN. YOU are a little young to remember this, Mr.
Weber, but when I was young, every Saturday you would go to the
movies to see Tom Mix or one of those old cowboys, but you always
had to go the next Saturday to see the next issue in the serial, you
know, what happens next week.
So we are going to get as much as we can from these witnesses,
and hopefully, as we get to the next episode, we might learn a little
more.
Now, at the June 15, 1982, meeting, Mr. Patterson noted his participation in what appeared to be a partnership. "Mr. Randolph
then inquired about possible conflict of interest. The chairman, Mr.
Jennings, stated the ethics committee reviews officer participations
as well as details of the borrowing/'
Could anyone on this panel tell the committee what members of
the board sat on the ethics committee?
Did any of you sit on the ethics committee?
Mr. Ross. No.
The CHAIRMAN. DO you know who the members of the ethics
committee were?
Ms. COE. NO.
The CHAIRMAN. Does anyone know who was on the ethics
committee?
Mr. RANDOLPH. NO, sir.
Mr. SMELSER. It is the first time we've heard of
The CHAIRMAN. Was it kept a secret from you?



it.

203
Mr. RICHARDSON. That's the first time we knew of it.
The CHAIRMAN. They answered your question, Mr. Randolph,
about a conflict by saying the ethics committee would take it up.
I was going to ask you what the procedures of the committee, of
the ethics committee were in reviewing potential conflicts of interest, but none of you know anything about the ethics committee at
Penn Square Bank?
Mr. RANDOLPH. I don't know anything.
Mr. Ross. No, sir.
The CHAIRMAN. Mr. Beller, were you on the ethics committee?
Mr. BELLER. There was not a formal ethics committee, to my
knowledge. There was a standards and conduct directive. All officers had
The CHAIRMAN. Directive?
Mr. BELLER. Yes, sir, an outline that we gave them that would, if
they were placed in any type of relationship that would give a conflict of interest at any time, that that should be reported in writing
to the chairman of the board and president of the bank. That is the
nearest thing to an ethics committee that existed to my knowledge.
The CHAIRMAN. But you are not aware of any ethics committee
that met in formal meetings?
Mr. BELLER. NO, sir.
The CHAIRMAN. And

people wonder why Penn Square had problems.
Ladies and gentlemen, we want to thank you very kindly for
your assistance.
There might be some written questions we might submit to you
and if you think of anything else that might be helpful to the
committee, please feel free to contact us or our staffs.
But on behalf of each and every member of the committee, we
want to thank you for your assistance, your openness, your frankness, your willingness to assist, and the help you have given us this
morning and this afternoon.
The committee will be in recess for 5 minutes in order to allow
our official reporter to retool and relubricate.
This fellow is fantastic. We have had him around the country
with us. We have had him all over the place. He is just outstanding.
Mr. BARNARD. IS that going in the record, Mr. Chairman?
The CHAIRMAN. Of course. That goes in the official record. We
asked for him to come with us because of the fact that he gets the
testimony accurately.
Ray, you have 5 minutes.
We will be back.
Our next panel will consist of, so that they know, Mr. Frank
Murphy and Mr. Cravens, Mr. Kenworthy, Mr. Kimberling, Dr.
Margo, Mr. Mead Norton, and Bill Stubbs, and we have already
had Gene Smelser.
[A brief recess was taken.]
The CHAIRMAN. The committee will come to order.
The Chair at this point in time would like to submit for the
record other documents that have been referred to in the questioning of the witnesses, and this would be the minutes of the meeting
of the board of directors of Penn Square Bank from April 14, 1981,
97-830

0-82-14




204

through June 15, 1982, and without objection, these will be put into
the record.
The CHAIRMAN. The Chair would also ask unanimous consent to
place into the record a communication from the Comptroller of the
Currency re Penn Square Bank from Mr. Conover, the Comptroller
of the Currency, dated August 15, 1982, and this is a summary, a
copy, rather, a formal agreement executed with the bank of September 1980, copies of the notice of charges of the order for ceaseand-desist order June and July 1982, and a summary of each examination report from 1976 through 1982.
I would inform the press and everybody else not to get too excited because this is a summary of the examination reports with all
kinds of names and I.D.'s deleted, and very frankly, I am afraid we
are going to have to ask for much more than the summary.
[The material referred to, with an addendum, appears in the appendix section as appendix C]
Mr. SPRADLING. I am Mr. Spradling, an attorney for Mr. Cravens.
With respect to the minutes first admitted, there is an error in
the minutes of the Dallas meeting. Mr. Cravens was absent and
Mr. Norton was present, and I think they have got it reversed.
The CHAIRMAN. They had it backwards.
Thank you.
At this time we have Mr. Frank Murphy, former president of
Penn Square; J. C. Cravens, Mr. Kenworthy, Mr. Kimberling, Dr.
Margo, H. Mead Norton, Mr. Stubbs, and Mr. Ron Burks.
If you gentlemen would be kind enough to rise with me.
[Witnesses sworn.]
The CHAIRMAN. The Chair would like to thank all of you again
for your assistance and your appearance here, and the members of
this particular panel have been with the institution since its inception, and it will be very helpful to get a real clear history of this.
And I think I would first like to ask Mr. Murphy, since he has
been with the institution or connected with it for a long period of
time, if you would be willing to tell us or give us a brief recap of
the history of the bank from the time you joined I believe in the
1960,s, a very brief one.
TESTIMONY OF FRANK MURPHY, FORMER PRESIDENT OF PENN
SQUARE BANK; J. C. CRAVENS, KEN L. KENWORTHY, C. F. KIMBERLING, DR. MARVIN K. MARGO, H. MEAD NORTON, BILL
STUBBS, AND RON BURKS
Mr. MURPHY. Yes, Mr. Chairman. I joined in January 1961 as assistant vice president. In September 1961 I went into commercial
loans as vice president. In April 1964, the executive vice president;
in January, I believe, 1965 until the present, then last year, as vice
chairman.
The CHAIRMAN. NOW, you became at any time between 1964
when Mr. Jennings left the bank and went to Fidelity and 1975
and 1976 when he regained control and returned, was the bank
under any level of criticism from the Comptroller of the Currency's
administrator, or from the Comptroller of the Currency?
Mr. MURPHY. NO letter of administration, no, sir.
The CHAIRMAN. Any cease-and-desist orders?



205
Mr. MURPHY. NO, sir.
The CHAIRMAN. In other

words, the bank was functioning properly as far as the Comptroller's office was concerned? Your reports
were relatively unexciting?
Mr. MURPHY. I would think operating above average, I would like
to believe.
The CHAIRMAN. NOW, could you tell the committee your impressions of what changes occurred at the bank subsequent to the
return of Mr. Jennings and his assuming control?
Mr. MURPHY. The primary change was directing the bank into
the energy field. That has been at the peak.
The CHAIRMAN. This was a rather substantial or dramatic
change in direction, was it not?
Mr. MURPHY. Yes, it

was.

The CHAIRMAN. Compared to what the bank had been doing previously.
Mr. MURPHY. Very much so.
The CHAIRMAN. What was your reaction to this right hand turn,
so to speak, or 180 degree turn?
Mr. MURPHY. Well, I guess I am known as pretty conservative. I
felt that with the proper direction and proper loans there would be
nothing wrong with it, even though I am conservative.
The CHAIRMAN. When did you indeed leave the institution?
Mr. MURPHY. Sir?
The CHAIRMAN. When did you leave Penn Square?
Mr. MURPHY. When the FDIC—I was advised I was no longer on
the payroll.
The CHAIRMAN. The minutes reflect considerable discussion of a
former officer, Mr. Thomas Orr, and the problems he had caused
prior to his resignation in 1981.
Could you tell us what was his function at Penn Square?
Mr. MURPHY. Mr. Orr was an executive vice president over commercial loans, excluding energy.
The CHAIRMAN. And do you know who brought him into Penn
Square?
Mr. MURPHY. Yes, sir, Mr. Jennings.
The CHAIRMAN. We have heard references this morning to horse
loans.
Was Mr. Orr involved in what is known, in these horse loans?
Mr. MURPHY. Well, we didn't think so, but apparently it has
turned out that way, yes.
The CHAIRMAN. And were other members of the board or officers
of the institution involved in these horse loans?
Mr. MURPHY. Not to my knowledge, sir.
The CHAIRMAN. NOW, again, he seems to have had problems.
Is he the gentleman about whom letters went to the Comptroller
in complaint?
Mr. MURPHY. Yes,

sir.

The CHAIRMAN. DO you know what the sum and substance of
those complaints were?
Mr. MURPHY. The sum and substance, no, sir, I do not.
The CHAIRMAN. YOU do not know what the allegations were?
Mr. MURPHY. Allegations, direct knowledge, I do not. Hearsay,
yes, but direct knowledge I do not.



206
The CHAIRMAN. Maybe we can get that from the Comptroller's
office.
Tell me, Mr. Murphy, would you be good enough to inform us as
to how long you had been acquainted with Mrs. Evelyn Wood who I
believe served as an assistant to Mr. Jennings?
Mr. MURPHY. I have been acquainted with her from the time she
became a secretary originally to Mr. Jennings.
The CHAIRMAN. And when would that have been?
Mr. MURPHY. Four or five years ago maybe. Maybe longer.
The CHAIRMAN. Subsequent to his return to Penn Square in
1975?
Mr. MURPHY. Yes, sir.
The CHAIRMAN. And to

the best of your knowledge she came on
board and worked for Mr. Jennings throughout?
Mr. MURPHY. Yes,

sir.

The CHAIRMAN. That period of time?
Mr. MURPHY. Yes, sir.
The CHAIRMAN. If the

committee members will allow, I am just
getting this in handwriting myself. I will go through with some of
these members their involvement and then open up for the other
members, and then that way maybe we will have a better handle.
Now, Mr. Stubbs, you have been a director since 1964?
Mr. STUBBS. Yes,
The CHAIRMAN.

sir.

Mr. STUBBS. Yes,

sir.

And you, therefore, were with the bank since
1964 and 1974 prior to the change of direction?
The CHAIRMAN. And then you were on from 1975 until the
demise, so to speak, on July 5 and 6?
Mr. STUBBS. Yes,
The CHAIRMAN.

sir.

Could you give us your impression of the direction the bank took, the difference between the manner in which it
functioned prior to 1974 and subsequent to 1975—a very capsulized
version?
Mr. STUBBS. I was on the board from 1964 to 1974. The bank was
basically a real estate bank and I am in the real estate business,
and that is the reason I was on the board. I offered to resign when
Mr. Jennings and his group bought the bank and he requested that
I stay on, and I did.
And it did take a complete change and go into the energy business, which was very foreign to me. And what I could see from sitting on the board, it seemed like it was a very profitable venture
for the bank.
The CHAIRMAN. Let me ask you this, Mr. Stubbs. Were you present at the Dallas meeting in 1981?
Mr. STUBBS. Yes, sir.
The CHAIRMAN. With the
Mr. STUBBS. Yes, sir.
The CHAIRMAN. Did any

Comptroller?

of the directors at any time say to the
Comptroller of the Currency—the people at that meeting—what is
our authority as far as the control of management is concerned
and do we have the power to remove management if we feel it is in
the best interest of the institution?



207
Mr. STUBBS. Yes, sir. I think that was reflected in such minutes
with Mr. Smelser, asking him, and he told us that if we did not
feel—I am sorry; I have got laryngitis
The CHAIRMAN. See if you can get a little closer.
Mr. STUBBS. That if he did not feel that we could move the people
that we could resign from the board.
The CHAIRMAN. This is what the Comptroller told you?
Mr. STUBBS. I am afraid he said that, yes.
The CHAIRMAN. The Comptroller, when asked
Mr. STUBBS. In the minutes.
The CHAIRMAN. In other words, when asked how you could reprove management if you felt that in some instances management
was poor, the answer was well, one way would be to resign from
the board?
Mr. STUBBS. Yes, sir. He said that.
The CHAIRMAN. That is a most unique way of solving the problem.
Now, Mr. Cravens and Mr. Norton, you were the two that we
had a little dispute about. We again want to thank you for your
appearance here. You two have been with the bank for a long
period of time.
Let me ask, because you were there both before and after the
original tenure of Mr. Jennings and then his return.
Mr. NORTON. Yes.

The CHAIRMAN. In your opinion, was the board of directors kept
sufficiently informed about the affairs of the bank by management
subsequent to 1975?
Mr. NORTON. YOU will have to talk a little bit louder. I am hard
of hearing.
The CHAIRMAN. DO you feel as though you were sufficiently informed about the manner in which Penn Square Bank was being
operated after 1975, when Mr. Jennings returned, until July of this
year?
Mr. NORTON. Well, before Mr. Jennings came there it was pretty
open, but after he got there, why it was not so open. In other
words, he did not explain a lot of things to us.
The CHAIRMAN. Mr. Cravens?
Mr. CRAVENS. Well, I am one of the original directors of the bank
and I am speaking more or less for Mead Norton and myself. We
are just advisory directors. I have been a nonvoting director since
inception, except I was a director until we sold out our interest in
1974, I believe it was, when we sold the majority interest to Jennings' group.
To my knowledge, and I guess I believe that of Mr. Norton, our
greatest knowledge was of the early years of the bank, we do not
know much about it after it became out of our control. I concur
generally with General Randolph and Mr. Cook's comments. I will
be happy to answer any questions that the committee may have to
the best of my knowledge.
The CHAIRMAN. Dr. Margo, you have been on the board since
1965, is that correct?
Dr. MARGO. Yes,

sir.

The CHAIRMAN. I tell you I must compliment you because prior
to coming to Congress I did a lot of work with workman's comp



208
with orthopedic surgeons and I have to have orthopedic men because of a back condition and I know how busy you are and the
fact that you were able to spend time on the board of this bank I
compliment you.
Tell me, do you feel as though the documents and the information provided to you by management of the bank subsequent to
1975 allowed you or gave you sufficient knowledge so that you
could in an intelligent and responsible manner carry out your
duties as a member of the board of directors of that institution?
Dr. MARGO. Well, at the time I thought I was getting enough information, but all of the information we received was at the board
meetings only. It was always recommended to us at the end of the
meetings that we not take home any of this information and keep
it there in our board manuals, and that seemed reasonable.
And so we very seldom, if ever, had any material to take home
and peruse and study.
The CHAIRMAN. For instance, let me ask you this. Did you ever
see the management letter from Peat Marwick and Mitchell that
cited the fact that a great number of steps should be taken to further improve the institution that was in oh, perhaps mid-1982?
Dr. MARGO. I believe that was in the June meeting and I do not
remember having that, no, sir.
The CHAIRMAN. The previous panel told us that it was mentioned
in passing, that a synopsis or a summary
Dr. MARGO. Yes.

The CHAIRMAN. But you never saw the actual letter?
Dr. MARGO. I don't remember seeing it, no, sir.
The CHAIRMAN. The recommendation of the Comptroller's office,
you signed the letter of agreement in Dallas, correct?
Dr. MARGO. Yes.

The CHAIRMAN. Did you get a copy of that letter to take home
with you—that agreement?
Dr. MARGO. NO, sir.
The CHAIRMAN. Did you
Dr. MARGO. NO, sir.
The CHAIRMAN. Would

ask for a copy?

it have been helpful to you to have a
copy?
Dr. MARGO. Well, in hindsight it would have been.
The CHAIRMAN. Well, you tell me you never asked for a copy.
Tell me why did you not ask for a copy? It is a rather lengthy
agreement. Frankly, I have read it a few times and I have a good
memory, but a half an hour after I read it I do not remember each
and every point in that letter.
Dr. MARGO. I assumed again that it was something that we
should not be taking out. It was not public information. Therefore,
they did not want it to get out into the public hands.
The CHAIRMAN. Yet you remember the board, you have, you are
looked upon as a responsible individual since you are elected to
that board. Don't you feel as though you were trustworthy enough
to take that material home, and particularly you as a doctor? Just
think of the responsibility you have under your Hippocratic oath,
right?
Dr. MARGO. Yes, sir. There was only one copy that I know of and
to my knowledge none of the members got a copy.



209
The CHAIRMAN. That is most unfortunate.
Mr. Kimberling, you came on the board in 1981?
Mr. KIMBERLING. In 1963.

The CHAIRMAN. And at that time you were treasurer of the CMI
Corp?
Mr. KENWORTHY. That is me.
The CHAIRMAN. Mr. Kenworthy. I am sorry.
So you came on board in August of 1981?
Mr. KENWORTHY. I came on board in September. I was elected in
August.
The CHAIRMAN. Your first meeting was September?
Mr. KENWORTHY. That is correct.
The CHAIRMAN. And that was immediately after the July 1981
meeting at the Comptroller in Dallas. Were you told about the
bank's problems prior to joining the board?
Mr. KENWORTHY. Yes. I was told that the bank was under a
letter agreement and had 10 points and were making progress
toward those.
The CHAIRMAN. Who gave you that information?
Mr. KENWORTHY. Eldon Beller.
The CHAIRMAN. By the way, who asked or who was it that invited you to join the board?
Mr. KENWORTHY. Eldon Beller.
The CHAIRMAN. But I have here information that during the
board meeting August 11 when Mr. Jennings was recommending
your election as director, the minutes state the following: "Jennings repeated Mr. Kenworthy's background. Mr. Beller noted Mr.
Kenworthy's knowledge of financial matters would be of special
benefit to the board and from the asset and liability side." So you
had both of them recommending you, so to speak. You could not
miss.
Now you, I think, except for two instances, attended every board
meeting from there on, right?
Mr. KENWORTHY. TO my knowledge, yes.

The CHAIRMAN. And there were extensive discussions about passthrough loans and overdrafts in those meetings?
Mr. KENWORTHY. Yes, there was.

The CHAIRMAN. The June board meeting—that is the next-to-thelast one before the bank was shut down—you raised questions
about the sudden changes and increases in loan loss reserves.
Mr. KENWORTHY. Yes, sir.
The CHAIRMAN. IS that correct?
Mr. KENWORTHY. Yes.
The CHAIRMAN. Would you share

with the committee your impressions of the board meetings and the adequacy of the information you received at these meetings?
Mr. KENWORTHY. They were—from the moment I began until the
last June meeting the information increased. The directors appeared to discuss the information in greater depth at each board
meeting. It was an improving information, to my knowledge.
The CHAIRMAN. YOU heard me ask Dr. Margo about whether or
not that letter of agreement that had been signed—incidentally, it
had been entered into even before you went on the board—but
when you were told about it.



210
Mr. KENWORTHY. Yes, it was.
CHAIRMAN. Did you ever see a copy of that actual
Mr. KENWORTHY. NO, sir.
The CHAIRMAN. Did you ever ask to see a copy?
Mr. KENWORTHY. NO, sir.
The CHAIRMAN. Would it have been helpful to you to

The

letter?

see a copy,
or to have a copy, so that you knew which direction the institution
was taking, whether they were complying with the requirements of
the Comptroller?
Mr. KENWORTHY. It was my understanding that that was the
blueprint for Mr. Beller to work against in the bank. It was also
my understanding that they were making progress against that
letter.
The CHAIRMAN. The minutes reflected both you and your company, CMI, were borrowers at the bank. Could you tell us the status
of your loans? Were any of them participated out or did they stay
with Penn Square?
Mr. KENWORTHY. Personal loans or CMI?
The CHAIRMAN. The CMI loans.

Mr. KENWORTHY. The CMI loans, they are both—both in the
bank and participated out.
The CHAIRMAN. What committees of the board did you serve on?
Mr. KENWORTHY. I was elected to the audit committee this year
in March.
The CHAIRMAN. HOW about the ethics committee? Were you ever
on the ethics committee?
Mr. KENWORTHY. NO, sir.

The CHAIRMAN. Was anybody on this panel ever on the ethics
committee?
Mr. KENWORTHY. NO, sir.

The CHAIRMAN. Did anybody on this panel—were they ever
aware of the existence of an ethics committee?
Mr. KENWORTHY. Only as it was mentioned.
The CHAIRMAN. A S it was mentioned earlier this morning?
Mr. KENWORTHY. Yes, sir.
The CHAIRMAN. Mr. Kimberling,

you have been a director since

1963?
Mr. KIMBERLING.

Yes.

The CHAIRMAN. And do you have stock holdings in either Penn
Square Bank or the holding company, the parent holding company,
First Penn?
Mr. KIMBERLING. Yes.
The CHAIRMAN. And would you describe those for
Mr. KIMBERLING. I have 450 shares of stock, I

us?
believe, in the

holding company.
The CHAIRMAN. And in the bank itself?
Mr. KIMBERLING. None.
The CHAIRMAN. Are you involved in the partnership that is still
in the Penn Bank Tower?
Mr. KIMBERLING. NO, sir.

The CHAIRMAN. DO you have any relationship with Kimberling's
Inc., a supermarket concern?
Mr. KIMBERLING. My son is the operator of those and I have
some interest in them.



211
The CHAIRMAN.
Square Bank?

DO

you have any personal loan from Penn

Mr. KIMBERLING. No, sir.
The CHAIRMAN. DO you know

if Kimberling's Inc., the supermarket chain, does?
Mr. KIMBERLING. Yes. They have one loan.
The CHAIRMAN. Are there any loans to any partnerships that you
are a part of or have an interest in with Penn Square Bank?
Mr. KIMBERLING. Only the supermarket loan.
The CHAIRMAN. DO you know what the status of that loan is?
Mr. KIMBERLING. It is current.
The CHAIRMAN. YOU have faith in your son?
Mr. KIMBERLING. Yes,
The CHAIRMAN. OK.

sir.

On June 15, 1982, meeting, however, the
minutes state that you were not at this meeting. Mr. Murphy commented on Kimberling's loan, 15-0055, noting he expects its overdraft to be cleared in a week or 10 days. Do you have any familiarity with that?
Mr. KIMBERLING. Yes, sir. The reason it was an overdraft, we
were in the process of selling a supermarket and it did not go as
soon as we thought. And so we made some—paid some bills to
shake the deal.
The CHAIRMAN. Selling anything at this point in our economy is
difficult.
Lastly, Mr. Kimberling, did you or any company you are involved in make any large withdrawals in the last few weeks prior
to the demise of this institution?
Mr. KIMBERLING. NO, sir.
The CHAIRMAN. And lastly,

Mr. Burks, would you be good enough
to tell the committee a little bit about your background and business background?
Mr. BURKS. I went to Stanford University and graduated from
Harvard Business School and have spent the major portion of my
business career in real estate activities, primarily in regard to the
financial aspects of the real estate practice.
The CHAIRMAN. NOW when did you become a director of Penn
Square?
Mr. BURKS. In February 1980.
The CHAIRMAN. February 1980?
Mr. BURKS. Yes.
The CHAIRMAN.

And do you have any interest in any of the corporations or partnerships involved in the construction of the building that was to be named Penn Bank Tower?
Mr. BURKS. Yes, I did.
The CHAIRMAN. Could you describe that
Mr. BURKS. I would be happy to. I am

for us?
the general partner of a
limited partnership which is entitled "Penn Bank Tower Investors. ,, This partnership contributed some $4.6 million toward the
equity of the construction of the Penn Bank Tower Building.
The basic structure of the transaction was based on the $4.6 million equity contributed by the limited partner and the general
partners and some $32 million of construction financing provided
by Seattle First National Bank. The composition of the limited
partnership was such that to the extent that a tenant in the build


212
ing would occupy space in the building then he would have a right
to participate to the extent of having to come up with his percentage of the equity required, his percentage of the loan guarantee
that Seattle First and, of course, his lease in the building.
The CHAIRMAN. This is somewhat almost akin to a condo-type?
Mr. BURKS. It really is. That really was the kind of concept. For
instance, if—I have precise numbers for you which I could give
you, but just in terms of round numbers for simplification, one
floor of the building approximated approximately 5 percent of the
space of the building. The building was 22 stories, 300,000 square
feet.
So that if an individual signed a lease for one floor, for 12,000
square feet, they would have had to come up with approximately 5
percent of the $4.6 million in equity, which would have been approximately a quarter of a million dollars. They would have to
have personally guaranteed 150 percent of their pro rata share of
the construction loan.
So, let's say, here is this hypothetical tenant that is leasing a
floor which approximates 5 percent of the building and he would
have had to have guaranteed 7% percent or 150 percent of his pro
rata share. He would have had to have guaranteed IVz percent of
the $32 million construction loan personally.
In addition, he would have had to have personally guaranteed
the lease, which was a 10-year lease. All the leases in the building
were the same, with the exception of the bank's. The bank's space
was—the bank's lease was 20 years, and all other tenants were 10.
So that individual who was signing the lease was on the hook for
essentially— if a floor, using round numbers again, if a floor leased
for $20 a square foot and it comprised 12,000 square feet, that
would a quarter of a million dollars a year in lease payments, and
it was a 10-year lease with the rent escalating 5 percent a year.
But even if it did not, the individual would be responsible for
some, in excess of $2.5 million in lease payments over the term.
The CHAIRMAN. Let me ask you this and see if I understand this
correctly. Who is the general partner?
Mr. BURKS. If I could, I am the general partner.
The CHAIRMAN. That means that no matter what happens with
the Penn Square Bank, you are still on the line as the general
partner.
Mr. BURKS. That is correct.
The CHAIRMAN. AS I think most of us here understand what a
general partner is and limited partners and the liabilities that
accrue to the general as opposed to some of the limited partners, so
that the failure of Penn Square Bank does not inure to or enhance
your position as a general partner. In fact, I do not think I envy
you very much.
Mr. BURKS. Well, I think on the basis of the number of telephone
calls that I have received from people who want to buy the building, they seem to infer that I am in somewhat precarious position.
The CHAIRMAN. Well, I hope you get your price. [Laughter.]
Let me ask you this. You attended quite a few of the meetings.
Mr. BURKS. Yes.

The CHAIRMAN. And as a matter of fact you did attend the 1981
and 1982 meetings at the Comptroller's Office in Dallas.



213
Mr. BURKS. Yes, sir.
The CHAIRMAN. HOW

about giving us, as a fellow New England
student—I did not get to Harvard, but I got to Boston University.
Mr. BURKS. I understood you were in the neighborhood.
The CHAIRMAN. AS a neighborhood boy who has done well, you,
Mr. Burks, what is your impression? Do you feel you were getting
adequate information from the Comptroller's Office and that you
were kept fully informed by management of what was occurring at
Penn Square Bank?
Mr. BURKS. That is two questions. Let me try and answer the
first one. Let me start out by saying that prior to 1980 I had never
served on a board of directors of a bank and so had no real standard of comparision with what kinds of information a person should
get and should not get.
And I was obviously coming on the board in February 1980 and
going down to Dallas that summer. Thihgs were already in motion.
To be honest, I never questioned the fact of the amount of information that the Comptroller should be providing the bank directors.
I did feel, frankly, that the summer meeting with the Comptroller, I reviewed my notes of that meeting. I took fairly specific notes
at that meeting and time and again Mr. Poole reiterated that the
real problem with Penn Square Bank was the growth of the bank
and the capital and that in fact if it were not for the issue of adequate capital within the bank that the bank would not have been
placed in the special projects area. And, as a matter of fact, my
notes indicate Mr. Poole mentioned that three different times
during the course of that meeting.
So I left the meeting very concerned about the direction of the
bank and the situation in which we found ourselves and the high
growth rate. Very frankly, the energy industry in Oklahoma and
the economy in Oklahoma up until very recently has been going at
a fairly rapid rate compared to other areas of the country and so
while we were concerned about the level of growth, we felt like it
was somewhat symptomatic of the economy in which we were operating.
And in the summer meeting of 1981 I would say really the only
thing that I would disagree with in terms of any of the outside directors that made any comments prior to, in the group prior to us,
was just one slight remark that was made as to the summer of
1981 meeting being very harsh. I understand that the minutes reflect that Mr. Poole was very harsh with the board.
But I came away from that meeting with a very good attitude
and feeling about their confidence and knowledge of Mr. Beller and
Mr. Preston, who they had known for some time. So I had a high
degree of confidence.
In regard to the amount of management information that we received as directors, once again I really was not aware of what a
bank director should be receiving. As several people have pointed
out, I was—I really did not like the situation of not being able to—
of always keeping the bank information at the bank. It is very difficult to have information presented to you and then taken away
and you never see it again.
But I feel like and felt like that the reports that management
provided, especially after Mr. Beller came, that there was a high



214
degree of confidence on the part of the board of directors t h a t we
relied on Mr. Beliefs background and experience. We relied on his
commitment to be tough and to be strong and to bring areas t h a t
had been uncontrolled to bring them under control. And there was
a high degree of comfort.
The CHAIRMAN. NOW were you aware of the fact t h a t Mr. Beller
was doing his utmost but t h a t he had his hands tied behind his
back? I do not know if you were here earlier today, were you, when
he cited
Mr. BURKS. That comment of Mr. Beller's came as great a shock
to me as it did to the previous outside directors t h a t were on this
panel and, I would imagine, as it did to the people t h a t sit at this
table right now.
The CHAIRMAN. A S a matter of fact, would it not be rather difficult to really do things in t h a t institution when you are hamstrung
in that manner and a major portion of t h a t portfolio you are not
allowed to touch, so to speak?
Mr. BURKS. It would be very difficult.
The CHAIRMAN. Very difficult.
Incidentally, I would point out to you t h a t there is a booklet, and
there are quite a few of them out there, an official booklet, some
put out by the Federal Reserve Board, some by the regulatory
agencies, this by a former Chairman of the FDIC, Mr. Robert Barnett—"Responsibilities and Liabilities of Bank Directors." It is a
very tiny book, $8.50. I will admit it is expensive. It was published
in 1980 and I do not get a profit out of it. I am not trying to sell it.
But there are publications available from the regulatory agencies
as well t h a t perhaps you might get for nothing, but they do outline
the responsibilities and liabilities of bank directors, and I think it
would be very helpful and I wish t h a t more—how many of you
here are aware of the fact t h a t these are available to you?
[A show of hands.]
The CHAIRMAN. All right, you are all aware of it? Swell. I am
really not trying to sell this, really and truly.
Mr. Burks, are you involved in various other enterprises other
t h a n Penn Square or in partnerships or in companies in which you
are a stockholder or director, where other officers of Penn Square
or directors of Penn Square are also involved?
Mr. BURKS. I am involved in four different partnerships, of which
the Penn Bank Towers is one partnership. There are three other
partnerships of which I am the general partner and in which there
are limited partners, of which there are Penn Square Bank directors and officers involved as limited partners.
The CHAIRMAN. IS Mr. Jennings involved in some of these?
Mr. BURKS. Yes, he

is.

The CHAIRMAN. What type of businesses are those? You are talking about three other partnerships?
Mr. BURKS. Those businesses are three hotels with one partnership, also owning real estate and previously owned an office building t h a t we sold a couple of years ago.
The CHAIRMAN. Mr. Leach.
Mr. LEACH. Thank you, Mr. Chairman.
Mr. Murphy, when you were president of the bank, did you also
have authority as either chief executive officer or chief administra


215
tive officer? Would you describe your functions the same way as
Mr. Beller described his, or were they very different?
Mr. MURPHY. During which period, sir—the 1964 to 1965 or after
1975?
Mr. LEACH. Please begin with the first period.
Mr. MURPHY. I was the chief executive officer and chief administrative officer from, say, 1965 to 1975. After 1975 Mr. Jennings was
chief executive officer. I was chief administrative officer. I saw that
on a call report one day. I did not know I had been appointed that.
Mr. LEACH. Were you as surprised as the rest of the directors at
the reading of the various duties of the president as compared to
the head of the petroleum division and the chairman of the board?
Mr. MURPHY. I certainly was, yes.
Mr. LEACH. Have you ever known of a bank structured that way,
where the president had such a limited role?
Mr. MURPHY. Well, I operated that way for a while, yes. I must
says in other banks I do not know, sir.
Mr. LEACH. Mr. Burks, you stated that the chief problem of the
bank was lack of capital and too much growth, but Mr. Conover,
head of the Comptroller's Office, testified before us in Washington
several weeks ago, that the bank was repeatedly warned of illegal
banking activities. Was this board ever informed of the fact that
illegal practices—by illegal I mean violations of the banking law—
were occurring?
Mr. BURKS. We were informed that there were some violations of
the law at the summer of 1980 meeting, and I was extremely
shocked that a bank upon which I was a member of the board of
directors had violated any law.
Mr. LEACH. It is one thing to say abstractly we are dealing with a
problem of a lot of growth and not quite enough capital. Many good
companies as well as good banks in America deal with that problem all the time. In fact, I cannot think of a company that says it
has too much capital. But there is a distinction between a problem
that is abstract, that is dealt with in the Harvard Business School
case study method all the time and a corporation in which the U.S.
Government tells the board of directors that violations of law are
occurring. I am just wondering how seriously the board of directors
took those descriptions.
Mr. BURKS. I took that comment very seriously and it disturbed
me a great deal and I did not mean to minimize the violations of
the law that Mr. Poole cited that day. I merely meant to indicate,
which my notes reflect, that Mr. Poole said that the Penn Square
Bank would not be under the administrative letter if it were not
for the single issue of capital.
Mr. LEACH. I appreciate that and I do not want to stress it too
much. Frankly, I think that in terms of the outside directors we
are perhaps spending more time than we need to, Mr. Chairman. It
is the inside directors who I think will provide the most interesting
insights into this problem. I suspect many of you outside directors
are going to be embarrassed as to your pocketbooks and some perhaps as to your judgment, but I doubt very much if many of you
will suffer any embarrassment to your reputation.
I think it should be stressed that when something goes wrong, a
lot of very good and very decent and very reasonable people get



216
tainted. In this case, it appears that the vast majority of people
should suffer no damage to their reputations in a situation which
frankly, has upset the Nation's whole banking system. While there
is some suggestion of less than perfect ethical behavior on the part
of some insiders, that certainly does not apply to the vast majority
of those associated with this bank.
The CHAIRMAN. Mr. Annunzio?
Mr. ANNUNZIO. Thank you, Mr. Chairman.
I do not have any questions. I do not want to go over the same
ground that we have been over. I look at the witness list and we
are only about halfway, but just one comment.
I take it that after listening to the panel, the last group of directors—outside directors—and this panel, I just get this feeling that
some of you or most of you think that the closing of the Penn
Square Bank was a mistake by the Comptroller of the Currency,
that things were really not as bad as the Comptroller pictured
them to be, and that this is similar to an "Alice in Wonderland"
story, despite the fact that millions and millions of dollars were
lost and the Comptroller warned about the $41 million and a
couple of directors here that lost a couple of million dollars and
hundreds of thousands of dollars and bad loans all around the
country.
How many of you feel that the Comptroller made a mistake
when he closed the bank?
Mr. MURPHY. Sir, with the information I had on July 1—I was
out of town that week and was called back in—at the meeting on
July 1, when the cease-and-desist order was issued, the requirement of $30 million in capital given until July 9, the loan losses as
shown at that time, which in my opinion some of them are not
losses—that is a personal opinion—I, from that, what happened
after that, I do not know. I left town again and came back in and
heard it on the news—the 10 o'clock news July 5.
I was shocked, of course.
Mr. ANNUNZIO. That is why I detect this, Mr. Murphy. That is
the reason I detect this feeling all morning that nobody knew what
was going on.
Mr. MURPHY. Unless there is a lot of changes between the first
and when the decision was made, which I am not aware of, it
should not have been closed. The shareholders should have been
given the opportunity to raise the capital and change management
if they wanted to—fire Frank Murphy or some of the others. That
would be fine.
But I do not think—to save the bank I do not think an effort was
made to try to save it. That is my personal opinion, sir.
Mr. ANNUNZIO. Were there any other comments? Let's get this
thing out in the open.
Mr. STUBBS. I think we definitely needed to have an effort to
save the bank and I think there were commitments already made
to cover the—cover $40 million instead of $30 million. I lost
$800,000 in that bank myself and I had all the faith that we could
keep it going.
Mr. ANNUNZIO. HOW much worse would it have been, Mr. Stubbs,
if you got rid of Mr. Patterson and Mr. Jennings and the bank had
remained open? The Comptroller, after all, could have recommend


217
ed that both of these gentlemen get out. How much worse could it
have been?
Mr. STUBBS. It could not have been this bad. [Laughter.] [Applause.]
Mr. ANNUNZIO. Anybody else? Mr. Burks?
Mr. BURKS. One of the things that I still cannot understand is
the reason why.
Mr. ANNUNZIO. Let's get it out. That is right.
Mr. BURKS. Why the Comptroller did not make some of the information available to management. I do not understand why the
Comptroller did not have some conversations with the Federal Reserve before this took place.
I read in the testimony before your committee that it came as a
surprise during the last week or so. Just 2 or 3 days before the
bank was closed the Comptroller found out that there were 150
credit unions that had $250 million in Penn Square Bank. I think
the ramifications of the decision that the Comptroller of the Currency made, I think it would be very interesting to have those exposed to the light of day.
Mr. ANNUNZIO. YOU know, Mr. Burks, when he appeared before
the committee I asked him if he knew of any banks that were
going to close on the weekend, and our hearings were on, I think it
was on a Thursday. So the weekend was coming. I said can you
give me some advance information? Are you going to close any
banks? And he did not know of any. But a few days later I read in
the Wall Street Journal—that is how I got my information, and I
am a senior member of the House Banking, Finance and Urban Affairs Committee—that he closed a bank in Abilene.
Mr. BARNARD. That was an aberration. [Laughter.]
Mr. ANNUNZIO. Right. But the point I wanted to make here was
they pumped in a lot of money at Abilene and kept it open.
Mr. BURKS. We were prepared to do that here in Oklahoma City
as well.
Mr. STUBBS. We were going to do it with private capital. They got
the FDIC loan. We were going to do it with private capital.
Mr. ANNUNZIO. Thank you.
The CHAIRMAN. Mr. Weber.

Mr. WEBER. TO the best of your recollection, was there ever an
occurrence where the chairman or anyone else on the management
team suggested that the board would voluntarily declare the bank
insolvent?
Dr. MARGO. NO.
Mr. KIMBERLING. NO.
Mr. WEBER. There was

never any discussion about that possibil-

ity?
Mr. KIMBERLING. NO.
Dr. MARGO. NO.
Mr. MURPHY. NO.
Mr. BURKS. My memory

escapes me exactly, but on the afternoon
of the 4th, Mr. Jennings made a statement to the board that based
on certain events that had taken place he had thought that the
bank was technically—and I am not sure what the definition of
"technically solvent" or "technically insolvent" is—but said that
the law was such that it was his responsibility to notify the Comp


218
troller of the Currency at such time that he thought that the bank
was insolvent.
He advised certain people—and it was in a board room and some
of the board had come and gone; it was not like the board was in
session all day long. I happened to be at the bank that entire day
and certain people had come and gone, but he came in and said it
is my belief, based upon the information that we have because of
all of the publicity in the newspapers and in the media, that there
was a run, that there was in fact a run on the bank and that it was
his opinion that the bank was probably technically insolvent and
that it was his responsibility to notify the Comptroller.
Now I am just telling you what I heard. Mr. Jennings was gone
for 30 or 45 minutes meeting with a representative of the Comptroller's office, and to the best of my knowledge came back to the
room and said the Comptroller does not accept our position, that
the bank is insolvent. It is the Comptroller's position that the bank
is solvent and that the Federal Reserve is willing to lend up to $27
million to protect a run on the bank, and that the bank will be
open for business on Tuesday.
Mr. WEBER. What day was that? Do you have any idea?
Mr. BURKS. That was Friday.
Mr. WEBER. Which would have been July 2?
Mr. BURKS. Yes,

sir.

Mr. WEBER. And was that an official meeting of the board of directors?
Mr. BURKS. I can't really tell you. There were certain of the directors that were around the bank. The meeting started at 8 in the
morning, as I recall, and certain people came and left. As I recall,
that was midafternoon or so.
I had a subsequent conversation later that afternoon with a gentleman who, I believe, was the chief lending officer of the Federal
Reserve, who advised me that the Federal Reserve was in fact
going to support Penn Square Bank and I walked him to his car as
he was racing to the airport, and we shook hands and he said he
would see me next week. And I said I look forward to seeing you,
with the thought that Penn Square would open on Tuesday morning.
Mr. WEBER. I believe that the chronology is that on that same
day the OCC sent a letter to the FDIC formally requesting assessment of the prospect for an FDIC-assisted transaction and merger
or something of that kind. And then it was on July 5, 1982, that
the Federal Reserve Bank of Kansas City indicated that it was not
prepared to extend further credit, and that was the day that the
insolvency was declared.
Mr. BURKS. I am not sure I understand the disagreement in fact.
Mr. WEBER. I am not saying I disagree with anything you are
saying at all. I do not want to recount the statement that I made to
the earlier panel, but it does seem to me that we have got a failure,
a problem of trust, I guess—who trusts whom.
You are being charged as a board of directors with the failure to
exercise your powers as directors who control the operations of this
bank. You were relying upon the officers to get that job done. I believe probably the officers were a major part of the problem. You
signed an agreement—and I guess most of you were signatories to



219
the formal agreement dated September 9, 1980. Are there any that
were not on the board at that time?
Mr. KENWORTHY. I was

not.

Mr. WEBER. Mr. Kenworthy, you were not a signatory, but were
aware of it when you came on the board later.
One of the provisions of that agreement was not to grant additional loans unless current and satisfactory credit information was
available and the loans were supported by appropriate collateral
documentation.
One of the other points of that agreement was to revise the lending policy and establish procedures to monitor and enforce adherence and, very frankly, in October of 1981 the Comptroller of the
Currency, as a result of its examinations, thought the bank was on
the right road to correcting or to putting corrective procedures into
practice. After having given the board great warnings—at two of
the directors' meetings at least—they felt that you were on the
right road.
I think the board felt it was on the right road to correcting the
situation. You were relying on the officers, Mr. Beller and Mr. Jennings and Mr. Patterson. Mr. Beller tells us in effect this morning
that he was relying upon Mr. Jennings and Mr. Patterson.
And I think that what needed to be done was to put into place
some procedure for an independent review of the actions of the officers by a committee of the board of directors or agents that reported to the board of directors and had the power to review and control the actions of the officers specifically and could override the
officers' actions in that way.
Apparently there was no such procedure. Am I correct that you
had no independent group that was overriding the decisions of the
officers? I guess I do not have any further questions.
The CHAIRMAN. Thank you.
Mr. Burks, since you were asked to bring certain documents with
you today, are the documents that we requested available?
Mr. BURKS. Yes, sir, they are.
The CHAIRMAN. Would you be good enough to provide them to
the committee at the conclusion of your testimony? Well, we will
take them now. Thank you for your cooperation.
Prior to going to my colleagues, one question. The previous
panel, we went back and forth on this. Now I am informed and I
would like to ask this panel—I am informed that when a copy of
the examiner's report was sent to the bank there is a signature
sheet attached and it is the duty of each director to review the examination report and to sign the sheet attesting to his or her
review. The examiners then check that signature sheet at the next
exam.
Mr. Stubbs, have you signed the signature sheet on the examiner's report?
Mr. STUBBS. I think, if I recall correctly, that the examination
would be reviewed at the board and passed around and everybody
sign it.
The CHAIRMAN. And then everybody would sign the signature
sheet to the effect that they had either reviewed or had reviewed
for them?
Mr. STUBBS. It was reviewed for us.
97-830

0-82-15




220
The CHAIRMAN. By management?
Mr. STUBBS. By management and then passed around and we
signed it.
The CHAIRMAN. In other words, management told you what they
wanted you to know about the examiner's report? Let's be honest
now, Mr. Stubbs.
Mr. STUBBS. I never ever read the report.
The CHAIRMAN. YOU were told what they wanted to tell you
about it, right? I mean, you are a $700,000 or $800,000 loser in this
situation.
Mr. STUBBS. More than that.
The CHAIRMAN. DO you think maybe you should have read those
reports rather than have them just summarized for you?
Mr. STUBBS. Maybe I am easier to con than Continental is. I do
not know. [Laughter.]
The CHAIRMAN. YOU have got some sense of humor, taking the
bath that you took, if you can still laugh about it.
Mr. STUBBS. I would rather laugh than cry.
Mr. ANNUNZIO. YOU know, in Congress we have a procedure
known as the signing of a conference report that is passed around
for all the members of the conference; and 80 percent do not know
what is in that conference report.
Mr. BARNARD. Frank, don't tell it all. [Laughter.]
Mr. ANNUNZIO. Don't feel so bad.
Mr. STUBBS. Thank you, sir.
The CHAIRMAN. I assure you that there are very few Members of
Congress who have lost the kind of money you have lost for not
reading a conference report.
Mr. Barnard.
Mr. BARNARD. Thank you, Mr. Chairman.
Mr. Cravens, you and Mr. Norton are indicated as advisory board
members. Why is that so?
Mr. CRAVENS. Well, it is automatic when you are 70. That is in
the bylaws.
Mr. BARNARD. YOU do not have the same function and responsibilities as the other directors?
Mr. CRAVENS. We have no vote, no.
The CHAIRMAN. They do not get paid, either.
Mr. BARNARD. I would doubt that, Mr. Chairman.
Mr. Cravens, I know you are speaking somewhat for Mr. Norton.
Your membership on the board dates back to what date?
Mr. CRAVENS. I was one of the original organizers of the bank.
Mr. BARNARD. One of the original organizers. Then I think that
you and Mr. Norton and Mr. Murphy, your membership is dated
back to the early 1960's, right?
Mr. MURPHY. I joined the bank in January 1961, sir, and became
a board member in 1964,1 believe it was.
Mr. BARNARD. Mr. Stubbs, I believe you were an early member of
the board.
Mr. STUBBS. Frank came on in 1963 and I came on in 1964.
Mr. BARNARD. Did it disturb you gentlemen that after the change
in organization in 1975 there was a change in modus operandi of
the bank?



221
Mr. CRAVENS. Well, I thought there was a very enthusiastic
bunch in trying to do something.
Mr. BARNARD. YOU did not question at all the thrust of the new
enthusiastic bunch?
Mr. CRAVENS. Well, I kind of figured I was a little old fashioned.
Mr. BARNARD. DO you still feel that way about it?
Mr. CRAVENS. That I was not keeping up with the modern times.
Mr. BARNARD. But you felt that it was worth a go, right?
Mr. CRAVENS. Well, I do not know. I lost about a half a million in
it too.
Mr. BARNARD. That is hindsight, isn't it. What about you, Mr.
Murphy? Did you express any dissent about the new thrust of the
management?
Mr. MURPHY. I say dissent? No; I cannot say I dissented, sir. Previously I was more conservative.
Mr. BARNARD. Well, hadn't this modus operandi been considerably different than the previous operation of the bank?
Mr. MURPHY. More aggressive, yes, sir.
Mr. BARNARD. Well, did you consider the concentration of loans
that was developed? Did you think that was healthy for the bank?
Mr. MURPHY. Concentration with proper loans I felt would be
healthy.
Mr. BARNARD. What about the lack of diversity?
Mr. MURPHY. It depends upon which area you are in. When real
estate is up, you should be in real estate, and I am not saying 100
percent.
Mr. BARNARD. DO you remember the experience that some great
banks had in the country during the era of REIT's?
Mr. MURPHY. Yes, sir, I sure do.
Mr. BARNARD. Wasn't that a problem of concentration and not
being aware of the marketplace?
Mr. MURPHY. Yes, it

was.

Mr. BARNARD. Would you go so far as to say that it is an example of poor bank management to concentrate in one particular area
of loans?
Mr. MURPHY. Well, I personally would not dwell on that. I never
did. But I did accept the philosophy—Mr. Jennings being from Oil
Patch and all—and I had confidence that he knew what he was
doing, sir.
Mr. BARNARD. Mr. Stubbs, you and Mr. Kimberling, how did you
feel about this change in direction of the bank?
Mr. STUBBS. I was not adverse to oil. I was strictly real estate
and I did not feel qualified to express myself on it. The profits
looked great and the interest rates were high and nobody could
afford to pay the interest rates but the oilers anyhow. I thought we
were dropping a little too much real estate myself.
Mr. BARNARD. Let me ask Mr. Burks, was the board brought up
to date from time to time as to how active brokers were in finding
deposits for the institution?
Mr. CRAVENS. NO, sir.
Mr. BURKS. I was never aware that the bank utilized brokers.
Mr. CRAVENS. We never heard that.
Mr. BARNARD. And yet they were paying brokers 100 or 200 basis

points for deposits brought into the bank. From time to time were



222
you able to see the makeup of deposits such as the concentration of
credit union deposits in the bank?
Mr. BURKS. Absolutely not.
Mr. BARNARD. Did any of you on the board except Mr. Murphy—
I presume you knew about the brokers' activities.
Mr. MURPHY. I knew that. Yes, sir.
Mr. BARNARD. Did any of the other members of the board understand how broker deposits functioned?
Mr. STUBBS. NO.
Mr. BARNARD. They

are very expensive, you know—very expensive deposits to bring in.
Mr. Chairman, I have no further questions.
The CHAIRMAN. Mr. Wortley.
Mr. WORTLEY. Thank you, Mr. Chairman.
Mr. Murphy, just for the record, what is the fee for a director's
meeting?
Mr. MURPHY. $400 a meeting if you attend.
Mr. WORTLEY. $400 a meeting.
Mr. MURPHY. Yes,

sir.

Mr. WORTLEY. That is about the same fee which prevails all over
Oklahoma City area in other banks?
Mr. MURPHY. I have no idea, sir.
Mr. WORTLEY. Mr. Burks, I wonder if you could straighten me
out on some information I have here. According to some annual reports you had a number of interests with Bill Jennings and Carl
Swan—for instance, First Penn Corp. You owned about 5.9 percent
and Jennings owned 26.7 percent and Swan 7.6 percent.
Peachtree Hospitalities—you seem to be equal partners, the
three of you—Jennings, Swan, and yourself had one-third interest.
The Chi-Chi property in Atlanta, at least at one time you owned
about 11 percent and Mr. Jennings around 25 percent and Mr.
Swan 21 percent.
What is this Skirvin Plaza Investors? You had a 1 percent interest and Mr. Jennings had about 16 percent; and Copeland Energy
you owned about 5 percent and Mr. Swan about 23 percent; and
Northwest Investors you owned around 23 percent-plus and Mr.
Jennings about 15 percent.
Would these be reasonably close figures as to common endeavors
that you shared with these other gentlemen?
Mr. BURKS. Yes, sir. Those are reasonably close percentages.
Mr. WORTLEY. I would imagine that those various business endeavors did some of their banking at least with Penn Square.
Would it be safe to say?
Mr. BURKS. TO the best of my knowledge, Mr. Wortley, the
amount of business that was done with Penn Square was very, very
minor and I would be happy to go down with you, if you would like,
the list of each one of those entities and describe the financial relationships, if you would like.
But from the time I went on the board of directors it was a personal policy of mine to limit the amount of business that I did with
Penn Square Bank to the absolute minimum and my major bank is
another bank here in Oklahoma City.
The CHAIRMAN. Would the gentleman yield on that?
Mr. WORTLEY. Yes.



223
The CHAIRMAN. By investment are you talking about shares of
stock in the bank or the holding company?
Mr. BURKS. Yes, sir.
CHAIRMAN. Did you

The
time?

also have deposits in Penn Square at the

Mr. BURKS. Yes, sir.
The CHAIRMAN. H O W did you do?
Mr. BURKS. Well, I don't know whether

it is good or bad, but I
was not in the position to have lost the amount of money t h a t some
people did, but we had two different accounts which exceeded
$100,000.
The CHAIRMAN. All of those records are available to us. Did you
or any of your—do you mind, George?
Mr. WORTLEY. Go right ahead, Mr. Chairman.
The CHAIRMAN. Did you or any of your businesses have any deposits in Penn Square t h a t were removed within the last 4 or 5
days?
Mr. BURKS. N O , sir.
The CHAIRMAN. YOU

were not one of those lucky ones who had
the benefit of the unnamed financial consultant?
Mr. BURKS. I personally deposited $80,000 in Penn Square Bank
on Wednesday or Thursday of the week before it closed.
The CHAIRMAN. Was t h a t a brand new account?
Mr. BURKS. N O , it was an account t h a t I had maintained. While
it was an account that—it was one of my company accounts—I did
maintain a number of business accounts at Penn Square Bank.
But, as I said, my borrowings at the bank were very, very modest.
The CHAIRMAN. But the point is t h a t you lost too.
Mr. BURKS. A great deal.
The CHAIRMAN. That does not help the others who lost.
Mr. BURKS. Misery loves company, I guess.
Mr. WORTLEY. Thank you, Mr. Burks, for your very forthright
answers.
Mr. BURKS. YOU are welcome.

Mr. ANNUNZIO. Mr. Chairman, could I ask each of the witnesses
one question with a yes or no answer?
Mr. Stubbs, could the bank have been saved, yes or no?
Mr. STUBBS. Yes.
Mr. ANNUNZIO. Mr.

Kimberling?

Mr. KIMBERLING. I believe so, yes.

Mr. ANNUNZIO. Dr. Margo?
Dr. MARGO. I am not sure. I was not there at the last two meetings.
Mr. ANNUNZIO. Mr. Murphy?
Mr. MURPHY. From the information I had, yes.
Mr. ANNUNZIO. Mr. Burks?
Mr. BURKS. I have no knowledge of the information t h a t the
Comptroller had a t his fingertips in making the determination that
the loan losses were $50 million. I do know t h a t t h a t figure, as late
as 2 or 3 days before the bank closed, was as low as $22 and the
number was bouncing around like a ping-pong ball.
Mr. ANNUNZIO. Mr. Kenworthy?
Mr. KENWORTHY. I have no knowledge.
Mr. ANNUNZIO. Just your opinion.




224
The CHAIRMAN. IS what you are saying that once you went on
the board that rather than borrow from Penn Square, either yourself or the partnerships in which you are involved, you went to
other institutions? You were better off avoiding any conflicts?
Mr. BURKS. Yes,

sir.

The CHAIRMAN. IS it safe to assume that your involvement—because I had the same questions—that as far as borrowing from
Penn Square are concerned they were de minimus? You provided
us with volumes of documentation.
Mr. BURKS. I would be more than happy to provide you with detailed information, but it certainly is my position that my borrowings with Penn Square were very negligible.
Mr. WORTLEY. Your personal borrowings or the borrowings of
these institutions I just recited?
Mr. BURKS. Both.
Mr. WORTLEY. In other words, are you also saying that those institutions never borrowed any money from Penn Square Bank?
Mr. BURKS. AS I said before, I would be delighted to give you a
detailed description. I would not want to say never, but I can tell
you that it is very minimal and I will be happy to provide as detailed an information as this committee would like.
Mr. WORTLEY. Maybe just a bottom line item, if I could ask you.
At the time Penn Square was closed, did any of these organizations
I just mentioned owe any money to Penn Square Bank?
Mr. BURKS. One company, called Copeland Energy, of which I
was a very small investor, I am not sure even what their borrowings were with the Penn Square Bank, so I would hate to make
any—I do know that they borrowed from a correspondent. Northwest Investors had no borrowings, had their borrowings from Liberty National Bank. Skirvin Plaza Hotel had $110,000 laundry lease
with the Penn Square Bank, which was at a market rate and
which I was asked to give— I have got $10 million of financing on
the Skirvin Plaza Hotel and $110,000 at Penn Square Bank.
I have got $10 million of financing at Northwest Investors and
virtually none at Penn Square Bank.
So they are modest numbers.
Mr. WORTLEY. DO you think that business relationships that you
may have enjoyed with Mr. Jennings and Mr. Swan in any way
might have impaired your ability to exercise some independent
judgment as an outside director of the Penn Square Bank?
Mr. BURKS. Well, let me speak to that question. You indicated
two individuals and I would like to speak to the two individuals as
opposed to just one question.
Mr. Swan has had a long relationship with Mr. Jennings and so
anything that I was involved in with Mr. Swan was a result of his
close and long-term friendship with Mr. Jennings, and any of my
investments with Mr. Swan were extremely minor, as I think the
information that I have provided you will show.
In regard to my ability to be an objective director of the Penn
Square Bank, I think the record will show that I had more money
invested in Penn Square Bank than Mr. Jennings had invested in
any of my real estate projects of which he was a limited partner. I
believe that I was able to indicate to him total objectivity.



225
Mr.
Mr.
Mr.

KENWORTHY. I have no opinion.
ANNUNZIO. Mr. Cravens?
CRAVENS. I do not have an opinion.

Mr. ANNUNZIO. Mr. Norton?

Mr. NORTON. NO opinion.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
The CHAIRMAN. I want to thank all of you for assisting us here
today. And for those who suffered such losses, it is not easy, and
unfortunately it is part of the process. And your presence here and
your assistance has been deeply appreciated. Thank you.
Now we will ask Jim Blanton, the managing partner, and Dean
York, engagement partner of Peat Marwick and Mitchell, to please
join us.
[Witnesses sworn.]
TESTIMONY OF JIM BLANTON, MANAGING PARTNER, AND DEAN
YORK, ENGAGEMENT PARTNER, PEAT, MARWICK, MITCHELL &
CO., OKLAHOMA CITY, OKLA.
The CHAIRMAN. Mr. Blanton and Mr. York, we want to thank
you for your appearance here today. We would like to inform the
committee or remind them of the fact that a friendly subpena was
issued to these gentlemen to appear. They have, however, indeed
been most cooperative. They have submitted a statement that I
would like to place in the record at this point. If there is no objection, we will put your entire statement in the record at this point.
[The statement submitted for the record follows:]




226
STATEMENT BY JAMES D. BLANTON, M A N A G I N G PARTNER, PEAT, MARWICK, MITCHELL
& Co., OKLAHOMA CITY, OKLA., AUGUST 16, 1982
Mr. Chairman and Members of the Committee:

I am James Blanton, managing partner of the Oklahoma City office of Peat,
Marwick, Mitchell & Co.

I served as our firm's partner in overall charge of

our relationship with First Penn Corporation and its subsidiaries, principal of
which was Penn Square Bank.

With me today is one of our partners, Dean York,

who was in charge of our 1981 audit of First Penn Corporation and Penn Square.
With banks as with all clients, the code of ethics governing our profession dictates that we not discuss publicly confidential client matters. We are
able, however, to discuss Penn Square with you today because we appear pursuant
to your subpoena.
Your staff asked that we provide a chronology of our relationship with the
Bank, a relationship which began ten months ago.

This statement reviews that

chronology in brief.
Penn Square Retention of Peat Marwick
During the Spring of 1981, the Bank hired several new senior executives.
We were later to learn that recruitment of new management talent was a part of
the Bank's response to the critical findings of the Office of the Comptroller
of the Currency during prior examinations of the Bank.
Certain of the new senior officers who joined in 1981 —
Eldon Beller, as President and Chief Administrative Officer —

including Mr.
came to Penn

Square as experienced bank executives from other banks in the area which are
clients of Peat Marwick.

We knew Mr. Beller and many of his colleagues to be

respected, professional bankers.
people and our reputation.

They in turn knew our firm, our services, our

As you may know, Peat Marwick serves clients of all

sizes in all industries around the world.

We are particularly known, however,

as a leader among accounting firms providing services to the banking industry.




227
In November 1981, Mr. Beller contacted us to discuss the possibility that
Peat Marwick consider serving as independent auditors for the parent company
and the Bank.

Important aspects of the discussions included three matters:

(1) The Bank's Response to the Agreement Between
the Board of Directors and the Comptroller
Mr. Beller advised us that the Bank was operating under an Administrative
Agreement with the Comptroller requiring changes in various areas noted by the
Comptroller's prior examinations.
what

was

necessary

and

His mission, as he explained it, was to do

appropriate

to

satisfy

the

regulators' concerns.

Additionally, he wished to improve the Bank's policies, procedures and practices to sustain its continued growth and profitability consistent with sound
banking practice.
would

perform

He indicated that the Bank's independent accounting firm

the annual audit and also be asked

to provide professional

services needed to assist management in establishing improved accounting procedures, controls, and information systems to better manage the Bank's growth.
(2) The Prior Auditors, Arthur Young & Company
During these discussions we obtained the prior audit reports and noted
that while the 1979 report was unqualified, the 1980 report reflected a qualified opinion by Arthur Young.

The Arthur Young report indicated that they were

unable to satisfy themselves as to the adequacy of the reserve for possible
loan losses at December 31, 1980 "due to the lack of supporting documentation
of collateral values of certain loans."
As is customary, we contacted Arthur Young to discuss their relationship
with the parent company and the Bank and to inquire of any disagreements or
problems they might have had in serving this client.

They indicated they had

served this client for several years with a good professional relationship,
free of significant problems.




They cited the qualification in their 1980

228
report to be certain we were aware of it.

They also indicated that in accord-

ance with usual practices there would be no problem in our reviewing their
working papers whenever we desired.
We have seen reports in the media which imply

that Arthur Young was

"fired" because they gave a qualified opinion in 1980.

We have never had that

impression.

Based on everything we were told by that firm, and by Penn Square,

they were not "fired" because of their qualified opinion.

We believe we were

engaged at a time when the new president and the new management team were doing
their utmost to bring to bear all necessary resources, both within and outside
the Bank, to remedy the past problems.
During our discussions, we advised Penn Square that if the conditions
Arthur Young encountered had not been corrected, we would also qualify our
report for 1981.
(3) Peat Marwick Independence
The requirements

of our firm and profession specify

independent of our clients before serving as auditors.
banks, this means, among

that we must be

In terms of client

other things, that our partners should not have

unsecured loans with a client bank in excess of ten percent of individual net
worth.
Since our office serves a number of banking clients, Penn Square was,
until late 1981, one of the banks where our partners could borrow money with no
independence concern.

Hence, several of our partners had loans at Penn Square.

As is our usual practice, we asked our Executive Office in New York for
advice on the steps to take to ensure our independence.

After consultation

with our Executive Office, we advised the Bank that the loans must be sold by
the Bank to non-client banks to ensure that Penn Square would not be at risk of
loss.




229
The Bank sold the partners' loans to non-client banks.

During the audit,

we satisfied ourselves that such loans were out of the Bank.
After thorough discussions of these and other matters we agreed to accept
appointment as the independent auditors.

The 1981 Audit
Our audit of the financial statements was as of and for the year ended
December 31, 1981.

On the other hand, the Arthur Young audit was as of and for

the year ended December 31, 1980.

At no time did we have any quarrel with the

qualified opinion on their 1980 audit and our report disclosed the existence of
their 1980 opinion with its qualification.
Our audit of the 1981 financial statements was conducted in accordance
with generally

accepted

auditing

standards as promulgated by the American

Institute of Certified Public Accountants.

In accordance with these standards

and based on our evaluation of internal controls, our audit procedures were
principally substantive in nature.
balances at or near year
designed

to verify

end and

That is to say that we focused on account
performed

such year-end balances.

procedures, on a test basis,
So, for example, we obtained

written confirmations directly from selected borrowers and depositors as to
their account balances.
As I am sure you know, Penn Square had sold many loans, without recourse,
to other banks.

Once sold, these loans were no longer assets of Penn Square

but were assets of the purchasing bank.

Accordingly, these loans were no

longer in the financial statements of Penn Square.

We did, however, check the

accuracy of Penn Square memorandum records on loans sold to other banks by
'obtaining written confirmations from the purchasing banks of the amount of the
loans they had purchased from Penn Square.




230
As part

of

the

1981 audit, we spent considerable

time reviewing

adequacy of the Bank's "allowance for possible loan losses".
had

established

Department.

a

loan

review

function

as

a part

of

the

We noted the Bank
the

Credit

Review

This Department was established in September 1981 to review all

significant loans in the Bank.

Its objective was to identify and evaluate all

problem loans and use such information to assist management in correcting the
problems where possible and

to establish

the "allowance for possible loan

losses" at the proper level.

This ongoing process was the basis of the Bank's

"allowance" recorded as of December 31, 1981.
In our audit, we reviewed information, including financial and other data,
on selected borrowers, principally those loans which were past due or had other
indications of problems, to assess the risk of loss in the loan portfolio.
Much like the Comptroller's examiners, we categorized such loans by our evaluation as to risk of loss.

After summarizing this information, we satisfied

ourselves that the "allowance for possible loan losses" at December 31, 1981
was a reasonable estimate by management of possible loan losses in the loan
portfolio at that time.
From our review of the Arthur Young workpapers we ascertained that the
"certain loans" which were the subject of their qualification in 1980 and to
which they referred as lacking supporting documentation of collateral value
aggregated approximately $14,700,000 or about 7% of the total loans of the Bank
at December 31, 1980.
Our audit work in 1981 disclosed

that subsequently

12 of these loans

totalling approximately $3,000,000 were completely or substantially paid-off.
Of these loans, $800,000 were charged-off in 1981.

Other of these loans had

little, if any, documentation problems in 1981 due to follow-up by management
to correct deficiencies.

Those loans that still had documentation problems

were considered in assessing the overall adequacy of the allowance for possible
loan losses at December 31, 1981.




231
As part of its ongoing monitoring process, the Comptroller's office in
October 1981 conducted an examination to follow up on progress made in correcting deficiencies noted by them in prior examinations.

Their report indicated

that although significant problems remained, improvement was reflected in all
areas and commended the Directors for their efforts in recent months.
During the course of our audit, we also noted the improving picture with
respect to the Bank's operations, procedures, policies, credit review, and loan
administration.

While a definite improvement had occurred, the Bank still had

problems with much still to be done.

Areas which we believed needed attention

and further improvement were covered in our extensive 22 page management letter
to the Bank's Board of Directors —

a document separate from the audited state-

ments.
This management letter contained our specific recommendations with respect
to the many problems of the Bank, including:
o

loan

administration, and

specifically

loan review and docu-

mentation;
o

organization structure;

o

written policies and procedures and related employee training;

o

internal monitoring and reporting to the Board of Directors; and

o

increased internal auditor effectiveness.

While these were important areas to the Bank, they did not, in our view,
significantly impact the Bank's financial statements at December 31, 1981 or
our opinion that such statements were fairly presented.
The independent auditor's function is to determine whether the financial
statements

including

the notes

thereto, as prepared by management, fairly

present the financial position and results of operations in accordance with
generally accepted accounting principles for the reporting period.

The facts

disclosed in the Bank's 1981 financial statements include:
o

the provision for possible loan losses in 1981 was $6,343,000 as
compared with $1,407,830 in 1980.

o

loans

charged

off

in

1981 were

$4,835,557 as compared with

$617,401 in 1980.
o

the allowance for possible loan losses at December 31, 1981 was




232
$4,141,447 as compared with $2,004,587 at December 31, 1980.
After the audit work on the financial condition as of December 31, 1981,
was completed in March 1982, 50 copies of the audit report were delivered to
First Penn Corporation and the Bank, and our 22 page management letter to the
Board was subsequently delivered.
The Bank, as you may know, produced and distributed an annual report for
1981.

This report contained limited financial data but did not contain the

full set of financial statements or our accountant's report or that of Arthur
Young for 1980.

As the Bank is not publicly held, it is not required to

present this information in its printed annual report.

After the Audit
We had involvement with the Bank management following delivery of the
report, principally
contact with
limited

on financial systems consulting

the Comptroller's

examiners before

and tax matters.

they

closed

Our

the Bank was

and we have had no communication with them since then as to the

problems they found.
We did have one meeting on July 1, 1982, with management of the Bank who
informed us that one of our partner's loans, which had been sold to another
bank, apparently had been repurchased by Penn Square Bank. This repurchase
occurred without our knowledge and was completely contrary to our prior understanding with the Bank.

Immediately after being made aware of this matter, our

partner arranged to repay the Bank in full.
Neither the Comptroller nor the FDIC have indicated to us specifically why
they concluded that the Bank had to be liquidated.
We appreciate this opportunity to provide a brief overview of our audit of
Penn Square.

I will be pleased to answer questions that you may have of us.




233
The CHAIRMAN. I think you are both aware of the fact that there
are two primary areas that we would like to inquire into. And
indeed, you have also been cooperative prior to today with staff in
providing us information in these areas. And so I would at this
point, with your statement in the record, just approach the loan relationship situation.
Mr. BLANTON. Mr. Chairman, may I read my statement into the
record?
The CHAIRMAN. Well, it is in the record already. If you want to
summarize it, I am just trying to get along with the situation. We
have put the entire statement in as presented. It is one of our
standard procedures. OK?
Mr. BLANTON. Yes,

sir.

The CHAIRMAN. NOW, you have provided us with memorandum
relating to loans to Penn Square Bank with various individuals
with Peat, Marwick, Mitchell & Co.; correct?
Mr. BLANTON. That is correct.
The CHAIRMAN. What were the origination dates on the loans
discussed in your memos? By "memos" I mean the memo from
Peat, Marwick, Mitchell & Co. in New York to you here in Oklahoma City, dated December 30, 1981.
Mr. BLANTON. There were, to my recollection, approximately six
different loans. There were three loans to one partner in our firm.
There was one loan to another partner in our firm. I don't know
the exact dates, but I believe they were in 1979 and 1980. There
were two additional loans that were made to a group of partners.
One loan was a line of credit that I believe was in place about the
latter part of August. The first draw was in September.
The CHAIRMAN. Of?
Mr. BLANTON. 1981.
The CHAIRMAN. Would that be Doral
Mr. BLANTON. Yes. Both of those are

Associates?
Doral Associates.
The second loan was committed to, I believe, in about September
of 1981. It was a permanent financing loan, if you will, a mortgage
on a project. And it was funded and closed in January of 1982.
The CHAIRMAN. Were these loans subsequently sold, the Doral
loans?
Mr. BLANTON. Yes, they were.
The CHAIRMAN. DO you know when that occurred, the date of the
sale?
Mr. BLANTON. I don't know the exact dates. I believe they were
both sold. It is my understanding that the permanent loan, the
mortgage, was actually sold when it was closed, that presumably it
was never on the books of the bank. The first loan, the equity loan,
was sold, I believe, in January.
The CHAIRMAN. DO you know to which institutions these were
sold?
Mr. BLANTON. It is my understanding that—and both of those
were Doral loans—that they were sold to Utica Bank, the Bank of
New England, I believe, and Citizens Bank in Muskogee.
The CHAIRMAN. And were these loans sold in their entirety? And
does Penn Square have any remaining interest?
Mr. BLANTON. Penn Square has QO interest.
The CHAIRMAN. Were they nonrecourse sales?



234
Mr. BLANTON.

Yes.

The CHAIRMAN. Has Penn Square Bank ever bought back any of
these loans or taken back any of these loans whether they be the
Doral loans or the other loans referred to in the memorandum?
Mr. BLANTON. It is my understanding that one of the loans that
belonged to one of our partners did get returned to Penn Square
for collection or renewal and was not reparticipated.
The CHAIRMAN. DO you know which one that was?
Mr. BLANTON. It was approximately, I believe, a $300,000 loan.
The CHAIRMAN. And to whom was that one? I see $50,000 to Dick
Turner; $600,000 to Marshall Snipes
Mr. BLANTON. It was one of the loans to Mr. Snipes.
The CHAIRMAN. And that was repurchased by Penn Square?
Mr. BLANTON. It was returned to Penn Square.
The CHAIRMAN. And where does it stand now?
Mr. BLANTON. It has been paid.
The CHAIRMAN. SO there is no loan outstanding from Penn
Square to any of the Peat, Marwick, Mitchell & Co. people?
Mr. BLANTON. That is correct.
The CHAIRMAN. The memo from your New York office dates December 30, 1981. And that memo describes what has to be done to
assure independence. Do you know when your New York office was
asked to provide the advice concerning this issue?
Mr. BLANTON. From my memory, I don't know the exact date. It
was late November.
The CHAIRMAN. Then it would have been about the time that
Arthur Young was terminated, November 20, 1981?
Mr. BLANTON. Yes. My recollection of the facts was that it was,
in fact, before Arthur Young was terminated.
The CHAIRMAN. But as a matter of fact, the independence issue
was resolved subsequent to Peat, Marwick, Mitchell & Co. having
been retained by Penn Square? By that I mean the memorandum
of independence.
Mr. BLANTON. The memorandum that you have there was dated
after we were retained.
The CHAIRMAN. December 30, 1981?
Mr. BLANTON. Yes. But the independence issue, we believe, was
resolved prior to our engagement as auditors.
The CHAIRMAN. DO you have your material? I think there is a
typo here. We have a memorandum, and I would like to put these
in the record, but before I do, I would like to correct this. There is
the December 31, 1981, memo from Mr. Guinan to Mr. Blanton.
Mr. BLANTON. Correct.
The CHAIRMAN. And then there is a March 4, it says, 1981, but I
think it should be 1982 memo to the file from C. D. York, the engaging partner.
Mr. BLANTON. If that is dated in 1981, you are correct.
The CHAIRMAN. That is a mistake, is that not correct, because it
indeed tells us what you have just been telling us about the loans
have been participated out, Doral to Utica, and to Idaho First National Bank of Boise?
Mr. BLANTON. Yes, that is correct.
The CHAIRMAN. And another one, a line of credit to Citizens National in Muskogee, Okla.



235
Mr. BLANTON. Yes.

The CHAIRMAN. SO the record will show that there is a typo in
that. And at this point I would ask unanimous consent that both
those memoranda be put into the record.
[The material referred to follows:]




236

P

Marwick.Muchell&Ca

I Ptal.
To:
Office:

3. D. Blanton
Oklahoma City

Fnim.
Office-

3. M. Guinan
Executive

Subject-

D<ue:
Stcno:

December 30, 1981
as

Independence - Borrowings from Financial
Institutions

C. E. Graese - Executive
L. E. Levy - Executive
Independence Files

Personal
This memorandum summarizes our discussions regarding certain loan arrangements that
partners in your office have with Penn Square Bank, a new audit client. The loan
arrangements have been grouped into three separate categories below for ease of
discussion. All of the loans described herein were negotiated with the Bank prior to it
becoming a client.
In connection with a real estate venture, a group of partners have a $2.3 MM loan with
the Bank. Eighty percent of the Joan is secured by a first mortgage on the property; the
remainder is guaranteed personally by the partners involved. The loan is material to the
partners, but not to the Bank. Penn Square Bank currently has arranged to fully
participate out the loans to nonclient financial.institutions. It would service the loan
for the nonclient. The Bank would bear no risk for default because the participationwould be without recourse. The participation arrangement should be completed by
December 31, 1981, the Bank's fiscal year-end. As we discussed, an independence
problem would not arise if the above arrangement were completed as proposed.
A partner has a loan of approximately $50,000 for a partnership investment which is
secured by those partnership assets and which he personally has guaranteed. Under
AICPA and Firm independence rules, this type of unsecured Joan would not c.-euie an
independence problem if the loan were not to exceed ten percent of the partner's net
worth. It is my understanding that the loan amount is below the ten percent threshhold;
therefore, nojndependence problem exists with regard to the subject loan.
Another partner has three separate loans that total $600,000. The loans relate to various
investments and are secured either by investment assets or by the partner's personal
guarantee. The loans are material to the partner's net worth. None of the investments
involves participation with prohibited companies or persons. The partner intends to pay
off the loans within six months. . As we discussed, the appearance of independence would
not be impaired if the partner were to pay off the loans prior to the year-end of the
Bank. In no event, however, should the pay off period extend beyond the date of our
initial accountants' report. If the partner were unable to pay off the loans within that
time period, he would have to obtain a letter of credit from a nonclient bank to support
the loans.
If the client were to fully participate out the loans similar to the
participation arrangement discussed above, the appearance of independence also would
not be impaired.




237

P

I Pbat,Marwick,Mitchell&Ca
IPeaLV
CONFIDENTIAL
To: • File
Office^

Dale:
Steno:

From: C. Dean York
Office:' Engagement Partner

gnc:
^

Subject: Independence re:

March 4, 1981
jk

Penn Square Bank

In response to the instructions from John Guinan in his memo dated December 30, 1981,
regarding the Firm's independence with Penn Square Bank, a new client, I am satisfied
the following has occurred:
(1)

The Doral Associates related loans in which the partners of the office
equally participate amount to the following with the related actions
taken by the Bank:
o

The interim first mortgage loan which approximates $1.6 million
on a real estate project in Oklahoma City has been fully participated to Utica National Bank & Trust Co. in Tulsa. Plans are to
make the permanent loan with the Idaho First National Bank in
Boise, Idaho.

o

The line of credit of $1. million to Doral Associates has been
participated to Citizens National Bank of Muskogee.

(2)

A $50,000 loan made by Dick Turner for an oil and gas personal investment is not considered to be material to Mr. Turner's net worth.

(3)

The loans to Marshall Snipes, which approximates $600,000 to his interest, to the extent material to his net worth, have been participated out of the bank on a nonrecourse to non-client banks.

All of the above was reviewed with Mr. Rick Dunn, Executive Vice President, on this
date. I am satisfied the above arrangements conform to the spirit of Mr. Guinan's
memo and that the Firm is independent of Penn Square Bank and its related entities.




238
The CHAIRMAN. Mr. Leach.
Mr. LEACH. With reference to the Arthur Young audit statement,
which they qualified, how unusual is it to have a qualified statement on a bank audit?
Mr. BLANTON. My reaction is t h a t it probably would not be t h a t
unusual.
Dean, would you feel differently?
Mr. YORK. Well, I would only say that a qualified opinion, while
it is unusual, it certainly does occur.
Mr. LEACH. When I look at the Arthur Young contract dated
J a n u a r y 6, 1981, it makes specific mention t h a t they would be looking at the possibility t h a t illegal acts might have occurred. When
you audited the bank, did you find t h a t any illegal acts had occurred?
Mr. BLANTON. NO, we did not.
Mr. LEACH. Were you aware that

the Comptroller's Office had repeatedly warned the bank about violations of the banking laws of
the United States?
Mr. BLANTON. Yes.
Mr. LEACH. Would you call a violation of the law an illegal act?
Mr. BLANTON. I think the way t h a t we would interpret that—and

let me say that we were, as we said, aware that those were technical violations as opposed to someone knowingly or willingly violating the law.
Mr. LEACH. The Comptroller of the United States has talked
about repeated violations of the banking laws of the United States.
As a banking committee, we write legislation in the banking area,
and we have a high respect for what we do. Repeated violations of
law are something that one raises one's eyebrows about. And I
think t h a t this would be particularly the case from an auditor's
perspective.
None of us knows how this situation is going to unfold, but certainly there are widespread rumors t h a t activities have occurred
here t h a t go beyond the realm of bad judgment into the realm of
conflict of interest and, very possibly, if not probably, violation of
the law. Did you find any indication of this at any time during
your audit?
Mr. BLANTON. NO, we did not.
Mr. LEACH. When you prepared

a second audit that explained
your major audit, it indicated some negative things at the bank.
Did you consider including part of this in the public audit?
Mr. BLANTON. We only conducted one audit and rendered our
opinion on the financial statements. The management letter, which
I presume you are referring to, was a byproduct of t h a t one audit.
Mr. LEACH. YOU probably heard mentioned by a number of public
directors of the bank that they had a good deal of confidence in
how the bank was doing based upon your audit of the bank. Do you
think they had reason, based upon your discussions with them, to
be concerned otherwise? In particular, one director asked at a
board meeting whether there was anything that should be brought
to the attention of the board of directors, and he indicates t h a t you
said no. Do you recall that question being asked, and do you recall
your response?




239
Mr. BLANTON. I don't specifically recall that question being
asked. Obviously, there were many things in our management
letter that were of importance to the board and areas that they
needed to direct their attention to. But I think it would be fair for
the board to say that when we met with them to briefly discuss the
results of the audit, that we gave them the impression of an improving picture. And I presume that maybe that is what he is referring to.
Mr. LEACH. But you do not think that any member of the board
has the right to feel somewhat misled by a failure on the part of
the auditors to stipulate that things were not perhaps as good as
they might have been?
Mr. BLANTON. I believe that we—well, as I said, we advised the
board of an improving situation which is what we believed.
Mr. LEACH. Sometimes improving situations mask troubles. One
can say that some parts of the situation were improving and new
people were brought in to handle certain things. But in terms of
bank assets being leveraged, in terms of loans being made with perhaps less than adequate documentation, one might argue that the
problem was not improving but worsening. Even if it were improving, things could still have been very, very bad.
Mr. BLANTON. Yes, that is correct. Let me clarify what I mean by
"an improving situation/' Not that the bank's financial condition
was improving, because we looked at it only at one date, but that
they were addressing those areas that the Comptroller had criticized bank management for and that they were making improvement.
Mr. LEACH. Perhaps I am confusing roles here. You are responsble for the figures, and the Comptroller is responsible for the structural things like whether or not there are enough people in place.
Are you saying that there was no improvement in the figures but
that with respect to what the Comptroller was concerned about
there might have been improvement in some areas?
Mr. BLANTON. I am not quite certain how to answer that. Let me
try. The context of the Comptroller's report, as I recall it, was that
the bank had numerous administrative problems. It is also my recollection of that report that although the Comptroller did have
classified loans, that they were not of such a magnitude that we
were concerned. Our own evaluation of the loans on December 31,
and the Comptroller, his review was either September 30 or
October 31, was that we had classified loans in excess of what the
Comptroller had.
Mr. LEACH. HOW many banks does your office audit?
Mr. BLANTON. We provide auditing, tax, and consulting services
to approximately 50 banks.
Mr. LEACH. Of the 50 banks, how many have loans with inadequate documentation in the same proportion as Penn Square?
Would you say that Penn Square was average in terms of its documentation problems, or substantially worse than average?
Mr. BLANTON. Worse than average.
Mr. LEACH. Out of the 50 banks, would you place it 20th from the
bottom or at the bottom?
Mr. BLANTON. I am not sure that I know the answer to that. Certainly, it was worse than average.



240
Mr. LEACH. Just barely worse than average?
Mr. BLANTON. It was substantially worse than average.
Mr. LEACH. DO you know of any bank that is worse?
Mr. BLANTON. I don't have the basis for knowing the details of
the other banks. I personally do not audit the banking clients.
Mr. LEACH. Have you ever personally audited a worse bank in
terms of documentation?
Mr. BLANTON. I personally have never audited any bank, including Penn Square.
Mr. LEACH. Why are you before us?
Mr. BLANTON. Well, I was hoping to read my statement, or at
least portions of it, to somewhat explain my role. I am managing
partner of the office.
Mr. LEACH. Has your office ever audited a bank with worse documentation?
Mr. BLANTON. I don't know the answer to that, but I suspect we
have audited, perhaps not banks, but companies whose records
were as bad or worse.
Mr. LEACH. But no bank? You cannot think of a bank?
Mr. York, can you?
Mr. YORK. I can say, yes, that I have.
Mr. LEACH. HOW many? How many have you audited?
Mr. YORK. Because I am speaking from personal knowledge, I
can think of one.
Mr. LEACH. Out of 5 or out of 50?
Mr. YORK. Out of the client base that is
Mr. LEACH. DO you compete with other

in our office.
auditing firms to get cli-

ents?
Mr. BLANTON. Yes, we do.
Mr. LEACH. When you take

on a firm that has had a qualified
audit report and you give an unqualified audit report, you bear an
extra burden of responsibility, particularly when you take over for
one of the reputable firms—and yours is one of the reputable
firms—in America. Do you agree that you bear an extra burden?
Mr. BLANTON. NO, sir, I think that our responsibility lies with
our opinion. In other words, we have responsibility for our opinion
regardless of what the previous auditors did.
Mr. LEACH. Was there any in-house dissent? Did anyone in your
firm say that this ought to be a qualified audit or that there might
be something going on beneath the surface that appeared to be a
violation of the law?
Mr. BLANTON. NO, sir.
Mr. LEACH. There was

no dissent? This was a unanimous opin-

ion?
Mr. BLANTON. Yes, sir.
Mr. LEACH. I have no further questions.
The CHAIRMAN. NO one on your examining

team saw anything at
Penn Square that they felt was a violation of the regulations or the
statutes that apply?
Mr. BLANTON. I did not. Are you asking about my answer to Mr.
Leach's question? Was it the same question?
The CHAIRMAN. I changed the question slightly. Would you
answer the question?



241
Mr. YORK. When you speak of violations of the law, one that is
commonly referred to by the Comptroller is in the area of legal
lending limit violations. And, yes, those did occur in the bank, we
did observe them, and we did comment on them in our letter to the
board.
The CHAIRMAN. Were you aware of the participations that were
indeed supposedly nonrecourse and yet it now appears as though
they were recourse participations?
Mr. YORK. Yes, we were aware of one of them.
The CHAIRMAN. YOU do not think that there is anything illegal
about that to label them nonrecourse, whereas in reality they were
recourse?
Mr. BLANTON. We were not aware of any participations with any
understandings that they were not nonrecourse. It was our understanding that all participations were nonrecourse.
The CHAIRMAN. Did your people observe the fact that there were
a number of nonrecourse loans that had been repurchased by Penn
Square from the upstream banks?
Mr. YORK. I was not aware of a number of them. As I can recall,
I can think of one loan that did come back to the bank that we
reviewed.
The CHAIRMAN. Just one?
Mr. YORK. Just one that I can think of.
The CHAIRMAN. Mr. Annunzio.
Mr. ANNUNZIO. I have no questions, Mr. Chairman.
The CHAIRMAN. Mr. Weber.
Mr. WEBER. Thank you, Mr. Chairman.
Did you have any discussions of your yearend audit report with
the Comptroller of the Currency's office, with the OCC?
Mr. BLANTON. NO, we did not.
Mr. WEBER. Were you aware

that they made an examination of
this bank on March 1 of 1982 and that in their findings they report
that the external audit was unacceptable to the examiner?
Mr. BLANTON. I am not aware of that. That is the first that I
have heard that.
Mr. WEBER. YOU are not aware whether they were referring to
the external audit of Peat Marwick or not?
Mr. BLANTON. I don't know what they're talking about. We have
had virtually no communication with the Comptroller or the FDIC.
Mr. WEBER. YOU know, I was looking at, on May 4, 1982, a confidential report to the board of directors of the bank from Peat Marwick. It is quite a few pages long, 20 pages or so, giving recommendations on management procedures that should be improved and so
forth.
And there is a statement on page 5 that it says, in summary, virtually every significant area of the bank has been reviewed and
changes have either been made or in process.
And on page 20 of the report, the bank has made great strides in
correcting or improving practically all of the areas addressed in
this agreement of September or the administrative agreement that
had been entered into between the board and the Comptroller of
the Currency.
You know, it was at that very same time that the Comptroller of
the Currency was engaged in another examination of a bank that



242
was leading, in their own words, to uncovering serious problems
with the bank.
What t h a t says to me is t h a t the board of directors was receiving
very, very mixed signals here. On the one hand they were being
told by people, their own officers and Peat Marwick, t h a t everything was coming along just fine. And on the other hand there
were these things going on with the Office of the Comptroller of
the Currency that indicated things were quite different.
Specifically, did you know the president had no control over the
lending functions of the department of energy or the energy
department, the energy lending, and that was being carried out by
Mr. Jennings and Mr. Patterson?
Mr. BLANTON. It may be necessary to ask Mr. Beller. But as I interpreted Mr. Beliefs comments was t h a t Mr. Jennings had the authority to override him on lending decisions. I did not interpret,
nor was it our observation, t h a t Mr. Beller did not have authority
over the operations of the Energy Department.
Mr. WEBER. SO you, in fact, did not know the differentiation of
responsibilities between the president and the chairman?
Mr. BLANTON. Well, I think t h a t it has been represented t h a t 80
percent of the banks lending activity was devoted to energy and
Mr. Beller had no involvement over t h a t 80 percent. That was not
our understanding or observation. That is not my understanding of
his comment.
It was my understanding t h a t if Mr. Jennings could override Mr.
Beller on making an energy loan; t h a t was my understanding of
the comment. If he is here, perhaps we need to ask him.
The CHAIRMAN. Would the gentleman yield?
Mr. WEBER. Yes, I would.

The CHAIRMAN. I think the gentleman and I both heard Mr.
Beller read his instructions from the CEO and the chairman of the
board. Were you here when he read those?
Mr. BLANTON. Yes, I was.
Mr. WEBER. My recollection,

Mr. Chairman, was very clearly
t h a t Mr. Patterson reported to Mr. Jennings and Mr. Beller reported to Mr. Jennings.
The CHAIRMAN. And Mr. Beller was told t h a t as far as energy
loans are concerned, don't you worry about them, we are taking
care of them.
Mr. WEBER. I want to get back to the differences between the
A r t h u r Young report on the 1980 audit and your findings. In the
1981 audit, Arthur Young qualified their report on the basis t h a t it
was the adequacy of the reserves for possible loan losses due to the
lack of submitting documentation and collateral values of certain
loans. That was the reason why they qualified their report.
You have, in turn, in your report found, I quote, "that the bank
formed a loan review function and adopted a formalized approach
to the evaluation and documentation of credit risks within the loan
portfolio, ,, and went on to say t h a t this satisfied your judgment.
That was not satisfactory to the Office of the Comptroller of the
Currency. But can you explain what improvement there had been
in the evaluation of the loan reserves as the result of what you call
the formalization of that systematic analysis and so forth? How did
t h a t actually work to the benefit of the bank, or did it work at all?



243
Mr. YORK. In our judgment, it was in place and working, acknowledging the fact that the people who came to the bank to establish that review function came basically in September of 1981.
They had in place people with the background in credit review
and evaluation. They had established their own internal procedures as to how they would classify loans internally, how they
would relate those classifications to the reserve for loan losses, and
help management and the board establish the necessary reserves.
We certainly noted that. And very frankly, Arthur Young, the
previous auditors, did not have that to review.
Mr. WEBER. I would yield back, Mr. Chairman.
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Thank you, Mr. Chairman.
Mr. York, I presume you had the largest part to play in the
report to the board after your initial examination. Is that true?
Mr. YORK. Yes. I signed the firm's reports.
Mr. BARNARD. Have you had any second thoughts about that
since this time? Do you think that you should have probably been
stronger in your recommendations of some of the things that you
found in the examination of the bank?
Mr. YORK. Well, certainly, when you read the newspapers now,
you might surmise that. The problem that I am still dealing with,
and I think a lot of people are dealing with, is factually why the
bank was closed. We understand that the Comptroller classified $40
million or whatever the number is in loans, which caused the bank
to become insolvent.
Mr. BARNARD. Well, at the time of that examination, you did
know, of course, about the administrative agreement?
Mr. YORK. Absolutely.
Mr. BARNARD. What is the general approach of Peat Marwick
and Mitchell when writing an audit report about revealing administrative agreements?
Mr. YORK. TO my knowledge, there are banks that are under
other administrative agreements. It is my understanding generally.
I have never seen those disclosures made, for some good reasons. If
you make those kind of disclosures in financial statements, since
public confidence is such that that type of disclosure, in essence,
could trigger some kind of run on the bank.
Mr. BARNARD. Well, would you kindly interpret this to me? As I
understand it, this is a footnote that is on the audit reports. It is in
the work papers.
Mr. YORK. This was a memorandum written by the manager on
engagement regarding the letter of agreement. Since that agreement did exist and we were aware of it, in one of my review notes,
as I recall, I felt like that it needed to be addressed as a matter of
import as far as the audit goes, but not from the standpoint that
the administrative agreement would require disclosure.
In footnotes to financial statements, that is not a typical disclosure.
Mr. BARNARD. But what you wrote—and I would like for you to
read it into the record—it seems to be pretty substantial to me as
far as your opinion of the operation of this bank. Could you read it
into the record for us, please?



244
Mr. YORK. I will try. This copy is not real clear. I believe it says
something to the effect—may I take just a moment and look at this
to make sure I am reading the same thing?
The directorate of the bank signed an administrative agreement with the Comptroller. Until Mr. Beller became president of the bank in 1981, the bank remained
in total noncompliance with the agreement. Presently, the bank is in substantial
compliance with the agreement and expects to be released from it during the next
ongoing examination.
Due to the fact that the new management has worked so vigorously towards correcting the situation that led to the issuance of the agreement and the fact that
they expect to be released from it shortly, it is not necessary to disclose the agreement in the footnotes to our report.

Reading on:
In order to ensure that substantial compliance existed, PMM examined all areas
of agreement either through review and observation or inquiry of personnel. All
areas appear to be satisfactory with the exception of occasional lending limit violations and a substantial number of loan document exceptions which the bank is
working on vigorously to correct.

Mr. BARNARD. Mr. York, in the fourth line of that, is it not true
that the word "total" was originally in that, and it was struck out
and the word "substantial" written over it?
Mr. YORK. That is correct.
Mr. BARNARD. In other words, originally it read "Until Mr.
Beller became president of the bank in May of 1981, the bank remained in total noncompliance with your agreement. At present,
the bank is in total," and then that "total" was scratched out and
"substantial compliance" with the agreement? Right?
Mr. YORK. That is correct.
Mr. BARNARD. But the question I asked you originally was, you
did not feel that this was important enough to be in the report
itself?
Mr. YORK. NO. And I am not sure it would ever normally be,
merely because of the existence of an administrative agreement.
Mr. BARNARD. Well, what happened to these poor institutions
that put money in there, relying upon your report? You think that
they would have had the same attitude about this bank if they had
seen that the auditors had said that they were in even substantial
noncompliance?
Mr. YORK. I don't how they might interpret that.
The CHAIRMAN. Would the gentleman yield?
Mr. BARNARD. Yes.

The CHAIRMAN. Does Peat Marwick and Mitchell audit any
credit unions?
Mr. BLANTON. We do not audit any credit unions in Oklahoma
City out of the Oklahoma City office.
The CHAIRMAN. I mean in the United States of America.
Mr. BLANTON. I am very sure we do.
The CHAIRMAN. DO you audit any savings and loans?
Mr. BLANTON. Yes, we do.
The CHAIRMAN. DO you think

it is possible that some of those you
audit, that your firm audits, may have had funds in excess of
$100,000 at Penn Square Bank?
Mr. BLANTON. It's possible.
The CHAIRMAN. I thank the gentleman for yielding. I would not
be too happy if I were they.



245
Mr. BARNARD. Mr. York, another question I would like to ask
you about your report. On page 8 of the management letter it says,
"after reviewing the new organizational chart which is currently in
the process of implementation" and I emphasize this "there is only
one recommendation that we wish to make" and I will read on
very hurriedly:
The oil and gas division is quite large and has several key personnel reporting to
the senior vice president in charge of the department. Because of the relatively
large span of control which now exists and the variety of tasks performed within
the department and particular talents of the department head, we recommend that
the organization of this key department continue to be reviewed.
The review should be made from the standpoint of continuing to improve the administration of the day-to-day activities of the department and yet capitalize on the
strengths of the department head and his relationship with key loan customers and
upstream correspondents. For him to maintain these relationships and effectively
administer the department may be unrealistic as the bank continues to grow.

Do you think possibly on reflection you might want to make that
a little bit stronger? I presume we are talking about Mr. Patterson
in that statement; is that correct?
Mr. YORK. That is correct.
Mr. BARNARD. Would you care to answer that?
Mr. YORK. Well, I feel like our recommendation is still good
today because of the span of control that he did have and all of the
things that Mr. Patterson was doing.
Mr. BARNARD. On another subject, let us talk about the adequacy
of loan loss reserves. In a memo written during March, Mr. York, I
believe that you discussed the adequacy of Penn Square's loan loss
reserves. The memo states that:
In connection with our review of the loan charge-offs for 1981 and our review
made to determine the adequacy of the reserve for 1981 there was nothing specifically noted that would indicate the 1980 reserve was materially inadequate at that
point in time.
One could surmise because of the large charge-offs which occurred in 1981 that
perhaps the 1980 reserve was inadequate at that point in time. However, on review
of what happened during 1981, this would not necessarily be the conclusion that one
would draw.

So I ask the question, was it your opinion today that the 1980
reserve was understated, according to Peat, Marwick, Mitchell &
Co.'s formula?
[The memorandum referred to follows:]




246
Client:

First Penn Corporation and Penn
Square Bank, N.A.

From :

C D . York, Engagement Partner

Subject: 1981 Accountants' Report

Because 1981 was our first year to audit the Company and its related entities,
principally, Penn Square Bank, it was necessary for us to refer to the prior
auditor's report which was qualified. Arthur Young's qualification was
quite unusual due to the fact they qualified their opinion on the basis
of a scope restriction because they were unable to satisfy themselves as to
the adequacy of the reserve for loan losses due to certain collateral information being insufficent for their purposes. Naturally it was necessary on
our part to consider their qualification in relation to our opinion on the
1981 financial statements.
After much review of the professional literature regarding auditors reports
and qualified opinions, I was unable to find an example of the particular
problem that we have. In considering our opinion for 1981, first I determined that we are satisfied that the 1981 balance sheet is fairly stated. I
am satisfied we will give a clean opinion on the 1981 financial position
without any problem. The next question is, due to Arthur Young's qualification, should it have any impact on our opinion on the 1981 results of operations. In analyzing this particular problem the following was considered:
1.

AY's qualification did not indicate they were satisfied
or dissatisfied with the reserve for loan losses. Their
qualification only indicated they could not make a determination as to the adequacy or inadequacy and accordingly
resulted in their "except for" opinion.

2.

Management of the Company and the Bank maintain that, in
their opinion, the 1980 reserve for loan losses was sufficient. This is borne out by a number of statements made
by management in their offering document for the sale of
stock in November 1981.

3.

In connection with our review of the loan chargeoffs for
1981 and our review made to determine the adequacy of the
reserve for 1981, there was nothing specifically noted that
would indicate the 1980 reserve was materially inadequate
at that point in time. One could surmise, because of the
large chargeoffs which occured in 1981, that perhaps the 1980
reserve was inadequate; however, on review of what happened
during 1981, this would not necessarily be the conclusion
that one would draw. Several things were noted in our review of 1981 such as:
o

The Bank's senior management changed considerably
with the addition of a new president, a new executive vice president in charge of credit and collection and a new executive vice president in .charge




247

o
o

of finance.
The establishment of a loan review department,
A formalization of their approach as to how the
reserve for loan losses should be reviewed and
adjusted periodically.

Also, in reviewing what happened in 1981, we noted that the federal
examiners' report had a number of classified loans in their examination of early 1981. However, such classifications, insofar as losses
and doubtful loans, was not in excess of the reserve which was established at the end of 1980. It was also noted that when Mr. Beller,
the new bank president, came on board he took a very conservative
view of the loans they had reviewed internally. If loans were determined to be anywhere near doubtful in collection, he placed them on a
nonacc&£al status and gave them a very conservative classification
which in turn caused an upward adjustment in the reserve for loan
losses. Also, if in their view, a loan could not be recovered in the
very near term, the loan was charged-off and litigation was immediately
instituted against the borrower; even though they knew, and subsequently, it has occurred there were significant recoveries to be had on
such loans. In reviewing the prospectus that the Bank prepared as of
September 30, 1981, it was noted that the reserve for loan losses was
about $2,600,000. Subsequently, due to a softening in the local economy, and particularly the energy industry, the Bank believed it was
necessary to increase the reserve for potential problems that appear
to exist in the loan portfolio.
So, in reviewing what happened in 1981 with respect to the reserve
for loan losses, it appears to me that the Bank's new management is
taking a much Ltronger stance in it's estimation of the reserve and
has adjusted the reserve upward to recognize potential losses in the
loan portfolio which are more visible due to the change in the economy
in the latter part of 1981 as compared to what the picture was at the
end of 1980.
Consequently, my conclusion is that the change in the reserve is just
a natural progression of the estimating process which management must
continually undertake. Although, I do recognize that the attitude of
senior mangement now is probably different than it was in 1980; however, this is still a part of the estimating process.
In summary, it is my opinion that what we have is a situation where
management has certainly improved its documentation of their rationale
for maintaining the reserve for loan losses at a certain level. It
was also obvious to me and our staff, during the course of the audit,
that the Bank's system of loan review and documentation of credit and
collateral has certainly improved over the prior year. In the course
of our review and evaluation of the loans, we were able to have at
our disposal documentation and and information with which to make a
review of the individual loans. Management also uses such information




248
to help determine the necessary adjustments to the reserve on a
quarterly basis.
In view of the foregoing, it's my opinion that the 1981 adjustments
made to the reserve for loan losses are part of the normal estimating process. Management's opinion as to the adequacy of the reserve
at the end of 1980 further confirms that whatever happened in 1981
is again reflective of the estimating process and the actual occurances during 1981. As a result of our review and tests of the reserve including the above information, I believe that we can give
an opinion on the 1981 results of operations.
In order to help bridge the gap between AY's qualified opinion for
1980 and our clean opinion for 1981, I felt that it was necessary
to have language in our opinion drawing the reader's attention to
footnote 4 of the financial statements which discusses improvements
made in 1981 in the formalization of their approach to evaluating
the reserve and related documentation. Such language was added
immediately following our reference to AY's qualified opinion. The
location of the reference, I believe, should be there as opposed to
a middle paragraph in order to immediately draw the reader's attention to the fact that something has changed in 1981 as fyt compared
to 1980. While professional literature speaks to middle paragraphs
where an emphasis of a matter is concerned, I believe, in this case,
the notation of that reference is best shown immediately following
our reference to AY's qualification as opposed to a middle paragraph.

Due to the unusual nature of these reporting problems, I consulted
with various of my audit partners as to what they thought about the
problems encountered and my recommendations as to how to handle them.
I spoke with Hugh Hyde, bank partner in the Houston office, Mr. Jack
Noftsger, our audit PIC and Mr. Jim Blanton, the managing partner.
After discussing the various points mentioned herein with them, they
all indicated that my assessment of these problems and the resulting
resolutions were acceptable.




249
Mr. YORK. DO I believe that the 1980 reserve was understated?
Mr. BARNARD. Right.
Mr. YORK. Not necessarily, no.
Mr. BARNARD. What about the 1981 reserve?
Mr. YORK. I am aware of no information to this date as to why
that reserve would be inadequate.
Mr. BARNARD. According to the information that we have, Penn
Square in each instance, did not reserve nearly the percentage that
most banks did against its substandard loans or the next classification, doubtful loans. It did reserve 100 percent of its loss loans. But
the percentages of substandard and doubtful were far less than
what the normal average was.
Do you know any reason why that was done?
Mr. YORK. NO, I don't. The whole area of loan review, as you can
appreciate, is a highly judgmental area, and there are different
rules of thumb that are used.
Mr. BARNARD. Mr. Chairman, I have no further questions.
The CHAIRMAN. Mr. Wortley.
Mr. WORTLEY. Thank you, Mr. Chairman.
In the scope of your audit of a client, what portion of the loan
portfolio do you verify?
Mr. BLANTON. We took the total loan portfolio of the Penn
Square Bank. We performed tests of that portfolio in total, but
they were only tests. In other words, we did not verify every loan.
The total population was the portfolio of Penn Square Bank.
Mr. WORTLEY. HOW much of the loan, how much of the Energy
Department, since that was about 80 percent of the portfolio?
Mr. BLANTON. It was in the total population, so the entire energy
portfolio had an opportunity to be tested.
Mr. WORTLEY. And you did not find any deficiencies in it, and
you were satisfied with what you saw that these loans were in good
shape that were on the books and were verified?
Mr. BLANTON. Our review of those loans was to form an opinion
on the financial statements as a whole, which we did; not to discribe the energy portfolio in particular, some of the energy loans
were classified in our examination.
Mr. WORTLEY. In view of the fact that the Comptroller of the
Currency was critical of the Penn Square Bank, do you feel that
the internal controls of Penn Square were adequate?
Mr. BLANTON. NO, sir. We don't believe that they were adequate.
Mr. WORTLEY. Well, did you criticize them in the public statement?
Mr. BLANTON. NO, sir.
Mr. WORTLEY. YOU only

criticized them in the management
letter?
Mr. BLANTON. That is correct.
Mr. WORTLEY. DO you think that is fair to the public? And is that
a custom of the profession?
Mr. BLANTON. I am not sure that I can determine what is fair or
unfair to the public. I can say that it is a normal procedure to issue
a management letter, and that we do not address in the financial
statements or in footnotes all of the problems of a client.
Mr. WORTLEY. Well, do you not feel that you have a responsibility to someone other than your client, in this case Penn Square? Is



250
the whole purpose of an audit not to make certain that things are
verified and the public is adequately informed of it, and shareholders and investors and depositors?
Mr. BLANTON. Penn Square Bank was a privately held bank. We
were engaged by and to report to the board of directors. We did not
report to depositors. We did not report to the public. We reported
only to the directors of Penn Square Bank.
Mr. WORTLEY. But was not your audit report, in turn, passed on
to depositors?
Mr. BLANTON. TO my knowledge, our audit report was not passed
on to depositors.
Mr. WORTLEY. What was the distribution of the report then? Who
would get it?
Mr. BLANTON. We delivered 50 copies of our report to the board
of directors. We would assume that that report was for the use of
the directors, and we would presume that the report would probably be requested by the upstream banks. The bank itself, as far as
putting information to whomever, they produced their own slick, if
you will, annual report, with pictures. It did not include a complete
set of financial statements. It did not include our opinion, nor did
it include Arthur Young's opinion.
[The documents referred to will be found in the appendix section
as follows: Appendix D, Penn Square Bank, N.A., Annual Report,
1981; appendix E, Penn Square Bank, N.A., Annual Report, 1982;
appendix F, filings of First Penn Corp. with the Federal Reserve
Bank, received in Records Section, June 4, 1982, which includes
amendments to organizational documents, First Penn Corp. minutes of special shareholders' meeting, Tuesday, June 14, 1981, and
consolidated and parent holding company financial statements
with Peat, Marwick, Mitchell & Co. report thereon.]
Mr. WORTLEY. It did not include your statement at all?
Mr. BLANTON. That is correct.
Mr. WORTLEY. IS that the custom for most banks?
Mr. BLANTON. If a bank is publicly held, then it is required to
produce an annual report in accordance with the rules of the SEC.
Penn Square, not being publicly held, was not required to do that.
In other words, a publicly held bank would include a complete set
of financial statements, the auditor's report, and other management information that are required to discuss the operations of the
bank. And those are SEC rules. Where you have a private company
or bank, they generally don't publish anything. But in an instance
like this, I can't recall any specific examples, but, yes, this is done.
It is not that unusual.
Mr. WORTLEY. Well, in other words, your audit is only for their
personal gratification? It went nowhere else?
Mr. BLANTON. Our audit was for the board of directors, and that
is who we reported to. If I might distinguish, we were not a part of
any offering document. So from our viewpoint, well, if we were
part of an offering document, then we would, in fact, know that investors were going to rely on it. That was not the case here.
Mr. WORTLEY. I yield back the balance of my time. I am finished,
Mr. Chairman.




251
The CHAIRMAN. If it were indeed going to be part of an offering
document, what would you have put in there that you did not put
in?
Mr. BLANTON. If it were
The CHAIRMAN. Say, you were auditing Chase Manhattan, and
that is publicly held; right?
Mr. BLANTON. If it were an offering document, it would have financial statements in it, as we have reported. But it would also
contain other disclosures by management.
The CHAIRMAN. I am talking about Peat, Marwick, Mitchell &
Co.
Mr. BLANTON. If it were an offering document?
The CHAIRMAN. If your report was going to be part of an offering
document, tell me what you would have done.
Mr. BLANTON. If our report were going to be part of an offering
document, it would be the same set of financial statements, assuming that it met regulatory requirements. From time to time there
are differences. For example, the SEC wants certain information,
or perhaps the Federal home loan bank wants certain information.
Basically, our product, or our opinion on the financial statements
would be the same, with one exception, and that is that they would
require our consent to the use of our opinion. To obtain our consent for the use of our opinion, we would presumably have insisted
that other disclosures be placed in there by management, something so that an investor would be aware of all events up to the
date of his investment.
The CHAIRMAN. Would that include the letter of agreement with
the Comptroller of the Currency?
Mr. BLANTON. I don't know.
Mr. LEACH. Would the gentleman yield?
The CHAIRMAN. I would yield to the gentleman.
Mr. LEACH. The chairman asked a question earlier as to whether
you audited any credit unions that might be involved. Are you responsible for auditing any activity of Seattle First, of Chase Manhattan, or of Continental Illinois?
Mr. BLANTON. Our firm is the auditor for Chase Manhattan.
Mr. LEACH. In this instance, did you have any contact with your
firm regarding the audit of Chase Manhattan, and would you have
given any information to Chase Manhattan that might have been
relevant to them?
Mr. BLANTON. TO my knowledge, we gave no information to our
firm regarding that.
Mr. LEACH. If you knew what we presume is new knowledge in
comparison with 6 months ago, what are your obligations as an
auditor? Would that information be immediately given to your firm
in New York as relevant to Chase Manhattan's audit?
Mr. BLANTON. My response would be no, that we would not give
information. I have never encountered that. So in a real-life situation
The CHAIRMAN. YOU have never encountered it. You encountered
it right here. You have it right here. Are you wearing blinders?
Mr. BLANTON. While we were doing the audit of the Penn Square
Bank, we didn't share anything.
97-830

0-82-17




252
The CHAIRMAN. YOU were not aware of the fact that there were
numerous classified energy loans in Penn Square Bank?
Mr. BLANTON. Are you asking did we notify our New York office
after conducting our examination?
The CHAIRMAN. Excuse me. I am asking you if you were aware of
the fact that there were numerous classified energy loans at Penn
Square Bank.
Mr. BLANTON. AS of what date?
The CHAIRMAN. During your audit.
Mr. BLANTON. I don't believe that there were numerous classified
energy loans as of the date of our audit.
The CHAIRMAN. Were you aware of the fact that Penn Square
was paying the interest on behalf of borrowers on participation
loans that had been sold upstream to Chase Manhattan and to Continental?
Mr. BLANTON. Yes, we were aware of that. We discussed it in our
management letter.
The CHAIRMAN. YOU were aware of that?
Mr. BLANTON. Yes, we were.
The CHAIRMAN. YOU do not and did not feel an obligation, therefore, as an auditing firm to inform Chase Manhattan of the fact
that this bank in Oklahoma City was pulling the wool over their
eyes on some of those participation loans that they purchased from
Penn Square?
Mr. BLANTON. I don't believe that you can conclude that if they
were advancing interest on these participations that they were
pulling the wool over anyone's eyes without knowing why the
advance was made.
The CHAIRMAN. Mr. Blanton, Mr. Blanton, please, please. This is
one of the problem areas. Mr. Beller stated earlier that as a result
of the December 8 memorandum that has been placed in the record
that there was over $2 million of interest that was paid to upstream banks on loans that were nonperforming loans, and some of
these moneys were going to your other client, Chase Manhattan.
And there is only one reason to do something like that, and that
is so Mr. Patterson and his colleagues could continue selling participations to upstream banks. Otherwise, if too many of the loans
were found to be nonperforming, they could not continue their
sales around the Nation, could they?
So to say that that was not improper, that they were not pulling
the wool over Chase Manhattan's eyes, you are maybe hoping they
were not. But I think perhaps you should think twice about that
one.
You have two clients, and I think maybe you think you did not
have an obligation to the borrowers or rather to the depositors who
put sums in excess of $100,000 into Penn Square. But it seems to
me that since your firm was collecting fees from both Chase and
Penn Square, that you might have had some kind of obligation
there.
[Witnesses conferred.]
Mr. BLANTON. I think Mr. York can add to that. Some of those
advances were investigated, the information available to us indicated the practice was decreasing and there were some reasons for
those instances where it was continuing.



253
Mr. YORK. Yes. We also read the memo that you had presented
this morning to you. We looked at that area as well. We inquired
and reviewed what management was doing, and still felt that it
was the type of thing that should still be a subject matter in our
management letter, which we covered.
The CHAIRMAN. What do you mean, a subject matter? What is
that? Absolution? I mean you say you are forgiven for your sin, we
will make it a subject matter rather than a sin?
Mr. YORK. NO.

The CHAIRMAN. Well, what do you mean by "a subject matter"? I
mean something is either right or it is wrong.
Mr. YORK. And it was wrong from a viewpoint of good business
practice.
The CHAIRMAN. OK. Well, why call it a subject matter? Why not
just say it is wrong? I mean this obfuscation and semantics and all
of that, let us talk English that the people in Oklahoma and the
people in Rhode Island and Georgia and Iowa can understand
rather than some gobblydegook?
Now, Mr. Blanton, you know those 50 copies you say you delivered to the board of directors because it is a privately held bank; is
that correct?
Mr. BLANTON. Yes,

sir.

The CHAIRMAN. YOU are not aware of the fact that the people at
Penn Square dealing with brokers gave your reports as well as
those of Arthur Young of those money brokers who, in turn, cited
those, your reports, to people, credit unions, S&L/s around this
Nation who put enormous sums of money into this institution
based on your audit reports, since that was all that was available
to them?
Do you mean to tell me you are not aware of the fact that your
reports are used by brokers for that purpose and by the people at
Penn Square Bank who were attempting to get large deposits into
that institution?
Mr. BLANTON. I have read newspaper reports that money brokers
had copies of our financial statements.
The CHAIRMAN. And this is the first time it ever occurred to you
in your career with Peat Marwick and Mitchell that your reports
of Peat, Marwick, Mitchell & Co. were used in this manner by financial institutions, whether it be Penn Square or any other institution that you do auditing for? Did this come as a complete and
total surprise to you, like the fact that when you get to be 10 years
old you find out there is no Santa Claus?
Mr. BLANTON. Because there were two sets of financial statements that we discussed, I do not know whether the credit unions
had the financial statements that we issued or the financial statements that the bank issued. Obviously, I do not know what the
bank did with those financial statements.
The CHAIRMAN. YOU have heard of Xerox machines?
Mr. BLANTON. Yes,

sir.

The CHAIRMAN. I have a letter here that was handed to me.
Mr. LEACH. Will the gentleman yield to me?
The CHAIRMAN.
Mr. LEACH. At

Yes.

any time, whether directly after the audit or up
through late June, did you talk to your office in New York with an



254
understanding that they might talk to Chase Manhattan about difficulties at this bank?
Mr. BLANTON. TO my knowledge, we never initiated any calls to
our New York office concerning Penn Square Bank.
Mr. LEACH. HOW about vice versa?
Mr. BLANTON. It is my understanding that our New York office
did call us and ask that we perform certain procedures with respect to their participations that were being serviced by Penn
Square.
Mr. LEACH. At what time was this?
Mr. BLANTON. In March.

Mr. LEACH. In other words, by virtue of the fact that Peat, Marwick worked as an auditor for both banks, Chase came to have earlier knowledge of this particular bank's situation?
Mr. BLANTON. Not to my knowledge. To my knowledge, no one in
our office involved with Penn Square Bank ever initiated any calls
to Chase or to New York.
Mr. LEACH. But you indicated a moment ago that your office in
New York initiated a call to your office here.
Mr. BLANTON. They asked us to perform certain procedures.
The CHAIRMAN. I feel as though now we are in General Hospital.
[Laughter.]
The CHAIRMAN. What do you mean by a certain procedure—I
mean, is this a blood transfusion or a transplant or a bypass? Could
you be more specific?
Mr. BLANTON. When we audited Penn Square Bank we were
looking at Penn Square's portfolio, not the participations. They
asked us to perform similar types of procedures with respect to participations.
The CHAIRMAN. Your New York office, on behalf of Chase Manhattan?
Mr. BLANTON. That is correct.
Mr. LEACH. Earlier you indicated that if you came upon problems, you would not feel it your obligation to inform Peat, Marwick
in New York and to inform Chase. Is that your position? Do you
think that intra-company obligation is something that the auditing
community is going to have to look at very carefully in terms of its
future procedures?
Mr. BLANTON. Mr. Leach, as the chairman pointed out, yes, that
did happen in this instance where Penn Square was closed, but we
had no advance notice to give our New York office that it was
coming.
All I am saying is that that never became an issue, and to my
knowledge, I don't ever recall that being an issue on any client. So
I guess what I am saying—my response would be I think that we
probably would not notify, but I have never encountered it.
Mr. LEACH. I understand exactly what you are saying. I suspect
that this might become a problem in your intracompany discussions. It poses a very serious philosophical dilemma for the company as well as for the auditing profession.
Mr. WEBER. Would the gentleman yield?
Mr. LEACH. I would be happy to.
Mr. WEBER. It seems to me you could do us a favor if you would
restate, as best you understand it, what are the rules of ethical



255
conduct that pertain to the accounting profession so far as the confidentiality of client information is concerned.
I assume that you keep all confidences of the client just that,
confidential, between you and the client only. Is that correct?
Mr. BLANTON. That is correct.
Mr. WEBER. And the thing that clouds the issue here is that we
may be dealing in an area of civil fraud or actual illegality, and the
question is at that point, do you maintain the confidentiality of
those potential violations of law from other people who may be affected by that information, I assume. Is that the way you read that
question also, or that problem?
[Pause.]
Mr. WEBER. Can you answer?
Mr. BLANTON. I am thinking. I really do not know the answer to
that question. It obviously has been the subject of much debate
among accountants.
Mr. WEBER. YOU are in a situation of a conflict of interest. You
are representing two clients who have conflicting interests. The interest of the one client is to keep the information totally confidential. The interest of the other client, of course, is to be informed.
Mr. BLANTON. I think that I can safely say that it is our firm
policy that we do not ever discuss the condition of one client with
another client. And I do not think that that was the question being
asked.
The CHAIRMAN. Let me rephrase the question for you. No. 1,1 do
not think that accountants are in the stead of attorneys or doctors.
Mr. BLANTON. That is correct.
The CHAIRMAN. YOU do perhaps have a code of conduct within a
profession.
Mr. BLANTON. That is correct.
The CHAIRMAN. But you do not have an immunity, say, where if
you were brought into a courtroom.
Mr. BLANTON. That is correct.
The CHAIRMAN. Don't you really face the dilemma, in this instance, when indeed, that which is happening at Penn Square has
a very direct relationship, as we found out, on Chase Manhattan?
Both of whom are your clients. I would suspect that the fee for auditing Penn Square doesn't begin to compare with the fee Peat,
Marwick, Mitchell & Co. gets for auditing Chase Manhattan.
Now, it is not as though Chase Manhattan says, We want to
know about the internal workings of this competitor institution.
What you are faced with here is a situation where they are dealing
with each other; there is an interaction, a business relationship,
and the health of one affects the health of the other.
Don't you really have a compounding of your dilemma because
gee, if the people at Chase Manhattan say to themselves, Why
didn't that Oklahoma City group of Peat, Marwick, Mitchell & Co.
let us know what was happening or what was going on at Penn
Square, when they knew that this would affect our losses at Chase
Manhattan, also being audited by Peat, Marwick.
Mr. BLANTON. Mr. Chairman, you are assuming that we knew
what was going on at Penn Square.
The CHAIRMAN. I think that is because I am told you are an excellent firm.



256
Mr. BLANTON. YOU are assuming that we have knowledge of
what the Comptroller found during his examination.
The CHAIRMAN. Mr. York said he was aware of the memo of December 8 about what was happening on those participations. That
is not an assumption. I am not assuming, sir.
Mr. BARNARD. Mr. Chairman, would you yield for a minute?
The CHAIRMAN. I would be happy to.
Mr. BARNARD. Mr. Blanton, what was the substance of the inquiry from the Chase Manhattan Bank? Was it about a specific
participation, or was it about general participation policy? Can you
tell us what that inquiry was?
Mr. BLANTON. Mr. Barnard, I would like to decline to answer
your question, only because we are getting now out of the discussion of Penn Square and into a discussion of Chase Manhattan.
And I am not free to discuss Chase Manhattan.
Mr. BARNARD. Well, may I just differ slightly in saying that we
are really talking about what information is privy to Chase Manhattan and not privy to other people who also stand to lose.
The CHAIRMAN. And excuse me, we are talking—the question is
directed to the situation at Penn Square, not Chase Manhattan.
What was that procedure?
Mr. BARNARD. In other words, we were talking here about an inquiry that the Peat, Marwick, & Mitchell Co., office in New York
made to the Oklahoma City office as a result of a Chase Manhattan
inquiry. Was that about a specific participation loan or was it
about a general participation policy? You don't think you could tell
us that?
Mr. BLANTON. I do not believe I could tell you that.
Mr. LEACH. If you would yield, Mr. Barnard.
Mr. BARNARD. Yes.

Mr. LEACH. Was this request based upon a standard audit of
Chase Manhattan, or was it a request based upon some concerns
reflected by Peat, Marwick, Mitchell & Co.?
Mr. BLANTON. I do not know the answer. If I did know the
answer, I do not think I could say.
The CHAIRMAN. DO you want to state that question again for me,
Jim?
Mr. LEACH. The question was whether this was a standard operating procedure stemming from a normal audit of Chase, or whether it was a special request growing out of a nonstandard audit procedure.
The CHAIRMAN. If the gentleman would yield, I would like to
rephrase his question. Actually, the question was propounded by
Mr. Barnard, and the question was, you were asked as you stated,
"to perform a procedure" at Penn Square relative to participation
loans. Is that not correct?
Mr. BLANTON. That is correct.
The CHAIRMAN. I think I am quoting you. Is that correct?
Mr. BLANTON. That is correct.
The CHAIRMAN. We are now asking you to tell us whether that
procedure had to do with participations in general, whether it related to the December 8 memo about prepayment of interest,
whether it was on a particular participation. You now tell us you
don't feel you can answer, but the Chair at this point would state



257
to you, sir, that this committee is investigating the failure of Penn
Square Bank, a matter of which we have jurisdiction and, indeed,
the responsibility to look into to see if any changes in legislation or
bank regulatory procedures or processes are necessary.
Your answer to the question would help this committee, and
would be invaluable to this committee and necessary to this
committee to carry out its duties. The Chair rules that the question
is pertinent and directed to the situation at hand. I would respectfully request on behalf of this committee that you, indeed, answer
the question.
[Witness conferring with counsel.]
Mr. BLANTON. Mr. Chairman, my counsel has advised me that we
would be pleased to discuss any information concerning Chase only
if we can obtain Chase's permission first.
Mr. BARNARD. Mr. Chairman, I don't believe we are asking anything about Chase.
The CHAIRMAN. Excuse me. Let me ask you this question. The inquiry to perform a procedure, did it come from Chase Manhattan
or from Peat, Marwick, Mitchell & Co. in New York?
Mr. BLANTON. I do not know the answer.
The CHAIRMAN. Mr. York? I assume Mr. York is the gentleman
who performed the procedure.
Mr. YORK. It is my understanding that the request came from
Chase.
The CHAIRMAN. Directly or through Peat, Marwick, Mitchell &
Co.?
Mr. YORK. Through Peat, Marwick, Mitchell & Co.
Mr. LEACH. Mr. Chairman?
The CHAIRMAN. Mr. Leach.
Mr. LEACH. This is a very interesting area of concern and of
philosophical import. Since we are going to be holding additional
hearings, however, and given the position of the gentlemen present
and their counsel's advice, I would suggest that we postpone further consideration of this issue. To press the point at this time
could be unnecessarily embarrassing both to the witnesses and
their company, which is one of the great American auditing firms.
With the understanding that this matter will be pursued further, I
recommend that we not pursue it at this time.
The CHAIRMAN. Well, if we don't pursue it, Mr. Leach, I think
that by the same token, it leaves unanswered from this moment
forward the fact that Chase Manhattan asked that certain procedures be performed in March of this past year.
We were told by the Comptroller in a briefing by the Comptroller
and the FDIC that they informed—the Comptroller didn't inform
their office; that they, in turn, informed Continental Illinois and
Chase Manhattan and the others until 6 or 7 days before July 5,
the date the D-Day here.
We are finding out that it appears as though Chase Manhattan,
through some ESP—which in this instance I don't criticize; I think
it is great of Chase Manhattan—that they had some inklings about
the fact that maybe procedures ought to be performed here at
Penn Square to try to learn a little more about these participations.



258
It appears that Chase Manhattan may have been privy to something through the Peat, Marwick, Mitchell & Co. route back in
March of this year. If we want to leave that hanging—and certainly I want to assure Mr. Blanton and Mr. York that we will not
leave it hanging for ad infinitum, because this committee does
pursue these things. If you want to leave it hanging and you make
a conscious decision that you are better off letting it hang out there
unanswered than to face up to it now, perhaps then we will allow
you to leave it hanging.
[Witness conferring with counsel.]
Mr. BLANTON. Mr. Chairman, let me just make this statement.
To the best of my knowledge, no one in Peat, Marwick, Mitchell &
Co. in Oklahoma City had any conversations with any individual
from Chase Manhattan specifically concerning Penn Square. To my
knowledge, no one in Peat, Marwick, Mitchell & Co. in Oklahoma
City initiated any discussions with anyone in our New York office
to discuss specifically Penn Square Bank.
I would be pleased to
The CHAIRMAN. But you are leaving one—let's go this way. To
your knowledge, did anyone at Peat, Marwick, Mitchell & Co. in
New York City initiate any discussions with personnel in Peat,
Marwick, Mitchell & Co. in Oklahoma City relative to performing a
procedure in Oklahoma City? That is one you did not include.
Mr. BLANTON. AS I stated earlier, we would be pleased to discuss
that matter, but we feel that we need the consent of Chase Manhattan.
Mr. LEACH. Mr. Chairman?
The CHAIRMAN. Just let me get an answer to this. He told me to
his knowledge, no one from Chase contacted Peat, Marwick, Mitchell & Co. in Oklahoma; no one from Oklahoma contacted either
Peat, Marwick, Mitchell & Co. or Chase. Now I am saying did
anyone from Peat, Marwick, Mitchell & Co. New York contact
somebody at Peat, Marwick, Oklahoma City relative to performing
a procedure at Penn Square on participations?
Mr. BLANTON. I have already answered that question, that yes,
we were contacted by New York.
Mr. LEACH. Mr. Chairman?
The CHAIRMAN. Yes?
Mr. LEACH. I certainly understand the dilemma you gentlemen
face in wanting to discuss this with your client. It would be my
suggestion at this point, given the potential for contempt citations,
that the representatives of Peat, Marwick, Mitchell & Co. relating
to Chase Manhattan be invited to testify at a future hearing to resolve all of this.
The CHAIRMAN. May the Chair just state that I wanted to get it
clear on the record, because of his last reply, that there was communication. I didn't want to leave it hanging that there was not. I
am satisfied that we will have—certainly, there are going to be further hearings on this, and not only for the benefit of Peat, Marwick, Mitchell & Co., but for many others who are happy to testify,
or who were unhappy to testify today or didn't want to testify
today.
I want to make it very clear that we are going to be chatting
with them in the months ahead, and maybe the years ahead. There



259
is too much of this case that has to be cleared up that we are not
going to forget about it.
Mr. Barnard, do you have any further questions?
Mr. BARNARD. NO, Mr. Chairman.
The CHAIRMAN. Does anyone else have any questions of these
witnesses?
[No response.]
Let me ask you this, Mr. Blanton and Mr. York. You have heard
the panel preceding who testified that in their opinion, Penn
Square should not have been shut down on July 5. You were here,
weren't you?
Mr. BLANTON. Yes.
Mr. YORK. Yes.
The CHAIRMAN. NOW,

you are the auditing firm. Do you agree or
disagree with that panel? Do you feel that Penn Square should
have been shut down and this unusual procedure entered into by
establishing the special deposit insurance bank? Or should that
have been triggered, or do you think other means should have been
taken?
Mr. BLANTON. Because we do not have the facts that caused the
Comptroller to reach his decision as of that date, let me say this. If
the Comptroller had closed Penn Square Bank on December 31,
1981, then I believe that would have been done in error.
The CHAIRMAN. Thank you, gentlemen. At this time, I would ask
unanimous consent to have placed in the record the two documents
from Peat, Marwick, Mitchell & Co; one dated June 14, 1982, addressed to Mr. James Gunter, executive vice president, Penn
Square Bank; and the other dated May 4, 1982, board of directors,
Penn Square Bank in Oklahoma. Without objection, so ordered.
[The documents referred to follow:]




260
Certified Public Accountants

P

First Oklahoma Tower
Oklahoma City, Oklahoma 73102

Peat,Marwick,Mitchell&Ca
I Peat,!

June

14,

1982

CONFIDENTIAL

Mr. James J. Gunter, Executive Vice-President
Perm Square Bank, N.A.
Oklahoma City, Oklahoma
Dear Mr. Gunter:
In connection with our examination of the financial statements of Perm
Square Bank, N.A. as of December 31, 1981, we noted certain matters relating to
the Bank's system of internal accounting control and accounting procedures that
we wish to call to your attention.

In your consideration of the items men-

tioned in the following paragraphs, please understand that our recommendations
are intended to assist you in the presentation of and accountability for the
Bank's assets, liabilities, income and expense accounts.
of

internal accounting

control and operating

An effective system

procedures should help guard

against any irregularities that our test work may not disclose.
and

effectiveness

The efficiency

of Bank personnel are determined by adequate managerial

policies and periodic reviews of such policies and employee performance.

As you read

this letter, please bear in mind that its purpose is to

supplement our letter which was issued to the Bank's Board of Directors on May
A, 1982.

Also, please consider that we have not reviewed the Bank's internal

accounting controls since March 19, 1982, the date of completion of our fieldwork in the Bank, and therefore, we may not be aware of changes subsequent to
that date.




261
GENERAL
As noted in our previous letter, the Bank's growth rate over the last few
years has been phenominal.

This type of rapid expansion normally increases

processing requirements and tends to stretch existing personnel. This in turn
increases the opportunity

for errors to occur, processing short cuts and the

circumventing of existing internal controls.

The remainder of this letter will

speak to individual areas of the Bank which we believe merit your attention;
however, we urge you to continually be aware of and make improvements in other
areas of the Bank where controls may have been weakened during this period of
rapid growth.

OPERATIONS
Efficient workflows 'are essential
maintain excellent customer satisfaction.

to

any

organization

to ensure and

The following items are intended to

enhance the Bank's ability to process items orderly and efficiently.

o

Require all departments to release work immediately to the Proof
Department. This will assist the department in meeting important deadlines and reduce the late afternoon volume;

o

Clean checks of all staples, rubber bands, paper clips and other
fasteners prior to delivery to the Proof Department to avoid
rehandling the items and to reduce the number of rejected items;

o

Encode account numbers on unencoded deposit and withdrawal
tickets at the funds receiving areas to assist in assuring that
the encoded number is correct and to encourage the use of
pre-encoded customer deposit slips;




262
o

Establish procedures in all funds receiving areas to prepare
items for MICR encoding by arranging items in proper sequence
before sending them to Proof;

o

Prepare a notice of missing documents for inclusion with the
customer's monthly statement when an item or items are missing
from the statement. The notice should explain that an item is
missing but to prevent delay, the statement is being mailed.
The notice should continue with a statement indicating that
should the customer need a copy for tax purposes, to circle the
needed item, return the statement to the Bank and a copy will be
forwarded as soon as possible. This procedure will reduce the
amount of time necessary for research and filmwork;

o

Review the types of manually prepared reports to the reports
produced by the data processing system. When the same or
similar information is available from the" system, the manual
reports should be deleted;

o

Close select departments to outside calls (bookkeeping, proof,
tellers, etc.) except during posted operating hours. This
allows individual departments to prepare and process the bulk of
their work without disruptions;

o

Encourage customers to properly endorse all checks with name and
account number. This procedure reduces bookkeeping research
time for deposited items returned;

o

Request a program change in order to automatically assess
insufficient , check charges through the data processing system.
This, method decreases the amount of time required to manually
handle the items and decreases the number of paper items in the
system.
In addition, it requires positive officer response to
waive insufficient charges, improving controls over excess
waivers;

o

Revise the overall Bank policy regarding NSF items. We realize
that the Bank will tiot collect 100% of the income generated and
that special arrangements have been made for zero balance type
accounts or customers who maintain substantial balances in other
accounts;

o

Establish a cut-off time in which loans may be brought to the
note area for same day processing. This will assist the note
departments in forwarding their work to proof in a timely
manner;




263
o

Discontinue manually posting payment activity on the reverse
side of commercial notes. This is time consuming and unnecessary. Department personnel indicated that an account history
can be requested from the processor's automated system and
received the following day; and

o

Relocate operational departments (bookkeeping, proof, transit,
data processing, etc.) within close proximity of each othej:. At
the present time, these departments are located in separate
sections of the Bank, creating disruptions in the efficient flow
of work. This recommendation is currently being reviewed by the
senior operations officer.
CASH MANAGEMENT

The realization of any bank's earning potential is dependent upon the
effective management of its earning assets. An overall goal for employing Bank
assets effectively is to maintain an average of 90% of total assets in an
earning capacity.
o

Due From Bank Accounts - The Bank continually monitors the
activity of its primary correspondent banks in order to maintain
balances to compensate for services performed.
At the same
time, it was indicated that "due from" accounts with little or
no activity were reviewed periodically. We recommend the Bank
review these relationships and eliminate or reduce balances
where possible*;

o

Clearinghouse Cash Letter - At the present time the Bank does
not make / a cash letter send to the 10:00 A.M. clearinghouse
exchange. The Bank's check volumes may be significant enough,
due to holdovers and early morning mail, to indicate an opportunity may exist to reduce float by making an additional send to
the clearinghouse exchange.
We understand this option is
currently being evaluated;

o

Large Item Procedures - The Bank should ensure that large item
procedures are clearly defined and understood for all funds
receiving areas, by documenting the procedures and reviewing
them periodically with the staff who processes these items.
Additionally, the money manager should monitor areas where large
items are normally received to ensure that all large items are
identified, pulled and processed in time to meet key deadlines.




264
LOANS
The following represent opportunities for possible improvements in the area of
loans (commercial and installment):
o

As of December 31, 1981, the Bank was approximately two months
behind on preparing its daily commercial loan reconciliations.
We recommend that the loans and their related interest be
reconciled on a daily basis without exception and that an
officer scrutinize and approve each reconciliation. Subsequent
to year end, the Bank corrected, in varying degrees, many of the
problems that plagued this process; however, we urge the Bank to
devote a great deal of attention to this area until the reconciliation process is operating smoothly.

o

A formalized daily reconciliation of installment loans (principal and interest) is not being consistently prepared. Personnel within the department should be required to prepare daily
a formalized reconciliation on a standardized form. Once this
reconciliation is complete, a subsequent review and approval by
a supervisor in the department should be performed.

o

On certain participated loans, we noted that the Bank had
maturity dates on certain of the notes and corresponding participation certificates which did not correspond. The Bank should
consider improving procedures in this area to ensure such dates
are the same on future participated loans.

DEPOSITOR ACCOUNTS
During our examination, we noted the following with respect to depositor
accounts:
o

There was no supervisory review and approval of the demand and
savings accounts reconciliations. Such a review would encourage
a more timely recognition of errors or unusual reconciling
items.

o

Although all depositor account reconciliations are being performed timely, they only reconcile dollar amounts.
The Bank
should consider instituting a requirement in the reconciliation
process that a reconciliation of the numb e r of accounts be
performed in addition to reconciliations of dollar amounts.
This procedure will ensure that accounts are not inadvertently
or purposely dropped from the system and the dollars transferred
to another account.




265
OTHER
The following represent other areas of the Bank where improvements can occur:
o

The Bank sometimes releases loan collateral without requiring
proper authorization and documentation of the released items.

o

The Bank does not always prepare reconciliations of all "due
from bank" accounts on a timely basis. Procedures should be
implemented to require that such accounts be reconciled on a
current basis.

o

The control logs for travelers checks in both the main bank and
drive-in bank were not posted up-to-date on the day of our
surprise count. Also, it was noted the log had only a grand
total with no denominational break down. We recommend a review
of policies in this area for possible improvement.

********
Jim, we trust these operational comments will be of benefit

as you continue to

improve the Bank's financial controls and procedures.

Very truly yours,

cc.

Mr. Bill Jennings
Mr. Eldon Beller
Board of Directors




266
Certified Public Accountants

P

Peat, Marwick, Mitchell &Ca

First Oklahoma Tower
Oklahoma City, Oklahoma 73102
(405) 239-6411
May 4 ,

1982

CONFIDENTIAL

The Board of Directors
Penn Square Bank, N.A.
Oklahoma City, Oklahoma
Gentlemen:
Recently, we completed our examination of Penn Square Bank, N.A.'s financial
statements for the year ended December 31, 1981 along with the consolidated
financial statements of First Penn Corporation (collectively referred to herein
as the Bank).

Because this was the first year for us to be associated with the Bank, we spent
considerable time reviewing such areas as the Bank's organization, policies,
procedures, information systems, internal reporting, income tax strategies, data
processing, internal accounting controls, etc. The topics as outlined herein are
the result of such review.

Our recommendations are designed to address the broader issues which confront
management that have been brought about by che Bank's phenomenal growth over the
past five years.

These recommendations, if adopted, will enhance the Bank's

security over its assets and depositor accounts and increase overall profitability and control of the organization as a whole. Matters which relate directly
to accounting

procedures and internal controls of an operational nature are

covered in a separate letter to Mr. James J. Guncer, Execucive Vice PresidenC of
Finance.

A copy of such letcer will be made available to you.




267
After reviewing the letter, we recommend that you ask Bank management to respond
to the various recommendations and indicate in writing which recommendations will
be implemented and the reasons for those which are rejected, if any. Also, a time
frame should be established for implementation of the recommended procedures.
Periodic progress reports should be made to the Board and/or Audit Committee as to
the progress the Bank is making with its implementation schedule. However, as new
controls and procedures are considered, please bear in mind that organizational
changes and effective systems of internal control evolve over a period of time and
the cost-benefit of such changes must be evaluated by management and the Board
prior to implementation.

Gentlemen, you have the overall responsibility for the financial health of the
Bank and protection of its assets.

We trust the recommendations herein and our

involvement with your organization will be beneficial as each of you fulfill your
duties as directors.

OVERVIEW
Presently the Bank is the fourth largest bank in Oklahoma City with assets in
excess of $400'million.

Three years ago, assets were only $100 million which

indicates the Bank's remarkable growth in such a short time.

Typically when an institution experiences rapid growth of this magnitude, tremendous stress is placed on virtually every aspect of the Bank to keep pace, but in
particular, it is difficult on personnel and support systems.
bppn

HO d i f f p T P n r

97-830

in

0-82-18




f f l p l l'ncr

rKo

ef-r-oce

nf

i ro

"i"'^

„,-^,,,-U

Penn Square has

268
The positive results of growth are generally obvious and occur almost immediately
with accelerating growth in assets, deposits and increased profits.

However,

there are usually negative aspects to growth if the growth is not carefully
controlled.

Such negative aspects are not so obvious and take longer/to surface.

The negative aspects to the Bank's virtually uncontrolled growth (fulminated in
1980 and early 1981 with a qualified audit report for 1980 and a critical bank
examiners' report from the Comptroller's office in early 1981.

The more significant problem areas within the Bank which caused these reports
were:
o

Inadequate asset, liability management;

o

Poor liquidity;

o

No monitoring of credit and collection;

o

Large number of loan collateral documentation deficiencies and
technical violations;

o

Rising loan losses;

o

Inadequate financial management information;

o

Support systems in the commercial and energy lending area could not
keep pace with the loan volume. As a result, the details of commercial loans along with accrued interest were very difficult to
reconcile to the general ledger control accounts;

o

Numerous extensions of loans for both principal and interest were
made with no cash payments required of the customer;

o

Many of the Bank's best loans were participated upstream to large
correspondent banks which often left Che lesser quality loans on
Che Bank's books. The Bank's loan volume at year end was becween
$1.5 billion and $2 billion, most of which had been participated
with other banks;




269
o

Inadequate information with respect to customer balances, profitability and his total relationship with the Bank;

o

Numerous lending limit violations;

o

Large overdrafts on which fees were often waived;

o

Insufficient level of equity capital to support the Bank's growth;
and

o

Inadequate internal monitoring through committees of the Board and
management to set policy, follow-up and measure results.

These and other problems were only symptoms of the larger problem.

Due to the

Bank's unparalleled growth, there were insufficient numbers of personnel to cope
with the growth and a corresponding lack of experienced senior managemenc to
direct the efforts of departmental personnel.

During the second quarter of 1981, the Bank's senior management responded to these
problems by making a commitment to do whatever was necessary to correct the
problems and bring the Bank's growth under control. Some of the steps taken which
have been quite visible to us were:
o

Hiring of a new president who had experience in a large bank.

o

Hiring of additional senior management all with
experience to support the president in the areas of:
-

o

large

bank

Loan administration, credit and collection
Finance
General legal, counsel

Hiring of additional supervisory personnel and staff to support the
new senior management as well as additional personnel to adequately
support existing departments within the bank.
This meant the
hiring of personnel ranging from senior loan officers to file
clerks.




270
o

The Bank's number of personnel more than doubled in a nine month
period from a level of approximately 160 to a level of almost 325 by
December 31, 1981.

o

Internal committees of the Board and senior management have been
formed to set policy and monitor performance.

o

Some of the Bank's policies have been formalized in writing while
others are in the process of being formalized.

o

Procedures manuals are in the process of being written.

o

A credit department has been established to review and evaluate
loan collection and documentation.

o

Controls have been placed'on the making of new loans and the extension of existing loans.

o

A process has been established for determining the necessary level ;
of the loan loss reserve and the related monthly provision.

o

Controls over letters of credit have been established.

o

Criteria has been established for the charge off of loans and the
placement of loans on a noninterest accrual status.

o

An asset, liability program has been established with the related
review of liquidity.

o

Financial controls have been improved and the accounting department
significantly strengthened.

o

The Bank's current and long-term financial management information
needs are currently being reviewed with an action plan to make the
necessary charges in. a cost-effective orderly fashion.

o

The Bank's entire organization structure has been reviewed from top
to bottom with consequent changes made which are in the process of
being implemented.

In summary, virtually every significant area of the Bank has been reviewed and
changes have either been made or are in process.




271
During the course of our audit of the Bank for 1981, we had an opportunity to work
with virtually all of the Bank's new senior management and many of the new
supervisory personnel. Without exception we have been highly impressed with their
professional banking knowledge and ability to bring about change in their area of
responsibility.

It appears to us that the Bank has put together, in a very short

time, an outstanding management team which has the skills to bring the Bank's
growth under control.

But more importantly, they have the talent to take advan-

tage of the growth the Bank has achieved to date by strengthening the existing
asset base and use it to develop a long-term program of controlled growth and
profits. The positive changes which have occurred in less than one year have been
truly remarkable and impressive.

As mentioned in the first part of this letter our remaining comments and recommendations are designed to help the Bank bring about further change and/or to
encourage the changes which are already underway.

Such comments and recommenda-

tions should also help the Bank further formalize and structure its program for
changes and improvement in the Bank's operations and performance.

These comments have been reviewed with senior management to ensure that factual
content is correct.

In the process of such review, it was gratifying to note

there were few comments which we had that management had not previously considered
or was in the process of reviewing.
cance.




In short, there were no surprises of signifi-

272
PLANNING FOR CONTROLLED GROWTH AND PROFITS
Goal Setting and Long Range Planning
One of the characteristics of a high performance bank is having clearly defined
goals and objectives for growth and profits with the necessary short and long
range plans for achievement of such goals.

As the Bank considers a variety of changes throughout the organization, we recommend that the Board of Directors and senior management consider the need to
formalize the Bank's goals and objectives with the related short and long range
plans for achievement. Also, in conjunction with such strategies, the Bank should
consider establishing budgetary controls over all general ledger accounts and
cost centers for certain departments of the Bank.

Establishment of a formal planning process and budgetary controls will provide the
Bank with multiple benefits and allow the following to occur:
o

Penetrating questions are asked by both members of the Board and
senior management as to what the organization is now and where would
they like for it to be in the future.

o

Careful analysis is made of the organization's strengths and weaknesses.

o

Realistic and measurable goals and objectives are set with a plan
for periodic monitoring and reporting to the Board on the Bank's
progress.

o

Management develops a short
achievement of its goals.

o

Reward systems are reviewed and often revised to encourage the
achievement of established individual and departmental goals.




and

long

range

strategy

for the

273
There is no question that organizations perform better when they have a clear
understanding as to where they are going and a well developed plan to get there*as
opposed to organizations which just operate from day-to-day and let the future
take its course.

While we recognize the Bank has begun to address the area of long range planning
and budgetary control, we urge you to continue the progress on perhaps a more
formalized basis. By doing so, we believe it will be easier to treat longer range
organizational problems on an overall basis rather than by the traditional piecemeal approach.

Organizational Structure
Recently, the Bank's organizational structure was revised for the effect of new
additions of senior and intermediate levels of management personnel which was
mentioned earlier.

As a result, new positions and even new departments have been

created.

While the organizational changes are still in an evolutionary state, we urge chat
senior management and the Board continue to review the organizational structure
and personnel positions and ask yourselves "is it right now and for the future, or
does it need revision?"

After reviewing the new organization chart which is currently in the process of
implementation, there is only one recommendation we wish to make.




274
The Oil and Gas Division is quite large and has several key personnel reporting to
the Senior Executive Vice President in charge of the department.

Because of'the

relatively large span of control which now exists, the variety of tasks performed
within the department and the particular talents of the department head, we
recommend that the organization of this key department continue to be reviewed.
The review should be made from the standpoint of continuing to improve the administration of the day-to-day activities of the department and yet capitalize on the
strengths of the department head and his relationships with key loan customers and
upstream correspondents. For him to maintain these relationships and effectively
administer the department may be unrealisitic as the Bank continues to grow.

Policies and Procedures
Guidelines for the operation of a bank or any organization are generally set
through policies established by the board of directors and senior management.
Specific procedures are then designed by management and staff to implement the
various policies. In some organizations, policies and procedures are informal and
most often communicated orally or through internal memos. However, as an organization grows in terms of volume of business and number of personnel, such informal
means

of

communicating

efficient and effective.




important

operational matters

becomes

less and less

275
The above described method has been the way in which the Bank has operated with
respect to the setting of policies and implementation of related procedures.
However, with the Bank's rapid growth, principally in the past three years, it is
becoming more necessary to formalize old policies and establish new ones along
with the necessary procedures to carry out the various policies.

At the present time, the Bank has under its employment a systems group which is
responsible for reducing to writing all policies an4 procedures which govern
operations in various areas of the Bank. This is, indeed, a positive effort, for
approximately a year ago the Bank had practically no manuals in any areas. As the
Bank continues to complete the various manuals for each area of the Bank, we urge
you to consider the following:
o

As the systems personnel go into an area to formalize the policies
and procedures in writing, an officer from that area should be
assigned to work closely with this group. This will allow individual areas of the Bank to lend valuable input to the systems group
during the formulation of that area's policies and procedures.

o

When the policies and procedures have been written in a certain
area, management should consider having the internal audit department perform a detailed review of the policies and procedures of
that area before presentation to the Board for their approval. This
will help ensure that the policies and procedures provide for
proper controls in each area.

o

As procedures are being developed, management should strive to
design them to be functionally oriented rather than written for an
individual's duties. This approach will provide more flexibility
as the Bank continues to grow.

Completion of the policies and procedures manuals in each area of the Bank and
required compliance with them by all bank personnel will allow the Bank's operations to flow more smoothly and provide the Bank with stronger controls in each




276
Profitability
In the past, the Bank has not established formalized performance goals such as:
o
o
o
o
o
o
o
o

return on average assets,
return on equity capital,
ratio of capital to assets,
earning assets as a percentage of total assets,
ratio of loans to deposits,
interest spread,
liquidity ratio,
etc.

With today's volatile interest rates and inflationary pressures which the Bank
must operate within, the establishment of such measurable performance goals
becomes a necessity in order to monitor and control the Bank's growth.

When establishing

these goals, management must recognize

that profitability

levels of the Bank should be higher than most banks of similar asset size primarily due to the large loan portfolio which the Bank is currently servicing for
correspondent.banks and the related fee income generated therefrom.

Although the Bank has performed work in some of these areas, we encourage further
development of matters such as the following:
o

Review the pricing of all products and services.

o

Determine the actual profitability of the Bank's large customer
relationships.

o

Consider revising Bank policy with respect to service charges for
overdrafts and NSF items. It appears to us that some customers have
taken advantage of the Bank in this area.




277
o

Determine the direction of the Bank's trust department.
Our
limited analysis indicates that it will continue to be a loss center
for some time.

o

Establish an overall goal of maintaining an average of a percentage
of total assets (say 9QZ) in earning assets.
This is especially
important since the realization of the Bank's earning potential is
dependent upon the effective management of its assets.

o

As the Bank considers improved operational efficiencies throughout
the Bank, there are a number of ways in which improved workflow and
controls can be achieved in the processing of items. Specific
suggestions have been made in our letter to Mr. Gunter.

REPORTING AND MONITORING SYSTEMS
Internal Monitoring Reports
As described in the diagram at Appendix A, the "control environment" of the Bank
in its simplest form consists of the Board and senior management setting policies,
goals and

objectives

for

the organization with

the related monitoring and

reporting systems established to monitor adherence to policies and measurement of
performance.

Naturally, for proper monitoring to occur, the Bank must have a good information
system to meet the needs of the various levels of management and a well organized
and managed internal audit department to review and test adherence to policies and
procedures and report exceptions noted to the Board and senior management.




278
At the present time the Bank, aided by the consulting division of our firm, is
determining whether it is receiving the necessary reports to adequately monitor
the operations of the Bank.

This is a vital question facing the Bank, which

should receive a high priority until the management information needs of the Bank
have been determined and an action plan agreed upon as to how such needs will be
met.

Completion of this project will allow the Bank to determine the following:
o

Determine what information is necessary which will allow management
to properly monitor bank operations.

o

Once this is determined and cost estimates are developed, the Bank
can decide whether it needs to establish a data processing function
within the Bank, leave it at Fidelity Bank as a service bureau
operation or a combination of the tvo.

o

The Bank will then be able to formulate alternatives and ultimately
establish the necessary system along with related data processing
equipment which will benefit the Bank in the short and long run on a
cost-effective basis.

Reports to the Board of Directors
Although you as Board members are receiving various financial reports at the
monthly meetings, we believe

that

information would be beneficial.

the presentation

of additional

financial

We recommend the following as improvements in

this area:
o

The Board has been seeing financial information for only the Bank.
We recommend that the Board also receive consolidated financial
statements of First Penn Corporation. Such information represents
the true financial picture of your financial institution as a whole
and presents the only meaningful financial results from a stockholder point of view.




279
o

A presentation of
of time should be
made by the Bank
this spread has a

asset yield and cost of money trends over a period
presented to help you monitor the actual "spread",
on its interest margin. A proper management of
direct impact on the Bank's profit objectives.

o

After management establishes a budgetary system, they will be able
to present to you a comparison of actual financial results compared
with the corresponding budgeted data on a monthly basis. Such a
report should also contain explanations of material variances
between budgeted and actual information.

o

The loan administration area of the Bank presently prepares an
excellent "problem loan list" and a related calculation of the
necessary loan loss reserve. We believe thLs information will be an
excellent addition to your board reports and should be presented to
you on at least a quarterly basis. Because the level of the Bank's
reserve for loan losses has a direct impact on earnings, you should
be familiar with the rationale as ,to how the level of the reserve is
determined at any point in time.

o

Many times the presentation of financial information in the form of
illustrated graphs is beneficial to the readers of such information. This provides the preparer of information an opportunity to
provide the reader a view of asset, income and expense,, yields and
cost of money trends over an extended period of time in a clearer
but much less detailed presentation. Virtually all the measurement
goals which the Board establishes can be reported effectively
through the use of various types of charts and graphs. We encourage
the' use of such presentation due to the trends which are highlighted
and the time savings achieved when having to present and read a
large variety of financial data.

Increasing Internal Audit Effectiveness
The Internal Audit Department is an important and integral part of the monitoring
process. They serve as your "eyes and ears" to determine how well the rest of the
Bank is following established policies and procedures.




280
For any internal audit function to be effective, it must have direct and visible
support from the Board in order for them to have the proper stature within the
organization.

Their reports to the Board should receive due consideration and

significant exceptions reported should be appropriately dealt with in a decisive
and timely manner. The audit department also requires input and direction of the
Board with respect to their annual audit program, areas which require emphasis or
special projects in areas where the Board requires more information. At the same
time, the audit department should be accountable to the Board for their budget of
time and money to operate the department versus amounts actually spent.

The Bank has an active- internal audit department of six persons. To improve their
effectiveness, we recommend the following:
o

The development of a complete internal audit program which spans
the entire year and is approved annually by the Board's audit
committee. Such a program should relate audit risk to time spent
and be comprehensive enough to cover all significant areas of the
Bank. Presently, we are making arrangements with personnel of this
department to assist in .the development of such a program.

o

The stature and authority of the department within the Bank is
unclear among some of the Bank's officers and staff. The Board
should consider instructing its senior management to convey to all
personnel the importance of the internal - audit function within the
Bank and the cooperation they are expected to receive.

o

Development of an adequate working knowledge of EDP functions,
especially if processing is established "in house", could prove to
be extremely beneficial to the department. The use of audit software programs will allow the auditors to be more efficient and
effective in the work they perform.




281
LOAN ADMINISTRATION
Loan Review Function
In 1981, the Bank established a much needed loan review function which consists of
a grading system for all loans to be used to determine the necessary reserve for
loan losses at the end of each quarter.

A controlled expansion of this function

will allow the Bank to challenge its reserve for adequacy on a regular basis,
which is an admirable trait of any bank.

This is an extremely positive step for

the Bank, and we urge you to take full advantage of your capable staff in this
area.
Loan Documentation
As was pointed out in recent regulatory examinations of the Bank, documentation of
loans and their related collateral has been less than adequate in the past.
During the latter part of 1981, the Bank showed a marked improvement with respect
to loan documentation and will apparently continue to improve due primarily to the
perseverance of senior management to correct existing problems and reduce future
errors through the' hiring of an excellent staff to monitor, this area.

This is a

critical area for any bank but especially your bank, due to the expanding nature
of your loan operations.

Therefore, we believe it merits your utmost attention

until all problems are corrected.




282
Correspondent Banking
During 1981, the Bank was involved in certain practices with respect to loans
participated upstream to other banks which we consider questionable.

The most

significant of these involves the practice of making periodic payments of both
principal and interest to the correspondent banks without first receiving payments from the borrowers.

The Bank is not required to do this according to the

written participation agreements, but apparently the Correspondent Banking division has orally agreed to do this with some banks.

This practice is not desirable for the folldwing reasons:
o

It causes a continual increase in the Bank's accrued interest
receivable (a non-earning asset) which reduces the potential
earnings of the Bank.

o

It also causes an unplanned strain on the Bank's liquidity since
cash is paid out before cash is received from the borrowers.

o

When these transactions occur, an extension of credit has been made
to the borrower without official approval.

In our opinion, discontinuance of this practice is imperative to the Bank.

If it

remains necessary to continue on certain occasions, it should require documented
approval by the credit policy committee or executive management.

Other
During our examination, we observed other practices in the area of loans which we
believe merit your attention and possible improvement:




283
o

As of December 31, 1981, the Bank was approximately two months
behind on preparing its daily loan reconciliations. We recommend
that the loans and their related interest be reconciled on a daily
basis without exception and that an officer scrutinize and approve
each reconciliation. Subsequent to year end, the Bank corrected,
in varying degrees, many of the problems that plagued this process;
however, we urge the Bank to devote a great deal of attention to
thi3 area until the reconciliation process is operating smoothly.

o

We noted instances where loan officers have extended loans, some as
many as 15 times, without requiring a principal reduction and many
times without requiring the payment of the accrued interest. In
addition, we noted several cases when interest is not paid, the
accrued interest is not added to the principal of the new loan. As
a result, interest income is being lost when these situations
occur. Additionally, the effects of this practice resulted in a
situation at December 31, 1981 where there was approximately five
months of interest income for the year which had not been collected
compared to three months at December 31, 1980. The effect on the
Bank is a strain on cash flow and an increase in non-earning assets.
We recommend the Bank establish a policy of requiring interest to be
paid' when due and exceptions to this policy only approved by the
Bank's chairman, president or Board. If the interest payment is
extended, it should be added to the principal of the note.

o

Subsequent to December 31, 1981, we observed a continual increase
in customer overdrafts. Some of the overdrafts resulted in the Bank
violating its legal lending limit to certain of these customers. We
believe the Bank should make concentrated efforts to not allow
thes'e violations to occur in the future. Also, management should
consider working with customers in an effort to reduce the amounts
involved'in these overdrafts, especially since customers are often
not charged for their overdrafts. To also ease the problem in the
overdraft area, we recommend that the Bank's loan officers not make
loans until funds are available for such loans.

o

It came to our attention during our examination that loan officers
occasionally instruct their secretaries to prepare and sign
official documents such as official checks and loan instruments in
their absence. In most cases, such persons have no authority to
perform such a task. We recommend, if the loan officers are unable
to be in the Bank, they should arrange for other officers to perform
these tasks in their absence.

97-830 0 - 8 2 - 1 9




284
TRAINING
As discussed earlier herein, the Bank's number of personnel have more than doubled
in the past year. Such an increase was necessary to adequately staff the Bank in
order to handle its growth to date as well as future growth and changes which will
occur. When the Bank assimilates such a large number of personnel in such a short
time, little time is available to properly train new personnel in the Bank's
policies, procedures, practices and philosophy of operation.

Presently, the Bank has slowed its hiring to a more normal pace.

Now is a good

time to review the Bank's need to establish a formal internal training program.
Establishment of such a program will allow the following to happen:
o

All personnel can be instructed in an orderly manner regarding
recent changes which have taken place with respect to policies,
procedures and organizational changes.
An excellent training
program can serve to communicate the Board's and senior management's views on a variety of matters.

o

The Bank will have a vehicle whereby once an employee is hired, he
can be taken through a new-employee orientation program and
adequately trained to perform his job early in his employment,
thereby helping to avoid unnecessary and costly errors.

o

The Bank can also begin a program of cross-training for all positions in the Bank. This will provide adequate backup Co ensure that
during periods of vacation or illness, an employee's daily tasks
and routines are adequately performed by another employee in the
Bank.




285
OTHER MATTERS
Administrative Agreement
As you are well aware, the Bank has been operating under an administrative agreement with the Comptroller of the Currency throughout most of 1981.

Primarily,

during the later part of 1981, management of the Bank has made great strides in
correcting or improving practically all of the areas addressed in this agreement.
Management is to be commended for their efforts and progress to correct a serious
situation in such a short period of time.

Centralized Purchasing
During

this period

of rapid

purchasing function.

growth, the Bank has lacked control over its

It appears that several departments have purchased fixed

assets, such as minicomputers, cars, artwork, etc. without approval of the
purchasing officer.

Recently, controls in the purchasing area have been significantly strengthened.
The Bank now requires

that all purchasing be performed

or approved by the

purchasing department. These new controls are a must before previously mentioned
budgetary controls can be effective.




286
IMPLEMENTATION OF RECOMMENDATIONS
As you consider the comments and recommendations made herein, please remember that
responsibility for having effective internal controls and sound operating procedures within the Bank ultimately rests with each of you as Directors.

In

preparing to implement some or all of the recommendations, the following should be
considered:
o

Preparation of a formal response to this letter for the Board by
management of the Bank;

o

Preparation of a plan for implementation on a priority basis with
definite timetables established;

o

Identification of matters which can be performed by the Bank and,
those which will require outside assistance;

o

Reporting periodically to the Board the progress made regarding the
implementation schedule; and

o

Consideration of the concept of cost versus benefit as decisions
are made regarding controls and procedures to be installed.

********
Our examination of the Bank's financial statements is based on tests of data
supporting financial transactions and as such, you will appreciate that our examination will not necessarily disclose the existence of irregularities, if any. The
ultimate assurance as to the safeguarding of assets and reliability of the financial records and information is dependent upon an effective system of internal
controls, good management and the application of proper accounting principles and
procedures.

We

trust

that

the

recommendations

made herein will

serve to

strengthen and enhance such controls in your efforts to meet your underlying
managerial responsibilities.




287
Normally, the transition to a new accounting firm can be quite time consuming and
sometimes rather frustrating for certain of the Bank's personnel.

However,* we

trust that the benefits of our first audit will outweigh any of the negative
aspects and that on the whole, you will find it to have been a worthwhile
experience.

We have certainly enjoyed this first year in working with you and

Bank management and look forward to a lasting relationship in serving Penn Square
Bank and its related entities.

Should you have any questions concerning the matters discussed in this letter, we
shall be pleased to discuss them with you at your convenience.




Very truly yours,

288

P

Certified Public Accountants
345 Park Avenue
New York, New York 10154
(212) 758-9700

Peat,Marwick,Mitchell&Ca
I Feat J
Office of General Counsel

October 8, 1982

The Hon. Fernand J. St Germain
Chairman
Committee on Banking, Finance and
Urban Affairs
U.S. House of Representatives
2129 Rayburn House Office Building
Washington, D.C. 20515
Dear Mr. Chairman:
Peat, Marwick, Mitchell & Co. ("PMM&Co.") submits this
letter to clarify and to amplify its testimony during the
hearing on Penn Square Bank, N.A. ("Penn Square") before
your Committee on August 16. On behalf of the Firm, I request
the permission of the Committee to supplement the record of
that hearing.
During the hearing on August 16, PMM&Co.'s witnesses
respectfully declined to discuss, on the grounds of client
confidentiality, the services performed by PMM&Co.'s Oklahoma
City office for The Chase Manhattan Bank, N.A. ("Chase")
with respect to loan participations Chase purchased from
Penn Square. The witnesses faced a dilemma. They had appeared pursuant to a subpoena which, in PMM&Co.'s view, extended to services performed for penn Square, but not to
services performed for any other client of the Firm. With
respect to services performed independently for and at the
request of another client, _i.e., Chase, PMM&Co. was bound by
a professional code of ethics not to disclose the services
or the resulting communications.
PMM&Co.'s predicament, of course, could be resolved
by Chase's consent. As Mr. Blanton then stated, PMM&Co. would
be pleased to provide this information to the Committee under
such circumstances. Subsequently PMM&Co. requested and received permission from Chase for PMM&Co. to set forth its
views as to the request it received, the services performed
and the resulting communications with Chase.




289
As you, Mr. Chairman, noted during the hearing, the
assertion of client confidentiality could result, and did
result, in false accusations and misinformation being circulated in the media. We believe the disclosure, with the
client's permission, of the facts relating to the services
performed for Chase amply demonstrates the propriety of
PMM&Co.'s conduct.
PMM&Co.'s New York office, for many years, has served
as Chase's independent certified public accountants. In
late October, before Penn Square had approached PMM&Co. to
accept the engagement as Penn Square's auditors, Chase requested advice from our New York office on procedures Chase
might employ with respect to its loan participations from
Penn Square. PMM&Co.'s New York office recommended that
Chase engage Penn Square's auditors, with Penn Square's permission, to conduct the anticipated procedures. Arthur Young
& Company had been, and was then assumed to be continuing
as, Penn Square's auditors. Such a recommendation and course
of action is not uncommon in the case of loan participations.
Later, when Chase determined to proceed, Penn Square
had engaged PMM&Co.'s Oklahoma City office to conduct its
audit examination as of and for the year ended December 31,
1981. Thus, in early February 1982, Chase's request was
made to PMM&Co. personnel in New York who in turn discussed
it with PMM&Co.'s Oklahoma City office. Attached as Exhibit
A is a copy of a memorandum dated February 10, 1982 outlining
Chase's request. As expressly set forth in the memorandum,
Chase was to forward a letter of understanding to penn Square
once the scope of the assignment was determined.
PMM&Co. personnel in New York and Oklahoma City discussed
the work to be undertaken and then PMM&Co. New York personnel
reviewed the scope of the assignment with Chase. Once PMM&Co.
and Chase agreed upon the specific procedures, Chase on April 8,
1982 wrote to Mr. Bill P. Jennings, Chairman and Chief Executive Officer of penn Square, requesting Penn Square's approval. Following the approval of Peon Square senior management —
confirmed orally to PMM&Co. by Eldon Beller, President and Chief Administrative Officer and James Gunter, Chief
Financial Officer —
PMM&Co. began its work.
By letter dated May 21, 1982, PMM&Co.'s Oklahoma City
office forwarded a draft of the expected report, dated May 5,
1982, to PMM&Co.'s New York office. PMM&Co.'s New York office




290
subsequently provided a draft to Chase for purposes of review
and discussion, and determination as to whether further procedures were appropriate. The letter and draft report appear
as Exhibit B hereto. With the press of other matters, the
report was never completed nor any additional procedures
performed.
As is evident, there was nothing improper in these procedures. It is not uncommon for one financial institution
to approve the conduct of special procedures by its auditors
for a second institution when the first is servicing loans
for the other. Moreover, as the draft report indicates,
these limited, special procedures did not disclose significant
discrepancies or weaknesses. The proposed findings of the
draft report were not inconsistent with the information available at the time of the PMM&Co. report on Penn Square's financial statements.
We believe this information will clarify the testimony
presented on August 16 and will resolve the questions raised
concerning the services peat, Marwick, Mitchell & Co. performed for Chase with respect to the Penn Square loan participations .
Respectfully yours,

Edwin D. S<^6tt
Assistant General Counsel
EDS:bw
Attachments




291

P

Peat, Marwick. Mitchell & C a

To:
Office:

Mr. C. D. York
Oklahoma City

Date:
Steno:

February 10, 1982
rms

From:
Office:

J. S. Zvaik
New York

Enc:
cc:

Subject:

Performance of Agreed-upon Procedures at Request of Chase
Manhattan Bank

Pursuant to our telephone conversation of February 9, the purpose of
this memorandum is to outline certain procedures which you are being
asked to perform on behalf ,of The Chase Manhattan Bank. These procedures pertain to certain commercial loans (primarily production
payment loans) in which Chase is participating, with Penn Square (generally
90%-99% Chase share). These loans were originated by Penn Square, who
continues to service them. Currently, Chase has approximately 150 such
loans totaling approximately $230 million.
Based upon discussions I have held with Chase personnel, they are
requesting the following procedures to be performed:
o

review of Penn Square1s credit granting policies and
procedures

o

review of Penn Square's credit monitoring (subsequent to
credit extension) policies and procedures

o

review of Penn Square1s procedures for the servicing of loans
(including, but not limited to, collection of payments from
borrowers and forwarding appropriate amounts to Chase)

o

confirmation of 25% of the number of leans Chase is participating with Penn Square (confirmation with both borrowers
and any other participants). 'Selection to be on a random
basis.

o

review of credit files for all Chase participation loans over
$5 million, plus 15 such loans under $5 million, randomly
selected.




EXHIBIT A

292
Based upon the above, could you please prepare and forward to me cne
following:
o

proposed draft report

o

detail procedures to be performed

o

fee estimate

Based upon the procedures, etc., Chase personnel will prepare a letter
of understanding to be sent to Penn Square.
I
In addition, as we discussed, since Chase says that they will pay for
these procedures (Chase will address the question of passing the cost to
Penn Square with them at a later date), you should charge your time and
expenses to Kew York contract #176-07545-77.
I appreciate very much your cooperation in this matter.
questions, please call me at (212) 552-2873 (or 2874).




If you have any

293

I
.Mar\vick.Mitchell<kC
<405»239-r.M]J

May 21, 19S2

Joeseph Chu
Peat, Marvick, Mitchell & Co.
34 5 Park Avenue
New York, NY 10154
Dear Mr. Chu:
Enclosed is a draft of our special report performed for Chase Manhatten
Bank on Penn Square Bank, N.A. Please note any changes you wish to make
and provide me with the proper heading of our report and return to me as
soon as possible.
Sincerely,
PEAT, MARWICK, MITCHELL & CO.

Kim W. Shcemake,

Supervising Senior

KVS/clh




EXHIBIT B

294

OH1- r

Robert L. Denner, Vice-President
Chase Manhattan Bank, N.A.
One Chase Manhattan Plaza
New York, New York 10015
Dear Mr. Denner:
As you requested, we have performed certain agreed procedures on behalf
of Chase Manhattan Bank (Chase) on certain loans and records of Penn
Square Bank, N.A. (Penn Square). These procedures are in accordance with
our audit program (Exhibit B) which was attached to the authorization
letter from Chase to Mr. Bill P. Jennings, Chairman of the Board, Penn
Square Bank, N.A. Our resulting findings were as follows:
Credit Granting
We discussed credit granting policies with Mr. John Baldwin, Senior Vice
President, who informed us at the present time any lending officer in the
Bank has authority to make a loan, if such loan does not cause the
borrower's total indebtedness to exceed $50,000.
If such a loan does
cause total indebtedness to exceed $50,000, the loan is then approved by
either the Bank's credit policy committee, or the Bank's president or
Chairman.
We performed an inspection of the loan documents on a test
basis to determine whether all new notes which caused total indebtedness
to exceed $50,000 were so approved and discovered no discrepancies from
this p-licy. The Bank has plans in the near future to establish individual lending limits for each officer rather than the 350,000 limit for
all officers.
Credit Monitoring
During 1981 the Bank established a strong loan review function.
It is
presently a joint responsibility of the loan review department and each
individual loan officer to monitor the financial condition of their
customers.
The loan review department performs this task by reviewing
past cue reports and overdraft lists, performing periodic collectibility
reviews and maintaining a problem loan list. We performed various tests
and reviews to ensure the completeness of this work and discovered no
discrepancies. In addition, the loan review department reviews all new
loans within 90 days of the issuance date to ensure performance as agreed
on in the loan documents.
The individual lean officers are responsible
for maintaining contact with each customer in an effort to determine
their business needs and possibly detect potential problems with a Izzr.
•-hen they first occur.




295
Loan Servicing
We discussed with Bank officials the policies regarding servicing of the
loans participated with Chase and learned there are two types of payments
to Chase. The first type is simply when a customer makes a payment and
Penn Square wires Chase its pro-rata share.
The Bank has adequate
controls over this function. The second type of payment to Chase occurs
when Penn Square vires Chase money from its own funds to meet the
requirements of the note even though the borrower has failed to meet
these requirements.
This procedure occurred quite frequently in 1981,
due to the lack of a policy to govern it.
In 1982 a new policy was
established which requires the approval of Penn Square's credit policy
committee and therefore, due to these stringent controls, this situation
is occurring less frequently.
Confirmations
We randomly selected 252 of the total number of loans in which Chase is
participating with Penn Square for direct confirmation with the borrower
as of March 31, 1982. This resulted in 38 confirmations mailed and 36
being returned to us with no exceptions. . We performed alternative
procedures to ensure validity of the notes on those borrowers not
responding.
Loan Document Inspection and Payment History
We randomly selected 25 loans participated to Chase and
loan files for the following required documentation:
o
o
o
o
o
o
o
o

inspected

the

executed loan document
signed note
collateral properly perfected
appraisals when appropriate
engineering reports, Including a documented revie by Penn
Square's engineers, when appropriate
insurance coverage with Penn Square named as loss payee, when
appropriate
current financial information
properly executed extensions, vhen applicable

We discovered three minor exceptions which the Bank is in the process of
correcting.
Also, on these
sisted of:
o

25 loans we performed a payment history

test which con

Zezer-ir.ir.g whether lean payments ara -ace when due.




296
o

Determining
extended.

the number of times, if any, the loan has been

o

Determining the borrower is making his required payments or if
Penn Square is making them on behalf of the borrower to Chase
(see information under loan servicing).

We discovered no significant exceptions in this area.
Collectibility Review
We perfonned a credit file review for collectibility on all loans in
which the portion Chase owned, equaled or exceeded $5,000,000. Also, we
performed such a review on 15 additional loans • selected at random in
which Chase participated in an amount less than $5,000,000. See Exhibit
A for a detail list of loans reviewed and their related classification.

********
Because these procedures do not constitute an examination in accordance
with generally accepted auditing standards, we express no opinion on the
financial statements of Penn Square. In connection with the procedures
referred to above, no significant discrepancies or weaknesses were
discovered.
Had we performed additional procedures or had we cade an
examination of the financial statements in accordance with generally
accepted auditing standards, other matters might have come to our attention that would have been reported to you. It is understood that this
report is for the exclusive information of Chase Manhattan Bank and is
not to be distributed to others for any purpose.

May 5, 1982




297
Exhibit A

Kane, of Borrower

*&>
<&»
<$>
&
<&




Classification

Good
Good
Good
OLEM
Good
Good
Good
OLEM
OLEM
Good
OLEM
OLEM
Substandard
Substandard
Good
Doubtful
Substandard
OLEM
Good
* OLEM
OLEM
Substandard

298

Examination »f
-

i 1 T * ? * ^fi

"T.i

?«sn Square Bank. .H.A.

! D<*

X»4itin% Proc+dvrm

Br

Objectives;
The o b j e c t i v e o f t h e f o l l o w i n g a u d i t t e s t s i s t o d e t e r m i n e whether o r
a o c chac Penn Square Bank I s f o l l o w i n g i t s own p o l i c i e s and t h o s e o f
prudent banking w i t h r e s p e c t t o t h e l o a n s t h e y have p a r t i c i p a t e d t o
Chase H a n h a t t « i Bank o f Mew York. A s p e c i a l r e p o r t i n a c c o r d a n c e w i t h
SAS flU w i l l be p r e p a r e d w h i c h c o v e r s our f i n d i n g a f t e r a p p l y i n g t h e
b e l o w agreed upon p r o c e d u r e s .
Review e x i s t i n g p o l i c i e s and p r o c e d u r e s r e g a r d i n g P e s n Square B a n k ' s
c r e d i t granting p o l i c i e s .
Discuss a l l pertinent data with appropriate
p e r s o n n e l and p r e p a r e a mean d o c u a e n t l n g o u r f i n d i n g s .
Perform the same p r o c e d u r e s a s mentioned i n #1 r e g a r d i n g c r e d i t
coring.
P r e p a r e a aeao r e g a r d i n g t h e s e r v i c i n g of Peon Square B a n k ' s
w h i c h a r e p a r t i c i p a t e d t o Chase Han ha t t en Bank.
Randomly s e l e c t 25 l otans p a r t i c i p a t e d t o Chase and perform
;
following:
(A) Review and a n a l y z e l o a n document f l l s , t o d e t e r m i n e i f
documents a r e c o m p l e t e w i t h d a t a s u c h a s :
o
o
o
o
o
o
o
o

moni-

loans

the

such

E x e c u t e d l o a n document
Currently signed notes
C o l l a t e r a l properly perfected
A p p r a i s a l s o b t a i n e d where a p p r o p r i a t e
E n g i n e e r i n g r e p o r t s o b t a i n e d and r e v i e w e d
by t h e B a n k ' s e n g i n e e r s where a p p r o p r i a t e *
I n s u r a n c e c o v e r a g e o b t a i n e d w i t h t h e 3ank
named a s l o s s p a y a b l e payee where a p p r o p r i a t e
Current f i n a n c i a l s t a t e m e n t s
I f loan e x t e n s i o n s for p r i n c i p a l and/or
i n t e r e s t e x i s t , d e t e r m i n e chey have been
properly execuced.

(B) In r e v i e w i n g t h e l o a n d o c u m e n t a t i o n , c o m p l i a n c e t e s t t h e 3 a n k ' s
adherence t o t h e p o l i c i e s noted i n s t e p s 1, 2 and 3 a b o v e .
(C) On t h e l o a n s s e l e c t e d , perform a payment h i s t o r y c e s t of
l o a n or c r e d i t l i n e c r a c k i n g such i n f o r m a t i o n a s :

the

o

Are payments made when due f o r p r i n c i p a l and

o

Determine i f l o a n i s c u r r e n t or p a s t due and chac s u c h
s t a t u s i s r e f l e c t e d on t h e 3 a n k ' s i n t e r n a l r e p o r t s .

interest?

o

D e t e r m i n e number of t i m e s t h e l o a n has been e x t e n d e d
principal and/or i n t e r e s t .
,

o

D e t e r m i n e i f customer i s =aking t h e p r i n c i p a l and i n t e r e s t
payments o r i f the 3ank i s making chem i n the c u s t o m e r ' s
behalf to Chase.

CD) If s i g n i f i c a n t e x c e p t i o n s are found in c h i s c e s c . c a l l
- s N'ew f o r k f o r g u i d a n c e as to how -je s n o u l d p r o c e e d .




for

Jan Zvaik

299
?

*MiC3.
nomination at .

z r s e d =a r r s c e a u r e s for Z'r.&se

.-.acren Z&XXK.

Auditing Ptocrdutm

O a random basis as of a randoa date, select 251 of the total number
n
of loans i s vhlch Ciase i s participating vita Penn Souare and confirm
directly with borrowers via positive confirmations. Such leans were
previously confirmed as of December 31, 1981 and a i l exceptions were
cleared to our s a t i s f a c t i o n . The loans selected ia (4) above snould
be included in the t e s t .
Send second requescs as necessary.
Clear a l l exceptions to our satisfaction.
Reviev for c o l l e c t i b i l i t y a l l loans which Chase has a participation
equal to or greater than 55,000,000 plus fifteen other loans l e s s than
55,000,000 selected at random. Include a l l loans c l a s s i f i e d other
than "good" in the report to Chase.
Draft the report noting a l l procedures performed and any errors or
weaknesses noted during our work. Such report w i l l be prepared in
conformity with SAS /14.

97-830

0-82-20




Period

300
The CHAIRMAN. At this time, the Chair would call Mr. Harold
Russell, managing partner of Arthur Young & Co.
Mr. BARNARD. Mr. Chairman, might I ask a procedural question?
Because of the essence of time, might it not be possible to question
some of the witnesses whose testimony would be a lot more pertinent today?
The CHAIRMAN. I assure the gentlemen we will complete the witness list today.
Mr. BARNARD. We are going to complete it today?
The CHAIRMAN. Yes, sir.
Mr. BARNARD. Thank you.

You are not going to complete it
today; you might complete it tonight or in the morning.
The CHAIRMAN. AS the gentleman knows, we from Rhode Island
feel that all hours are daytime hours. The way you enjoy life, it is
a wonderful thing, and being in Oklahoma City is such a wonderful
pleasure
Mr. BARNARD. YOU are enjoying this? [Laughter.]
The CHAIRMAN. I enjoy being with these wonderful people and
with you and Jim, and the rest. [Laughter.] [Witness sworn.]

TESTIMONY OF HAROLD RUSSELL, ARTHUR YOUNG & CO.
The CHAIRMAN. Mr. Russell, you are the gentleman with Arthur
Young & Co. who was the predecessor firm to Peat, Marwick,
Mitchell & Co., doing the auditing at Penn Square Bank?
Mr. RUSSELL. Yes, I am.
The CHAIRMAN. For how

long a period of time were you auditing
Penn Square?
Mr. RUSSELL. We began to audit the bank in 1976. We examined
the balance sheets for 3 years, and then on the formation of the
holding company in 1979. We reported on the holding company in
1979 and 1980.
The CHAIRMAN. In addition to the bank
Mr. RUSSELL. We reported only on the holding company in 1979.
The CHAIRMAN. Would you be good enough to describe for us the
reasons given to you by the people at Penn Square when they informed you that they had no further need for your services?
Mr. RUSSELL. We really weren't given a reason; we simply were
sent a letter saying that—I think the term was executive management had decided to make a change.
The CHAIRMAN. Were you here this morning when the question
was asked of Mr, Beller as to this change, and among the reasons
were that he could not get any return phone calls from the people
at Arthur Young & Co.?
Mr. RUSSELL. I think he said Mr. Gunter complained of that. Yes,
I was here. There was a period for about a week when the individual who was responsible for the day-to-day work was ill, and there
was some difficulty in getting a hold of him.
The CHAIRMAN. Were the people at Penn Square informed of the
fact that that gentleman was ill?
Mr. RUSSELL. It was a woman, but yes, they were. And in fact, I
think she called them from home.
The CHAIRMAN. NOW, your 1980 audit, I think everybody is aware
of the fact, at this point had a qualifying statement. Do you feel as



301
though this necessarily placed doubt on the adequacy of the loan
loss reserves?
Mr. RUSSELL. In the 1980 accounts?
The CHAIRMAN. Yes.
Mr. RUSSELL. Yes. With

respect to 1980. Of course, t h a t is exactly
what we were qualifying for, and we said t h a t we had a scope
qualification which is a highly unusual thing, particularly in a financial institution. And particularly, when it goes to the reserve to
loan losses, as ours does.
We simply indicated t h a t the supporting documentation which
was inadequate was so inadequate t h a t we could not make the determination as to whether it was adequate or not adequate.
The CHAIRMAN. In 1979, you performed an extensive examination
of the oil and gas loans of Penn Square.
Mr. RUSSELL. Yes.
The CHAIRMAN. And

my information is t h a t you found t h a t they
were in pretty good condition?
Mr. RUSSELL. In 1979, they were in excellent condition.
The CHAIRMAN. In 1980, you analyzed the loans t h a t were criticized by the Comptrollers examiners. Did you find the Comptroller's people to be evenly balanced in their approach, or in your
opinion, what was the attitude of the bank officials about those
classifications?
Mr. RUSSELL. That is two questions. Yes, certainly in 1980, at the
end of the year, the Comptroller really had what I would call their
A team examining the bank.
The CHAIRMAN. Their best?
Mr. RUSSELL. Some of the best people t h a t they had because they
brought in people from the Dallas office, the Houston office and
other offices. So I think in answer to t h a t question, they had excellent people reviewing the accounts of the bank at the end of 1980.
And I have forgotten your second question.
The CHAIRMAN. A S you know, t h a t team did, indeed, classify a
number of those loans energy loans.
Mr. RUSSELL. Yes, they did.
The CHAIRMAN. DO you think t h a t the people—that the A team
was overly harsh in their classifications of those loans?
Mr. RUSSELL. Well, the bank suggested to officials t h a t they were
overly harsh. We reviewed those classifications and we agreed with
the classifications of the Comptroller, or those examiners.
The CHAIRMAN. Mr. Leach?
Mr. LEACH. Let me say t h a t in retrospect, it is quite clear t h a t
seldom has a caveat served an auditing company so well. [Laughter.]
Mr. RUSSELL. But it is not simply a caveat.
Mr. LEACH. I asked the gentleman from Peat, Marwick how
common a practice it was to have a qualification in a bank audit,
and he said it was not highly unusual. You have just stated t h a t it
is highly unusual to have a scope qualification. Could you elaborate
on that?
Mr. RUSSELL. Well, I don't know how I could elaborate other t h a n
expressing my opinion t h a t when you havira scope qualification
t h a t says there is inadequate documentation t h a t goes to the re


302
serve loan losses. I doubt very much if you will find very many of
those kinds of qualifications in a bank or any financial institution.
Mr. LEACH. Out of 1,000 banks that are audited by principal auditing companies in America, how many will have scope of qualifications?
Mr. RUSSELL. That run to the loan loss reserve? I would guess—
and these are hypothetical type questions—but I would guess, I
would be surprised if it exceeded five.
Mr. LEACH. Five out of 1,000 would qualify as a highly unusual
condition.
I was intrigued to read your letter of contract with the bank
dated January 6, 1981, in which you stated, and I will just quote,
"In conducting our examination, we became aware of the possibility that illegal acts may have occurred that may have a material
effect on the financial statements." Is that standard contractual
language?
Mr. RUSSELL. That is standard.
Mr. LEACH. That is not an unusual aspect?
Mr. RUSSELL. NO.
Mr. LEACH. In your

judgment, were there illegal acts that occurred?
Mr. RUSSELL. Almost in any bank situation there will be some
violation, some technical violations, which would be characterized
as illegal acts.
Mr. LEACH. Were you saying that your scope qualification indicated that the possibility of illegal acts was high or low?
Mr. RUSSELL. NO. Our scope qualification goes to the inadequacy
of the documentation of the loan loss ratios. We are saying that the
loan files themselves were inadequate, the documentation, so we
could not make a decision.
Mr. LEACH. I appreciate that and would yield briefly to the chairman.
The CHAIRMAN. I thank the gentleman for yielding. Now, you
said that paragraph on illegal acts is standard, and in many institutions you will find some violations, and we are aware of that. But
let's talk about Penn Square.
You just told us that in about 5 out of 1,000 cases you would
have a scope qualification such as was contained in your report?
Mr. RUSSELL. Yes, I would be surprised.
The CHAIRMAN. AS to illegal procedures at Penn Square, were
they within the ordinary realm, or would you say that they were a
little higher than ordinary?
Mr. RUSSELL. Well, I don't think I can make that comparison.
There were a number of illegal acts which were identified both by
the examiners and ourselves, and I really couldn't compare it to
other banks. I don't think I could add anything to that.
The CHAIRMAN. Except for the fact that—well, you perhaps do
not think you could add anything, but I think you could because I
am told that you have written a few manuals on bank procedures
and are very, very knowledgeable in the area, and this is why I
asked my colleague to yield for a moment.
Mr. RUSSELL. Well, I was as far as writing technically when I was
chairman of the Subcommittee for the American Institute which



303
was writing the Bank Audit Guide for the Institute. That is my involvement with that.
With respect to Penn Square at the end of 1980, I would have to
say that I think that the technical violations were probably, as far
as number, more than you would normally incur or see in a bank.
Yes. But I think they were well documented in the examiner's
report.
I think—as I say, I really think they did a fine job, and they sent
in excellent people to do that. So I think they did document that.
The CHAIRMAN. I thank the gentleman for yielding.
Mr. LEACH. In your judgment, do you feel the fact that you made
a qualifying statement in your audit was a factor in your not being
rehired to perform the audit the following year?
Mr. RUSSELL. I have no way of knowing. I have listened to the
testimony that you have heard today, and I would have to assume
that Mr. Beller would feel more comfortable with Peat, Marwick.
But beyond that, I have no knowledge.
Mr. LEACH. Firms can only make money when they have clients.
To make an audit finding that is less than perfect and will reflect
poorly on that company takes a degree of courage. I would like to
tip my hat both to you, sir, and to your firm. And I appreciate your
willingness to appear before us today.
Mr. RUSSELL. Thank you. It is, indeed, an easy thing to do as a
practical matter.
The CHAIRMAN. Mr. Barnard?
Mr. BARNARD. AS far as procedure is concerned, when an auditing firm such as yours finds the need to make a qualifying disclosure, where is it normally found?
Mr. RUSSELL. Well, I think you are speaking about the specific
situation.
Mr. BARNARD. Yes.
Mr. RUSSELL. DO you

mean where the report is found or where
the qualifying statement is?
Mr. BARNARD. Where the qualifying statement is found.
Mr. RUSSELL. The qualifying statement, when it goes to a scope
qualification, is normally found in the auditor's opinion letter.
Mr. BARNARD. And in your particular statement, it was found in
paragraph 2,1 believe.
Mr. RUSSELL. That is right.
Mr. BARNARD. Paragraph 2 of your letter?
Mr. RUSSELL. That is correct. It is actually in paragraph 1, which
refers you to paragraph 2. It is an "except for" letter.
Mr. BARNARD. IS that a generally accepted procedure among all
creditable
Mr. RUSSELL. AS far as the way it is presented, yes, that would be
the way; what we would call the statement of auditing standards
were presented, yes, sir.
Mr. BARNARD. That is the general modus operandi?
Mr. RUSSELL. Yes.
Mr. BARNARD. The acceptable modus operandi?
Mr. RUSSELL. Yes, sir.
Mr. BARNARD. SO in other words, if it was on the

four last pages
of a document that had at least 20 or 25 pages, you would find that
that might be a little unusual, right?



304
Mr. RUSSELL. Well, that would be unusual because you would
have to have a four-page opinion letter to do that. When you have
a scope qualification it must be in the opinion letter. It cannot be
in the financial statement.
Mr. BARNARD. Would you consider, then, a statement such as
this as being a scope qualification:
It should be understood that future loan losses involved an exercise of judgment.
It is the judgment of management that the allowance is adequate at both December
31, 1981 and 1980.

Is that an explanation?
Mr. RUSSELL. I think you must be reading from the Peat, Marwick report.
Mr. BARNARD. Yes, I am.
Mr. RUSSELL. NO, that would

normally—let me think about how I
might answer you. Well, it would not be a scope qualification. It is
more—it would be a representation of management in the financial
statements. I think you would have to characterize it as a representation of management.
Mr. BARNARD. It is a representation of management?
Mr. RUSSELL. Yes.
Mr. BARNARD. But

it is a statement from the auditors to whom?
The board of directors?
Mr. RUSSELL. Well, the auditors, ourselves, or anyone else really
only render an opinion letter. The financial statements themselves
are supposed to be the representation of management. They have
the primary responsibility for that. So the auditors would be responsible for their opinion letter.
Mr. BARNARD. I have no further questions.
The CHAIRMAN. Mr. Russell, when you prepared that report that
had the qualification, were you aware of the fact that it would be
reviewed not only by the board of directors of Penn Square or the
parent holding, but by many, many people around the country who
might be giving thought to investing funds in Penn Square?
Mr. RUSSELL. Well, the answer is that we were aware that it
would become public information, but it would not necessarily
become public information to the general public in that it was included in a filing with the Federal Reserve, which is required of a
bank holding company, and in a document entitled FRY-6 report.
So we were aware of that.
And obviously, we have been quite cognizant of the fact that our
report would be the only public information available—even
though it is on the holding company itself—for an investor who understood those reports to understand our qualification went to the
subsidiary bank.
The CHAIRMAN. And so, a sophisticated money broker who was
attempting to make a determination as to whether or not advise
clients to invest funds in a particular institution would know
enough to look at that report, would they not?
Mr. RUSSELL. Well, I don't know whether they would know or
not. It would depend upon the broker.
The CHAIRMAN. Would it surprise you to be told that quite a few
of the money brokers have told us that yes, indeed, they reviewed
your report and that of Peat, Marwick, Mitchell & Co.?



305
Mr. RUSSELL. I would think that brokers were sophisticated
would know where the information was, and would make sure they
had access to it, yes, sir.
The CHAIRMAN. SO it would not surprise you to learn t h a t your
report was being reviewed by those people?
Mr. RUSSELL. N O , I would expect it to be.
The CHAIRMAN. Thank you. Mr. Weber?
Mr. WEBER. Thank you, Mr. Chairman. Mr. Russell, your 1980 financial statement is qualified for the reason t h a t there was a lack
of supporting documentation of collateral values of certain loans.
Your 1979 report was not so qualified. Was there some change in
documentation between 1979 and 1980 t h a t caused you to qualify
the 1980 report but not the 1979?
Mr. RUSSELL. Yes, there was. In 1979, the bank did a very good
job in obtaining engineering reports from very reputable engineering firms like Keplinger and Lawson and others, and did that quite
well and quite thoroughly, and they were very current.
In 1980, t h a t deteriorated and there were not current engineering reports. In some cases, there were engineering reports which
did not include an opinion of the engineer, or did not include the
assumption t h a t the engineer used or the n a t u r e of the reserves
that he had estimated; volumetric versus historical data.
Mr. WEBER. DO you know any reason why t h a t was permitted to
deteriorate in t h a t fashion?
Mr. RUSSELL. N O , I do not.
Mr. WEBER. When did you

first bring to management's attention
the fact that you were giving consideration to qualifying the report
in this fashion?
Mr. RUSSELL. Well, we would normally begin really doing our
audit, the bulk of it, being able to look at loan reserves, after the
end of the year. So it would have been sometime prior to the issuing of the report obviously, but sometime in latter February or the
first part of March.
Mr. WEBER. I assume t h a t you did discuss this with management;
the fact t h a t you would include this type of statement?
Mr. RUSSELL. Yes, we

did.

Mr. WEBER. Who specifically did you speak to?
Mr. RUSSELL. Bill Jennings.
Mr. WEBER. What was his reaction?
Mr. RUSSELL. Obviously, he was not pleased with that, but the
meeting concluded on, I think, you have to do what you think you
have to do.
Mr. WEBER. Did he make any statement about future employment?
Mr. RUSSELL. N O , he did not.
Mr. WEBER. Did he make any

other threat or recommendation or
pleading or arm twisting of any kind?
Mr. RUSSELL. N O other threat.
Mr. WEBER. Did you perform any further services after March
13, 1981, for the bank?
Mr. RUSSELL. Yes, we did some various little, what we would call
management services activities. One was to help them look for a
new financial vice president. There was another, dealing with some
review of or actually just helping establish and supervising or help


306
ing direct internal auditors in a study of commitment fees. And
one was to look at some of the financial accounting and tax ramifications of some of the fringe benefits of the package.
Mr. WEBER. Did you give them any assistance in instituting procedures to remedy your qualification?
Mr. RUSSELL. They did not request that.
Mr. WEBER. Are you familiar at all with the procedures which
were instituted?
Mr. RUSSELL. Only as they have been. I, of course, knew that
Beller had been hired, or Mr. Beller had been hired, and that some
others had been hired, but nothing beyond that.
Mr. WEBER. DO you have sufficient knowledge of those new procedures to have an opinion as to whether or not they would have
satisfied you, had you been the ones to prepare the 1980 or 81
statement?
Mr. RUSSELL. NO, I wouldn't have an opinion.
Mr. WEBER. And did you have anything to do with instituting
further corrective procedures to bring the bank into compliance
with the administrative agreement which had been executed between the board of directors and the OCC?
Mr. RUSSELL. We were not requested to do so, no, sir.
Mr. WEBER. Thank you very much, Mr. Russell.
The CHAIRMAN. Mr. Wortley?
Mr. WORTLEY. I have no questions, Mr. Chairman.
The CHAIRMAN. Mr. Leach, did you have anything further?
Mr. LEACH. NO, sir.

The CHAIRMAN. Mr. Russell, there is another question I am
tempted to ask but I am not going to ask. Again, we want to thank
you for your patience in staying with us, and for your assistance
and willingness to cooperate.
[Subsequent to the August 16 hearing, Arthur Young & Co.
issued this statement in regard to the Lytel letter:]
PENN SQUARE

During the Congressional hearings on Monday, the Committee introduced a copy
of a letter from John Lytel of Continental Bank to William Patterson. This letter,
which we obtained in the course of our audit, related only to loans which Michigan
National had acquired. It did not indicate that any other bank had a right to resell
loan participations to Penn Square. And, in fact, the letter suggests that it was Continental and not Penn Square which had agreed to reacquire the loans.
In the course of our audit of First Penn Corp., we confirmed well in excess of 90
percent of the participation loans with the banks who purchased participations from
Penn Square. With the exception of the Michigan National loans covered by this
letter, none of the confirmations disclosed any repurchase arrangements.
With respect to the Michigan National participation loans identified in the letter,
those loans were in fact disclosed in the footnotes to the financial statements.

The CHAIRMAN. At this point, I would like to put in the record
the following: First, the February 11, 1980 auditor's letter from
Arthur Young & Co. regarding First Penn Corp.'s yearend 1979
consolidated statements; second, the February 18, 1980, Arthur
Young "Management Letter"; third, the January 6, 1981, letter
from Arthur Young & Co. re: scope of yearend 1980 audit; fourth,
March 13, 1981 "qualified" audit letter; fifth, Arthur Young "Management Letter" dated May 20, 1981; sixth, filings of First Penn
Corp. with the Federal Reserve Bank, received in records section,



307
June 22, 1981; seventh, letter dated November 20, 1981 from Bill P.
Jennings to Harold L. Russell, Arthur Young & Co., informing
them that Peat, Marwick, Mitchell & Co. will do yearend 1981
audit.
[The material follows:]
ARTHUR YOUNG &

COMPANY
1 9 0 0 LIBERTY TOWER
OKLAHOMA CITY, OKLAHOMA 73102

The Board of Directors
First Perm Corporation
We have examined the accompanying balance sheets (company
and consolidated) of First Penn Corporation at December 31, 1979
and the related statements (company and consolidated) of income,
stockholders* equity and changes in financial position for the
year then ended.

Our examination was made in accordance with

generally accepted auditing standards and, accordingly, included such
tests of the accounting records and such other auditing procedures
as we considered necessary in the circumstances.
In our opinion, the statements mentioned above present
fairly the financial position (company and consolidated) of First
Penn Corporation at December 31, 1979 and the results of operations
(company and consolidated) and the changes in financial position
(company and consolidated) for the year then ended, in conformity
with generally accepted accounting principles applied on a basis
consistent with that of the preceding year.

tftfiUvi,
February 11, 1980




iZucUff ?

fa^dttH^

308
ARTHUR

YOUNG

&

COMPANY
1 9 0 0 LIBERTY TOWER
OKLAHOMA CITY. OKLAHOMA 73102

Mr. Bill P. Jennings, Chairman of
the Board
First Penn Corporation and Penn
Square Bank N.A.
Dr. Marvin K. Margo, Chairman,
Examining Committee, Penn Square
Bank, N.A.
1919 Penn Square
Oklahoma City, Oklahoma 73118
Dear Mr. Jennings and Dr. Margo:
We have examined the consolidated financial statements
of First Penn Corporation for the year ended December 31, 1979,
and have issued our report thereon dated February 11, 1980. As
part of our examination, we studied and tested the Company's system
of internal accounting control to the extent we considered necessary
under generally accepted auditing standards. This was done to
establish a basis for relying on such system in determining the
nature, timing and extent of the other auditing procedures necessary
to enable us to express an opinion on the Company's consolidated
financial statements and otherwise to assist us in planning and
performing our examination of the financial statements.
Our examination of the Company's consolidated financial
statements, including our study and evaluation of its system of
internal accounting control, would not necessarily have disclosed
all conditions requiring attention in the system of internal accounting control because both the audit and the study employed, as is
customary, selected tests of accounting records and related data.
However, our examination disclosed the following conditions relating
to Penn Square Bank, N.A. as to which we believe corrective action
should be taken or documentation (including cost/benefit considerations) should be prepared as to the reasons why corrective
action was not considered necessary in the circumstances. (In
general, corrective action need not be taken when the cost of
installing or improving a control procedure would exceed the
benefit expected to be derived. Since precise measurement of costs
and benefits usually is not possible, any evaluation of such
relationship requires estimates and judgments by management.)




309
The following conditions captioned, "Conditions Requiring
Attention" were considered, to the extent necessary in determining
the nature, timing and extent of our audit tests applied in our
examination of the Company's consolidated financial statements.
CONDITIONS REQUIRING ATTENTION
Reconciliations
The following were noted in our review of the reconciliations of various general ledger accounts at December 31, 1979.
1.

Eleven official checks totaling $1,372,337 issued at
year end by the Bank were either unrecorded or recorded
in the wrong account at the time loan disbursements were
made.

2.

Accrued interest receivable on investment securities
according to the general ledger exceeded the amount per
the investment portfolio EDP printout by $19,446. It
was also noted that during the year two unexplained
journal entries had been made, apparently in an attempt
to balance the general ledger to the investment portfolio EDP printout. In addition, the pledging status
of six securities as listed on the investment portfolio
EDP printout did not agree with confirmation reponses of
the various state and political subdivisions for which
the securities were pledged.

3.

The accrued interest related to the single pay notes
carried on the instalment loan EDP printout was not reconciled to the general ledger.

4.

Company personnel were unable to locate 46 shares of the
Bank's stock which is supposed to be in custody of
First Penn Corporation.

5.

The detail EDP printout of participation loans sold included numerous classification errors and some unrecorded
transactions (see further comments immediately following
under transactions not recorded timely).

Transactions not recorded timely
Due to banks reconciliations - Our review of reconciling
items on the Healdton Bank account reconciliation at December 31,
1979 disclosed that two checks had been issued by Healdton to




310
purchase loans under participation agreements; however, the Bank
had not recorded these particular loans as being sold. We were
told by the Loan Department personnel that the Loan Officer had
not notified the Credit and Collateral Department of the transaction. The transaction was subsequently recorded by the Bank on
January 9, 1980.
Charged-off loans - Control ledgers and individual loan
subledgers are maintained by the Accounting Department for all past
and current year charge-offs and related recoveries. However, these
subledger cards are not balanced on a regular basis. On loans
charged-off and subsequent payments, the subledgers should be
reconciled to the control ledgers on a monthly basis.
Charged-off loan customers - At our request, the Bank's
internal auditor made an investigation of an official check payable
to the Bank not clearing in a reasonable time period which
disclosed a series of events resulting in two commercial loans,
one on an unsecured basis, being made in 1980 to a borrower.
This borrower had three instalment loans which were charged-off
in 1979 by the Bank. The internal auditor submitted a report
setting out the details of the transaction to the Bank's president
in February 1980.
Trust department income - During our review of the
Trust Department, it was noted that 1979 income from the purchases
and sales of gold certificates had not been recorded by the Bank
at December 31, 1979.
While the amounts proved to be immaterial in 1979, all
transactions should be recorded timely. The failure to do so
frequently leads to a breakdown in discipline which leads to other
accounts not being recorded.
Loans
Documentation - While loan file documentation has improved
since our last examination, we noted several technical deficiencies
in documentation during our loan file review. The technical
deficiencies noted are listed in Exhibit I. Among the more
significant deficiencies noted were:




311
1.

We noted four oil and gas loans on which the collateral
mortgages had not been filed.

2.

In several instances current financial statements,
engineering reports and appraisals were not in the
files but had been received by bank personnel. To
maintain up-to-date credit information in loan files,
the responsible individuals should route all documents
to the Credit and Collection Department in a timely
manner.

Loan policies - As mentioned in our 1977 and 1978 management letters, we believe a formal loan policy statement should be
adopted by the Board of Directors. In 1978, we were informed that
a draft loan policy was being prepared; however, the minutes of the
Board of Directors do not indicate that such a policy has been
adopted. We continue to believe strongly that a definitive loan
policy should be formalized and adopted by the Board.
With the Bank's continued activity in the oil and gas
area, the loan policies for this type of loan should include
detail standards for documentation, nature of oil and gas reserves
on which loans will be made, methods of reserve estimation and
discount factors which will be acceptable and the maximum amount
to be loaned as a percent of discounted values for each method
of reserve estimation.
Letters of credit - It appears that the various loan
officers may extend a letter of credit to a customer without
approval or r.eview from a second loan officer or the Loan Discount
Committee. In response to one of our inquiries, we were informed
there are no reconciliation procedures in effect for balancing the
individual letters of credit to the total letter of credit liability
ledger. Due to the increased volume of letters of credit during
1979, we suggest that the individual letters of credit be balanced
to the liability control ledger at least monthly and that approval
policies for letters of credit be instituted.
Loans in excess of legal lending limitations - At
December 31, 1979, our review of loan concentrations (obligations
direct or indirect of the same or affiliated interests) revealed
one line in excess of the Bank's legal lending limitation under
the Comptroller of the Currency's regulations by approximately
$250,000. Loan concentrations must be constantly monitored to
insure that lines of credit do not exceed lending limits. The
members of the Board of Directors are personally liable for loans
in excess of lending limits.




312
COMMENTS ON OTHER MATTERS
Interest income on municipal securities
The Bank maintains two separate general ledger accounts
for interest income on. municipal securities, municipal - other
and municipal - Oklahoma. The EDP printout received from R. J.
Edwards, Inc. does not segregate the Oklahoma municipal interest
from other municipal securities. During the year arbitrary percentages were applied to record monthly accrued income. The
misstatement of income between the two accounts was approximately
$30,000. At year end we made adjustments to classify the interest
properly. Since the income tax treatment for state return purposes
is different for Oklahoma and other municipal interest, we recommend
that a detail analysis be manually prepared each month and income
recorded to the proper account.
Travel and entertainment expenditures
A review of selected travel and entertainment expenditures and the related documentation disclosed that employee expenses
were not always properly supported or documented. To comply with
Internal Revenue Service Regulations, proper documentation and
support should accompany each travel and entertainment report.
Bank management has notified bank personnel of the documentation
requirements and new expense report formats were implemented in
January 1980.
Overdrawn accounts
When a customer's overdrawn balance is charged-off, the
"fees on checking" income general ledger account is charged for
the total balance. To improve the accounting for losses incurred
from overdrawn accounts and properly reflect fees on checking income,
we recommend the loss be recorded to a specified expense account and
the "fees on checking" income account be reduced only by the portion
of charges to the customer's account.
Prepaid expenses
No detail schedule of prepaid expenses and the related
monthly amortization to expense is maintained. Our review of
the prepaid balance at December 31, 1979 disclosed certain expenses
amounting to $14,696 which should have been fully expensed. A
schedule should be maintained of prepaid expenses to support
the monthly amortization to expense. This schedule should be reviewed
for propriety at least quarterly by the controller. We also noted that
some relatively minor amounts were recorded as prepaid expenses to be
amortized. To facilitate monitoring prepaid expenses, a policy should
be established setting out the type and a minimum dollar amount of
prepaid expenses which would be deferred. Expenditures not meeting
these criteria should be expensed.




313
Safekeeping of investment securities
We noted in our verification of securities held in safekeeping by Liberty National Bank that the listing contained the Bank's
securities, securities held for the Bank's customers, and securities
purchased by the Bank's Trust Department. To facilitate reconcilia-.
tions of Bank-owned securities, including the related pledging of
certain securities, we suggest Bank personnel request Liberty's
safekeeping department to segregate the various securities held by
type.
Expense checks
We noted several instances where invoices were marked
"paid" but no indication of the expense check number or date paid
was made.
Paid invoices should be stamped paid and the related
check number, date paid and account distribution also should be
indicated on the invoice. In addition, we recommend the establishment of a combination check register and expense distribution
journal. This record facilitates accounting for all checks issued
and serves as a source for verifying all paid expenses were charged
to the proper account.
Signature cards on demand deposit accounts
Our review of selected demand deposit accounts revealed
two instances where unsigned temporary signature cards were on
file for over a year. We recommend that check file clerks prepare,
on a monthly basis, detail lists of accounts with temporary signature
cards which are over 30 days old. This customer list should be
submitted to the head bookkeeper and reviewed by the internal
auditor periodically.
General ledger
The Bank still does not have a chart of accounts. To
facilitate general ledger postings and location of cards, each
account should be assigned a number and cards numbered sequentially
by account number when more than one card required for account
activity. The debit and credit slips prepared should include
account name and number which would facilitate postings to the
proper general ledger account.




314
Electronic data processing
Processing of accounting and operational information of
the Bank is dependent upon the data processing services provided
by Fidelity Computer Services. As a result of our review of
Fidelity's EDP Service Center, we developed the following comments
which we believe the Bank's management should discuss with Fidelity
management:
Disaster plan - We were told by Fidelity personnel that, with
the proposed move of the processing facilities, arrangements for
alternative processing will be formulated. However, at the time
of our review Fidelity had no alternative processing arrangements
for emergency processing in the event of disaster or prolonged
loss of use of EDP equipment.
We believe that a EDP Service Center such as Fidelity's
should develop a comprehensive plan directed towards providing
alternative manual and mechnical means for continued processing
in the event the computer systems are destroyed or become inoperative for an extended period of time.
The contents of such a plan should include:
•

Location and description of alternative processing
sites.

•

Production schedules and priorities.

•

Data conversion methods.

•

Procedures for establishing updated data and
program files.

After a disaster plan has been developed, the Bank should
be notified that it has been tested under simulated emergency
conditions. During the test the disaster plan should be
evaluated for its effectiveness, and modifications, if necessary,
should then be incorporated in the plan.




315
Standards manual - No formalized standards manual exists for
program development. Such a manual is a valuable aid in understanding the role of various EDP techniques utilized in
processing data. The development of a standards manual documenting
programming and system development methodology is an important
factor in continuity of data processing functions. Such a
manual should be developed which details the approach utilized
in the following:
•

Systems analysis and design activities.

•

Program development and testing procedures.

•

Program interface techniques to accessing
data base.

•

User coordination and acceptance procedures.

•

Documentation efforts concerning:
System specification.
Individual program narratives, flowcharts.
Operations and control instructions.
User processing and control instructions.

Production control - Production efforts are scheduled and
controlled by a manual production control system. In an EDP
service center the size of Fidelity Computer Service, enhanced
service can be provided by utilizing an automated production
control system. Such a system to lessens the possibility of
incomplete or misrouted output of the user bank's data. We
were told Fidelity has plans to implement an automated system.
Automated tape library system - Currently, all backup of master
files is managed by the production personnel in a manual fashion.
Files are stored offsite on tape and rotated according to a
predetermined schedule. Due to the large number of tapes
handled, the possibility exists for failure to create and retain
necessary backup copies of critical files. We recommend that
an automated tape librarian system be implemented to provjLde
greater assurance that proper backup is created for user banks.

*

97-830 0 - 8 2 - 2 1




*

*

*

*

*

316
This letter is issued solely for the information of
the Company's board of directors, management and counsel; it
should not be presented or quoted to anyone outside the Company
because of the possibility of misunderstanding by other persons
who may not be aware of the objectives and limitations of internal
controls and of our study and evaluation thereof.
We would like to express our appreciation for the
cooperation and assistance received from your personnel during
the course of the audit.
We would be pleased to discuss the matters reported or
to answer any questions you may have at your convenience.
Very truly yours,

£%a?^i;^d*~~),f
Oklahoma City, Oklahoma
February 18, 1980




&~y/*~~y

317
Exhibit I
Page 1
Borrower

Bank's portion at
12-31-79

Roger Casida

$

3500

Loan file deficiency
Note not made payable to
Penn Square Bank

ASA Energy
No financial statements
Corp.

36,232

James J. Cook

150,000

Eagle Drilling

-0-

Equity Drilling
Lambdin-Dawson
George C. Martin
Paramount
Drilling

280,000
34,285
225,000
86,887

No financial statements
No financial statements
No financial statements
No financial statements or
appraisal in file
No financial statements
Insurance expired 1-1-79
on airplane collateral

Steele
No financial statements
Construction

31,000

Bill Stubbs Co.

97,162

Thomas Oil Co.

19,258

Robert Daughterty

86,225

No financial statements
No financial statements
Financial statements (3-77)
and appraisal (1965) old

Century Oil &
Gas Co.

145,356

Engineering report (2-77)
and financial statements
(5-78) old

Dahlgren
Contracting, Inc.

100,087

Financial statements
(1-78) old

C. Hubert Gragg

125,000

Appraisal (1-77) and
financial statements (12-77)
old

Publishing
Industries, Inc.

394,449

Financial statements (9-77)
old




318
Exhibit I
Page 2
Borrower

Bank's portion at
12-31-79

Ivan Thompson

$200,000

Loan file deficiency
No appraisal on horse
collateral and collateral
title not in Borrower's
name

A Perm-O-Green
Lawn

35,709

No appraisals of collateral
and financial statements
(3-78) old

Rick Mason

40,000

Oil and gas mortgage filed
on one of two leases

E. M. McDowell
Sr. & Jr.

No financial statements

Delhi Pacific
Mines Ltd.

500,000

Oil and gas mortgages had not
been signed or filed. Title
opinions and engineering
reports not in borrower's
name

J. D. Helms

403,000

Engineering reports and title
opinions not obtained on all
leases

David Hostelly

700,000

Engineering report does not
segregate information
individual for lease
mortgaged.

David Kennedy

51,260

No assignment of oil and
gas mortgages in Borrower's
name

L & T Oil & Gas
Inc.

50,000

Oil and gas mortgages had
not been filed

Stanmark
Petroleum

400,000

Oil and gas mortgages had
not been filed on all
leases

Copeland Energy
Corp.

296,429

Title opinions not obtained
on all leases

Bob Carroll and
Peter Massion

290,000

Title opinions not in
borrower's name and no
assignments in file




319
ARTHUR YOUNG &

COMPANY
1900
OKLAHOMA

L I H I (<!Y

CITY, O K L A H O M A

I Ova W
/ >\<>^

January 6, 1981

Mr. Bill P. Jennings,
Chairman of the Board
First Penn Corporation
Dr. Marvin K. Margo,
Chairman, Audit Committee
Penn Square Bank, N.A.
1919 Penn Square
Oklahoma City, Oklahoma 73118
Gentlemen:
The purpose of this letter is to confirm our existing
relationship as certified public accountants for First Penn
Corporation and to provide an understanding of the scope1 of
services to be performed by our firm.
Our examination of your annual consolidated and
parent company financial statements will be made in accordance
with generally accepted auditing standards and accordingly will
include such tests as we consider necessary in the circumstances.
Unless unusual conditions not now foreseen make it impracticable
for us to do so, we will submit a report on our examination of
these financial statements which will express an opinion as to
the fairness of their presentation in conformity with generally
accepted accounting principles.
Under generally accepted auditing standards, t n '
i.
independent auditor has the responsibility, within the inherent
limitations of the auditing process, to plan the examination to
search for errors or irregularities (as defined in authoritative
professional literature) that would have a material effect on
the financial statements. Our search for material errors or
irregularities ordinarily is accomplished by performing those
auditing procedures that in our judgment are appropriate- in the
circumstances to form an opinion on the financial statements as
a whole. Our examination, which is based on the concept of
selective testing of the data being examined, is subject to the
inherent risk that material errors or irregularities, if they
exist, will not be detected.




320
In conducting our examination, we will be aware of the
possibility that illegal acts (as defined in authoritative
professional literature) may have occurred that may have a
material effect on the financial statements. Examinations
conducted in accordance with generally accepted auditing
standards are of limited effectiveness in discovering possible
illegal acts and cannot be expected to provide assurance that
illegal acts will be detected, although procedures that are
performed primarily for the purpose of forming an opinion on
the financial statements as a whole may also bring possible
illegal acts to the auditor's attention.
During the course of our examination, we may observe
opportunities for economies in or improved controls over your
operations. It is our practice to bring such opportunities to
the attention of an executive at the appropriate level of
management, either orally or in writing. Should you desire
any further information concerning our responsibilities and
functions as an independent auditor in making the examination,
we shall be pleased to furnish information to you upon request.
We will also prepare the Company's annual United States
Federal and Oklahoma consolidated income tax returns.
In addition to the preparation of the returns, upon
your request, we are also prepared to advise you generally on
tax problems and tax planning. In this connection, in order to
be of greatest assistance in minimizing the Company's tax
burdens, we should be advised in advance of any major transactions the Company proposes to undertake.
Should the Company be selected for examination by the
Internal Revenue Service or by other tax authorities,, we will
also be pleased to represent the Company or to assist you in
discussions with these authorities and in preparing any refund
claims or protests that may be necessary to obtain a final
determination of the Company's tax liability.
We would like to caution you that tax rules change
constantly. For this reason, any opinion expressed in
connection with a transaction at one time may not apply to a
similar transaction at a later date. Therefore, to be most
helpful, we should be able to take a fresh look each time a
transaction of a material nature is proposed.
Our fees for the annual examination and other
accounting and auditing services (as requested) will be based
on hours worked by the various grades of personnel, at our
standard rates applicable to each, plus out-of-pocket expenses.




321
We anticipate reducing the fees at our standard rates by a
discount of 23% for 1980. Other work, including preparation
of the Federal and Oklahoma income tax returns and specific
tax planning related projects upon special request, will be
billed separately at our standard rates, plus out-of-pocket
expenses.
Our report and accompanying financial statements will
be in the format required for the Company's filing of the
FR Y-6 with the Federal Reserve Board.
If this letter meets with your approval, please sign
one copy and return it to us.
Yours very truly,

^ • # £ t 7^CU^</'

The arrangements described above are acceptable to us.
FIRST PENN CORPORATION:

D y

' • • > ' • ] • • •

*--~-

~~

Bill P. Jennings,
Chairman of the Board
Date

PENN SQUARE BANK, N.A.
By

/
?*h>/' / 7-^-yp
Marvin K. Margo, M.D., ty
Chairman, Audit Committee




^

^

^

322

^ T ( M Y@M
ARTHUR YOUNG & COMPANY
1900 LIBERTY TOWER
OKLAHOMA CITY, OKLAHOMA 73102

The Board of Directors
First Penn Corporation
We have examined the accompanying balance sheets (company and
consolidated) of First Penn Corporation at December 31, 1980
and 1979 and the related statements (company and consolidated)
of income, stockholders' equity and changes in financial
position for the years then ended.
Except as stated in the
following paragraph, our examinations were made in accordance
with generally accepted auditing standards and, accordingly,
included such tests of the accounting records and such other
auditing procedures as we considered necessary in the circumstances.
We were unable to satisfy ourselves as to the adequacy of the
reserve for possible loan losses at December 31, 1980 due to
the lack of supporting documentation of collateral values of
certain loans.
In our opinion, expept for the effects of such adjustments, if
any, on the 1980 financial statements (company and consolidated) as might have been determined to be necessary had we
been able to satisfy ourselves as to the adequacy of the
reserve for possible loan losses, the statements mentioned
above present fairly the financial position (company and
consolidated) of First Penn Corporation at December 31, 1980
and 1979 and the results of operations (company and consolidated) and the changed in financial position (company and
consolidated) for the years then ended, in conformity with
generally accepted accounting principles applied on a consistent basis during the period.

C/0\A^AJ^^
March 13, 1981




LA&tA^&

^

C^sO*rf&~->

323

AGMwa mm®
ARTHUR YOUNG & COMPANY
1900 LIBERTY TOWER
OKLAHOMA CITY, OKLAHOMA 73102

May 20, 1981

Examining Committee, Penn
Square Bank, N.A.
Mr. Bill P. Jennings,
Chairman of the Board
First Penn Corporation and
Penn Square Bank
1919 Penn Square
Oklahoma City, Oklahoma 73118
Gentlemen:
We have examined the parent company and consolidated financial statements of First Penn Corporation for the year ended
December 31, 1980, and have issued our report thereon dated
March 13, 1981, As part of our examination, we made a study
and evaluation of the Company's system of internal accounting
control to establish the level of our reliance on such system
in determining the nature, timing, and extent of other auditing
procedures necessary to enable us to express an opinion on the.
Company's financial statements.
Our study and evaluation was more limited than would be necessary to express an opinion on the system of internal accounting
control of First Penn Corporation, taken as a whole. Accordingly, we do not express such an opinion. Because of its
limited nature, our study and evaluation would not necessarily
disclose all material weaknesses or other conditions requiring
attention in the system of internal accounting control.
Our study and evaluation disclosed the following conditions
that we believe results in more than a relatively low risk that
errors or irregularities in amounts that would be material in
relation to the Company and consolidated financial statements
of First Penn Corporation may occur and not be detected within
a timely period.
Our report on the financial statements of First Penn Corporation at December 31, 1980 was qualified since we were unable




324
to satisfy ourselves as to the adequacy of the reserve for loan
losses due to the lack of supporting documentation of collateral values of certain loans. With the significant growth of
Penn Square Bank's loan portfolio implementing sound loan
policies and procedures is a critical factor in both the
decision process in making loans and monitoring the portfolio.
Loan file documentation
Both our review and that of the national bank examiners disclosed documentation deficiencies in the loan files, the most
significant of which related to information supporting collateral values.
It is critical that the Bank correct the loan
file documentation deficiencies and implement procedures to
obtain all applicable information from new borrowers prior to
loan approval and to monitor existing loan files for complete
and current information.
Loan policies
Although the Bank has adopted a loan policy, we believe that a
more definitive loan policy specifically tailored for the
Bank's portfolio should be formalized and adopted by the Board.
The policy should include provisions which define by type of
loan (real estate, construction, oil and gas) criteria for:
(a) acceptance of loan, (b) review of applications, (c) acceptable appraisal or valuation techniques, (d) required documentation and (e) procedures for monitoring the loan.
With the Bank's continued activity in the oil and gas area, the
loan policies for this type of loan should include detail
standards for documentation, nature of oil and gas reserves on
which loans will be made, methods of reserve estimation and
discount factors which will be acceptable and the maximum
amount to be loaned as a percent of discounted values for each
method of reserve estimation.
Reserve for loan losses
Currently, the Bank's reserve for loan losses is based on a
percent of outstanding loans, which, in the opinion of management, is adequate to absorb potential losses in the loan
portfolio.
To properly monitor the loan portfolio and related
reserve for loan losses, we believe a more definitive policy
should be implemented to provide for review of individual loans
or lines of credit.
The policy should include procedures for
review of the adequacy of the reserve at least quarterly with




325

i

documentation of the loans reviewed and conclusions reached.
The policy should also include criteria for actual charge-off
of loans and subsequent monitoring of the charge-offs.
OTHER CONDITIONS REQUIRING ATTENTION:
The following conditions also came to our attention as to which
we believe corrective action should be taken or documentation
(including cost/benefit considerations) should be prepared as
to the reasons why corrective action was not considered necessary in the circumstances.
Participation loans
At December 31, 1980, there were approximately $23 million of
participation loans effected by the Bank which had participation maturity dates prior to that of the loan.
Subsequent to
year end the terms of the majority of such participation
loans were amended to conform with that of the underlying
loan. In addition approximately $2 million of participation
loans were not reflected in the Bank's subsidiary records due
to a direct transfer by the participating bank of the funds
advanced .
The Bank has had increasing activity in the participation loan
area. Accordingly, establishing specific procedures related to
processing of such loans is critical.
Such procedures should
include a review by a responsible employee of the terms of any
agreements, the amounts involved and proper recording in the
accounting and subsidiary records.
In addition, our confirmation procedures related to participation loans disclosed some differences in interest rates and
loan balances.
All differences were reconciled by the Bank's
internal audit department and reviewed by us.
We believe a
periodic confirmation program of participation loan balances
and terms by the internal audit department should be
established.
This procedures should identify any differences on
a timely basis.
Letters of credit
As mentioned in our 1979 management letter, there are no
standard procedures in effect regarding the issuance of letters
of credit including approval by a second loan office or the




326
loan discount committee.
A policy should be established
defining dollar limits for each officer and related approval
for letters of credit in excess of such limits.
In addition,
policies should be implemented, to define (1) acceptable
customers, (2) documentation, and (3) method of determining
and monitoring collateral value. The letters of credit should
be reconciled to the subsidiary records at least monthly.
Payroll and payroll tax reports
Our review of the payroll tax reports for 1980 disclosed
differences between the amounts reported on the payroll tax
reports for total compensation and that recorded in the general
ledger.
The Bank's internal audit department is reviewing
these differences and determined that a portion of the difference appears to relate the Saturday pay to employees.
Quarterly payroll tax reports should be reconciled to the
general ledger compensation expense prior to filing.
Consideration should be given to making payments for Saturday work
in the normal payroll process rather than the cash payments.
*

*

*

*

*

*

These conditions were considered in determining the nature,
timing, and extent of audit tests applied in our examination of
the Company's parent company and consolidated financial statements and this report does not affect our report on those
financial statements dated March 13, 1981.
COMMENTS ON OTHER MATTERS:
Commercial paper
The Company began issuing commercial paper during 1980.
We
noted a trend toward a negative interest factor due to the
short-term of the paper being issued not allowing for an
offsetting investment of funds in revenue producing investments.
We understand that subsequent to year end, the controller of the Bank who was responsible for commercial paper
transactions has terminated her employment.
Due to the highly regulated nature of commercial paper and an
indicated trend of negative cash flow, we suggest a qualified
employee be placed in charge of commercial paper transactions.




327
General ledger postings
The Bank still does not have a chart of accounts with assigned
account numbers.
We also noted some general ledger tickets
which lacked adequate information documenting the purpose of
the entry. To facilitate postings to the proper general ledger
account, we suggest assigning each an account number and including this number on the general ledger ticket.
Additionally,
the tickets should include a brief description of the purpose
of the entry and bear the approval of a supervisor.
An additional control which would facilitate subsequent review of the
entries would be to indicate the offsetting debit or credit on
the general ledger ticket.
Wire transfers
At the time of our review, the Bank had no formal procedures
relating to wire transfers.
Due to the nature and volume of
transactions, a system with good controls is imperative.
We
noted a lack of segregation of duties. In addition, there were
no formal limits or criteria for persons, both in the bank and
customers who were authorized to initiate transactions.
We
suggest an evaluation of the existing system be prepared and
control features be determined and implemented.
Reference is
made to the national bank examiners' comments on wire transfers
under internal control deficiencies for a summary of areas
which should be considered.
Accounts payable
At December 31, 1980, the liability for operating expenses
incurred at year end but not paid was accrued.
As payments
were made subsequent to year end, the liability was reduced.
In the past, the Bank has not accrued such expenses as management did not feel they were significant.
We understand there has been no procedure adopted regarding the
handling of such expenses in 1981 and that expenses will be
recorded as paid.
For January 1981, expenses will be understated by the amount of expense incurred at January 1981 but
paid subsequently as payment of expenses in January will have
been offset against the liability set up at year end.
To
properly reflect monthly and year-to-date expenses, accounts
payable for accrued liabilities should be set up monthly. This
could be accomplished by setting up a voucher system whereby
liabilities are recorded as incurred. Subsequent payment should
then be offset against the liability.




328
An alternative would be to record an estimate of such accrued
liabilities and adjust this payable to actual at year end.
For monthly and year to date information to be as accurate as
possible the estimate should be compared to actual on at least
a quarterly basis and infrequent or unusual items should be
accrued for separately.
Dual controls
Internal controls are strengthened by dual control.
Areas we
noted for which such controls could be implemented are as
follows:
•

Receipt

and

preparation

of

currency

•

Mail deposits.

•

Verification of night deposits.

•

shipments.

Access to automated teller machine.

The management of First Penn Corporation and its' subsidiary,
Penn Square Bank, N.A. is responsible for establishing and
maintaining a system of internal accounting control.
In
fulfilling this responsibility, estimates and judgements by
management are required to assess the expected benefits and
related costs of control procedures.
The objectives of a
system are to provide management with reasonable, but not
absolute, assurance that assets are safeguarded against loss
from unauthorized use or disposition, and that transactions are
executed in accordance with management's authorization and
recorded properly to permit the preparation of financial
statements in accordance with generally accepted accounting
principles.
Because of inherent limitations in any system of internal
accounting control, errors or irregularities may nevertheless
occur and not be detected.
Also, projection of any evaluation
of the system to future periods is subject to the risk that
procedures may become inadequate because of changes in conditions, or that the degree of compliance with the procedures may
deteriorate.
This report is intended solely for the use of management
should not be used for any other purpose.
We would be pleased to discuss the matters
respond to any questions, at your convenience.
Very truly yours,

UAsti^T^Ct^




reported

and

or to

329

B^pr-

1.

.„ r-^^**

feM

tfEC'D IN RECORDS SECTiOr;

f ^~

Consolidated and Parent Holding Company Financial Statements.
The required financial statements, at year ended December 31, 1980 are
provided, attached as Exhibit I, hereto.

2.

Annual Reports to Stockholders and to the Securities and Exchange Commission
(SEC).
a. The registrant does not prepare an annual stockholder report; attached
as Exhibit I please find the consolidated financial statements of First Penn
Corporation.
b. Neither the registrant nor its subsidiary files annual reports with
the SEC.

3.

Information on Subsidiaries

4.

Non-Bank Subsidiary Financial Statements

Information on the registrant's subsidiary is provided in Schedule A.

Information on the registrant's non-bank subsidiary is provided on Schedule
A. Financial statements are not submitted on this non-bank subsidiary, sin^e
it is a subsidiary of the bank that is fully consolidated on a line-by-line
basis in the registrant's consolidated report of condition.
5.

Information or. Organizations Other Than Subsidiaries
The registrant has no direct or indirect interest in any organization
other than its wholly owned subsidiary, Penn Square Bank, N.A.

6-

Activities of the Parent Bank Holding Company
Registrant engages in the activity of owning or controlling its wholly
owned subsidiary bank as set forth in the completed Schedule C attached
hereto and as a distributor of commercial paper.

7.

Terminations
No organization has ceased being a part of the bank holding company
organization during the registrant's fiscal year.




O

=2^>

330
8. Organization Chart - December 31, 1980

FIRST PENN CORPORATION
An Oklahoma Corporation

I PENN SQUARE BANK N.A.
Oklahoma City, Oklahoma

I
FIRST PENN LEASING
Oklahoma City, Oklahoma
9.

Amendments to Organizational Documents
The registrant has not amended the documents under which it was organized
and operates.

10.

Shareholders
The following shareholders of registrant, all of whom are either United
States citizens or corporations, own, control or hold, with the power to vote 5% or
more of the outstanding voting shares of registrant:
a. Mr. Bill P. Jennings, of Oklahoma City, Oklahoma, owns beneficially
and of record 56,049 shares of registrant's common stock.
b. The Rooney Corporation, located in Tulsa, Oklahoma, owns beneficially
and of record 15,080 shares of registrant's common stock.

11.

Directors and Officers
Information concerning the directors and principal officers of registrant
is as follows:
a. Mr. Bill P. Jennings of Oklahoma City, Oklahoma, owns 56,049 shares
of registrant's common stock and serves as President and a Director of registrant,
and Chairman of registrant's subsidiary bank, which constitutes his principal
occupation. In addition, Mr. Jennings serves as Vice Chairman and a Director of
the Bank of Healdton, Healdton, Oklahoma, and exercises voting control over 19.7%
of the shares of that bank as a result of shares individually owned and shares voted
as a trustee. Mr. Jennings also serves as President and a Director of First Healdton
Corporation, in which he controls the same percentage of shares as he controls in
the bank. Mr. Jennings serves as Director of Community Bank & Trust Company and




331
Community Corporation in Enid, Oklahoma, and has a 13% ownership in each
entity. In addition, Mr. Jennings, has the following business interests:
Penn Northwestern Land Development Co.
Petro Building Limited
J-Mc Aircraft Corporation
TSJ, Inc.
Chi-Chi's of Atlanta, Inc.
Trans-Central Airlines, Inc.
American Gypsum Company
Northwest Investors, Ltd.
Skirvin Plaza Investors
JJS, A Partnership

25%
25%
50%
25%
30%
20%
10%
15%
16.6%
33.3%

Stock Limited Partnership
Stock Limited Partnership
Stock Ownership Interest
Stock Ownership Interest
Stock Ownership Interest
Stock Ownership Interest
Stock Ownership Interest
Limited Partnership Interest
Limited Partnership Interesi
Limited Partnership Interesi

b. Mr. Frank L. Murphy of Oklahoma City, Oklahoma, owns 225 shares of
registrant's common stock and serves as Secretary/Treasurer of registrant and as
President of registrant's subsidiary bank, which is his principal occupation.
In addition, Mr. Murphy serves as Secretary and a Director of Edgewater Heights
Development Corporation in which he has a 50% ownership interest.
c. Mr. John E. Rooney of Tulsa, Oklahoma, owns 1,960 shares of registrant's
common stock and serves as a Director of registrant. Mr. Rooney's principal
occupation is ar President of the Rooney Corporation in which he has a 50% ownership.
The following entities are subsidiaries of Rooney Corporation or a subsidiary
of the subsidiaries which Mr. Rooney has a 50% ownership:
East Side Development Company
Fleet Finance Company
Lake Country Beverage
Leland Equipment Company
Leland-Manhattan Joint Venture
Penn Square, Inc.
Manhattan Constructioa Company
The Rooney Company
In addition, Mr. Rooney serves as Secretary and a Director of Hope Lumber
and Supply Company, in which he owns 140 shares. He also owns 14% of the outstanding shares of Citizens National Bank of Muskogee, Oklahoma. He is an
operating partner in the Rooney Oil Company in which he has a 1/3 interest.

97-830 0 - 8 2 - 2 2




332
d. Mr. W. A. Ross of Oklahoma City, Oklahoma, owns 2,944 shares of
registrant's common stock and serves as a Director of registrant. Mr. Ross's
principal occupation is as President and owner of Dub Ross Company, in which
he has a 100% ownership. In addition, Mr. Ross has the following interest:
Northwest Investors, Inc.
Colcord Association Ltd.
Skirvin Plaza Investors

10% Limited Partnership Interest
Limited Partnership Interest
20% Limited Partnership Interest

e. Mr. Carl W. Swan of Oklahoma City, Oklahoma, owns 9,819 shares of
registrant's common stock and serves as a Director of the registrant. Mr. Swan's
principal occupation is as an independent oil producer. Mr. Swan has the following
interests:
Copeland Energy
Swan Aviation
Director & President
World of Travel
Director
Longhorn Oil & Gas Co.
Director
Swan Coal Company
Director & President
American Gypsum Co.
Director
Intrepid Drilling Corp.
Director
Continental Drilling Corp. Director
Swan Petrcleum
Director & President
Haymaker Farms
Midwest National Bank
Texas Oilfield Supply
Olympic Expl
High Plains Drilling

23%
100%
80%
50%
100%
16.66%
15%
40%
100%
11%
20%
15%
40%
40%

Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock
Stock

Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership
Ownership

Interest
Interest
Interest
Interest
Interest
Interest
Interest
Interest
Interest
Interest
Interest
Interest
Interest
Interest

f. Mr. Ronald H. Burks of Oklahoma City, Oklahoma, owns 7,500 shares of
registrant's common stock and serves as a Director of registrant's subsidiary
bank and of registrant. Mr. Burks' principal occupation is as President
of Ronald Burks Investments, Inc. iu which he has 100% ownership. In addition,
Mr. Burks has the following interests:
Chi-Chi's
Chi-Chi's
Peachtree
Northwest

of Atlanta
of Sunrise, Florida
Hospitalities
Investors

11.1%
11.1%
33%
25%

Land & Building
Land & Building
Stock Ownership
Stock Ownership

Interest
Interest
Interest
Interest

Insider Loans
* The bank holding company organization has made no loans to any insider, or
his interests, aggregating more than 10% of the equity capital accounts of the
registrant.




333
ilEC'D IN RECORDS SECTION

• j j ^ r «?rj

JUN 22 1981

FIRST PENN CORPORATION
FINANCIAL STATEMENTS
YEARS ENDED'DECEMBER 31., 1980 AND 1979
with
REPORT OF CERTIFIED PUBLIC ACCOUNTANTS

JlfiillftliiJiii




FOR FILES
Cherie Suess

334

MOTKM WJKK
ARTHUR YOUNG & COMPANY
1900 LIBERTY TOWER
OKLAHOMA CITY, OKLAHOMA 73102

The Board of Directors
First Penn Corporation
We have examined the accompanying balance sheets (company and
consolidated) of First Penn Corporation at December 31, 1980
and 1979 and the related statements (company and consolidated)
of income, stockholders' equity and changes in financial
position for the years then ended.
Except as stated in the
following paragraph, our examinations were made in accordance
with generally accepted auditing standards and, accordingly,
included such tests of the accounting records and sucn other
auditing procedures as we considered necessary in the circumstances.
We were unable to satisfy ourselves as to the adequacy of the
reserve for possible loan losses at December 31, 1980 due to
the lack of supporting documentation of collateral values of
certain loans.
In our opinion, except for the effects of such adjustments, if
any, on the 1980 financial statements (company and consolidated) as might have been determined to be necessary had we
been able to satisfy ourselves as to the adequacy of the
reserve for possible loan losses, the statements mentioned
above present fairly the financial position (company and
consolidated) of First Penn Corporation at December 31, 1980
and 1979 and the results of operations (company and consolidated) and the changes in financial position (company and
consolidated) for the years then ended, in conformity with
generally accepted accounting principles applied on a consistent basis during the period.
C^JOJ^JJ^-S
March 13, 1981




uA&^a

**"

(^xytr^a~jL.

335
FIRST PENN CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1980 and 1979

ASSETS
Cash and due from banks
Investment securities (Note 3)
Loans, less reserve for possible loan
losses of $2,004,587 ($1,002,097 in
1979) (Notes 4, 5 and 12)
Federal funds sold
Premises and equipment (Notes 6 and 8)
Accrued interest receivable
Other assets (Note 2)
Total assets

1980

1979

$ 59,625,519
42,627,346

$ 25,671,661
22,982,819

199,894,664
16,000,000
3,724,388
7,372,553
1,213,248

106,484,882
1,100,000
1,936,348
2,495,276

$330.457.718

LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand
Savings
Time
Total deposits
Federal funds purchased
Other liabilities (Note 7)
Notes payable (Note 8)
Commercial paper
Loans sold under agreement to
repurchase
Total liabilities
Stockholders' equity (Note 10):
6.5% cumulative preferred stock,
$60 par value; 5,000 shares
authorized, 4,225 shares issued
Common stock, $1 par value; 250,000
shares authorized, 162,466 shares
issued (108,311 shares in 1979)
Surplus
Retained earnings
Total stockholders' equity

$135,029,063
13,341,126
136,522,794
284,892,983

$ 79,701,722
13,261,028
56,717,078
149,679,828

650,000
4,636,579
8,606,800
14,640,252

400,000
1,975,341
3,160,001

316,222,175

155,215,170

253,500

253,500

162,466
7,420,753
6,398,824
14,235,543

108,311
3,142,508
2,984,611
6,488,930

Total liabilities and
stockholders' equity




See accompanying notes.

$161.704.100

336
FIRST PENN CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1980 and 1979

1980
Interest income:
Interest and fees on loans
Interest on investment securities:
Taxable
Tax exempt
Total interest on investment
securities
Interest on federal funds sold
Total interest income
Interest expense:
Interest on deposits:
Savings
Time
Other
Total interest on deposits
Interest.on commercial paper
Interest on federal funds purchased
Interest on notes payable
Interest on subordinated notes
Total interest expense
Net interest earnings
Provision for possible loan losses
Net interest earnings after
provision for possible
loan losses
Other income:
Service charges on deposit accounts
Other service charges and fee income
Other
Total other income

$24,665,544

SI1,038,809

299,778
1,308,326

277,397
908,630

1,608,104

1,186,027

282,715
26,556,363

14,933
12,239,769

715,844
11,834,081
2,745
12,552,670

734,974
4,360,560
56,650
5,152,184

1,055,686
871,220
791,024
15,270,600
11,285,763

710,847
189,450
59,656
6,112,137
6,127,632

1,407,830

615,000

9,877,933

5,512,632

366,920
431,738
89,312
887,970

108,212
279,050
61,536
448,798

(Continued on following page)




1979

337
FIRST PENN CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(CONTINUED)
Years ended December 31, 1980 and 1979

1979

1980
Other expense:
Salaries
Employee benefits
Occupancy and equipment expense
Otber
Total other expense
Income before income taxes,
minority interest and
securities losses
Provision for income taxes (Note 9)
Income before minority
interest and securities
losses
Minority interest
Income before securities
losses

1,997,560
341,656
618,828
2,410,459
5,368,503

$ 1,243,156
237,381
390,363
1,208,478
3,079,378

5,397,400
1,966,710

2,882,052
969,675

3,430,690

1,912,377

-

232,112

3,430,690

1,680,265

Securities*losses, net of related
income taxes and minority interest
$ 3.430.690

Net income




7,111

See acompanying notes.

$ 1.673.154

338
FIRST PENN CORPORATION
(consolidated and Darent comDany)
STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1980 and 1979

Preferred
stock
Balance at December
31, 1978
Net income
Exchanee of stock
for stock of
subsidiary bank
(Note 2)
Exchange of stock
for subordinated
notes of subsidiary bank
(Note 2)

Common
stock

Retained
earnings

Surplus

$ 64,552

$1,387,918

-

-

-

$1,311,457
1,673,154

253,500

18,759

779,590

-

-

25,000

975,000

-

253,500

108,311

3,142,508

2,984,611

Net income

-

-

-

3,430,690

Common stock issued

-

54,155

4,278,245

Preferred stock
dividends

z

-

-

$162.466

$7.420.753

Balance at December
31, 1979

Balance at December
31, 1980




$

S253.500

See accompanying notes.

(16,477)
$6.398.824

339
FIRST PENN CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
Years ended December 31, 1980 and 1979
1980
Source:
Net income
Charges against (credits to) income
not involving funds in the current
period:
Depreciation and amortization
Excess of provision for possible
loan losses over net loan
charge-offs
Amortization of premiums on
securities
Accretion of discounts on
securities
Deferred federal income taxes
Amortization of cost in excess
of net assets of subsidiary bank
Net book value of property
dispositions
Funds provided from
operations
Decrease in federal funds sold
Proceeds of borrowings
Increase in deposits
Increase in federal funds purchased
Increase in other liabilities
Increase in commercial paper
Loans sold under agreement to
repurchase
Common stock issued in exchange for
subordinated notes of subsidiary
bank (Note 2)
Common stock issued in exchange for
subordinated notes of subsidiary
bank (Note 2)
Preferred stock issued in exchange
for stock of subsidiary bank
(Note 2)
Proceeds from the sale of common stock




1979

3,430,690

$ 1,673,154

307,887

187,858

1,002,490

374,606

129,209

$

57,303

(36,625)
76,710

(16,890)
(26,000)

21,348

21,314

12,562
4,944,271
5,606,800
135,213,155
250,000
2,584,528
14,640,252

2,271,345
2,900,000
1,000,000
59,033,185
400,000

2,795,561
1,000,000
786,226
265,623
4,332,400
$170.366.967

(Continued on following page)

$67.656.379

340
FIRST PENN CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
(Continued)
Years ended December 31, 1980 and 1979
1980
Application:
Increase in cash and due from banks
Increase in securities
Increase in loans
Increase in federal funds sold
Additions to premises and equipment
Increase in accrued interest
receivable
Increase in other assets
Decrease in other liabilities
Payments on notes payable
Cancellation of indebtedness of
subordinated notes of subsidiary
bank (Note 2)
Preferred stock dividends




1979

$ 33,953,858
19,737,111
94,412,272
14,900,000
2,106,886

$15,075,152
5,351,876
43,252,807

4,877,277
203,085

1,238,279
11,141
1,390,286
100,000

160,001

236,838

1,000,000
16,477
$170.366.967

See accompanying notes.

$67.656.379

341
FIRST PENN CORPORATION
(parent company only)
BALANCE SHEETS
December 31, 1980 and 1979
ASSETS
Cash on deposit with subsidiary bank
Certificate of deposit of subsidiary
bank
Receivable from subsidiary bank
Investment in stock of subsidiary
(Note 2 ) :
Equity in net assets
Cost in excess of net assets
acquired

1980
$ 7,595,651

Total assets

$

7,442

8,300,000
873,083

701,500

20,422,403

8,936,511

747,180

767,322
9,703,833

21,169,583
1,242,721
48,046

Land (Note 8)
Other assets

1979

$39.229.084

S10.431.557

977,535
752,089
16,865
1,746,489
14,640,252
8,606,800
24,993,541

766,490
1,271

3,160,001
3,942,627

253,500

253,500

162,466
7,420,753
6,398,824
14,235,543

108,311
3,142,508
2,984,611
6,488,930

$39.229.084

$10.431.557

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Other liabilities:
Income taxes payable
Interest payable
Othei
Commercial paper
Notes payable (Note 8)
Total liabilities
Stockholders' equity (Note 10):
6.5% cumulative preferred stock, S60
. par value; 5,000 shares authorized,
4,225 shares issued
Common stock, $1 par value; 250,000
shares authorized, 162,466 shares
issued (108,311 shares in 1979)
Surplus
Retained earnings
Total stockholders' equity
Total liabilities and
stockholders' eauity




See accompanying notes.

782,626

342
FIRST PENN CORPORATION
(parent company only)
STATEMENTS OF INCOME
Years ended December 31, 1980 and 1979
1980
Income from subsidiary bank:
Dividends
Interest on subordinated notes
Interest on certificates of deposit
Total income from subsidiary
bank
Expenses:
Interest
Amortization
Other expenses
Total expenses
Income (loss) before income tax benefit,
equity in undistributed earnines of
subsidiary and securities losses
Income tax benefit (Note 9) Income (loss) before undistributed
earnings of subsidiary and
securities losses
Equity in undistributed earnines of
subsidiary before securities losses
Income before securities losses
Equity in securities losses of subsidiary,
net of related income taxes

300,000

See accompanying notes.

$

233,125
7,533

270,375
570,375

240,658

1,846,710
22,951
4,305
1,873,966

189,450
22,946
13,959
226,355

(1,303,591)

14,303

749,183

95,225

(554,408)

109,528

3,985,098
3,430,690

1,570,737
1,680,265

z

7,111

S3.430.690

Net income




$

1979

$1.673.154

343
FIRST PENN CORPORATION
(parent company only)
STATEMENTS OF CHANGES IN FINANCIAL POSITION
Years ended December 31, 1980 and 1979
1980
Source:
Net income
Charges against (credit to) income not
involving funds in the current period:
Equity in undistributed earnings of
subsidiary
Amortization of organization costs
Amortization of cost in excess of
net assets of subsidiary bank

1979

$ 3,430,690

$1,673,154

(3,985,098) (1,563,626)
1,603
1,632
21,348

Proceeds of borrowings
Increase in taxes payable
Increase in accrued interest payable
Increase in commercial paper
Increase in other liabilities
Common stock issued in exchange for
subordinated notes of subsidiary
bank (Note 2)
Common stock issued in exchange for
stock of subsidiary bank (Note 2)
Preferred stock issued in exchange for
stock of subsidiary bank (Note 2)
Proceeds from sale of common stock

21,314

(531,457)

Funds provided from (absorbed
by) operations

132,474

5,606,800
211,045
750,818
14,640,252
2,000

1,000,000
600,413
1,270
14,000
1,000,000
786,226
265,623

4,332,400
S25.011.858

Application:
Increase in cash
Increase in certificates of deposit
Increase in receivable from subsidiary
Purchase of land
Increase in other assets
Additional equity investment in subsidiary bank through (Note 2 ) :
Capital contribution
Cancellation of indebtedness of
subordinated notes of subsidiary
bank

$3.800.006

$ 7,588,209
8,300,000
171,583
1,242,721
30,867

$

(Continued on following page)




7,500,000

7,021
623,956
17,180
1,000,000

1,000,000

344
FIRST PENN CORPORATION
(parent company only)
STATEMENTS OF CHANGES IN FINANCIAL POSITION
(CONTINUED)
Years ended December 31, 1980 and 1979
1980
Acquisition of subsidiary bank
stock
Payment on notes payable
Preferred stock dividends




$

1979
$1,051,849
100,000
-

S25.011.858
See accompanying notes.

2,000
160,001
16,477

$3.800.006

345
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

1.

Summary of significant accounting policies

Principles of consolidation - The consolidated financial
statements include the accounts of First Penn Corporation ("the
Company") and its subsidiary, Penn Square Bank N.A. ("the Bank").
All significant intercompany transactions and accounts have been
eliminated.
Investment securities - Investment securities are stated at
cost adjusted for amortization of premiums and accretion of discounts on the straight-line method to maturity. Gains and losses
on sales of investment securities are computed on the specific cost
identification method.
Interest on loans - Interest on commercial and real estate
loans is accrued based on the principal amount outstanding.
Interest on instalment *loans is recognized as revenue based on- the
sum-of-the-months-digits method.
Reserve for possible loan*losses - The reserve for possible
loan losses is a valuation reserve which has been provided from
charges to earnings in the form of provisions for possible loan
losses. The provision charged to earnings is the amount which, in
Che opinion of management, is considered necessary to maintain the
balance in the reserve for possible loan losses at a level adequate
to absorb potential losses in the loan portfolio. The provision is
based on loans specifically identified as probable losses and other
factors which, in management's judgment, deserve recognition in
estimating possible loan losses.
Premises and equipment - Premises and equipment are stated at
cost less accumulated depreciation.
Depreciation is computed on
the straight-line and declining balance basis over the estimated
useful lives of the individual assets.
Retirement plan - The Bank has a noncontributory retirement
plan covering substantially all full-time employees.
The Bank's
policy is to fund costs accrued, including amortization of prior
service costs.
Income taxes - The Company and its subsidiary bank file a
consolidated income tax return.
Income tax charges are allocated
to the Bank on the basis of its taxable income included in the
consolidated financial statements.




346
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

1.

Summary of significant accounting policies (continued)

Deferred income taxes are provided on all significant timing
differences.
These differences relate primarily to (1) the difference between the provision for possible loan losses reported for
income tax purposes and that reported for financial statement
purposes and (2) amortization over a ten-year period of the effect
of the change for income tax purposes in 1978 from the cash basis
to the accrual basis of reporting certain revenues and expenses.
Investment
method.
2.

tax credits are accounted

for on the flow-through

Investment in subsidiary

During 1976 and 1977, the Company acquired 83,259 shares of the
100,000 outstanding shares of the Bank. This acquisition was
accounted for as a purchase and the excess of cost over fair market
value of the net assets acquired of $851,792 is being amortized on
a straight-line basis over a period of forty years. The unamortized balances of $747,180 and $767,322 at December 31, 1980 and
1979, respectively, are included in other assets in the consolidated balance sheet.
During 1979, the Company offered to issue to the minority
shareholders of the Bank for each share of the Bank's common stock
owned either (1) one and one-half shares of the Company's $1 par
value common stock or (2) one share of the Company's preferred
stock.
In

September

1979

the following

exchanges

Number of shares of
bank stock
exchanged

were

Number of shares of
company stock issued
Common

16,731

effected:

18,759

Preferred
4,225

The additional investment acquired in the Bank was recorded at
net book value of the Bank stock which in management's opinion
approximated fair market value of the net assets acquired.




347
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

2.

Investment in subsidiary (continued)

In addition, the Company offered to exchange one share of its
common stock for each $40 of principal face value of the Bank's
$1,000,000 subordinated notes.
All note holders exercised their
options in exchange for 25,000 shares of the Company's common
stock.
In October, the Company canceled the Bank's liability on
these notes resulting in an additional $1,000,000 investment in
the subsidiary bank.
In addition, a cash capital contribution of
$1,000,000 was made by the Company to its subsidiary bank in
1979.
In January, 1980, the Company purchased the remaining 10
outstanding shares of the Bank at a cost of $200 per share. The
excess of cost over fair market value of the shares acquired was
$1206.
This amount is included in the unamortized excess cost at
December 31, 1980. A cash capital contribution of $7,500,000 was
made by the Company to its subsidiary bank in 1980.
3.

Investment securities

The carrying values and estimated market values of investment
securities at December 31, 1980 and 1979 are as follows:
Consolidated
1980
Carrying
value

Market
value

$10,992,420

$10,643,000

31,334,926

26,546,000
300,000

$42,627.346

United States Treasury securities
Obligations of states and political
subdivisions
Otber

$37.489.000

1979
United States Treasury securities
Obligations of states and political
subdivisions
Other




$ 3,181,184

$ 2,816,000

19,741,635
60,000

18,013,000
60,000

$22,982,819

$20,889,000

348
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

3.

Investment securities (continued)

At December 31, 1980 and 1979 investment securities with book
values aggregating $18,549,000 and $9,460,000, respectively, were
pledged to secure public funds.
4.

Loans

Loans are s t a t e d at f a c e value l e s s unearned income. The
amount of unearned income at December 3 1 , 1980 and 1979 was
$1,537,889 and $1,903,264, r e s p e c t i v e l y .
Loans at December 31,
1980 and 1979 are as follows:
Consolidated
1980
1979
Commercial
Real estate
Instalment
Other

*

Reserve for possible loan losses

$155,798,134 $ 83,424,493
26,763,002
10,532,265
16,356,789
13,263,098
2,981,326
267,123
201,899,251
107,486,979
(2,004,587)
(1,002,097)
$199.894.664

$106.484.882

Included in outstanding loans at December 31, 1980 were loans
totaling $3,846,129 to officers and directors, or their affiliates.
Also during 1980 the Bank purchased loans from and sold loans to
two banks in which an officer-director of the Company held an
equity interest.
At December 31, 1980 outstanding transactions
with these banks consisted of:
Loan participations purchased

$1,737,484

Loan participations sold

$6,767,646

Management believes all such'loans are made in the ordinary
course of business.
5.

Reserve for possible loan losses

Changes in the reserve for possible loan losses during
and 1979 were as follows:




1980

349
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

Reserve for possible loan losses (continued)
Consolidated
1980
Balance at beginning of year
Provision charged to operating expense
Recoveries of loans previously charged
off
Losses charged off
Balance at end of year
6.

$1,002,097
1,407,830

32,004.587

1979
$

212,061
(617,401)

627,491
615,000
19,038
(259,432)

$1,002,097

Premises and equipment
An analysis of premises and equipment follows:
Consolidated
1980
Land
Building
Furniture and equipment
Other

1979
$

$3.724.388

Less accumulated depreciation

$1,712,146
1,607,244
1,158,227
459,455
4,937,072
1,212,684

469,426
1,461,562
845,699
74,259
2,850,946
914,598

$1.936.348

The land account is composed of land on which the drive-in
facility is located and unimproved land.
7.

Other liabilities
Other liabilities consist of the following:
Consolidated
1980
Accrued interest payable
Income taxes payable




1979

$3,186,239
1,032,859

$1,012,187
821,789

350
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

7.

Other liabilities (continued)
Consolidated
1980
S

Deferred federal income taxes
Other

176,710
240,771

54.636.579
8.

1979
$

75,000
66,365

$1.975.341

Notes payable

Notes payable
parent company:

consist

of

the

following

obligations

of

tbe

Parent Company and
consolidated
. 1980
Demand notes payable secured by
98,354 shares of the Bank's stock:
Due February 26, 1981 at Chicago
floating prime interest rate
Due February 26, 1980 at New York
prime interest rate not to exceed
8%
Due December 28, 1980 at New York
prime interest rate
Demand note payable, due February 27,
1981 at Dallas prime interest rate,
secured by land held by the parent
company at cost of $1,242,721

$7,500,000

1979

$
2,160,001
1,000,000

1,106,800

-

$8.606.800

53.160.001

Subsequent to year end, the 57,500,000 demand note was extended
to February 26, 1982 and the 51,106,800 demand note was extended to
May 29, 1981. It is the intention of management to seek to renew
the debt upon maturity of the demand notes.




351
FIRST PENN CORPORATION
(consolidated and parent comDany)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

9.

Income taxes

Consolidated income tax expense, including the tax effects
of securities losses, consists of the following components:
1980
Current tax:
Federal
State

1979
$888,400
100,000
988,400
(26,000)

$1,966.710

Deferred

$1,710,000
180,000
1,890,000
76,710

$962.400

A reconciliation of the amount computed by applying the federal
statutory rate of 46% and the effective income rate follows^:
1980
Income tax at statutory rate
Tax exempt interest
Investment tax credit
State taxes, net of federal benefit
Other

1979

$2,482,804 $1,318,468
(585,059)
(392,375)
(42,955)
(12,200)
97,200
54,000
(5,493)
14,720
$1.966.710

$

962.400

An analysis of the provision (credit) for deferred income taxes
follows:
Provision for possible loan losses for
income tax purposes in excess of
financial provision
Amortization of effect of the change for
income tax purposes in 1978 from the
cash basis to the accrual basis of
reporting certain revenues and expenses
Provision for state income taxes for
financial purposes in excess of tax
provision
Other




$72,400

$ 15,400

(10,800)

(10,800)

15,110

(32,000)
1,400

$76.710

$(26.000)

352
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

9.

Income taxes (continued)

The income tax benefit for the parent company represents
the excess of amounts payable by its subsidiary in lieu of paying
federal income taxes on a separate return basis over the taxes
payable on the consolidated return.
10. Common and preferred stock
On September 6, 1979, the stockholders approved an amendment to
the Articles of Incorporation increasing the number of $1 par value
common stock authorized to 250,000 shares from the previously
authorized 100,000 shares.
The stockholders also approved the
authorization of 5,000 non-voting preferred shares with a par value
of $60 and with dividends cumulative at the annual rate of 6.5%.
Each preferred share is convertible into one share of the common
stock of the Company at any time at the option of the holder and is
subject to redemption at the option of the Company upon payment of
the par value plus accrued dividends at any time following January
1, 1989.
No cash dividendjs may be paid on common stock if the
dividends on the preferred stock is in arrears.
11. Commitments
The Bank has lease agreements for (1) the land under the main
bank, which expire in 2029, and (2) office facilities one of which
expires in 1985 with renewal options for three five-year terms, one
of which expires in 1981, and two which expire in 1984 both with
renewal options for three one-year terms. Minimum annual rentals
under these leases are as follows:
1981
1982-1983
1984
1985
1986-1989
1990-2029

$118,353
122,752
21,119
7,980
7,200
3,000

In addition to the minimum rental for one of the office facility
leases, the Bank also pays additional rental based on a percent of
average total deposits as defined for each lease year. The lease
covering the land provides for rental payments to be adjusted every
10 years based on a cost of living index. Total rental expense for
1980 amounted to approximately $99,000.




353
FIRST PENN CORPORATION
(consolidated and parent company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1980 and 1979

12. Participation loans
At December 31, 1980, there were participation agreements in
effect with maturity dates prior to that of the underlying loans.
Subsequent to December 31, 1980, the majority of the agreements
totaling $18,651,497 were amended to reflect terms that coincide
with the terms of the note.
Accordingly, the participation agreements amounting to
$20,969,203 at December 31, 1980 have not been reflected in the
accompanying balance sheet as loans outstanding.
However, the
National Bank Examiners required that certain of these loans be
reflected as loans outstanding in reports submitted to their
office. After renegotiation of the terms of agreements subsequent
to December 31, 1980, these amounts will not be included in such
reporting.
13. Subsequent event
Subsequent to December 31, 1980 the Company acquired, from
certain officer-stockholders,^ all of the outstanding stock of a
company involved in a real estate development project for approximately $1,250,000. The acquired company's principal asset is the
uncompleted development project which is subject to debt of approximately $3,000,000.
Approximately $400,000 of this debt, at
December 31, 1980, was payable to the Bank. The lead lending bank
has filed foreclosure proceedings on the project.
In addition,
certain suppliers of the project have filed third party claims
against the Bank for materials supplied the project and punitive
damages.
Management is of the opinion that no significant loss
will be incurred in connection with this transaction.




354

D O M E S T I C

BANK

h O L D l N G
P O R T

OFFICIALBMttttftT*"
lAK ENDING

C O M P A N Y

F . R. Y

w

JUN 2 31981'
/

•

SDPFTEMFJT

19BC/12/3

NAME UF BANK HOLDING COMPANY: FIRST PENN CORPORATION

/
MAILING ADDKESS
STREET:

2o206

/

191S PENN SQUARE

P.O. BOX

!

CITY:

OKLAHOMA CITY

STATE:

OKLAHOMA

ZIP COOE:

/
/
/
/
/

741Z6

/

/
/
/

/

LOCATION OF PRINCIPAL OFFlLE:
CITY:

OKLAHOMA CITY

/

CCUNTY:

GKLAnOMA

/

STATES

UKLnrtOMA

/

ZIP CODE:

7^12t>

/

/
/
/
/

1 (NAME) JENNN1NGS, BILL P

/
n i T u u PRESIDENT

/

AM AUTHORIZED UFFICEK OF TttE HOLDING COMPANY NAMED ABOVE,HER£BY CERTIFY ON
THE / ,
/ DAY OF /
/ 1V/ / . T H A T THIS REPORT HAS BEEN EXAMINED BY
ME ANu li> TROE AND COMPLETE TO THE BEST UF MY KNOWLEDGE AND BELIEF,
SIGNATORY / _
NAME,TiTLE,AND PrtONE NUMBER OF PERSON TO WHOM INQUIRES MAY BE DIRECTED:
NAME:

TRUESUELL,

PAITI

/

/

T I T L E : ACCT SUPERVISOR

/

/

:

TELEPHONE N.UMbER:

{*<}$) 8 4 * - 7 4 * 1
(AREA CObfc)-NUMBfck

/_

TfllS REPORT I S RtMUlRED LY SECTION 5 ( C ) OF THE BANK HOLDING COMPANY ACT
( I x U . S . C 1 8 4 * 1 AND SECTION < ^ 3 . 3 ( B ) OF REGULATION Y ( 1 2 C . F . R . 2 3 3 . 5 ( b ) ) .




355
SCHEDULE A

PAGE 1 OF 3

INFORMATION ON SU8S1D1 AR1ES<1>
SEE F.R. Y-6, REPORT ITEM 3.
TO BE COMPLETtO FOR EALH BANK AND NONBANK,DIRECT AND INDIRECT,FOREIGN AND
DGMESTIL SUbSIDIARY OF THE BANK HOLDING COMPANY.
NAME:

FIKST PENN LEASING CORPORATION

/
CITY:

/

OKLAHOMA CITr
•
OKLAHOMA

STATE:

/
CJUNTY:

OKLAHOMA

/

/
ZIP CODE : 7312o

/
DATE OF SUBSIDIARY'S
1.

/
FISCAL

Yfc*R ENDS

196G/12/31

I F THIS SUBSIDIARY BECAME PART OF THE BHC ORGANIZATION DURING THE LAST
FISCAL YEAK.cNlcR T Hfc DATE AND NATURE OF CONSIDERATION PAID I F OTHER" THAN
MUNtTARYM V*ilCH SHUULD BE REPORTED I N ITEM 13 ON PAGE 3 OF THIS SCHEDULE)
DATE(YYMMDD):
CONSIDERATION!

FOR ITErtS 2 AND ^,PLACE

/
/

/
/

THE APPROPRIATE NUMBER I N THE BOX PROVIDED.

2. THIS SUBSIDIARY IS:
A.

(1) A BANK (AS DEFINED I* THE ACT)
t2) A N G N b A N K OHGAN1~ZAT10N<2>

/2/

(*:) A P A R T N E R S H I P
(3) N O T A L U R P U R A T I O N

D» (1)
(2i
E. (1)
(2)

(SPECIFY TYPt:
ACTIVE
INACTIVE
D0MEST1C<3>
FuREIGN<4>

/

/

/2/

/

/

/l/

B. 41) A JU1NT VENTURE
12) NOT A JOINT VENTUkE __.
C. ill A CORPuRATiON

/

/

OR P A R T N E R S H I P

)
/!/

/

/

/l/

/

/

3, IF THIS IS A SUBSIDIARY OF A BANK, IS IT FULLY CONSOLIDATED WITH THE BANK?
CI) YESiNAME OF BANK) PtN* SQUARE BANK, N. A.
/I/

/

/ /__/

(2) No
C3) NOT APPLlCABLEiNOT A SUBSIDIARY OF A BANK)
<1> RtFcK TO DEFINITIONS 5 AND 7 IN GENERAL INSTRUCTIONS FOR SUbSIDIARY DEFNS.
<2> ttULSTIO.*S 2A2: A NONbANK IS ANY ORGANIZATION THAT IS NOT A BANK,AS DEFINED
IN THE brtC ACT.
<3> WOESTIC^ 2E: A bANKCAS DEFINED IN THE BHC ACT) IS CONSIDERED DOMESTIC.
<«r> REFcK TU DEFINITION o AND 7 IN THE GENERAL INSTRUCTIONS FOR FOREIGN
OKGANIZATIUNS.




356
irxrs^i

rcratx Lt-Aaxmu, uurvruivM i xum

SCHEDULE A

PAGE 2 OF 3

INFORMATION ON SUBSIDIARIES
<*. LIS! EACH ORGANIZATION WITHIN THE BANK HOLDING COMPANY ORGANIZATION THAT
DIRECTLY OWNS OR CONTROLS VOTING SECURITIES OF THIS SUBSIDIARY,AND INDICATE
THE TYPE(S) OR CLASS (LS) OF SHARES OWNED OR CONTROLLED ANO PERCENTAGEUO THE
NtAREST TENTH 0 F Ond PERCENT) OF OUTSTANDING SHARES OF EACH TYPE OR CLASS
4
OWNED OR CONTROLLED.
DlKtCT PARENT

CLASS OF SHARES

PLNN SQUARE BANK. N. A.

COMMON STOCK-VOTING

/

_/ /

_/ /

PER CENT
OWNED
100.00

/

-/ /_

! . SPtClFY TnE EXtMPTIvt FRGVlSluN AND REGULATION OR BGARD OROER(INDICATE DATE)
>
RELIED UPUrt Fuk RETtNTlbf* OF THIS SUBSIDIARY.<1>
SECTION M O t
>

/
SECTION
/

/

«*(C> 5

L I S T CURktNl A C T I V I T I E S CONDUCTED BY THIS SUBSIDIARY
ACTIVITY CODt<i>
CONDUCTED I N U . S . < 1 = Y E S , 2 = N 0 )
G6AA /
/
1
U6AC
1

IN ORDER OF

IMPORTANCE.

Li^T ACTIVITIES COMMENCED BY THIS SUBSIDIARY THIS YEAR.
ACTIVITY CUDt<2>
C0NL*OLTCD IN U.S.fl=YES,2=N0) EFFECTIVE DATE(YYMMDO)
C6AA /
/
1
/
/
79/01/01 /
/
CoAC /
/
1
/
/
7V/C1/01 /
/

/

/

/

/

/ /

L I S ! A C T I V U I L S TERMINATED tJY T h l i . SUdSIDlAKY
ACTIVITY CQUt<2>
EFFECTIVE OATc(YYMMOD)
olfo
/
/
79/ui/ul
/
/

/
/

/
/

/ /
/ /

LIST A C T I V I T I E S NbT C U K R E M L Y
APPROVAL E X I S T S .
ACTIVITY CGDc<z>

/
/
/

/
/

/

DURING THE FISCAL

/

YEAR.

/
/'

CUMuUCTtD BY T H I S

SUBSIDIARY

BUT FUR WHICH

/
/
/

<1> yULSriOiM i>: K L F E N Ip D t F l M T l O N S 9 Mil) 10 lM THE GENtRAL INSTRUCTIONS.
<2> VOCATIONS 6 , # , i > , y : > K E F L k 1 0 THE CMC ACTIVITY MANUAL FOR CODfcS.USE THE'
t UXblT ALPHANUMtRlC CUDtS WHENEVER POSSIBLE.




357
'. r i . t \ ^ i

rciMCM LEAdJ-nit? uur\.rur\M i xun

i

SCHEDULE A

PAGE 3 OF 3

INFORMATION UN SUBSIDIARIES
lc. If THIS SUbSlulA*Y«S HtAu UFFILE IS LOCATED IN THE UNITED STATES,FURNISH
InE FOLLOWING INPCRMATiLN:<l>
A. WuMbtR UF EXISTING uhhlL-LS
i
/ /
6. NUh^tR UF OFFICES ESTABLISHED DURING FISCAL YEAR
/
/
C. NUHbcR OF OFFICES TERMINATED DURING FISCAL YEAR
/ /
D. huhxt* OF OFFICES APPKOVEU oUT UNOPtNED
/ /
11. IF THIS SUBSIDIARY'S HEAD OFFICE IS LOCATED IN A FOREIGN COUNTRY,
FuRNlSn TrtE FOLLOWING INFORMATION:
LUU.tTRY OF HEAD OFF let
NUMBER OF OFFICES

/
_

COUNTXY OF OTHCA OFFICES

/

NUMBER OF OFFICES

/

/

/

AMOUNTS I N THOUSANDS OF U . S . DOLLARS
TOTAL AMUUNT A) WHICH THAS SUBSIDIARY I S CARRIED
ON THE BOO^S OF I I S U'WNfcRlS) WITHIN THE BANK
rtOLulNG COMPANY ORfc»ANl2ATIUN.
226 /
/
1 3 . TGIAL HISTORIC CuST OF THIS SUBSIDIARY
100 /
/
l-». BANK HOLDING COMPANY'S{PARENT UNLYl INCUM= FROM THIS
SUBSIDIARY DURING TrtE PARENT'S FISCAL YfcAR:<2>
A. DIVIDENDS D E L L A R E D ( P A I D UK PAYABLE DIRECTLY TO
THE PARENT).
/
/

12.

b. OTHER I1NTCREST,MANAGEMLNT,AND SERVICE FEES,ETC.)
EXCLUDING THE PARENT'S EvUlTY 1M UNulSTRIBUTED
EARNINGS OF THIS SUBSIDIARY.
lt>. OUTSTANDING LOANS AUD ADVANCES TO THIS SUBSIDIARY AS
OF THE END UF THE BANK HOLDING COMPANY'S!PARENT
0*LY) FISCAL YEAK:<2>
A, FROM THE BANK HOLDING COMPANY(PARENT ONLY)
B. FRO* SUBSIDIARY BANKS OF THE HOLDING COMPANY
C» FROM OTHER SuaSIolARlES OF THE BANK HOLDING COMPANY
16. LOANS AMD LEKSci,fitT OF UNEARNED INCUME AND RESERVE
FOR POSSIBLE LOAN L0SSES<3>
17. TOTAL ASSEIS<3>
lb.

S T O C K H O L J E R S • E3UnY<3>

TOlAL OPERATING RtVcNUL«0>
TOTAL OPERATING tXPENSES<3>
NET INC0ME<3>
UO THt AMOUNTS FUK THIS SUBSIDIARY IN ITEMS 16 THROUGH
*1 CONSOLIDATE OK A LINE BY LINE BASIS THE ACCOUNTS OF
ANY OF ITS SUBSIDIARIES? ENTER •!• FOR YES,*?" FOR NO,
m m
* FOR INAPPLICABLE.
23. IF l l FINANCIAL STATEMENTS OF ThIS SUBSIDIARY HAVE NOT
it
IctH SUL-MITTED IN REPORT ITEM 4 BECAUSE ITS ACCOUNTS
HAVE BEEN CONSOLIDATED ON A LlNE-BY-LlNE BASIS WITH
ANOTHER SUBSIDIARY FOR WHICH STATtMENTS HAVE BEEN SUB-

<L>
<2>

/

/
/
/

/
/
/

/
/
/

IV.
20.
2.1.
22.

MITTED, INDICATE THE NAME OF THAT

/

/
/
/

3 / /

SUBSIDIARY.<3>

viJESTIOK 10: NEED NOT BE COMPLETED FOR ANY &ANKSUS DEFINED IN THE BHC ACT)
wUcSTION 1-4-.15: NEED NUT B£ COMPLETED FOR COMPANIES THAT FILE FR 2314
OK FR 28BoB.
<„>> QUESTIONS lo-2i: NEEu NCT BE COMPLETED FOR A BANK,A SUB UF A BANK CONSOLIDATED IN ITS PAKLNI'S CONSOLIDATED REPORT OF CONDITION,OR ANY SUBSIDIARY
FILING AN FR 23lt- OK FR 2bfcoB: REFER TO REPORT ITEM 3 INSTRUCTION^.




358
SCHEDULE A

PAGE 1 OF 3

INFORMATION UN SUBSIDIAR1ES<1>
SEE h.R. Y-o, REPORT ITEM 3.
TO BE COMPLETED FOR E*Cri BANK AND NONBANK,CIRECT ANO INDIRECT,FOREIGN AND
DOMcSTlC SUBSIDIARY OF THE BANK HOLDING COMPANY.
HKML:

PCNN SQUARE BANK, N. A.

/
CITY:

/

OKLAHOMA CITY

/
STATE:

/

OKLAHOMA

/

/
COUNTY:

OKLAHOMA

/
ZIP CODE : 73x1b

/

/

_/

DATE OF SUBSIDIARY'S FISCAL YEAR END: 1960/12/31
1. IF THIS SUBSIDIARY BECAME PART OF THE BHC ORGANIZATION DURING THE LAST
FISCAL YEAR,ENTER THE DATE AND NATUKE OF CONSIDERATION PAID IF OTHER THAN
M0NE1ARY:(WHICH SHOJLU BE REPORTED It* ITE* 13 ON PAGE 3 OF TrtIS SCHEDULE)
DATE(YYMMDD):
CONSIDERATION:

/
/

/
/

FG* ITEnS 2 AND .*,PLACE THE APPROPRIATE NUMLER IN THE BOX PROVIDED.
I. TMIS ^UtiilJlAKY IS:
A. (1) A BANK CAS OEFlNcD IN THE ACT)
(2) A NONBANK OR.«ANlZATlUN<2>
t. (1) A JOINT VcNTUKE
iZi NOT A JOINT VcNTUKt

/!/

(i) A PARTNERSHIP
(3) NOT A CukPurtATlOU UK PARTNERSHIP
(SPECIFY TYPE:
0. (1) AC11VE
(2) INACTIVE
E. (1) UuME^TlC<3>
(<c> PukElGN<*>
I F TrtlS I S A SUSSlDlAhY
( I I YtSUAME UF BANK)

Ol^ A BANK,

/ /

/l/

C, (1) A C U R P J R A U O N

3.

/ /

/2/

/

/

)
/l/
/l/

I S I T FULLY CONSOLIDATED

/

/ /
/ /
WITH THE BANK?
/3/

/ /_/

(<1) NU

(j) Nul APPLICABLE(NUT A SUBSIDIARY OF A BANK)
<1> KEFE.N TO DEFINITIONS : ANU 7 IN GENERAL INSTRUCTIONS FOR SUBSIDIARY DEFNS.
>
<2> QUESTIONS 2A2: A NuNfcANK IS ANY ORGANIZATION THAT IS NOT A BANK,AS DEFINED
Xti THE btxL ACT.

<*> QULSTION 2E: A B A N M A S DEFINED IN THE BKC ACT) IS COKSlDbRED DOMESTIC.
<4> KEhtfx TO DEFINITIONS 6 AND 7 IN 1 Ht GENERAL INSTRUCTIONS FOR FOREIGN
ORGANIZATIONS.




359
(PtliN SwoARE BAN*, N. A.
SCHEDULE A

PAGE 2 OF 3

INFORMATION ON SUBSIDIARIES
LIST EACH ORGANIZATION WIlhlN THE BANK HOLDING COMPANY ORGANIZATION THAT
DIRECTLY UW»»S OR CONTROLS VUTING SECURITIES OF THIS SUBSIDIARY, AND INDICATE
1HL TtPcU) Ok CLASSIES) OF SHARES OWNED OR CONTROLLED AND PERCENTAGE (TO THE
NEAktST TENTH OF ONE PERCEN1> OF OUTSTANDING SHARES OF EACH TYPE OR CLASS
OWNED UR CONTROLLED.
CLASS OF SHARES

OIRECI PARENT

COMMON

FIRST PcNN CORPORATION

/ /
/
/
/
/

/_
/
/
/
/_

STOCK-VOTING

5 . SPECIFY THt EAErtPTIVE PROVISION AND REGULATION OR BOARD ORDER(INDICATE
R L L l t u UPON FUR RETENTION OF THIS SUBSIDIARY.<1>
SECTION 3 ( A )
ill

/.

to.

/

LIST CURRENT ACTIVITIES CbNuUCTED BY TrllS SUBSIDIARY
ACTIVITY CuD£<.2>
CUNDUCTLu IN U . S . i 1 = Y E S , 2 = N Q »
c>Q2:> /
/
I
/
/

/
/
/
/

7.

DATE)

/
/
/
/

/
/
/
/

/
/
/

/
/
/

IMPORTANCE.

/
/
/
/

Ll^T A L T l V l f l E S COMMENCED bY 1H1S SUBSIDIARY THIS
ACTIVITY CuOE<£>
CONDUCTED IN u . S . ( 1 = Y E S , 2 = N O )

/
/
/

IN ORDER OF

/
/
/

YEAR.
EFFECTIVE

/ /
/ /
/ /

DATE(YYMMDD)

/
/
/

£. LIST ACTIVITIES TERMINATED bY THlo SUBSIDIARY DURING THE FISCAL YEAR.
EFFECTIVE DATE(YYMMDD)

/ /
/ /
/ /

/
/
/

/
/
/

/
/
/
*

LIS! ACTIVITIES NOT CURRENTLY CONDUCTED BY THIS SUBSIDIARY BUT FOR WHICH
APPRJVAL EXISTS.

<1> *ULS»1UN t>i RCFEK TU DEFINITIONS 9 AND 1C IN THE GENERAL INSTRUCTIONS.
<Z> vUtSTIONb o,?,o,9: REFER TO THE BHC ACTIVITY MANUAL FOR CODES,USE THE
• DIGIT ALPHANUMERIC CODcS WHENEVER POSSIBLE.
*




360
I H t N f * iWUAKL tSANN, W . A .

SCHtDULE A

PAGE 3 OF 3

INFORMATION ON SUBSIDIARIES
IC. IF TrilS SOBSlDlARY'S HEAD OFFICE IS LUCATED IN THE UNITED STATES,FURNISH
Tut FOLLOWING 1NFURMAT1UN:<1>
A. tfUMBLR OF fcXlSTING OFFICES
1
/
/
b. NUMBER OF OFFICES ESTABLISHED DURING FISCAL YEAR
/
/
C. NUMBER OF OFFICES TERMiNATtD DUKlNG FISCAL YEAR
/
/
O. *UMUJ_K OF OFFICES APPROVED BUT UNOPENED
/
/
11. IF TtnlS SUBSIDIARY'S HEAD OFFICE IS LOCATED IN A FOREIGN COUNTRY,
FOKN1SH THE FOLLOWING INFORMATION:
COUNTRY OF HLAD OFFICE
NUMBER OF OFFICES

/
_

COUNTRY OF OTHER OFFICES

/
12.

13.

NUMBER OF OFFICES

/

/

/

AMOUNTS I N THOUSANDS OF U . S . DOLLARS
TOTAL AnUlAT AT XrtlCH THIS SUBSIDIARY I S CARRIED
ON THE BOOKS OF ITS UWNEtUS) HITttlN THE BANK
HOLDING COMPANY G R G A N I Z A I I O N .
21,170 /
TOTAL HISTORIC Cu^T OF TrtiS SUBSIDIARY
7,134 /

1*. BAN* HOLDING COMPANY'S(PARENT ONLY) INCOME FROM THIS
A.

SUBSIDIARY DUKING I H L P A R E N T S FISCAL Y E A R : < 2 >
DIVIDENDS DECLARED*PAID OK PAYABLE DIRECTLY TO

THt PARENT).
B. OTHER (INTEREST,MANAGEMENT,AND SERVICE FEES,ETC.)
EXCLUDING IHE PMRENT*S LWOlTY IN UNDISTRIBUTED
fcAKNlNGS OF THIS SUBSIDIARY.
lt>. OUTSTANDING LUANS AND ADwANCtS 10 1HI5 SUBSIDIARY AS
OF THE fcNu OF THE BANK HOLDING COMPANY'S(PARENT
OfiLY) FISCAL YcAK:<<:>
A. i-RQM THE BANK HOLDING CUMPANY (PARENT ONLY)
£. FROM SUBSIDIARY EAM'.S UF THt HOLDING COMPANY
C. FROM OTHER SUBSIDIARIES LF THE BANK HOLDING COMPANY
le>. LOANS ANu LEAStS.NtT OF UNEARNED INCOME AND RESERVE
FOR POSSIBLE LOAN LOSS£SO>
17. TOTAL ASSETS<3>
Id. STOCKHOLDERS' EWUlTYO>
IV. TulAL OPtRATlNG KEVtN0E<3>
20. TOTAL OPtKATINo LXPcNSESO>
2i. NET

300 /
'/

/
/
/
/
/
/
/
/

1NC0MC<3>

2*1. DU THE AMuUNTs FOR TniS MJBSlDlARY IN ITEMS 16 THROUGH
21 CONSOLIDATE J* A Line BY LINE BASIS THE ACCOONTS OF
ANY OF ITS SUBSIDIARIES? ENTER "1" FOR YLS.^Z" FOR NO,
•3 n FOR INAPPLICABLE.
Z3. IF THt FINANCIAL SIATEMLNTS OF TrtlS SUBSIDIARY HAVE NOT
LfcEN SUBMlTTcO IN REPORT ITEM 4 bECAUSE ITS ACCOUNTS
HAVE BEEN CONSOLIDATED UN A LINt-t>Y-LlNL" BASIS WITH
ArtuThcR SUBSIDIARY FOR WHICH STATtMcNTS HAVE BEEN SUBMIT TtD,INDICATE THt NAML OF THAT SUBSIDIARY.<3>

<1>
<^>

/

2

/ /

woEsllUN iC: NEEU NOT EE COMPLETED FOR ANY BANKSCAS DEFINED IN THE EHC ACT)
wULSTIcm 14, li>: NfcED NOT BE COMPLETED FOR COMPANIES THAT FILE FR 2314
OR FR 2*8oB.
<3> WOc^TIONs lt>-2i: N E L D NCI BE CUMPLtTED FOR A BANK,A SUB OF A BANK CONSOLIDATED IN ITS P*KtNl»S CONSOLIDATED RtPGRT OF CONDITION,OR ANY SubSlDlARY
FILING AN FR 231** OR FR 2b*6t>: REFER TO REPORT ITEM 3 INSTRUCTIONS.




361
PAGE 1 OF 1

SCHEDULfc C
ACTIVITIES OF PARENT BHC
*AML:

FIRST PENN CORPORATION

/

CITY:

OKLAHOMA CI1Y

STATE:

OKLAHOMA

COUNTY:

OKLAHOMA

ZIP COut: 73126
LIST CURRENT ACTIVITIES CONDUCTED BY PARrNT IN ORDER OF IMPORTANCE:
ACTIVITY C0UE<1> CONDUCTED IN US(1=Y£S,2=N0)
CCAA /
/
1
/ /

/
/
/
/

/
/
/
/

/_/
/_
_/
//
//

LiST ACTIVITIES COMMENCED BY THE PARENT THIS FISCAL YEAR:
ACTIVITY CduE<.i> CONDUCTED IN USl 1=YES, 2=NU > EFFECTIVE DATE(YYMMDD)

/ /
/ /
/ /

/ /

/
/
/

/
/
/

LloT ACTIVITIES f t K r t i * A T t b BY PARcNT THIS FISCAL YEAR:
ACTIVITY CGDE<.1> cFFECTlVE uATE

/
/
/

/
/
/

/ /
/ /
/ /

/
/
/

/
/
/

LIST ACTIVITIES NOT CURRcMTLY CU*DUC1£D BY PARENT FOR WHICH A VALID APPROVAL
BY AUTHORITIES AS xN fcFFECT.
ACTIVITY ctiJE<l>

f>.
A*
B.
C.
D.
6.
7.

/
/
/

/
/
/

NoMuLK OF OFFICES OF THE PARENT COMPANY:
NurttiER OF t X l S T i N b OFFICES(INCLUDING HEAD O F F I C E ) .
I
NUMBER OF OFFICES E S T A & L I S H L O DURING FISCAL YEAR.
NUhfacR OF OFFACLS TcRniUATfcD UURifcG FISCAL YEAR.
NUMBER OF OFFICES APPROVED BUT UNOPENED.
OOLS COMPANY FILE WITH StC? ( l - Y E S , i : - N C )
R
SPECIFY THE EAfcMPTiVt PROVISIONS AND REGULATION O BOARD ORDER(INDICATE DATE)
RELifcU UPON FOR AUTHoKUY Tu CONTINUE Tu ENGAGE I N THE BUSINESS ACTIVITIES
LISTED I * ITEM 1 A3uVE.<Z>

•NOT APPLICABLE OK N O N C "

/
/
/
/
/
<1>

/
/
/
/
/

wUcSTIUNS 1 , 2 , 3 , * : KEFER TO BnC MANUAL FOR ACTIVITY CODES,USE THE 4 DIGIT
ALPnANUMERlC CUUcS WHENEVER POSSIBLE.
<±> WJESIIUN / : REFtK TO D E F l N l T l u N 1 1 I N THE GENERAL INSTRUCTIONS.




362

PAGE 1 OF 1

SCHEDULE D
TERMINATIONS

PROVIDE THE FOLLOWING I N F U R M A T I U N FOR ANY ORGANIZATION SUBSIDIARY AND"ORGANIZATluN OTHER TrtAN A SUbSlUlARY",BANK AND NONBANK,DOMESTIC AND FOREIGN) THAI
CLAWED BEING PART OF Trtt BANK HOLDING COMPANY ORGANIZATION DURING THE BANK
nOUUftG COrtPANY^S FISCAL YEAR. IriCLUDE ALL ORGANIZATIONS THAT WERE LIQUIDATED,
J l V E S l E D , OR MERGED OUT UF EXISTENCE. I F MORE SPACE I S NEEDED,ATTACH A SEPARATE
PAGE SUPPLYING THE INFORMATION I N THE SAME FORMAT.
I F TuE ORGANIZATION WAS DISPOSED OF: DESCRIBE THE MANNER AND TERMS OF D I S P O S I T I O N ; INDICATE THE AMOUNT OF CREDIT EXTENDED TO THE PURCHASER BY THE BANK
hULDlNG COMPANY UKGANIZATIGN,IP ANY; AMD INDICATE WHETHER THE PURCHASER HAS ONE
UR MUKE O F F I C E R S , D I R E C I U R S . T K U S T C E S , O R BENEFICIARIES I N COMMON WITH.OR SUBJECT
TO CONTROL far, THE BANK HOLDING COMPANY ORGANIZATION.
COL A . NAME AND ADDRESS OF EACH ORGANIZATION TERMINATED.
NAME:
CITY:
COUNTY:

/
/
/

/

STATE:

/

Z I P CODE:

/

/
/

/

/

COL 6, NAME AND ADDRESS OF EACH ORGANIZATION THAT ABSORBED A MERGED ORGANIZATION.
NAMES

/

/

CITY:

STATE:

COUNTY:

ZIP CODE:

COL C» EFFECTIVE DATE OF lERMiNATIUN
IV / /
/_
CUL 0. ENTER(l=LiUUlDATEO,^=LilVESTED*J=MERGER,^=OTHER)

/ /

COL A . hAME ANO ADDRtSS OF EACH ORGANIZATION TERMINATED.
AAMt:

CITY:
COUNTY:

J
,

/
/

/

/
STATE:

/

:

_/

/
ZIP CODE:

/

/

/

CUL fc. N*ME AND ADDRESS UF EACH ORGANIZATION THAT ABSORBED A MERGED ORGANIZATION.
rtAME:
CITY:

/

/___:

CUUNTYi

STATE:
Z I P CODE:

COL C . EFFECTIVE DATE OF TERMINATION
19 /
/
/_
COL t>. ENTER U = L i w U l D A l ED,2=*U VESTED,3=MERGER,*=OTHER)




/—/

363

o

PHONE NUMBER (Area Code & Number)

TA^j^SfP

(3^ANNUAL R P R y ^ J ^ ^ S ^ f e ^ / — T *
EO T
RKS:

7& K.A D

JUN 2 3 1981

(BANK HOLUflVl

^ g ?

; ~x?fi-7rr/

|BANK HOLDING COMPANY NAME

| B S T ) IN RECORDSSECTTDNT^

o

TELEPHONE MESSAGES

|DATE OF PHONE CALL

REGISTRAT,0N

STATEMENT

^

&^jbtm

<^#r ^ <&#?/ r&sfr*

& s & s/,^.
/&

/?£ sex. / /S*r

^^r* :

&C. C

<£™* <***? ?<?*&

'< * /

•& Z- ' ^ ^

/?/&:

Q/£&

/f/^^&rf*/? %&* j&jtte*^.

ASSISTANT EXAMU4€«:
NT EXAI

.

_ _ ^

s

OFFICIAL RECORD COPY

97-830

0-82-24




Sb

>& x?3s&?

^76*&&l
&**+-rr

y^^^^^^A^^^^.

SUPPLEMENT

364

)Z

November 29. 1978
A p p r o v a l expires January 1 , 1 9 8 1

| . •| - i
\fcjj l j Q

,u f u / U L -

>•
U L U W W U U - /

W

d'
V

•

•
•

MAR 0 3 1981

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Washington. D.C. 20551

BANK HOLDING COMPANY FINANCIAL SUPPLEM
/

Oft

Reporting period (fill in appropriate line below)
For the fiscal year period ending on December 31 I Q 80
For the 6-month period ending on
, 19
O S .

n,r.Y-

Name of bank holding
Mailing address:

F i r s t Penn

Corporation

P . 0 . Box 26208
Street

Oklahoma City Oklahoma

73126
State

City

Oklahoma

Location of principal office:

City

Oklahoma

City

Oklahoma

73126

Bill P. Jennings
an authorized officer of the bank holding company named above, hereby declare that this report has been examined by me and is
true and complete to the best of my knowledge and belief.
F e b r u a r y 1? r
Sipnej*^/

1QR1

/ "

Name, title, and phone number of person to whom inquiries may be directed:
S h e r y l A. Walker

405 8<+2-7441
Area Code

E x t . 274

Number

General Instructions
Who must report: This report is to be filed by domestic bank
holding companies that have $50 million or more in total consolidated assets. The following companies are not required to
file the report: (a) a bank holding company that is a subsidiary
of another domestic bank holding company; (b) a bank holding
company that-has been granted an exemption under Section
4(d) of the Act; and (c) a bank holding company that is organized under the laws of a foreign country, and more than half
of whose consolidated assets are located, or half of whose consolidated revenues are derived, outside the United States. The
Federal Reserve Bank may require this report from bank holding
companies that are not required to file this report under the
above criteria..
Full year reporting: Bank holding companies that have $50 million or more in total consolidated assets must file this report
once a year for the 12-month period covering their fiscal year.
Midyear reporting: In addition to full-year reporting, bank
holding companies that have $300 million or more in consoli-

dated assets must file this report for the 6-month period covering
the first half of their fiscal year.
Time and place of filing: The report must be filed within 45
days after the end of the reporting period. Submit the original
and three copies of the report to the Federal Reserve Bank of
the district in which the bank holding company is registered.
Confidentiality: The report will be made publicly available
after the bank holding company has released its financial
statements to the public or 90 days after the end of the reporting period, whichever comes first. In the interim period, the
information contained in this report will be regarded as confidential by the Federal Reserve System. If it should be determined that any information contained in this report must be
released during this period, respondents will be notified.

. FOR FILES
frM ess

Detailed instructions: Please refer to the jnitructions manual
u
for the Bank Holding Company Financial Supple

This report is required by Section 5(c) of the Bank Holding Company Act ( f 2 VS.C. 1844) and Section 225.5(b) of Regulation Y (12 CFR 225.5(b)).




365
FR BANK USE ONLY

1 MV1».

I

Consolidated Balance Sheets

1

,19 80

11

23

D»v

25

27

30

Dollar amounts
Bil

Cash and due f r o m deoositorv institutions:
b

Mo.

12-31

ASSETS
1

• I
9

Yr.

I . . . 11 I I I I . lliJ

(Including foreign and domestic subsidiaries)
As of the close of business nn

.8.2.1I1

3

BHCNo.

2 . U.S Treasury securities
4 . Obliqations of States and political subdivisions in t h e U n i t e d States.
._„

6 . Federal Reserve stock and corporate stock

,

Thou

0
59 626
10 992
0
31 3 3 5 !
0

Other

5. Other bonds, notes, and debentures ,.

Mil

300 '

0 2

I

0
8 . Federal funds sold and securities purchased under agreements t o resell in domestic offices including

mmmz
I 16)000

9. Loans:

W^^

a. Loans made at domestic offices:
(2)

Loans to financial institutions., . . . .

29 433
0
U 4 099

..

n

^

(5) A l l other loans

37=i

490
0

1 4fi7
? nm

196 9?1)
0

"\fiRR
n
r

747
f 196
1fi

TDTAI

ASSPTS

I

0 5

.J3ZJ _,,aQ3

1 / Bank holding companies with lets than $100 million in total consolidated assets need not complete the consolidated balance sheet and income statement
(parts A and B of this report).
2J D O not enclose amount in parentheses.




366
FR BANK USE ONLY
D.st

1 1 MY|9|

Consolidated Balance Sheet - continued

1
BHC No.

I •••
11

|8,2,

II , 1

3

9
Yr.

Mo.

M • I .
23

25

iLiisi
27

30

LIABILITIES AND STOCKHOLDERS' EQUITY
17. DEPOSITS:
a. Deposits in domestic offices:
(1) Demand deposits
(2) Time deposits:
(a) Time deposits of $100,000 or more
(b) Other time deposits
(3) Sayings deposits:
(a) Corporations and other profit organizations
(b) Other savings deposits
,
b. Deposits in foreign offices and in Edge and Agreement subsidiaries _
c. TOTAL DEPOSITS
18. Federal funds purchased and securities sold under agreements to repurchase ii domestic offices
including those of Edge and Agreement subsidiaries
19. Commercial Paper
20. Other borrowings with an original maturity of one year or less
21. Other borrowings with an original maturity of more than one year (excluding mortgage
indebtedness and subordinated debt)
22. Mortgage indebtedness and liability for capitalized leases_
23. Subordinated notes and debentures
24. Other liabilities
25. TOTAL LIABILITIES
26. Minority interest in consolidated subsidiaries
27. STOCKHOLDERS'EQUITY
28. TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
MEMORANDA
29. Amount of debt reported above in Items 21, 22, and 23 that is scheduled to mature within
o.s year
Standby letters of credit outstanding
Deferred taxes (included in Item 24, "Other liabilities"):
a. IRS bad debt reserve
b. Other
32. State the amount of intangible assets reported in Item 14 that is subject to amortization

Line 20 & 29 . It is the intention of management to seek to renew the debt upon
maturity of the demand note.




367
FR BANK USE ONLY
Dis

Consolidated Report of Income^
(Including foreign and domestic subsidiaries)

fT i iv 9 1
1
BHC No.

1 • • •
Reporting period (fill in appropriate line below)
For the fiscal year ending nn i ^ - T l
, 19_£Q.
For the 6 month period ending on
, 19

8|2|

3

JU
23

n

Mo.

'II

1

I

9

Day

J_i_Jl±J
25

27

Dollar amounts

1. OPERATING INCOME:
a. Interest and fees on loans .
b. Interest on balances with depository institutions
c. Income on Federal funds sold and securities purchased under agreements to resell in domestic
offices including those of Edge and Agreement subsidiaries
d. Interest on U.S. Treasury securities
,
e. Interest on obligations of other U.S. Government agencies and corporationsInterest on obligations of States and political subdivisions in the United States _
Interest on other bonds, notes, and debentures
Dividends on stock- .
Trading account income, net (including commissions and fees)Income from lease financing
k. Income from fiduciary activities
I. Service charges, commissions, and fees_
m. Other operating income
. TOTAL OPERATING INCOME (sum of Items 1a through 1m) _
OPERATING EXPENSE:
a. Salaries and employee benefits
b. Interest on deposits _
Expense of Federal funds purchased and securities sold under agreements to repurchase ii
domestic offices including those of Edge and Agreement .subsidiaries _
d. Interest on borrowed funds (excluding subordinated notes and debentures) _
s. Interest on subordinated notes and debentures
Net occupancy expense, and furniture and equipment expense —
Pro"is;on for possible loan losses
. Other operating expenses
TOTAL OPERATING EXPENSE (sum of Items 2a through 2h)_
3. INCOME (LOSS) BEFORE TAXES AND APPROPRIATE ITEMS BELOW (Item 1n n
Item 2 0 4. Applicable income taxes (foreign and domestic)
5. Minority interest (required to be reported here only if material) - '
6. INCOME (LOSS) BEFORE SECURITIES GAINS OR LOSSES AND EXTRAORDINARY ITEMS7. Securities gains (losses), net of applicable taxes and minority interest
8. Extraordinary items, net of applicable taxes and minority interest
9. NET INCOME (LOSS).
MEMORANDA
. Total operating income on a fully taxable equivalent basis (Item 1n, adjusted) _
. Allowance for possible loan losses:
a. Balance at end of previous year
,
b. Recoveries credited to allowance .
—
. Cnanges incident to mergers and absorptions, net _
. Provisions for possible loan losses
e. Less: Losses charged to allowance f. Foreign currency translation adjustmentsBalance at end of period (must equal Item 9d of Page 2.) _

T2T

h?

Toa
J&&}

^#^%^
Y/zw^/W/A

than $100 million in total consolidated assets need not complete the consolidated balance sheet and income
}J Bank holding companies w
(pjiis A and B of this report).
trial (see detailed ir
2J Minority interest may be reported in It
2 / Do not enclose amount in parentheses.




30

368
FR BANK USE ONLY
Y9 ,

1 , II

Parent Company Only: Balance Sheet

1

,8

3

9
Yf.

BHC No.

1 2 IU L L J
Mo.

1 . . . JLL.
As of the close of business on D e c . 3 1

23

11

, 19 80

-LULiJ
25

27

30

Dollar amounts

I1 7

1

Cash anri rash iterm

9

Securities 1 /

6

Premises, f u r n i t u r e , fixtures, and equipment

|

Mil

Thouj

7
8

Bit

ASSFTS

596
300
0 |
0 1

W///////////A
7. Other assets
ft T O T A I

I

1 8

ASSFTS

21 877
1 243
56
39 072

LIABILITIES A N D STOCKHOLDERS' EQUITY
9 . Borrowings w i t h an original maturity of on» year or less:
b

Other

1 0 . Other borrowed funds
1 1 , Siihnrriinaterl nntes anri
1?

riehenfures

_

OrhPr liahil'.tips

I 19

W///////////A

13. Stockholders'equity:
h

C o m m n n stock (par value)

c

Capital surplus

d. Retained earninps
e. Less- Treasury stock U
f

THTAI

14 640
8 607
0
0
1 578

s-rnrKHm nFRS'FnuiTY

1 20

14 TOTAI I IARII ITIES AND STOCKHOI DERS' EQUITY
MEMORANDA
15. a, Equity investments in bank subsidiaries and associated banks: ^
(1)

C n m m n n and preferred stock (net of amount reported in Item 1 5 a ( 2 ) ) , „ ,

(9)

254
162
7 421
6 410
0
14 247^
39 072

2C 422
747

Excess of cost over fair value of net assets acquired, net of amortization _

,

15a1
15a2

Y////////A

WA
0
708

b. N o n e q u i t y investments in and receivables due f r o m bank subsidiaries and associated banks:

15b1
15b2

W/s'/////////A

0
0

b. N o n e q u i t y investments in and receivables due f r o m nonbank

mm

subsidiaries and associated

0
0

w///////////y
0
0

19. Does the a m o u n t reported in Item 13f equal that reported in I t e m 2 7 of page 3 of this report?
atrarh a (ft?t»mf nt o f rprnnriliation

. ,. ....

1 / Exclude investments in subsidiaries and "associated companies." See Item 5.
2J D O not enclose amount in parenthes«s.
21 The sum of Items 15a(1) throuo.h 16b(2) must equal the amount reported in Item 5.




_

ntn
1

16a1
16a2

16b1
16b2

369
FR BANK USE ONLY
Y»«r

Parent Company Only: Income Statement

JLU

1 1 1 |V|9| |8|2|
1

3

9

BHC No.

Yr.

Mo.

1 . 1 I I I I 1 JLLJISJ
I
Reporting period (fill in appropriate line below)
For the fiscal year ending nr\ Tier . "31
_,i9_ao_
For the 6-month period ending on_
,19_

11

23

25

27

30

1. OPERATING INCOME:
a. Income from bank subsidiaries and associated banks excluding equity in undistributed income:
(1)

niuirlpnrk

JLH

(2) Interest
:
(3) Management and service fees_
(4) Other
(5) Total of Items 1a(1) through 1a(4)
. Income from nonbank subsidiaries and associated nonbank companies excluding equity in
undistributed income:
(1) Dividends
(2) Interest
(3) Management and service fees _
(4) Other
(5) Total of Items 1b(1) through 1b(4) _
. All other operating income
d. TOTAL OPERATING INCOME (Sum of Items 1a(5), 1b{5), and 1c)_
. OPERATING EXPENSE:
a. Salaries and employee benefits
b. Interest expense
c. Provision for possible loan losses _
d. All other expenses
e. TOTAL OPERATING EXPENSE.
3. INCOME (LOSS) BEFORE TAXES AND APPROPRIATE ITEMS BELOW (Item 1 d minus Item 2e)_
4. Applicable income taxes
5. Extraordinary items, net of tax effect
6. lUCOMc xL0SS) BEFORE UNDISTRIBUTED INCOME OF SUBSIDIARIES AND
ASSOCIATED COMPANIES
J. Equity in undistributed income (losses) of subsidiaries and associated companies:
a. Bank
b. Nonbank _
8. NET INCOME (LOSS)
MEMORANDA
9. Cash dividends declared:
a. Common
b. Preferred.
Remarks:




2DS1

lid

£&
W////////^///A

r»

Ml

jSTtr

d^7
e /T7'
(

WWWA
WWWA
2S1

m

WA

M

It*

, 0

370

BILL P. JENNINGS
Chairman of the Board
Chief Executive Officer

PemxSmmre Bni\l<^
November 20, 1981

Mr. Harold L. Russell
Arthur Young & Company
1900 Liberty Tower
Oklahoma city, Oklahoma

73102

Dear Harold:
At a recent meeting of our Bank's executive management, a decision
was made to change accounting firms. This was not an easy decision,
considering your firm's years of service to us and was only made
after thoughtful consideration. Please be assured that we have the
highest regard for your firm, and have been most pleased with the
high professional standard evidenced by your associates.
We have asked that Peat, Marwick, Mitchell & Co., become our
accounting firm for all professional accounting services beginning
for the year ending December 31, 1981. We hope the timing of our
decision will not place your firm in a difficult situation with
respect to year end scheduling and personnel staffing.
I know certain communication has to take place between predecessor
and successor accounting firms and ask that your firm cooperate with
Peat, Marwick, Mitchell & Co. in making the transition as smooth as
possible. Messrs. Jim Blanton or Dean York, Partners with Peat,
Marwick, Mitchell, & Co., will be in touch with you to make arrangements to review prior year working papers, tax files, etc.
Should you have any questions please contact me.

Sincerely,

>*
^ e r i \ ""N^
^O^-'^^^V

NOV 2 3 tS3t
ARTHUR WUNG,
%L< &C0. < £ >
y




B i l l 2><Jennings
Chairman of the Board

371
The CHAIRMAN. NOW, the moment we have all been waiting for.
That is, we will call upon Mr. Clifton Poole, the Regional Administrator of the Comptroller's office, Mr. James Barton, Regional Surveillance Chief, and Stephen Plunk, National Bank Examiner. And
if my colleagues on the committee would like to join me in the
swearing in of these gentlemen, you could look upon this as a seventh inning stretch.
[Witnesses sworn.]
The CHAIRMAN. If all of you would like to stand for a few seconds, why don't we just stand and let the blood circulate a little
bit? I tell you, you Oklahoma City attorneys, you didn't know how
we northern attorneys operate, did you?
[Laughter.]
[Pause.]
The CHAIRMAN. We have with us now Mr. Poole, Mr. Barton and
Mr. Plunk. I see another individual whom I understand is counsel
to these people, and so I would repeat my caution to the effect that
we will hear from the witnesses, and they may want to consult
counsel if possible. But your appearance, Mr. Serino, is a distinct
surprise to us. We thought that these gentlemen could handle it.
Mr. SERINO. I am sure they can, Mr. Chairman.
The CHAIRMAN. Mr. Poole, I understand you have a very brief
statement. If you would like to enunciate it, you may proceed.
TESTIMONY OF CLIFTON A. POOLE, JR., REGIONAL ADMINISTRATOR, OFFICE OF THE COMPTROLLER; JIMMY FRANK BARTON,
REGIONAL DIRECTOR FOR SPECIAL SURVEILLANCE; AND STEPHEN PLUNK, NATIONAL BANK EXAMINER
Mr. POOLE. I have some brief remarks I would like to make with
regard to the statement that I have submitted. As you indicated
Mr. Serino is also counsel for the Comptroller and is head of our
Division of Enforcement and Compliance in Washington.
The CHAIRMAN. We have seen him before.
Mr. POOLE. What I would like to do is just very briefly cover the
series of events that found our office involved with Penn Square,
beginning in early 1980 and concluding with July 5, 1982 with the
closure of the bank and its declaration of insolvency.
As you have indicated and as you requested, I brought Mr.
Jimmy Barton and Mr. Plunk with me. Mr. Barton, also as you indicated, is the Regional Director for Special Surveillance in the regional office and is in charge of our problem banks in that capacity.
Mr. Barton is an examiner with some 12 years of experience with
the Comptroller's office. Mr. Plunk is an examiner with 10 years of
experience. He is currently examiner in charge of the Oklahoma
City subregion, and was the examiner in charge of the last examination of Penn Square National Bank.
I have been with the Comptroller's office myself for 26 years; 19
of those years were spent in the field as an examiner, and the last
7 years as the Regional Administrator; three of them in the fifth
region in Richmond, Va.; one of them in Memphis, Tennessee, and
then three years in Dallas, Tex.



372
The Dallas region encompasses the States of Texas and Oklahoma where we supervise the activities of some 900 national banks.
As I indicated, I will begin with the examination of April 1980, and
most of what I will say will pretty well follow the pattern of the
comments made by the directors of the bank and by the other individuals testifying here today.
We did conduct an examination completed in April of 1980. That
examination rated the bank as a 3 bank. We found a wide variety
of deficiencies in the bank, and I might add, however, that the
quantitative deficiencies that normally would cause us to rate a
bank 3 and put it in our special projects program and use administrative action were not present to a degree that we normally see in
a problem bank.
Such things as classified asset totals and other such data were
not of sufficient magnitude to cause us to have any great alarm,
but there were other factors that did cause us considerable concern; namely, the bank's lack of liquidity and difficulty in the
funds management area; its lack of capitalization and the rapid
growth of the institution, as many people have pointed out, and in
the face of that rapid growth, the understaffing of the institution.
As a result of that examination and based upon the information
that we drew up a formal from that examination, we gathered into
or drew up a formal agreement on the bank, and as I have indicated before, that formal agreement was a close call because the factors that tipped us over the edge in using the formal agreement
were the somewhat subjective judgments which we made regarding
capital adequacy, and primarily the weaknesses in the funds management area of the bank, and as I said, rapid growth of the institution.
We decided to have, as is our procedure in region 11, a meeting
of the board in the regional office. It is our procedure, as I indicated, to do this. We feel that by bringing the board of directors to the
regional office it impresses them with the seriousness of the situation, and we have found it to be a procedure that works well.
We held a board meeting on August 27, 1980, at which time we
presented the formal agreement to the board. We discussed the deficiencies that we found in our examination and went over the
formal agreement in detail.
At that board meeting, Mr. Jennings was resistive, openly resistive, to our efforts. He was concerned that our efforts and the use
of an administrative agreement would thwart the bank's progress,
and I might point out that to that point and continuing after that,
the bank was making money. It was very profitable. The bank was
growing rapidly, and as I indicated previously, we did not have an
inordinately high percentage of classified or problem loans, as identified by our examination.
He was, as I recall, concerned that our administrative action and
our actions in the bank would displace management's discretion. In
spite of the objections, the board did sign the administrative agreement and returned it to the regional office. They also indicated at
that point that they were already doing much of what was called
for by the agreement.
We subsequently conducted a visitation of the bank on September 9, 1980, and we noted some improvement, but were still noting



373
problems in funds management, and growth was continuing and
also, the understaffing conditions remained.
Because of these continuing concerns we conducted an examination as of December 31, 1980, which was concluded on February 27,
1981. As several have indicated, I personally handpicked the crew
that conducted that examination. I was personally concerned regarding the funds management area of the bank and its lack of determination to address the problems in that area and the exposure
that this was presenting to the bank.
The individuals who conducted that examination were some of
our best people from the regional office, from the Oklahoma subregions, and other subregions around the region. That examination
showed a significant deterioration in the condition of the bank;
classified assets had increased, the loan documentation was very
poor, the bank continued to experience rapid growth in the face of
the continuing condition of being understaffed, capital growth was
not keeping pace with the overall asset growth of the bank, and the
bank had substantially failed to comply with the formal agreement
which we had placed on the bank at the previous full examination.
After reviewing the report, the Washington amd regional offices
were faced with what steps to take to correct the situation. Basically, we had two choices; we could either go with a cease-and-desist
order which was a more formal type of administrative action, or we
could stick with our administration agreement, which was also a
formal document.
Arguing for the use of a cease-and-desist order were our concerns
regarding the attitude of the board of directors of the bank, as exhibited by their failure to comply with the agreement that we had
in place, and by their apparent inability or unwillingness to correct
the deficiencies that we had identified at previous examinations.
The CHAIRMAN. Excuse me, Mr. Poole, have you been here today
during the day?
Mr. POOLE. Yes,

sir.

The CHAIRMAN. Did you hear the two panels of the outside directors testify?
Mr. POOLE. Yes,

sir.

The CHAIRMAN. What you just said does not square with what
they told us. They impressed us that they were very concerned individuals and perhaps were not given enough guidance as to what
they should do.
Now, one of the individuals said when he complained, he was
told well, why don't you get off the board. He said that came from
the Comptroller's Office. How do you square that with what you
are saying to us.
Mr. POOLE. I am not sure I understand.
The CHAIRMAN. What do you mean, you don't understand. I will
repeat my question.
Mr. POOLE. All right, sir.
The CHAIRMAN. YOU have been here today. Forget the statement.
We will put it all in the record for you. It is all in the record, by
unanimous consent, OK?
You state just now in your statement that the board of directors
either were not that concerned or did not know how to go about
making changes. Isn't that what you just said?



374
Mr. POOLE. Yes,

sir.

The CHAIRMAN. I repeat. We have listened to the board, the outside directors. It seems to me they were very concerned. If anything, perhaps they did not have enough guidance given to them.
Mr. POOLE. I would have to disagree with that because the administrative agreement was a detailed document which, if followed,
would have, in my opinion and I think everyone else's in the office,
have corrected the deficiencies in the bank.
The CHAIRMAN. But that was ignored, was it not?
Mr. POOLE. It had been ignored substantially up to that point.
The CHAIRMAN. NOW, what did you do about it? Did you recommend to Washington the removal of a few people like maybe Mr.
Patterson or Mr. Jennings or what have you?
Mr. POOLE. There were no grounds for the removal of those gentlemen.
The CHAIRMAN. There weren't?
Mr. POOLE. NO, sir.
The CHAIRMAN. Did

you read the exchange between Mr. Homan
and myself in Washington on that?
Mr. POOLE. I am not certain.
The CHAIRMAN. YOU are not certain. Well, we did have an exchange.
Mr. POOLE. In my opinion, sir, there were no grounds for the dismissal of any officer of the bank at that point in time.
The CHAIRMAN. OK. Let me ask you this: Were you quoted correctly when you were quoted as saying to the board of directors at
one point in time, l 'There are those who wanted a cease-and-desist
order, but I argued against that, and we have gone into this letter
of agreement instead/'
Mr. POOLE. What I believe what I said in the board meeting—
well, prior to the board meeting, the Washington office and our
office discussed the appropriate type of administrative action to
take, and we decided that what we would do would be to go to the
board meeting with the idea of telling the board that if they did
not give us the impression that they were going to correct, or did
not convince us that they were going to correct the deficiencies
that we had found, we would use a cease-and-desist order. But what
I would like to point out is that the level of deficiencies, in my estimation, would not have at that time fully supported the use of a
cease-and-desist order. If we had used it, it would have been a very
marginal situation.
The CHAIRMAN. Let me see if I can help you here, because I
think this is the way I read you when I read this last night.
You were using a little psychology here that said, "Hey, listen,
you have this management letter, this compliance thing, and there
were those who wanted a cease-and-desist. Now, if you shape up
here, if you make the necessary corrections and changes, then you
don't end up with a cease-and-desist. But unless you do,"—is that
what basically you felt they should read between the lines?
Mr. POOLE. Yes, sir. There was some use of psychology, as you
put it, in my statement.
The CHAIRMAN. I have no quarrel with that. I commend you for
it.



375
Mr. POOLE. However, there was basis in the fact that there were
people in Washington, during our discussions, and also in the
region who felt that we should use it, and sometimes I felt that we
should have used a cease-and-desist order.
The CHAIRMAN. Let me ask you this for the benefit of the
committee. In the face of a cease-and-desist, what would the classification have been? Would it still have remained a 3?
Mr. POOLE. We have used cease-and-desist orders in some cases
on banks rated 3, but the majority of them I would say would probably be—well, I don't have any statistics, but many of them would
be 4's and in some cases 3.
The CHAIRMAN. We are told that you are very experienced and
that is why we are asking for your opinions in this matter.
Mr. POOLE. Yes, sir.
The CHAIRMAN. SO you

don't have to qualify your answers. It is
just your best judgment and we accept it.
Mr. POOLE. I would say really I don't remember. I don't recall
what number of banks that we have dealt with that were 3's or 4's
with cease-and-desist orders, or in which, you know, ones.
The CHAIRMAN. Well, let me put the question to you this way:
There would be more likelihood of a bank being classified 4 if it
were under a cease-and-desist than if it were just under this letter
agreement?
Mr. POOLE. Yes, sir, probably.
The CHAIRMAN. OK. Do you want to proceed with your statement?
Mr. POOLE. Yes,

sir.

In any case, we viewed that we had the two choices and, as you
put it, one of the reasons for the statement I made in the meeting
was to use psychology to some degree. But it was a statement of
fact, and we told the board that if we did not see significant improvement in compliance we would indeed convert the formal
agreement to a cease-and-desist order.
And I would also like to point out that the contents of the ceaseand-desist order, had we drawn it up, would have been virtually,
probably virtually the same as the formal agreement, the document would have covered the same areas.
We did decide to use the agreement, or at least proceed in the
manner which I indicated, to go into the meeting with an open
mind and then determine by our assessment of the attitude of the
board as to which action we would take. We did feel, however, that
the administrative agreement in both content and detail covered
all of the problems in the bank. And as I indicated before, I felt
that if they were to respond and comply with that agreement it
would solve the bank's problems and bring it to a recuperative position.
At the board meeting, as in previous board meetings and in all of
our board meetings, we presented the condition of the bank as detailed in the examination report. We detailed the areas of noncompliance with the agreement. We told the bank of the extremely serious situation of any bank which does not comply with an agreement which they have signed. We told them of the basis for our
decision.



376
Throughout the meeting, in stark contrast to the previous meeting, Mr. Jennings was completely silent until the very end, and at
the end of the meeting he acknowledged that we had been—had
done an accurate job of examining the bank. He agreed with our
conclusions and our findings and he promised and committed himself to the correction of all of these deficiencies to bring the bank
into full compliance.
Also at that meeting was Mr. Beller and several other members
of the new senior staff of the bank. As indicated previously in testimony today, these individuals were known to the Comptroller's
Office, they were known to our examiners in Oklahoma City, who
had known them in their previous capacity with a large, conservative, well-managed institution in Oklahoma City.
We felt that they represented, as they were presented to us, a
meaningful addition to the staff of the bank. Because of this we determined, as the record shows, that we would stay with the administrative agreement.
And I would like to point out that at the end of that board meeting almost to a person every director came up to me personally,
shook my hand and thanked me for our attention and pledged
themselves individually to correct the deficiencies in the bank and
to bring the bank into full compliance with our wishes.
Following that examination, we conducted our visitation as of
September 30, 1981, and I would like to point out that, while there
are several comments this morning I think by members of the
board regarding comments made to them at the board meeting in
December, I believe it was, or January, the examination actually
was as of September 30, 1981. So our representation was as of the
picture of the bank in September.
That visitation found—well, first of all, that visitation was conducted by an examiner who had been in Mr. Barton's position as
Regional Director of Special Surveillance throughout our dealings
with Penn Square up to that point in time, and that examiner had
been present at both board meetings and had recently been appointed as examiner in charge of the Oklahoma City subregion.
And I felt that he was, and still do feel that at that time he was,
the examiner best suited to conduct that examination.
As a result of that examination, we found that the bank had
made in our opinion significant progress in beginning the correction of the systems, installing the systems and correcting the deficiencies that they had to correct to bring the bank back into compliance.
As several people have indicated and I will also support, the
bank was not anywhere near a position where we would be willing
to take it out of special projects or rate it other than a three at
that time. But we had—we did find that the directors appeared to
be following through on their promise to us at the earlier board
meeting, as most of them have stated today.
In keeping with our policies, thereafter we conducted our examination, beginning on April 19, 1982. On May 13, Examiner Plunk
telephoned me to report that he was finding significant deterioration of the condition of the bank. He indicated it was far too soon
for him to accurately identify exactly how bad the situation would
be, but he did say that he felt the situation had certainly worsened



377
since our last examination and could be truly significantly increased in severity.
On May 21 I was in contact with Mr. Roy Jackson, Regional Director with the FDIC in Dallas, on another matter and indicated
Mr. Plunk's phone call to him at the end of that conversation. On
June 23 I spoke further with Mr. Jackson regarding the status of
our examination.
I might also point out that the FDIC also gets copies of all of our
examination reports and numerous other forms that attest to the
condition of our banks, and we normally have ongoing telephone
conversations between various levels of staff and Mr. Barton and
his counterpart there on an ongoing basis with regard to all of our
problem banks.
I think it bears repeating briefly the degree of deterioration that
took place between September 30, 1981, and July 5, 1982: As has
been indicated previously, $45.7 million in loans that were
classified as loss in our last examination. Approximately $30 million were booked by the bank after September 30, 1981. There was
an increase in the loan portfolio in that same period of $161 million and an increase of $1 billion in the participations sold over
that same period. This represents an increase in the loan portfolio
of 63 percent and an almost doubling of the participations sold by
the bank during that period.
In hindsight, I think there were two major causes for the bank's
problems. One was the failure of the board to follow through on
the corrective action which they promised to the Comptroller's
Office at the board meeting in the regional office that they would
make at that meeting on July 29, 1981, and the corrective action
which our examination of September 30, 1981, showed to have been
underway.
The second major cause was the downturn or the slump in the
oil and gas industry. It was unprecedented and it was unpredicted,
and that slump in the oil and gas industry, to which the bank had
a large concentration of loans, with the absence of controls in the
bank, left the bank in an extremely vulnerable position, a vulnerable position which led to its failure.
There has—I might say that in conclusion I'm fully satisfied that
our supervision of Penn Square was completely consistent with the
OCC guidelines and procedures, and I think it was totally appropriate to the condition of the bank as revealed to us by our supervisory efforts.
There has been some discussion by a number of people regarding
the appropriateness of the action of examiners in charging off the
loans that they did, which totaled I think $49 million in total assets
charged off. I can tell you that in my estimation these loans were
dead losses. This does not mean that there could not be some recovery, and I have no idea what that could be. But these are losses in
the truest sense of losses as classified by bank regulatory agencies.
They were, the examiners in the bank, were the best examiners
we had in the region and some of the best we have in the country.
We strengthened the examination force in the bank on several occasions during the examination, and I am fully confident that the
losses that we classified are definitely losses.



378
The bank had roughly $37 million in capital, and with losses of
nearly $50 million in my estimation the Comptrollers Office had no
choice but to declare the bank insolvent. When a bank has a book
insolvency, you cannot allow it to stay open, especially if the Fed
will not continue to fund the liquidity needs of the bank, which
were materializing at the latter days of this bank's existence.
I just might add that in my own personal experience I would
have to say that the Penn Square Bank as we found it as a result
of our April examination was in the worst condition that I have
ever seen a bank in my 26 years of experience as a national bank
examiner and a regional administrator. It doesn't even have any
close rivals in that condition.
And the only reason I say that is to get my feelings on the record
as to the reasoning behind the Comptroller's Office's decision to
close the bank.
In essence, I feel we did our job in an exemplary fashion in notifying the board again and again as to the condition of the bank.
We examined the bank a number of times. The condition of the
bank, as the question has been raised, it was rated a 3 up and
through our examination of September 1981 and it was ultimately
closed 8 to 9 months later.
In my personal estimation, based upon my experience and based
upon the examinations, the bank was simply a 3 bank through the
series of examinations that we conducted, and we could not and
should not have taken actions any different from those that we
took in view of the condition of the bank as revealed to us through
our examinations.
The CHAIRMAN. Let me ask you this. After 26 years, you say this
is the most horrible thing that you've ever approached. How could
they do it so quickly? September 30, not too bad, things are improving. October, November, December, January, February, March.
April Mr. Plunk goes in with his team, right? You started in April?
Mr. PLUNK. Right.
The CHAIRMAN. Seven months, and you go from a 3 classification
to the worst example you have seen in 26 years.
Mr. POOLE. Yes, sir.
The CHAIRMAN. NOW,

the economy certainly—aren't there other
banks around this area of the country with a lot of energy loans, a
lot of oil and gas and drilling and so forth?
Mr. POOLE. Yes,

sir.

The CHAIRMAN. Aren't there other banks that also are pretty
heavily involved in this type of lending?
Mr. POOLE. Yes, sir.
The CHAIRMAN. And

the slump in energy would have affected
them as well, didn't it?
Mr. POOLE. I've seen no more Penn Squares.
The CHAIRMAN. But did that slump—you gave two reasons, the
failure of the board of directors to comply with your letter of agreement and the slump in the economy as far as energy is concerned.
I'm reading from your statement. Right?
Mr. POOLE. Yes, sir, the interaction of the two.
The CHAIRMAN. And you agree that there are other banks heavily committed to energy loans. So that all we are left with, therefore, is the failure of the board of directors to comply. And yet, Sep


379
tember of 1981 you conclude that the board is doing a pretty good
job, they are moving forward, they've got Mr. Beller onboard and a
new general counsel, et cetera, et cetera, right?
What happened?
Mr. POOLE. The comments we made regarding the job being done
by the board as of September did in no way indicate that the job
had been done. It was that it had been started.
The CHAIRMAN. That's the same comment Mr. Conover made in
Washington.
Mr. POOLE. I think Mr. Beller, his comments this morning, indicated that the loan review process, which is an essential process in
any bank, an independent loan review function where the bank assesses the quality of its own loans, had only begun the function and
had not at that time gotten into the oil and energy credits, which,
as you pointed out, were the great bulk.
The CHAIRMAN. Mr. Poole, that is inaccurate.
Mr. POOLE. Had not gotten into.
The CHAIRMAN. Had not gotten into? You have understated it.
Were you aware of the agreement or the memoranda or what
have you, the directive to Mr. Beller: Hands off energy loans, Patterson and I, Mr. Jennings, are going to handle the energy loans
and your loan review committee is not to get involved with energy
loans?
Mr. POOLE. NO, sir. We were under the impression of—we had information to the contrary, that Mr. Beller was indeed—and I remember your comments this morning, your questions to Mr. Beller,
or some others, regarding his lack of background in the oil and
energy area.
We knew that he did not have a background in oil and energy
credits directly. But we felt that what the bank needed was good
loan administration.
The CHAIRMAN. OK, a loan review committee, a good loan review
committee.
Mr. POOLE. Right.
The CHAIRMAN. Were you aware of the fact that the loan review
committee was not allowed to look at the energy loans?
Mr. POOLE. We were not aware of that.
The CHAIRMAN. When did you find this out?
Mr. POOLE. I would have to say that we found it out at the April
examination.
Mr. LEACH. Would the gentleman yield?
The CHAIRMAN. Sure.
Mr. LEACH. Were you aware of the job descriptions?
Mr. POOLE. NO, sir.
Mr. LEACH. AS part

of your examination process don't you look
at job description?
Mr. POOLE. I don't know the extent to which the examiners did
in this case. In some cases we would look at job descriptions, but in
this particular case I don't believe—I think the job description, and
I'm operating from memory—indicated that Mr. Beller and Mr.
Patterson both reported to Mr. Jennings, that Mr. Beller was not
over
Mr. LEACH. Excuse me. You said you didn't read the job descriptions and now you remember the job descriptions?
97-830

0-82-25




380
Mr. POOLE. I remember the discussion this morning, the testimony.
Mr. LEACH. I see.
Mr. POOLE. But I

do not believe that that in any way conflicted
with Mr. Beliefs responsibility as head of loan administration to
oversee the lending function and to have control of and commit to
us that he was going to install a loan review function at the bank.
The CHAIRMAN. Mr. Poole, you were here. Mr. Beller read his job
description to us, and it wasn t one he made up himself. That is the
one that he was handed and said, here, you are going to be paid x
number of dollars per year plus bonuses, you've got a 5-year contract, and this, man, is what you're going to do: You're going to
keep hands off energy loans.
Mr. Plunk, you were in there. You were in Penn Square. Did you
see those job descriptions?
Mr. PLUNK. NO, sir, I did

not.

The CHAIRMAN. Were you in there in September of 1981?
Mr. PLUNK. NO, sir.

The CHAIRMAN. Who was there? Who did the examining that
time?
Mr. BARTON. The bank was examined by Jerry Lanier, who is no
longer with our Office.
The CHAIRMAN. He left the Comptroller totally?
Mr. BARTON. Yes,

sir.

The CHAIRMAN. At that time did he make any mention of the restrictions placed on Mr. Beller?
Mr. BARTON. NO, sir, not that I'm aware of.
The CHAIRMAN. Mr. Plunk, in May of this year, May 13, you
called Mr. Poole and you told him how bad things were.
Mr. PLUNK. I told him that I suspected the bank could be in a
serious condition.
The CHAIRMAN. Right. Now, subsequently—how many examiners
did you have with you?
Mr. PLUNK. I had somewhere around 15 examiners.
The CHAIRMAN. Subsequently, subsequent to that May 13 phone
call, did you indeed leave the bank for a period of time, for a week?
Mr. PLUNK. We had a mandatory training session, yes, sir, that
involved, among other things, equal employment and so forth. That
is mandated pretty much by the Treasury Department.
The CHAIRMAN. HOW often are those held?
Mr. PLUNK. That's the first meeting in I believe 3 years.
Mr. POOLE. We had a combination staff conference, the first time
in 3 years, and a training session which covered, as Mr. Plunk indicated, EEO, personnel evaluations, and several other areas.
The CHAIRMAN. Where was that held, by the way?
Mr. POOLE. It was held in Austin, Tex.
The CHAIRMAN. For the Dallas region?
Mr. POOLE. For the whole Dallas region.
It was my decision to pull the examiners out of Penn Square at
that point in time, for two reasons: One, I wanted them to attend
the conference. There were a significant number of our people
there. And I also felt that the pulling them out for 1 week would
not, in my opinion, and did not detrimentally affect the examination.



381
And as a matter of fact, there was an indication that we needed
to give the bank some time to gather records for us regarding certain large credits which we were accumulating at that time, and
we felt that with the benefits of the training, plus the time given
the bank to pull together records, it would be as a total package
beneficial.
The CHAIRMAN. Even though Mr. Plunk said, hey, Mr. Poole,
things are very bad, very bad?
Mr. POOLE. Yes, sir.
The CHAIRMAN. The worst you've seen in
Mr. POOLE. Not at that time.
The CHAIRMAN. Oh, you mean they got

26 years.

bad after the seminar?
What were the dates of the seminar?
Mr. POOLE. It was in May. I don't remember the exact date.
The CHAIRMAN. DO you remember the dates, Mr. Plunk?
Mr. PLUNK. It was May

24.

The CHAIRMAN. May 24 through 31?
Mr. POOLE. It was the week after he called me.
It was not the worst bank I had ever seen at that point. It was a
judgment call.
Mr. BARNARD. Will the gentleman yield for a question?
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Mr. Poole, who scheduled the examination in
April of 1982?
Mr. BARTON. I would have set up the schedule for that examination.
Mr. BARNARD. Mr. Barton, how far in advance was it scheduled?
Mr. BARTON. HOW far in advance? We have a scheduling process
which looks forward two quarters. So we would have set up the
schedule for the second quarter of 1982 in the fourth quarter of
1981.
Mr. BARNARD. It's very interesting that on April 26, 1982, a very
exhaustive article appeared in "The American Banker," one of the
best I've ever read about a financial institution, and you went in
there on April 28. This article didn't prompt you to make that examination so hurriedly, did it?
Mr. BARTON. NO, sir, it did not.
Mr. BARNARD. If I would have been you, I would
Mr. POOLE. That was purely coincidental. As a

have
matter of fact, I
didn't read the article until after the examination commenced.
Mr. BARNARD. Well, it was an excellent article. And as a matter
of fact, the fellow who wrote the article ought to be a bank examiner.
Thank you, Mr. Chairman.
[The article referred to follows:]




The Only Daily Banking Newspaper
VOL GXIAU NO.

Monday, April 26, 1982

Oklahoma's Peim Square Bank, Maverick Oil Patch
Lender: Some Say It's Bet Too Heavily on Energy
By PlfflLLIP L Z EG
WI
OKLAHOMA CITY — They call it
Co.itincntal Illinois' Oklahoma City
loan production office. Its real name is
Perm Square Bank NA, the principal
subsidiary of Perm Square Corp. But
judging from the pace at which the
$•100 million-asset institution sells oil
and gas loans to its friends in Chicago,
the distinction may be more nominal
than real.
What was just six years ago a sleepy,
$30 rniiiion-asset suburban retail bank
is today a mammoth loan brokerage
operation that is originating and
participating out energy loans at a rate
that gives some veteran energy lenders
and correspondent bankers the shivers.
Here in oil and gas country, energyrelated credits have for years constituted a large portion — as much as




30% or more — of the portfolios of most
large banks. In contrast, 80% of fVtin
Square's portfolio is made up of these
loans.
Lately, however, declining oil and
gas prices, the surge in idle rigs, and.
the well-publicized cash flow squeeze
of some large independent oil and gas
producers have given rise to concern
among some bankers and analysts that
the bank may have bet too heavily on
the energy business.
Having sold more than $2 billion in
participations — almost seven times the
$300 million in loans the bank now has
on its own books — Penn Square may
well have originated more loans relative
to its own portfolio than any other bank
in the nation. The volume of participations relative to loans varies • con-

siderably from bank to bank, but it is
certainly unusual for outstanding
participations to exceed net loans.
Energy lending and correspondent
banking are so tightly knit at the bank
that the five-man correspondent department is actually melded into the oil
and gas division.
Of the $2 billion in participations,
most have been sold upstream to four
banks: Continental Illinois (which Penn
Square says holds close to half of the
total), Chase Manhattan, Seafirst, and
Northern Trust. About $125 million
(G%-7% of the total) have been sold to
some 30 or so smaller correspondents,
mainly loan-hungry Oklahoma country
banks.
This volume of energy deals is
»• Penn Square: Page 14

147th Year

Penn Square
Continued from page 1
particularly awesome when one considers that the energy loan portfolios of
Manufacturers Hanover Trust and
Chase Manhattan Bank at yearend 1981
were approximately $4 billion and $3.5
billion, respectively.
Object of Some Sharp Criticism
In recent months, the bank's huge
volume of participations, rapid growth,
highly aggressive lending practices,
some acknowledged snafus in loan
documentation, and a dramatic rise in
chargeoffs in 1981 have made it the
object of some sharp criticism in
Oklahoma banking circles. '
The bank's flamboyant 58-year-old
chairman and largest stockholder. Bill
P. Jennings, and a large coterie of
admirers in the energy business attribute this criticism to jealousy over
Penn Square's phenomenal growth and
*• Penn Square: Page 15

CO

00

to

383
Penn Square

Deep Anadarko Basin

Continued from page 14
profitability. "When you've grown as
fast as we have," says the feisty, whitehaired banker, "people tend to shoot at
you."
To be sure, merchant banking has so
far paid off handsomely for Penn
Square. In 1980, the bank earned $4.2
million on average assets of $358
million, a return of almost 2.1%, far
above the average for its peer group.
Return on average equity was a
phenomenal 33%. These results reflect
primarily an abundance of fee income
as well as relatively low noninterest
expenses.
But traditional lenders question
whether the bank can sustain these
results over the longer term, particularly if energy prices continue to de-'
teriorate. Indeed, 1981 was a year of
reckoning in which the operational and
administrative strains of originating
billions in loans took their • toll.
Acknowledges one director, "The bank,
has had to run to keep up.":.
Big Hike in Loan Loss Provision

; •

- Although net operating earnings rose
last year to $4.7 million, the increase
was due mainly to a lower income tax
• provision, since pretax operating re• venues essentially remained flat. Non-'
interest expense doubled, while the
provision for loan losses was boosted
five fold, from $1.4 million to $6.3
million. Loan chargeoffs rose from a
comfortable $405,000 in 1980 (0.27% of
net loans) to more than $4.2 million in
1981 (1.895 of net loans).
,
In 1980, average net chargeoffs for
'banks in Penn Square's regional peer
group were 0.36%-ofnet loans, accord-.
--ing to Cates Consulting AnalystsVlnc.J
^"(Comparisons for-' 1981* were "nbfyet
available.")

Consequently,

return

on

average assets arid average equity
'"• slipped to 1.3% and 18.6%, respective-^
• ly.

•

-"•

•

'

•

'.•'•*

'.-'o

-jp

Rather than pay dividends to • its
wealthy stockholders, Penn Square has
ploughed earnings back into capital,
creating a capital base that amounted
to $30.4 million by yearend 1981. That
resulted in an equity-to-assets ratio of
7.7%, about the norm for banks of this
size.
Many of the bank's customers are also
stockholders. A closely held institution,
Penn Square has 120 shareholders, 10
of whom own 80% of the bank.
The personal wealth of the bank's
stockholders and directors is said to be
one of the bank's key strengths. As one
observer put it, "The board has very
deep pockets" that could probably see
the bank through a downturn in the
energy picture.
The bulk of the energy portfolio
consists of reserve loans and letters of
credit made to independent producers
operating in Oklahoma, according to
the bank. The remainder — about 10%
— consists of rig and equipment loans
and loans to energy service firms. The ,
bank says it is involved in virtually no
national or major oil company credits.




bad, p a r t i c u l a r l y loans sold
downstream. They point out that most
Many of Penn Square's customer base
of their own downstream participations
of some 200 independents are active in
are not made as ovcrlines but rather as
the Deep Anadarko Basin, a vast
accomodations to their country banker
natural gas pool In the western part of
customers.
the state. / But one local banker concedes that
These customers include some of the
"about 50% of the criticism is sour
most illustrious figures in the Oklahoma
grapes and the other 50% is deserved."
oil and gas business, such as Robert L.
At least..some of the snickering stems
Hefner 3d, head of GHK Corp., a
from the fact that Penn Square has built
pioneer in exploration and development,
its oil and gas division by pirating
of the' Anadarko Basin; An-Son Corp.'s
energy lending officers, an increasingly
Carl Andersen Jr., and Carl W. Swan,
scarce commodity, from its competitors,
co-chairman of Continental Drilling
namely First National Bank, and Trust
Co. and a director, of the bank..,;
of Oklahoma City, Fidelity, and LiberBut there.aretalso somejesser names , ty National Bank and Trust. For exambelieved \o be'BxperfenclAg serious cash
ple, Penn Square's new president,
flow difficulties^ ijever'al" 'other"*" Eldon L. Beller, was recruited last year
Oklahoma banks have lately become so
from First National, where he had been
, concerned about, the-outlook, for small
an executive vice president.
'independent operators that they'have
established lists' of firms requiring
special monitoring.
Even More Painful
According to Mr. Jennings, almost all
its loans are secured, floating-rate
What pains them even more is that
credits priced at about lk% to 2% above
Penn Square has snared some of their
the prime rates of its upstream cormost valued customers. For example,
respondents. Typically, Penn Square,
First National Bank of Oklahoma City,
whose legal lending limit is $3.5
the cornerstone • of the Vose family's
million, will sell off about 80% of a loan
Oklahoma banking empire, is said to be
— and sometimes even the entire loan
. smarting1 s6yer the. loss to Penn Square
— receiving an origination fee of lA%
"a few month's'ago of M r ' ' ArK?or.scri\
to 1%. So on a $5 million loan, $4
An-Son Corp.
million of which is sold, Penn Squaru
Whatever reservations bankers have
would receive an origination fee of •
about Penn Square, oilmen admire its
$20,000 to $40,000.
hustling, entrepreneurial style and fast
response to big loan requests. Pointing
Penn Square and the upstream cortoward the high-rise tower of a wellrespondent will usually charge Vi% on
established Oklahoma City bank from
the unused portion, though Mr. Jenhis downtown office window, one leadnings says this is rare "because our
ing independent, who also happens to
Customers use their money." Individual
be a Penn Square stockholder, says,
participations average $1 million,"They may be good for a few million
though some have exceeded $30
without much difficulty. But if you
million, according to Mr. Jennings.
need $50 million, they want to tell you
But-he says there is no "typical" deal,
how to run your business." Adds James
because rates, balances, and fees are
G. Randolph, president of Kerr McGee
juggled differently on every credit.
Coal Corp. and a Penn Square director,
Penn Square's portfolio is funded
"They're a bunch of good old boys who
with a liability mix. that consists of
understand the language of oil and gas.
about 40% demand deposits and 60%
And Bill Jennings is a good salesman
time, savings, and NOW accounts.
and promoter."
Although Penn Square is where many
What is indisputable is that since
banks say they'd like to be — specializ1975, when it was acquired by a group
ing in a particular market and earning
of investors headed by Mr. Jennings,
plenty of fee income by originating
Penn Square has been transformed
rather than holding assets - the older,
—
from an undistinguished shopping
downtown Oklahoma City banks say
center bank to a go-go institution that
they are uneasy with the degree to
is one of .the major originators of energy
which Penn Square has embraced this
loans in the Southwest.
practice, and they disclaim any intention of imitating it.
Returned to Buy It
Violating Taboos
Known to his friends as "Billy Paul"
or "Beep," Mr. Jennings first joined the
According to conversations with
bank as executive vice president when
senior officials of some of Penn Square's
it was founded as a consumer bank in
competitors and downstream cor1960, then quit in 1964 to work for
respondents, the upstart bank appears
Fidelity in the same capacity. After 10
• to have violated some of the taboos of
years with Fidelity, he returned to Penn
energy lending and correspondent
Square to buy it.
banking. They believe it has based its
Penn Square maintains corresponreserve lending on an overly optimistic dent relationships with Fidelity, the
view of oil prices and interest rates, that
First National Bank, and Liberty Nait lends on brand-new properties and
tional, among others. Fidelity, for exto inexperienced oil and gas operators ample, handles the transaction process— criticisms dismissed as "sour grapes"
ing of Penn Square's commercial and
by Perm Square officials.
instalment loans and checking and savCorics^v-ndent bankers say that the ings accounts.
Penn Square's volume of participations
Located in the sprawling Tenr.
exceeds their own "comfort level" Square shopping mall in the northwest
because of what they called the quadrant of this city, the bank's
customary "moral obligation" of a loan whitewashed, thrcc-story headquart
originator to b ly back loans that go building, drive-in facility, and ?.j

384
instalment loan office are today little
more than vestiges of an earlier era.
Only a small fraction of its business is
now consumer related.
Having outgrown these facilities, the
bank expects to move into a new 22story office tower in mid-1983. The $36
million building is being financed as an
off-balance sheet joint venture involving several Penn Square customers.
'Continental's Local LPO'

No one questions Mr. Jennings' interest in the oilman. But some criticize"-''
his interest in operators just going into
business for themselves — precisely the
reason Mr. Jennings offers for the
success of Penn Square. He says that
while some of his customers may not
have been in business for themselves for
very long, most of them have extensive
experience in the oil and gas industry,
having been employed as engineers,
geologists, and "even mud salesmen."
Mud is any fluid used to remove dirt,
rock, and other "cuttings" produced
while drilling for oil and gas.
•* Penn Square: P*ge 16

For one thing, he says, most of his
customers are diversified into natural
gas as well as oil, often deriving as
much as 70% of their revenues from
deep gas production. Prices for deep gas
— reserves found below 15,000 feet —
are unregulated and lately have ranged
between $8.50 and $10 per, cubic
, thousand feet.
Second, he says that because of the
margin of safety built into his reserve
loans, a drop in prices would simply
require the stretching out of the loan,
and the loans still would be repaid
before reserves run out.

Having his bank called Continental
Illinois' local LPO doesn't seem to
bother Mr. Jennings, an old-school entrepreneur who also owns a large share
of the fledgling Trans-Central Airlines '
Three Years Becomes Four Years
("more of it than I'd like," he quips), .
Even if "oil hits $20 a barrel, a threedabbles in real estate as a partner in
year loan would become a four-year
three local hotels, and is said to have
Continued from page 15
loan," Mr. Beller says. Experts agree
sizable oil and gas holdings of his own.
"Most of our customers were not
that because of the windfall profits tax
customers of other banks," he says.
Indeed, he relishes the association
on oil selling for more than $25 a barrel,
with banks that he regards as the top
"We recognized the potential of ina substantial drop in prices must occur
names in the oil and gas business, and
dependent producers just getting
before oilmen incur a dollar-for-dollar
protests with mock scorn that if Penn
started. These were producers who did
Square is an LPO for Continental, It is
not have substantial net worth but who I loss. This is because higher priced oil
also an LPO for Chase, Seafirst, and
had experience, integrity, and a willing- I is more heavily taxed than lower priced
I oil under the extremely complex
Northern Trust.
ness to work."
j windfall profits tax formula.:
However, he bristles at what he calls
Banks generally lend about half of the
the "street talk" about his institution
A Practice Frowned Upon
discounted net cash flow from oil and
being stretched too thin in the energy
Asked if Penn Square was actually
gas production for three to four years.
business. Taking a short puff on his
Before the oil glut really took hold,
ever-present cigar, Mr. Jennings assorts > supplying venture capital, Mr. Jennings
replied, "We'd like to be," noting that
many banks were discounting cash
that his institution has been a boon to
he was thinking about forming a venflows at about 12% and escalating
the expansion of the capital-intensive '
ture capital subsidiary.
prices about 8% per year on a base of
oil and gas industry in" Oklahoma, a
According to a lender who says he has
$32 per barrel.
state he describes as relatively cashturned away loan requests later apA survey taken by Fidelity Bank of
poor despite its robust energy economy.
proved by Penn Square, the bank is also
The loan origination concept, he says,
willing to lend on "brand-new" pro- I major energy lenders indicated that
is particularly well suited to Oklahoma,
perties, a practice frowned upon by . many were revising these assumptions
a unit banking state where the capital
to. reflect lower prices and the higher
most energy lenders. Generally, the
needs of bank customers are often
cost of funds. Penn Square says that for
. performance of one or more wells is
greater than the ability of individual
the last two months it has figured on
used as collateral for loans to finance
banks 'to meet' them.'" Moreover,
oil prices holding at $30 a barrel for two
additional drilling, whereas" investor
Oklahoma's hanking laws mnk<- it difyears, then rising at 8% per year. It is
capital is used to fund the first wells
ficult for an out-of-state bank to operate
now discounting reserves at 15%.
on new properties. Mr. Jennings
there,' which explains the absence of
"It's realistic," Mr. Jennings says, "to
acknowledges that Penn Square lends
money-center-bank loan production* ofasume that for a year or more oil will
on new properties, but only when
fices in the state.
hold at $30-$32, and possibly decline
: "supplemented by seasoned properties
to $28 or $25. But we don't look for
Growing Up with Oil and Banks
or other assets."
oil to go below $25. Any prudent oil
Penn Square's chairman insists that
In a lengthy and candid interview,
1 and gas lender.will have a substantial
the $4.2 million in 1981 chargeoffs
Mr. Jennings and his top associates
represented a. one-time writeoff of bad • cushion," he adds. "There is adequate
sought to dispel the bank's high-flying
coverage for reduction in the price of
real estate loans, not energy credits,
image, stressing that contrary to all the
> much of which he says he expects to j product."
rumors, Penn Square lends money in
recover. At the same time, he | ' The spot market for OPEC oil has
much the same way as its downtown "
acknowledges that nonaccruals also rose ' recently ranged from $28.50 to $32 per
competitors, using credit criteria that
jLbarreh depending on the grade, accord- r"substantially" in 1981. :
are "standard in the industry."
Moreover, he says that the decision j ing to the New York-based Petroleum
"Our growth," he says, "appears so
Intelligence Weekly.
to take the chargeoffs in one lump was
dramatic because we started with such
the bank's, not the Comptroller of the
a small base. By moving into an active
A Number of Shakcouts
Currency's, as some sources nave sugposture early, and concentrating efforts
gested.
Energy lenders at other institutions
on independent producers, perhaps '
Mr. Beller, regarded by some obagree that most loans could simply be
when other banks were not, we
".'. servers as a force for discipline,.: in-the-* extended if oil prices continue to drop,
established an orginal base of producers
bank, responded with a terse "yes"
but only if the engineering estimates of
who are our very best salesmen. Word
when asked if the move to charge off
reserves prove to be accurate. But one
gets out pretty quickly that Penn
the bad loans reflected his influence.
prominent energy lender says that "in
Square is interested fruthe oilman." ^
the past, rising oil prices covered up a
Mr. Jennings himself grew up around
lot of mistakes" that would be accented
oil and banks. His 85-year-old mother
No Acceleration of Chargeofls
by declining prices. As a result, there
still runs the Bank of Healdton in
Despite the weakening of oil and gas
will be a number of "shakeouts" of
Healdton, Okla. (pop. 3,380), a small
prices, Mr. Jennings says that he does
energy operators, large and small, in
southern Oklahoma town located in one
not expect chargeoffs of energy loans I 1982, he says.
of the state's original, Depression-era
to increase dramatically in 1982, adding
oil patches. "I've seen rigs stacked for
that there are a variety of mitigating
years," the affable Oklahoman recalls.
factors that woi.ld cushion his institu"I've seen boom and bust. I have a
tion even if oil dropped to $20 a barrel.
great attraction and feeling for the oil
and gas business."




Penn Square . . .

385
One of the bank's upstream institu- II ;re well managed. They have a strong
board and excellent acceptance in their
tions, which also asked not to be idenThe market for used drilling equipcommunity." Continental and
tified, concedes that "there was a time
ment has fallen off 50% in the last six
Northern Trust declined to comment.
when they were really stretched," but
months, he adds, "so if you've got a
One leading correspondent banker
it adds that "now they've got that
bad rig loan, you've really got a prosaid he "took comfort" in knowing that
behind them." Says Mr. Jennings, "We
blem."
Continental, one of the nation's leading
have problems with documentation and
As for rig loans, Mr. Jennings says
so do other banks. It's a constant j oil and gas lenders, would certainly
that they make up a small portion of
" have scrutinized a Penn Squareproblem."
the total energy portfolio and are
originated credit as thoroughly as jr
generally secured with long-term conwould one of its own.
——ww---*tracts. However, one knowledgeable I Understaffed, Overstaffed
""' While Mr.' Jennings and his col*•
source contends that these loans are
Mr. Jennings acknowledges that "two —leagues-do-not-«eem_ta_be_ia.ttled by
more often secured by one-year conyears ago, we were understaffed. Tocriticism from their fellow bankers
tracts.
.
,day," he says, "I think we're over("We don't care what bankers and
In the week ending April 18, there
staffed. Our staff is more than adequate
analysts think, we only care what our
were 3,422 active rotary rigs in the U. S.,
when coupled with assistance we recustomers think," he says), they do
a drop of almost 10% from the same
ceive from participating banks. The
acknowledge that their future growth
time last year, according to the Hughes
state banking department and the nawill be less dramatic and more
Tool Co. of Houston, which maintains
tional examiners have been helpful, in
diversified than it has been.
a running count of working units. The
many instances, in making recommenMr. Jennings says he expects assets
827 active rigs in Oklahoma
dations on procedures and documentato rise by about 25% a year to about
represented a significant rise over last
tion."
$1 billion within five years, substantialyear, but the number has been declinMr.. Jennings emphasizes that "our
ly less than the frenzied pace of the last
ing fairly steadily since last January.
credit criteria are the credit criteria of
few years. Earnings for 1982 should
the uDstream banks" and that Penn
Upsurge In Problems
L Square is under no obligation, moral or • increase to about $6.0 million, a gain
of about 28%, he says. "Future growth
There has also been * what one I contractual, to buy back loans. "Their
won't be allowed to be as fast as in the
engineers get together with our
Oklahoma City energy lender called a
past," adds Mr. Beller.
engineers before a commitment is I
"tremendous upsurge" in problems —:
made," insists Bill G. Patterson, senior
including lawsuits alleging misBranching Out
executive vice president in charge of
representation — with drilling fund
Asked if a-more formal. affiliation
the oil and gas division.
loans backed ' by standby letters of
with Continental Illinois or another
credit. Because the oil revenues in
Mr. Jennings explains that while his
upstream correspondent might occur
many of these deals have not been
engineers occasionally differ with their
forthcoming, Oklahoma City banks are I counterparts at the upstream banks, | when and if the banking laws permit
drawing on the letters of credit at an ' those differences are inevitably "re- i it, Mr. Jennings said, "That is a potential that exists for us or any other bank
increasing rate.
solved in favor of the upstream banks."
in the state." Then, he adds, he is not
And Mr. Patterson declares, "No corOften, bankers say, letters of credit
worried that the upstream banks may
respondent has ever lost a penny on a
for drilling funds have been bought by
attempt to steal his customers because
Penn Square loan."
, of their "strong loyalty to the bank that
limited partners and issued by a bank
without the expectation that they would
However, one source says that Penh
helped them get started."
ultimately have to be funded.
, Square has avoided letting its cor- j
Meanwhile, "We'll probably do more
Another criticism that has been ! respondents take losses by arranging, in
in real estate and construction lending,
leveled at the bank is that its lending
several instances, for stronger
industrial financing and leasing, and
staff is not large or experienced enough
customers to buy out weaker clients
mortgage servicing,", he says. To that
to service a portfolio of this size. Inwhose loans were on the verge of going
end, Penn Square has recently joined
deed, the : bank's growth has been
-bad.
with four other institutions — which he
achieved with a commercial lending
refuses to name — in creating a finanstaff of jewer than 20 officers,' most of
Some Decline to Comment
cial and estate planning firm —
Thompson, Tuckman, and Andersen —
Responding to the controversy surbased in Palo Alto, Calif. The firm will
rounding Penn Square, a spokesman for
soon open offices in Oklahoma City and
Chase Manhattan said,' "Penn Square
other cities, according to Mr. Jennings.
is a strong and competent bank, but our
Although he admits to being confuture relationship would depend on
cerned about the sensitivity of his
what they bring to us." John R. Boyd,
institution to the vagaries of the energy
senior vice president for eneTgy lending
market, he says with a touch of smugat Seafirst, said, "They have been a
ness, "I'm awfully grateful we're not
strong and close correspondent of ours
diversified into apartment houses, car
for the last five years and we feel they
loans, cattle ranching, and wheat farmthem young lenders recently hired
ing."
away from First National Bank, Liberty, Fidelity, as well as Continental and I
several New York institutions. The oil
and gas division also includes four fulltime petroleum engineers, according to
Mr. Jennings.
"In this business," says one energy
lender, "it pays to have a few grey hairs
and to have lived through boom and
bust."
A few of the bank's downstream
correspondents are known to have rejected or sold participations back to
Penn Square because of what one
termed "sloppy documentation." An
officer at a major southwestern bank
said it had refused to buy Penn Square
participations because "they weren't up
to our standards." He would not 'I
elaborate.

m

Pei\i\ Square mwlia•




386
The CHAIRMAN. At page 5 of your statement you say that:
We are still not at a level at which you would normally find us using a formal
letter of agreement, let alone a formal cease and desist. Also, although we see the
bank's funds tend to be very risky, those activities are extremely profitable. On the
one hand, the classified assets totals and other quantifiable measures of the bank's
lending were not at a level which would by themselves normally find us using a
formal agreement, let alone a formal cease and desist order.
For how long a period of time had they been making these
energy loans when you reached this conclusion? In other words,
how old were these loans? Relatively new, weren't they? You know,
looking at the charts, these charts of the Comptroller's Office, total
loan growth rates for 1979, 1980, 1978, 1979, and 1980, the big push
was in 1980, was it not?
Mr. POOLE. I believe so.
The CHAIRMAN. That compares to the chart
Mr. POOLE. I can't see the chart.
The CHAIRMAN. Well, we will have them brought up a little
closer.
[The charts referred to follow:]







GROWTH RATE

Penn Square Bank, N.A. Compared with Peer Group Banks

1981
DATA

1980

Source: Comptroller of the Currency

GRAPH PREPARED BY STAFF OF THE BANKING, FINANCE
AND URBAN AFFAIRS COMMITTEE

1979

1978

1977




GROWTH RATE

Penn Square Bank, N.A. Compared with Peer Group Banks

TOTAL LOANS
120 i

1120
I f Penn Square

100

100

Peer Banks
80

H80

8 60

CD
3

a.

40

40
20
0

fc*
1981

HI ^
1979

1980

DATA Source: Comptroller of the Currency
GRAPH PREPARED BY STAFF OF THE BANKING, FINANCE
AND URBAN AFFAIRS COMMITTEE

1978

M

1977

20
0




TIME DEPOSITS OVER S100M AS
A PERCENT OF AVERAGE ASSETS
Penn Square Bank, N.A. Compared with Peer Group Banks
60 i
160
Penn Square

50

_|
50

Peer Banks
40

40

§ 30

30

20

20

10

10

0

1981

1980

1979

DATA Source: Comptroller of the Currency
GRAPH PREPARED BY STAFF OF THE BANKING, FINANCE
AND URBAN AFFAIRS COMMITTEE

1978

1977

0




PENN SQUARE BANK, N.A.

1981
DATA

1980

1979

1978

1977

1976

1975

Sources: Moody's Bank & Finance Manual; Polk's World Bank Directory
GRAPH PREPARED BY STAFF OF THE BANKING, FINANCE
AND URBAN AFFAIRS COMMITTEE




COMMERCIAL AND INDUSTRIAL LOANS AS
A PERCENT OF TOTAL LOANS
Penn Square Bank, N.A. Compared with Peer Group Banks
100 i

1100
Penn Square
Peer Banks

80

60

80
60
C
D
O

c
0)
o
Q.

CD

40

40

20

20

0

1981

1980

1979

DATA Source: Comptroller of the Currency
GRAPH PREPARED BY STAFF OF THE BANKING, FINANCE
AND URBAN AFFAIRS COMMITTEE

1978

1977

0




U.S. BANKS WHICH BOUGHT PARTICIPATIONS FROM
PENN SQUARE BANK, N.A.

CHART PREPARED BY STAFF OF THE BANKING,
FINANCE AND URBAN AFFAIRS COMMITTEE

393
The CHAIRMAN. "But on the other hand these loans are comparatively new." But then we go to page 9 and $30 million of the $45.7
million in loans that were eventually classified as loss were made
after September 30, 1981. Now, those got bad awful fast, didn't
they?
Mr. POOLE. Yes,

sir.

The CHAIRMAN. SO they couldn't have been very good ab initio,
from the beginning, right? How did they get that bad that fast?
Mr. POOLE. I think it was a matter of, in some cases, of the
amount of lending to specific borrowers in relation to their collateral and in relation to the various comfort factors in the condition of
the loans.
The CHAIRMAN. DO you know who was responsible for making
these loans, $30 million of the $45.7 million in losses eventually
classified as losses?
Mr. POOLE. Mr. Plunk might be able to answer that better.
Mr. PLUNK. Most of those were originated in the energy
department.
The CHAIRMAN. Pardon?
Mr. PLUNK. Most of those were originated in the energy division.
The CHAIRMAN. OK. And who was the very efficient individual in
the energy division who would have originated those?
Mr. PLUNK. We found in our loan review that Mr. Patterson supervised virtually all of the loans, I would say as a guess 70 percent
or greater.
The CHAIRMAN. I have a little chart here that indicates, just as
you've said, "The attached document provides some criticized loans
of 1980, revealed that Mr. Patterson was the lending officer for
over $20 million of the $34 million in such loans," right?
Then we come to 1982, and again he gets the prize, the big
banana. That being the case, was that brought to your attention,
Mr. Poole, that you had one particular gentleman in that institution who was a real hot-shot loan officer with a lot of bad loans?
Mr. POOLE. Yes, sir. But I have to point out that the deficiencies
in loan portfolio were not that severe at previous examinations.
That was basically what I meant when I was talking about quantifiable factors. And even the 1980, December 1980 examination, one
of the major factors we used in judging what type of administrative
action we would use was the level of classified assets.
The CHAIRMAN. Mr. Poole, your criticized loans in 1980 revealed
Mr. Patterson was lending officer for over $20 million of the $34
million in such loans. OK, that's 1980. Now we come to 1982, and
Mr. Plunk just stated that he was an all star again in these
classified, brand-new classified loans in 1982.
I'm asking you if it was brought to your attention that you had a
very, very capable gentleman here named Patterson making
energy loans that had a habit of becoming classified?
Mr. POOLE. Well, it was the oil and energy department primarily,
and I guess he was in charge of that if I am not mistaken.
Mr. BARTON. Yes, he was, and we were aware of it.
The CHAIRMAN. YOU were aware of it, Mr. Barton?
Mr. BARTON. Yes.

The CHAIRMAN. OK. You were also aware of the fact that this
institution had problems?



394
Mr. BARTON. Yes, sir.
The CHAIRMAN. And

did you give any consideration whatsoever
to saying to Mr. Poole, so he could say to Mr. Conover, say, we've
got a hot shot here that we can't keep up with, he's too fast for us.
September of 1981 things weren't too bad at this institution. But
now we come back and we've got classified loans that were made in
a short period of time. This young gentleman, perhaps we should
ask him to step aside.
Under the powers that you have, it doesn't have to be anything
critical, just deleterious to the financial condition of the institution.
Did you give that any consideration?
Mr. BARTON. We gave that consideration, but the condition of the
bank, the classified assets, was not that severe during history
coming up to 1982.
The CHAIRMAN. I'm talking about April and May of 1982. In May
of 1982 you found, and June, you found out that there were these
classified loans, comparatively new loans, correct?
Mr. BARTON. Yes.

The CHAIRMAN. And you also knew that the same gentleman
who was heading up this department had a lot of classified loans in
previous instances. It was the same gentleman again in May and
June. The players haven't changed.
So you know you brought in Mr. Beller, you asked for all of these
things to be done, and yet this area that is a rather critical one
still is bad. The same individual is there. Did you give any consideration to asking for a change?
Mr. POOLE. May I answer that?
The CHAIRMAN. Yes.
Mr. POOLE. You're talking about the April 1982 examination?
The CHAIRMAN. Yes, sir. And you know, you look at a little histo-

ry and you look at 1980. I read from 1980 as well, sir, the classified
loans in 1980. Mr. Barton is aware. He's nodding in agreement. So
I'm not isolating this so that you should have, you know, the Holy
Ghost lay whole knowledge on your head in 1982. I'm saying that
this has been going on for a period of time.
Mr. POOLE. I can personally assure you that had the bank survived and stayed in operation, that I feel personally very comfortable in saying that we would have recommended the removal of, or
the board remove certain individuals of the bank.
But as a matter of fact, our major concern in our April examination—you have to remember, we did not complete the examination.
It never was completed. The bank was closed in midexamination.
We were doing our best to try to keep up with—it is very difficult
to examine loans in a bank where documentation was as poor as
we found in this bank and where controls are so lacking.
It is extremely difficult. You've almost got to—you've got to do
everything yourself. And we sent additional staff into the bank.
It was really not a type of decision that we would have addressed
during the April examination as to who we would or would not
want to recommend getting out of the bank. Our major concern
was determining how much of the loan portfolio was loss, so that
was clearly the most critical and crucial element.
The CHAIRMAN. Weren't at the same time hoping to be able to
save the institution?



395
Mr. POOLE. Yes,

sir.

The CHAIRMAN. Just not find out how bad the loss was.
Mr. POOLE. If we could determine, for example, that the bank
had only $15 million in losses, I can assure you that we would have
probably taken action according to the nature of that.
The CHAIRMAN. Let me ask you, Mr. Poole. I've heard words like
procedures, visitations. It all sounds very medical. Now, frankly,
you know, if a doctor is examining a patient and finds out he's got
double pneumonia and a hernia and might also have ingrown toenails, does he just keep examining and making tests or does he
start treating immediately? You start treating immediately, don't
you?
Mr. POOLE. In my opinion the treatment that you're talking
about would have done no good whatsoever by that point in time.
The horse was already out of the barn.
The CHAIRMAN. But you knew at the beginning of the exam,
when Mr. Plunk called you on May 13, when he called you May 13
and he said, things are very bad here, they are very bad here. Did
you know the horse was out of the barn?
Mr. POOLE. NO, sir. It would be practically impossible for me to
make a decision to do something as drastic as even tell the board to
remove somebody based upon an incomplete examination. We have
to be extremely careful in documenting our position and knowing
where we stand and having conclusive information when we are
going to take such a step. And it would be very difficult to take
such a position in midexamination.
This is the same reason that the board has testified on several
occasions, that they did not know the extent of the condition of the
bank until the board meeting on July 1. We were keeping management of the bank constantly apprised of our findings in classified
loans and loan losses. Here again, it would be
The CHAIRMAN. Were you keeping the board informed as well?
Mr. POOLE. It would have been irresponsible for me or for the
Comptroller's Office to have called a meeting of the board of directors based upon inconclusive information and to tell them that we
thought their bank was in real bad shape. It would have been, to
the extent we were finding—and you have to understand that we
were getting on a daily basis—we were examining loans that were
extremely poorly documented. We had missing collateral sections,
we had missing deeds of trust, we had just, you name it, it was
missing. We were having to—and missing engineering reports.
We had to continually wait for the bank to bring us additional
documentation before we could make a decision on the individual
credit.
The CHAIRMAN. Would you agree that not only was this institution the worst that you have ever seen in your 26 years, but that
also it is a classic case that they were able to, or they managed to,
probably come up with every type of violation and misdeed and ignoring of regulations that you could think of? I look upon this as a
classic. How about you?
Mr. POOLE. I feel it is a classic based upon what happened after
September, but not prior to September. I feel very confident that
the bank was a solid three bank as of September, but it just went
to pot after September.
97-830

0-82-26




396
Mr. BARNARD. Mr. Chairman.
The CHAIRMAN. Yes, sir.
Mr. BARNARD. HOW can

you say that, Mr. Poole, when you
threatened cease-and-desist orders in the spring of 1981?
Mr. POOLE. But we didn't take a cease-and-desist order.
Mr. BARNARD. That's not the point, though. The point is that
your statement this afternoon, stated that after the spring 1981 examination, you brought the board in and you threatened cease-anddesist orders. But you used psychology and decided to just go with
an agreement. Oh, that was great. The directors came up and personally thanked you for your consideration.
And then, after threatening a cease-and-desist order, you sent in,
from what I can understand, a single examiner 6 months later. A
visitation by examiner, that was the statement. Was that a team of
examiners?
Mr. POOLE. Yes, sir. I don't recall how many.
Mr. BARNARD. Does Mr. Barton know?
Mr. BARTON. NO, sir, I don't know that.
Mr. BARNARD. Mr. Plunk?
Mr. PLUNK. I would have to guess. I would say five or six.
Mr. BARNARD. Five or six examiners. You normally use 15. And
the result of that is—and I'm quoting again—"made significant
progress in correcting deficiencies, not sufficient in taking out further classification."
Would it be logical for the Comptroller's Office, knowing of the
age-old difficulty with this bank, to let it go from the spring of 1981
to the spring of 1982 without a thorough examination?
Mr. POOLE. Yes, sir.
Mr. BARNARD. Even

though you had threatened cease-and-desist
orders?
Mr. POOLE. I think it was extremely logical, based upon our experience, not only in our region but throughout the Comptroller's
Office, with the use of formal agreements and with three-rated
banks that I would say were of not dissimilar condition to Penn
Square. My experience in three regions has been that when a
board of directors tells you that they will correct the situation,
they correct it. In the vast majority of cases, we are able to turn
around our three-rated banks and bring them back to a one or two
rating.
Mr. LEACH. Will the gentleman yield on this point?
Mr. BARNARD. If I might just finish quickly.
You don't think that you cried wolf just one time too many?
Mr. POOLE. NO, sir.

The CHAIRMAN. I just want to make one observation and then I
want to go to Mr. Leach. And that is that I would say to you, Mr.
Poole, I know you've got 26 years. I have got a few years overseeing
these things myself. And I don't know if you heard what I said earlier today. All because that institution, with that one strong individual who in essence is calling all of the shots and telling everybody what to do—and this gentleman, God bless his soul, I'm sure
he was well intentioned. But you know, we all make errors in judgment.
But he was very strong, Mr. Jennings, and perhaps that is why
that board of directors couldn't accomplish what they wanted. I



397
still would say to myself, was Mr. Beller brought in and used? Was
he brought in to sort of placate the Comptroller? I don't know.
Mr. POOLE. In my opinion, I don't think Mr. Beller thought he
was being used. The examiners were not told of any problems, for
instance, that Mr. Beller had with Mr. Patterson.
The CHAIRMAN. Mr. Jennings.
Mr. POOLE. That's right. He led us to believe—he not only led us
to believe, he assured us, that he had the horsepower, that he had
the staff, that he had the controls that he needed to accomplish
what we wanted accomplished.
The CHAIRMAN. But now we find out today that wasn't so.
Mr. POOLE. That's exactly right.
The CHAIRMAN. Mr. Leach.
Mr. LEACH. I would like to return briefly to some of the comments of the gentleman from Georgia, to tie this together from a
little different perspective. If we are dealing with a bank with a
possibility of failure and loss of moneys—and this situation has
probably occurred once a month or so in this country for the past
20 years—a once-a-year review is fairly reasonable. What distinguishes this bank, however is that it was in large measure a loangenerating office for other banks. It was a $500 million bank that
had generated $2 billion-plus in loans for other banks. In such a
case, you are not dealing with the small loss alone; you are also
dealing with the substantial losses of other banks. The ramifications end up shaking the entire banking system.
Under these circumstances, considering Penn Square's rate of
growth, the Comptroller's Office cannot stand back and say that it
lacks significant responsibility, that the only faults were the problems of the board of directors and the problems in the oil economy.
You people must bear up to the fact that your Office has not operated perfectly. I would like to ask a series of questions in this
regard.
Excuse me just a second.
[Pause.]
The CHAIRMAN. The committee—I would ask you not to jump
around, because there are a lot of witnesses to hear yet. We must
suspend operations for about 3 to 4 minutes. There's a satellite
going over that some of us can see. We will be back within 3 to 4
minutes. We are in recess for 3 to 4 minutes.
[Recess.]
The CHAIRMAN. The committee will come to order.
Mr. Leach?
Mr. LEACH. In the case of Penn Square, you closed the bank and
it's hard on the pocketbooks and the reputations of many people. It
was a very abrupt and tough thing to do. In July 1982, that was
the only action to take. But earlier one could have taken a less
abrupt but equally firm action and fired an officer or several officers of the bank. Was serious consideration given to that possibility?
In a prior hearing the Comptroller informed us he doubted he
had the authority to fire. I would like your authority in this regard
clearly stated for the record, whether you have the authority to
demand the firing of any officer of a bank that you supervise and
whether this would be channeled through the board of director.



398
Mr. POOLE. Mr. Serino may want to correct me, because I'm not
an attorney. It is my understanding that in the vast majority of
cases it would have to be the board's decision to fire management.
It is extremely difficult for an examiner to stand up in front of a
board and tell that board that they need to fire an individual if the
level of the criticisms in that examination is not of sufficient concern to support that action.
The board has the ongoing—the inherent responsibility, and the
first responsibility of any board is to
Mr. LEACH. I understand that, but I want an unequivocal statement. Do you have the right to demand the firing of an officer of a
bank that you regulate for proper cause?
Mr. POOLE. There is a procedure for removal and there are specific criteria that must be met under the law for removal procedures.
Mr. LEACH. But you have that authority?
Mr. POOLE. I do not have the authority to fire someone on the
board—I mean an officer. I'm sorry.
Mr. LEACH. YOU have no authority to remove?
Mr. POOLE. Through the procedures that I indicated, through the
removal procedures, we do, but not on the spot to say, you are
fired, or to demand—we can't demand
Mr. LEACH. We're not talking about on the spot. In looking at
this bank over a long period of time, there was strong reason to
suggest that several people in the bank were operating improperly.
One of the early actions of the regulatory authorities that you represent was to suggest that these individuals be removed from
office. Did you ever suggest that to the board of directors?
The board has testified before us that they received many statements from your office that indicated things were improving, that
indicated they were on the right track, that indicated a very positive direction. Wouldn't it have been a lot easier IV2 years ago or 1
year ago to suggest that someone be removed than it was to close
this bank?
Mr. POOLE. In my judgment, we absolutely did not have the necessary documentation. We did not have the foundation which
would support a removal action prior to September 1981.
Mr. LEACH. Have you ever requested removal of a bank officer?
Mr. POOLE. I've never initiated a removal proceeding and I'm not
sure under what statute that falls. There have been cases where in
a cease and desist order we have had an article requiring the board
to strip an individual of his administrative and executive authority
and to hire a new capable chief executive officer. Of course, the
board has the option of either signing that document, the consent
order, or not consenting to it. And it is still the board in that case
that is making the decision.
I have been a party to the use of that type of document at certain times.
Mr. LEACH. I raise this because at our hearings in Washington
the Comptroller indicated that he did not have that authority. Subsequently, he wrote the committee a letter. I would like to read the
first paragraph because it's quite clear that there is confusion in
your office about it. It says:



399
Dear Mr. Chairman: The purpose of this letter is to clarify the testimony before
your Subcommittee July 15, 1982, regarding removal powers of 12 U.S.C. 1818(e).
That statute permits each of the federal financial institution regulators to institute
removal proceedings against an officer or director of an insured financial institution
under certain specified conditions. In order to justify removal under the statute, the
regulator must establish in an informal hearing before an administrative law judge
that the following criteria have been satisfied.

Let me read a couple of those criteria:
That the officer or director of the insured bank has committed a violation of law,
rule or regulation or of a cease and desist order which has become final.

Your office has claimed that this bank violated the banking laws
of the United States on numerous occasions.
A second reason for which an officer may be removed: "If he has
engaged or participated in any unsafe or unsound practice in connection with the bank." Here it is relevant to go back to the
Arthur Young audit of this bank, which was a qualified audit. The
Arthur Young auditor said that it is highly unusual to have a
qualified scope audit, that it occurs maybe five times in 1,000 bank
audits. How unusual do you think it is to have a qualified audit?
Based on your experience, were there a large number of undocumented loans at this bank?
Mr. POOLE. At the April 1982 examination, I think the bank's
own internal review process identified 3,000 documentation exceptions. That is an inordinately large number, and I would have to
say that the quality—I asked Mr. Plunk earlier and he told me
that he had never seen a bank with poorer loan documentation.
Mr. LEACH. But none of this appeared in the September 1981
audit.
Mr. POOLE. That degree of lacking in quality of documentation
did not exist as of that date.
Mr. LEACH. There was no suggestion that perhaps the situation
ought to be tightened up by removing an officer?
Mr. POOLE. I believe all of our reports did cite the deficiencies in
documentation.
I might interject, with your permission, that I have a copy of
that letter and if we were to—you'll notice that in each case it says
"and" and it goes on from one to two and three. If we were to consider removal procedures against every officer that might fall
under A, B, C, or A, B, C of two or whatever, we would be looking
probably at removal procedures in every bank in the country, because there are no perfect bankers. They all make mistakes.
There are violations of law in probably every single bank that I
have ever examined.
Mr. LEACH. That is why it is awfully important to have a degree
of flexibility. We're not talking about a marginally bad bank; we're
talking about, in your terms, the worst bank you have ever seen.
Mr. POOLE. Based upon the last examination.
The CHAIRMAN. Would you please yield to me?
Mr. LEACH. Of course.
The CHAIRMAN. Mr. Poole, the reason the statute was changed
was that the regulators said to us, we are hamstrung, we are not
able to act unless there is a criminal violation. I'm going to have
my staff send you, and I think I will ask them to send it to every
regional director in the Comptroller's Office around the country,



400

the committee report and the legislation and the reason for the legislation, the change in the statute, and the fact that Mr. Homan
unfortunately misinterpreted it before our committee, just as you
are misinterpreting now.
Mr. Isaac and his general counsel agreed with myself and our attorney. We gave you the power. We gave you this power, not to
abuse it but feeling you were responsible individuals who would
use it in a very judicious manner. There is the appeals process, so
that if you abuse it the individual can appeal.
So please don't take that attitude, that you could do that in
every bank in the country, nobody is a perfect banker. Nobody is a
perfect Congressman, nobody is a perfect regional administrator,
nobody is a perfect general counsel, nobody is a perfect anything.
Perfection means divinity.
Mr. BARNARD. St Germain. [Laughter.]
The CHAIRMAN. And even St Germain isn't perfect. [Laughter.]
But just because you weren't aware of it, don't feel bad. Mr.
Homan wasn't aware of it, Mr. Conover was not aware of it. But by
cracky, you know, when I learn something new I am always happy
to say, gee, thanks for telling me, I wish I had known it. That
should be the attitude.
[The letter referred to follows:]




401

Comptroller of the Currency
Administrator of National Banks
Washington, D.C. 20219

J u l y 29, 1982

Dear Mr. Chairman: .
The purpose of this letter is to clarify the testimony before
your Subcommittee on July 15, 1982, regarding removal powers
under 12 U.S.C. §1818(e). That statute permits each of the
Federal financial institutions regulators to institute removal
proceedings against an officer or director of an insured
financial institution under certain specified conditions. In
order to justify removal under the statute, the regulator must
establish at a formal hearing before an administrative law judge
that the following criteria have been satisfied:
I.

That the officer or director of the insured bank has
committed:
A.
B.

has engaged or participated in any unsafe or unsound
practice in connection with the bank; or

C.

II.

any violation of law, rule, or regulation or of a cease
and desist order which has become final; or

has committed or engaged in any act, omission, or
practice which constitutes a breach of his fiduciary
duty as such director or officer; and

The agency determines that the bank has:
A.

suffered or will probably suffer substantial financial
loss or other damage; or

B.

that the interests of its depositors could be seriously
prejudiced by reason of such violation or practice or
breach of fiduciary duty; or

C.

that the director or officer has received financial
gain by reason of such violation or practice or a
breach of fiduciary duty; and




402
III. That such violation or practice or breach of fiduciary duty:
A.

is one involving personal dishonesty on the part of
such officer or director; or

B.

one which demonstrates a willful or continuing
disregard for the safety or soundness of the bank.

The removal provisions of the Financial Institutions Supervisory
Act of 1966 (FISA) as amended by the Financial Institutions
Regulatory and Interest Rate Control Act of 1978 (FIRA), as
described above, may be invoked only under the combination of
special circumstances delineated in the statute. 12 U.S.C.
§1818(e) has not been subjected to direct judicial review;
nevertheless, Congress made it clear when it gave the agencies
the removal power that it was . n extraordinary power and was not
a
to be used by the agencies to remove an officer or director from
a bank on simple grounds of incompetence or poor judgment.
The removal power is an extraordinary remedy which this agency
has used on 'only a few occasions.. The reason the agency has not
needed to utilize the power is that, ordinarily, when management
problems are brought to the attention of the directorate, the
directorate takes action to correct them. It is a principal
responsibility of the board of directors to ensure that the
institution is properly managed. Thus, in the normal course,
where problems are identified the board of directors will resolve
the difficulties through management changes. If the board of
directors does not take action to change management and there is
a statutory basis to remove the individual from the bank this
Office would not hesitate to consider the need to use the removal
statute.
In the instant case, while problems existed in the bank prior to
the April 1982 examination, in our opinion, based on the
information known at the time, these problems did not then rise
to a level satisfying the strict three-criteria removal standards
of 12 U.S.C. §1818(e). The problems as identified in prior
examinations indicated that the management team needed
strengthening. The formal cease and desist Agreement required,
among other things, that the board of directors evaluate and make
adjustments to the current management team both in quality and
depth. Because of that Agreement, the bank responded by
augmenting its management through the hiring of personnel from
other financial institutions. This was viewed as a positive
response to the previously identified management problems. Under
the circumstances, removal was viewed as neither appropriate
under the statute nor necessary to effect management changes.
Sincerely,

Paul M. Homan
Senior Deputy Comptroller
for Bank Supervision
The Honorable Fernand J. St Germain, Chairman
Committee on Banking, Finance and Urban Affairs
2129 Rayburn House Office Building
Washington, D. C. 20515




403
Mr. LEACH. We talk to bankers all the time, and they believe
that you have that power. There isn't a banker I know of who isn't
very concerned with that fact. I'm convinced that it was a failure
to take more timely and bolder action that has embarrassed this
community very much and perhaps reduced public confidence in
the whole banking system.
At what point did your office notify, either directly or indirectly,
upstream banks that there might be a problem in this particular
situation?
Mr. POOLE. I am personally not aware of who—or I understand
just generally that contacts were made. I don't know or when.
Mr. LEACH. Were they authorized contacts?
Mr. POOLE. I have no idea.
Mr. LEACH. Approximately when were they made and were they
generally made from your office? Were they made from Washington?
Mr. POOLE. I can only give you my understanding, and it may be
inaccurate. It is my understanding that may be 2 weeks prior to
the closure of the bank that the Washington office did notify certain upstream banks. The major reason, I m told, for those contacts
was twofold: One, it was to attempt a recuperative effort with their
assistance, potentially, for the bank; and the other was to begin to
try to assess the impact of the Penn Square situation on those
banks.
Mr. LEACH. Did Mr. Conover tell our committee that the Dallas
office
The CHAIRMAN. That they had notified Chicago, we're having the
transcript checked.
Mr. POOLE. You mean that we notified the banks?
The CHAIRMAN. NO, that the Comptroller's Office notified the regional office in Chicago.
Mr. LEACH. At what point did you notify the Federal Reserve?
Mr. POOLE. In Penn Square?
Mr. LEACH. Yes.

Mr. POOLE. That contact would probably have been made in the
Washington office.
Mr. LEACH. YOU don't know if or when?
Mr. POOLE. I'm sure contacts were made. I'm not certain when
they were made.
Mr. LEACH. When would you guess?
Mr. POOLE. I have no idea.
Mr. LEACH. Would it have been shortly before last July, or would
it have been 6 months or a year ago? You have no sense of that?
Mr. POOLE. I do not know.
Mr. LEACH. This is an awfully important point. What happens
with Penn Square Bank has affected Seattle First and Continental
at Chase Manhattan. If you're telling us you don't know when or if
the regulators of these other banks were notified, that indicates a
fairly extraordinary lack of governmental communication.
Mr. POOLE. I know when I notified the FDIC.
Mr. LEACH. That was May 21, in a casual conversation at the end
of which you indicated there might be a problem at this bank.
Mr. POOLE. I couldn't tell them something I didn't know.
Mr. LEACH. Understood.



404
Mr. POOLE. I'm not trying to be smart, but I did not want to overstate the situation in the bank.
Mr. LEACH. But at no point did your office make a profound decision to inform the Federal Reserve?
Mr. POOLE. I believe—I'm sure they were notified. I read someplace they were notified. I just don't recall where.
Mr. LEACH. You're the regional director.
Mr. POOLE. NO, sir, I would not notify the Fed normally.
Mr. SERINO. Mr. Leach, if I may interject. I am from the Washington office and there was extensive communication from the
Washington office to the Federal Reserve Board and to the FDIC.
The CHAIRMAN. Once the Federal Reserve Board had contacted
the Comptroller's Office because an unnamed individual in the Fed
office decided to make a call to find out. That is what Paul Volcker
told us.
Mr. SERINO. I don't know the exact time, Mr. Chairman, but
there were extensive contacts in the Washington office.
Mr. LEACH. Your July letter to the board of directors was partly
based on an audit which was completed in February. One wonders
why it took so long for the February results to be transferred to
the board when the situation was fairly serious. Can you explain
that?
Mr. POOLE. That would be—I will have to admit, that was a little
longer than would traditionally have been the period involved. And
Mr. Barton might, after I finish, comment on what would be a
more normal period of time.
Mr. BARTON. YOU would rather have that now?
Mr. LEACH. If you would like.
Mr. BARTON. We typically, in our problem bank processing, attempt to get the report out of the office within 30 to 45 days after
receipt for processing.
Mr. LEACH. Let me just stress again that you were dealing not
only with a problem bank but with a bank which was generating
loans that were affecting the entire American banking system. The
delay, in my estimation, takes away from Mr. Poole's comment in
his opening statement that the behavior of the Comptroller's Office
was exemplary. Do you consider that delay as being exemplary, or
would you give it another categorization?
Mr. POOLE. I feel that the delay was justified and I can explain to
you why the delay took place. It was not—it was the basis of a
judgment call on my part. It was—in the first place, the bank was
not in that severe a condition. It was rated three, and I would
hasten to point out that we were not in great fear of the bank's
demise at that time, even though we did find some significant deterioration.
There were several reasons. One was extensive discussions, as I
have pointed out, between Washington and the regional office as to
what type of action we would take.
The examiner in charge of that particular bank was handpicked
by me. He had a position at the regional office. He was out of the
office and worked 2 months on that examination, and he had his
duties in the office and brought the report back more or less in
pieces. There was significant work to be done on the report.



405
Once he came back, he could have extended the closing date of
that examination for say another 30 days, which he could have legitimately done, and made it look a lot closer, say the end of March
or the 1st of April. But we chose not to have him do so. But he was
the individual in the office that I felt was the most qualified with
respect to the funds management process and that was a major
area of concern on my part at that particular time. That is why I
chose him.
So that did lead to the delay. But in my opinion it did not—I did
not consider that it would damage our supervisory effort with the
bank. In retrospect I do not think that it did.
Mr. LEACH. We have heard from two panels of outside directors
made up of individuals who are respected in this community, individuals who strike me as being articulate, intelligent, and thoughtful human beings, not unlike many boards of banks throughout
this country. They indicated that one reason they didn't act with
more alacrity or alarm is they felt they received rather encouraging statements from your Office in recent times that things were
going better, that the bank was given a three rather than a four or
five, that your Office seemed to be giving a green light on the progress report cards. Would you care to comment on those assessments?
Mr. POOLE. Yes, sir. At the board meeting in Dallas, the second
one, the board was told. We were encouraged by the steps they
were beginning to take by the additions to the staff, but at the
same time I pointed out to them that the situation was very serious
and could very easily deteriorate, and three things, if the deficiencies are not corrected, could very easily materialize into a four or
five situation, and simply because we find some satisfaction with
work done by the board is no indication that we mean that they
are correct or that we mean they don't have remaining important
deficiencies.
Mr. LEACH. It strikes me that it might well have been appropriate for you to have said that although positive steps had been
taken, the board should remove this or that officer of the bank. Did
that ever enter you deliberations?
Mr. POOLE. Yes, sir, it did, and I can tell you without any shame
that I feel today and I felt then that had I made that decision, I
would have been irresponsible, based upon the information we had
and the lack of support for such action. It was a considered decision that we determined at that time that there was no basis for
such action.
Mr. LEACH. But it was considered? I think that is worthy of placing in the record.
Mr. POOLE. We always try to point a finger.
Mr. LEACH. In other words, your original assessment that removal of an officer is virtually never done doesn't quite apply because
you did consider it seriously in this case?
Mr. POOLE. Could I read something from this letter pertinent to
that?
Mr. LEACH. Of course.
Mr. POOLE. This is the letter you were quoting from before with
regards to removal procedures, the last two paragraphs. It says the
removal power is an extraordinary remedy which this agency has



406
used on only a few occasions. The reason the agency has not
needed to utilize the power is that ordinarily when management
problems are brought to the attention of the directorate, the directorate takes actions to correct them. It is a principal responsibility
of the board of directors to insure that the institution is properly
managed. Thus, in the normal course where problems are identified, the board of directors will resolve the difficulties through
management changes. If the board of directors does not take action
to change management and there is a statutory basis to remove the
individual from the bank, this office would not hesitate to consider
the need to use the removal statute.
In the instant case, while problems existed in the bank prior to
the April 1982 examination, in our opinion based upon the information known at the time of these problems, these problems did
not then rise to the level satisfying the strict three criteria removal
standards in the statute.
The problems as identified in prior examinations indicated that
the management team needed strengthening. The formal ceaseand-desist agreement required, among other things, that the board
of directors evaluate and make adjustments to the current management teams, both in quality and depth. Because of that agreement,
the bank responded by augmenting its management through the
hiring of personnel from other financial institutions. This was
viewed as a positive response to the previously identified management problems. Under the circumstances, removal was viewed as
neither appropriate under the statute nor necessary to effect management changes.
Mr. LEACH. Did you realize that the new management was
brought in without authority?
Mr. POOLE. NO, sir, we did not. We were assured by both the
board and I think the board has testified today that they felt that
he had that authority, and we were assured by the board and by
Mr. Beller himself that he did have the authority to correct the deficiencies.
Mr. LEACH. Even though removal is extraordinary, isn't it less
extraordinary than closing the bank? Isn't it a less wrenching situation for the bank, for the community, and for the banking system?
Mr. POOLE. Yes, sir, but I do not believe that would justify its inappropriate use.
Mr. LEACH. There has been a good deal of discussion about options that were considered in the last few weeks of the bank's life:
Whether the bank should be closed, whether there should be a
P&A, or whether the bank should survive. It is my understanding
that your office's recommendation was that the bank not be closed.
Is that correct?
Mr. POOLE. I'm sorry. We recommended the bank
Mr. LEACH. Not be closed. My understanding is that the FDIC
was very firm; based upon its statutory authority, there was very
little choice but to close the bank. Your office, and perhaps the
Federal Reserve, had a somewhat different opinion. Could you enlighten this panel as to the discussions held in the last week or two
and your recommendations?
Mr. POOLE. I was not present at those discussions. If I'm not mistaken, I believe they were between the Comptroller and the chair


407
man of the FDIC and Mr. Volcker. The Comptroller's Office declared the bank insolvent. It was then turned over to the FDIC,
and it would be the FDIC's decision as to whether to effect the closing of the bank.
Mr. LEACH. Did your office make a recommendation?
Mr. POOLE. I do not know.
The CHAIRMAN. AS a matter of fact, I think the FDIC said the
Comptroller's Office waited too long to declare it insolvent, giving
them no time whatsoever. That is one of the reasons they went the
route they want. That is not a question, that is a statement.
Mr. POOLE. Well, I would like to make a comment. The only comment I can make on that is that we declared the bank insolvent
when we knew it wasn't solvent, and it wasn't possible for us to do
so prior to that time.
The CHAIRMAN. YOU mean you couldn't do it Saturday afternoon
at 1 o'clock after the bank closed.
Mr. POOLE. I don't believe—as I recall, the loan losses were not
sufficient to wipe out the capital at that point in time.
The CHAIRMAN. But you did it before reopening on Tuesday.
Mr. POOLE. Yes,

sir.

The CHAIRMAN. AS I said, I wasn't asking that as a question.
Mr. LEACH. If the chairman would yield. Earlier you testified
that Jennings came to you and said the bank was insolvent, and
you disagreed. Is that an accurate assessment?
Mr. POOLE. I don't recall. I don't know about that comment.
Mr. LEACH. DO any of you know of that conversation?
Mr. PLUNK. NO.
Mr. BARTON. NO.
Mr. LEACH. Thank you.
The CHAIRMAN. I would

like to state that from the briefing that
was held in Washington a few weeks back, I said they were informed of the fact that this bank, prior to the closing, Mr. Conover—that is, it was during that previous week, yes, and the chairman of Chase Manhattan was informed, now Mr. Homan, I believe
that is correct, and Mr. Homan said they were advised they had
significant problems in their portfolio as a result of loans they purchased from Penn Square and were placing them under examination in terms of our trying to come to grips with them and their
internal people, come to grips with the loss exposure in those particular loans.
One further statement. Were you aware of the fact that one of
the people from Oklahoma, and I am quoting Mr. Homan at page
36 of the briefing:
We also sent our energy examiner, one of the experts in Oklahoma, to Continental, to A&R examiners in the assessment of their portfolio.

Were you aware of that?
Mr. POOLE. Yes, sir.
The CHAIRMAN. SO

you are aware of the fact that Continental
had been informed by an examiner from this area?
Mr. POOLE. Yes, sir.
The CHAIRMAN. I just

want to get that straight because there
seemed to be a little cloud on that earlier.



408
Mr. LEACH. Mr. Chairman, may I pursue one other point? It is
apparent that your office did talk with other regulators.
Mr. POOLE. Did or did not?
Mr. LEACH. Did.
Mr. POOLE. Yes, sir.
Mr. LEACH. Did it also

talk with the National Credit Union Administration?
Mr. POOLE. I have no knowledge that the Comptroller's Office
did.
Mr. LEACH. That is of some significance because, as you know, in
the last several weeks credit unions were pumping money into this
particular bank when banks were not. That raises some very interesting questions both in terms of Federal coordination as well as in
terms of
The CHAIRMAN. If the gentleman would yield, the NCUA and the
Home Loan Bank Board, by the Comptroller's Office in Washington
were informed about the time or maybe a day or two after Continental and Chase.
Mr. Annunzio.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
Now, Mr. Poole, what benefits were gained by closing the bank
that would have been lost had the bank been kept open and financially assisted?
Mr. POOLE. I believe we had a responsibility to close the bank, as
I indicated. I don't believe the Federal Reserve—the bank had a liquidity crisis. It was our assessment, it was the Comptroller's Office's assessment that the bank could not open on Tuesday morning
without experiencing a run on the bank. The bank had a negative
capital structure as a result of its losses, and it is my impression
that the Federal Reserve would not lend funds to a bank that we
would declare insolvent.
Mr. ANNUNZIO. Could it have been worse than it is now?
Mr. POOLE. No, sir, not the condition of the bank.
Mr. ANNUNZIO. I mean the condition of the community, the financial community.
Mr. POOLE. We don't have a choice in the matter, in my estimation. We have to close a bank that has a negative capital structure.
Mr. ANNUNZIO. I have no reason for saying this, but I have been
very patiently listening and asking questions all day. I am absolutely convinced that you people were conned just like the directors, and somebody tried to get to the two con artists and it was a
lot of emotion involved here and hundreds of people are suffering
because of the action that was taken by the Comptroller's Office.
Now Mr. Poole, Mr. Conover testified in Washington that he had
no choice except to close the bank because under the law he had no
other legal recourse. Isn't it true that you could have appointed a
conservator to run the bank, you could have removed management
and put your own people in place? That has been done in the past.
Why wasn't it done in Penn Square?
Mr. POOLE. The bank was insolvent. I don't believe that can be
done when the bank is insolvent. Here again, these are
Mr. ANNUNZIO. But I know of banks where it was done. It was
done in Miami where they appointed a conservator. It is being done



409

every day. Isn't it possible that your office panicked and closed the
bank? Could you have made a mistake?
Mr. POOLE. NO, sir, we didn't make a mistake.
Mr. ANNUNZIO. Why, then, why didn't you give the bank more
time to raise capital? I heard testimony today from the directors, if
they had the time, they didn't want money from one of the agencies or the regulators. They could have raised private capital.
Mr. POOLE. They had—the temporary cease-and-desist order was
issued and they were given until the following Friday to raise the
capital. As it turned out, the losses were so great that the bank
would have suffered a closure under any circumstances had it tried
to reopen.
Can I make one comment?
Mr. ANNUNZIO. Really, did you really give them time to raise
this capital? Did you sit down together and did you say you have a
week, 10 days, or a month?
Mr. POOLE. They didn't have that long because the bank was in
an insolvent condition. It was not in an insolvent condition the day
of the board meeting.
Mr. ANNUNZIO. Well, how long did they have? You said they
didn't have that long. How long did they have?
Mr. POOLE. They had to raise it by the 9th, and the Comptroller
declared the bank insolvent on the 5th.
Mr. ANNUNZIO. YOU said they had until the 9th. Was it the 9th
to close, to raise the money?
Mr. POOLE. I am informed that the agreement, that the temporary cease-and-desist was amended subsequent to give them to,
what, the 2d. It was said the capital should be in the bank originally, $30 million, by the 9th, and it was amended the next day to the
2d, the close of business.
Mr. ANNUNZIO. And when did the bank close?
Mr. POOLE. On the 5th.
Mr. ANNUNZIO. On the

5th?

Mr. POOLE. It did not reopen on the 6th.

Mr.

ANNUNZIO. And did they raise
Mr. POOLE. NO.
Mr. BARTON. NO, sir.
Mr. ANNUNZIO. Could you tell the

the money?

committee what they did? Did
they raise any amount?
Mr. POOLE. They made attempts, as I understand it, contacts
were made with individuals. This is only what I am told.
Mr. ANNUNZIO. It just doesn't sound right to me. In other words,
they are in the process of raising money and they are cut off even
before they have a chance to raise the money.
Mr. POOLE. But sir, if the bank is insolvent, we have no choice.
Mr. ANNUNZIO. It reminds me of a case of a few bad management officials like, again, like I stated, that are being punished by
ruining the lives of hundreds of people, and we have heard the testimony from people in this community who lost $850, who lost $2
million, who lost $1 million, not counting the reputation of the financial institutions in this country that have gotten publicity from
coast to coast. I don't really believe that you people realize that
you have created this monster, then you destroyed the monster, the
havoc that this would play on the economy of this country. I don't



410
think you understood that. I don't think the Comptroller understands it.
Mr. POOLE. We had no choice.
Mr. ANNUNZIO. YOU had a choice.
Mr. POOLE. We did not create the problem.
Mr. ANNUNZIO. YOU had a choice. I read a report where the bank
was in good shape in 6 months. It deteriorated fast. You would
think it had cancer.
Mr. POOLE. It did.
Mr. ANNUNZIO. Oh,

it had cancer, but a cancer can be cut out, a
cancer can be arrested, a cancer can be cured today, and that is
your job. What was the difference between the closing of Penn
Square—and I brought this up earlier today—and the closing of the
Abilene National? Just before Abilene closed, didn't your office
issue a public statement saying that Abilene was in good shape?
Mr. POOLE. NO, sir.
Mr. ANNUNZIO. Oh,

yes, you did. I asked the Comptroller in
Washington.
Mr. POOLE. I can give you a copy of my statement if you would
like to have it.
Mr. ANNUNZIO. I would like to have it.
Mr. POOLE. My statement was, and it was in the judgment of the
Washington office
Mr. ANNUNZIO. Are you talking now as an individual, your personal statement, or your office statement?
Mr. POOLE. It was a personal statement that I made after consultation with the Washington office, and it was a statement I made
with regard to the intentions of the Comptroller of the Currency's
Office, and that statement was that the Abilene National Bank is
not in liquidation and the Comptroller's Office has no plans to liquidate the bank at this time. That statement was good only for the
moment it was made.
That statement was made in response to a rumor that was circulating in the Abilene area and that was going to be discussed and
aired on a television station that night, that the bank was in the
process of liquidation, which was not a true statement, and the
office felt an obligation, as much as it would be our office to declare the bank insolvent and put it in liquidation, to refute that
statement.
It was unprecedented and that statement said nothing other
than we did not have plans to place the bank in liquidation. It did
not attest in any way to the condition of the bank.
Mr. ANNUNZIO. But your office has helped the people of Abilene,
but you sure have let the people of Oklahoma City suffer.
Mr. POOLE. It would be impossible for me to contrast for you the
relative conditions of the two banks and it would be improper for
me to do so, but I can assure you that they differ significantly.
Mr. ANNUNZIO. I want to give you another example. It has come
to my attention that some of your examiners have encouraged
other banks, national banks, to take the fast track route of Penn
Square. It has been reported to me that your examiners, in a meeting with officials of banks that were growing slowly, told those
bank officials that they should follow Penn Square's rapid growth



411

policy by getting into the oil and gas loan business in a big way.
Why would your examiners make such recommendation?
Mr. POOLE. I have no knowledge of such recommendations.
Mr. ANNUNZIO. And is it possible that maybe some other banks
are following your examiners' recommendations and it may well be
the future Penn Square problems?
Mr. POOLE. I have no knowledge of such recommendations and I
would doubt very seriously that they exist.
Mr. ANNUNZIO. If we get the proof and we bring it in, what
would you do?
Mr. POOLE. YOU will have to bring it in first and then we will
see.
Mr. ANNUNZIO. Oh, I've got to bring it in and then you will take
action as far as these examiners are concerned? I have news for
you. I come from the city of Chicago where we don't have one bank
but dozens and dozens of banks, and you know, after 18 years on
this committee how many times the Comptroller, the Regional Director in the city of Chicago has called in bankers and said, you get
rid of that cashier, you get rid of this, you get rid of that, and the
banks did it. They got rid of those people.
And if the bad actors in this bank were the people who created
this condition, it was your responsibility to get rid of them, to bring
action under the law that we passed in Congress. Your general
counsel is here to fight those individuals. They should have made
the changes that you recommended so that this could not happen
in this community, especially at this time when we are facing the
most serious crisis that we have ever faced in this country. I don't
think that that was taken under consideration, Mr. Poole, the general condition of the financial structure of this country and how
dangerous it is today.
Mr. POOLE. I would have been extremely irresponsible had I
taken such action based upon the information that we had at the
time prior to the April examination.
Mr. ANNUNZIO. Well, I just don't believe it, and I will bring you
my proof.
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Weber.

Mr. WEBER. Thank you, Mr. Chairman.
You know, our purpose in these hearings is to make sure we find
out what happened so that it doesn't happen again, and I would
have been much more happy if you had come in, Mr. Poole, with a
statement that said we are not satisfied with the results we have
achieved, we have tried our best, now we want to learn from this
experience, or that this isn't to be repeated. But instead you
brought us a statement that says, in conclusion, I am fully satisifed
with our supervision of the Penn Square Bank. The statement says
our conduct was totally appropriate, and then, I believe, although
it is not in your written statement, I believe I heard you say we did
our job in an exemplary fashion.
Well, I don't think any of us are satisfied where you had this
bank under your supervision for a couple of years and yet it continued to go downhill and ultimately failed, with the consequences
that Mr. Annunzio has pointed out. None of us is perfect, but I
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0-82-27




412
think we have to learn from this experience and do a better job
next time.
Now let me come to the chargeoff of the loans, and maybe we
can get Mr. Plunk into this. Mr. Plunk, what examination and test
of the soundness of collectability of these loans did you apply under
these circumstances? In other words, I think the people of this community and also the people across the country—and we had a
credit union in Toledo that had an investment—deserve to know
why this bank was suddenly declared insolvent, and what test did
you use to determine the fact that these loans were dead? I think
that was your expression.
Mr. PLUNK. I think we used general credit standards; that being
primarily the performance of those loans—as Mr. St Germain
pointed out earlier, there was a substantial instance of upstream
interest where these borrowers had to rely on the bank to pay their
interest. I might add that by the time our crew entered the bank,
that that amount, that $2.5 million amount had quadrupled. And
also the overdue percentage was quite substantial at 13 percent,
which was 4 to 5 times what we see in a normal bank.
Mr. WEBER. Well, you charged off something like $45 million in
loans, isn't that right? How many loans did you decide to charge
off?
Mr. PLUNK. The final report revealed slightly over $49 million in
losses, which would include loans and other accounts such as accrued interest.
Mr. WEBER. What was the criteria for charging those off? Were
they just overdue or overdue by a certain number of months, or
how did you do it?
Mr. PLUNK. Overdue. When you say overdue
Mr. WEBER. Did you have a rule-of-thumb that you used? I would
like you to explain to the people in this room how you decided
whether a loan was dead or whether it still should be carried on
the books.
Mr. PLUNK. When it could not perform as evidenced by its past
due status or its upstream interest status or substantial overdrafts;
second, the financial capacity of the borrower was not supportive;
and finally, when there was no collateral or insufficient collateral,
we determined it to be a loss.
Mr. WEBER. But you are absolutely sure that those $49 million
that you charged off were dead?
Mr. PLUNK. Yes, sir, I think they were uncollectable.
Mr. WEBER. HOW much do you think will be realized on those $49
million?
Mr. PLUNK. I don't know. It would surprise me if it were greater
than 25 cents on the dollar. And I might add that I think, given
the turn in the oil industry, that there are substantially more
losses in the portfolio.
Mr. WEBER. Some mention was made earlier of runs on the bank.
Can anyone elucidate? Were there runs on the bank in the last
days of Penn Square?
Mr. PLUNK. I'm not sure of the definition of a run. I know that
the lobby traffic was extremely heavy and that the bank initially, I
think on a Friday, they instituted a policy of letting no more than
$10,000 in cash go out, and then they made up the difference with



413
a cashier's check or official check. By Saturday that had been
amended to no more than $5,000 in cash, and then by closing on
Saturday, no more than $1,000 in cash.
Mr. WEBER. That sounds to me as though the bank had a liquidity problem of some dimensions.
Mr. PLUNK. Yes, sir, I would agree.
Mr. WEBER. In the report that you did dated March 31 of 1982,
there was a statement that the external audit was rated unacceptable. Can you explain what external audit you are speaking of?
Mr. PLUNK. That is the December 31, 1981, audit, the external
audit, the CPA audit.
Mr. WEBER. Performed by Peat Marwick?
Mr. PLUNK. I believe so.
Mr. WEBER. What were the reasons to lead you to believe that it
was unacceptable.
Mr. PLUNK. We had a difference over their approach toward the
loan review. My examiners told me that from their review of the
accountants' workpapers, that they had performed only a 15-percent penetration into the bank's loan portfolio, which, of course, as
you know, is a very limited type of approach. I think most banks
prefer to have an 80 percent coverage or penetration.
Second, the collateral and credit documentation exceptions were
just overwhelming. They were 3,000 in number. And on a gross
loan basis, it was about $1.1 million. These were also hard exceptions in that they were unsigned notes; the failure to take an oil
and gas mortgage, and the failure to get engineering reports. They
were quite substantial collateral exceptions.
And also we had trouble with various accounting in the bank,
such as the accrued interest account and I suppose to this date it is
still unreconciled.
Mr. WEBER. Did you bring those criticisms to the attention of the
auditors of Peat, Marwick, Mitchell & Co.?
Mr. PLUNK. They were outside the bank. They had left the bank
by the time our crew had gotten there. We did question some of
their techniques.
Mr. WEBER. Did you bring those specific criticisms to the attention of the auditors?
Mr. POOLE. The bank closed before we had an opportunity to do
that.
Mr. WEBER. Well, I was looking at something that I thought was
dated March 31, 1982, long before the bank was closed.
Mr. POOLE. That was as of the date of examination. It was commenced on April 17.
Mr. WEBER. I understand. Thank you.
Earlier I think you heard me talk rather critically about your efforts to communicate to the board of directors, and if you were
here earlier today, you heard the directors say that most of them
were not even aware of the numerous ways in which you were
trying to communicate to them because your reports were sent to
the bank and the board of directors wouldn't receive these reports
until they came to the board meetings, and then for different reasons they didn't even take them home. They were persuaded that it
was unwise to take them home.



414
Have you considered mailing your reports or your communications directly to the directors either at their own offices or at their
homes?
Mr. POOLE. Well, of course, a decision like that would probably
be one that would not only be made by—well, it would be made
certainly by the Comptroller's Office in Washington, but I personally feel that I would not recommend such a procedure because we
might have 25 directors and it would be not only voluminous to
send 25 copies of a report, potentially this thick, out to the directors, but I personally would not like to have that many copies of
such sensitive information floating around the community.
Mr. WEBER. Would you consider sending a resume or calling attention by direct letter to the directors to the fact that an important report containing sensitive information critical of the performance of the bank is on file in the bank's headquarters and they had
better make themselves aware of it?
Mr. POOLE. I think our current procedure is fully adequate. The
report is sent out with, as was reported earlier, a page, a copy of
which I have here and would like to submit as evidence, which
reads at the top: "We the undersigned directors of Penn Square
Bank, NA, Oklahoma City, Okla., have personally reviewed"—personally reviewed—"the contents of the report of examination dated
September 30, 1981." It is signed by every director of the bank and
it is dated. There is one here from each of the last three examinations.
Now, it would seem to me that since directors primarily do their
business regarding the bank at board meetings in the bank, that
that would be the appropriate place to discuss examinations, and it
would seem sufficient to me to have them sign a statement that
indicates they have personally reviewed, not had it read to them as
was discussed here earlier, but personally reviewed and signed that
statement, that should be sufficient.
The CHAIRMAN. Would the gentleman yield?
Mr. WEBER. I would yield to the Chairman.
The CHAIRMAN. Mr. Poole, that is amazing. You just finished
saying it is a voluminous report. Voluminous report. When did you
contact the regional Federal Reserve Board official here relative to
shutting down Penn Square? Excuse me, sir, I want Mr. Poole.
Mr. POOLE. I don't believe the regional office contacted the
Kansas City Fed regarding that. Contact was made in Washington.
We would normally not have reason to contact with the Federal
Reserve.
The CHAIRMAN. It seems to me there was a letter on July 5 that
went to the gentleman at the Fed from you.
Mr. POOLE. NO, sir, not from me.
The CHAIRMAN. OK, Mr. Serino.
[The witness conferred with counsel.]
The CHAIRMAN. Has you memory been refreshed?
Mr. POOLE. NO, sir. We contacted before—first of all, the Federal
Reserve gets copies of our reports.
The CHAIRMAN. I am sure that I read in my briefing papers that
on that fateful weekend of July 4, 5 and 6, that there was a contact
that had to be made between you and the gentleman who is going
to be testifying here, Mr. Guffey, wherein you sent him a letter



415
saying that—you sent this and he sent a letter back saying no, we
can't do anything, and that would sort of confirm that nothing
could be done.
Mr. SERINO. Mr. Chairman, may I clarify it for you?
The CHAIRMAN. Yes, Mr. Serino.
Mr. SERINO. Prior to the administrative action in 1980, there was
a letter sent, as is our procedure in all administrative actions.
The CHAIRMAN. I am sorry, that is not the one I am referring to.
Actually what I was trying to do was to make a point here.
Mr. POOLE. We did send the letter that you are talking about.
You are talking about the letter on the 5th.
The CHAIRMAN. Yes. It went and came back the same day.
Mr. POOLE. That was not my letter.
The CHAIRMAN. Whose was that, the FDIC?
Mr. POOLE. The Comptroller of the Currency himself.
The CHAIRMAN. Mr. Conover in Washington?
Mr. POOLE. Yes.

The CHAIRMAN. Terrific. You got him in Washington, to the regional office here and back? Fantastic.
Mr. POOLE. NO, sir.

The CHAIRMAN. Federal Express? Was that the Fed in Washington?
Mr. POOLE. At that particular time, the bank was under the control of the Washington office and its staff from Washington.
The CHAIRMAN. I stand corrected. I misread the thing. But my
point is you were saying—here are ordinary individuals that I
don't think are gifted with photographic memory, voluminous reports, they sign a sheet, yes, I've seen the report. In reality, realistically, do you think that they remember every point in that voluminous report at the end of that meeting at which they went over
that report of the Comptroller criticizing and making recommendations? In truth, can you expect any member of the board of directors to remember all of that?
Mr. POOLE. I expect them to remember a sufficient detail from
the report to enable them to live up to their responsibilities in supervising the activities at the bank. That is their innate responsibility.
The CHAIRMAN. Did you go through college and whatever schools
you went through with 100 percent on every test you took? I didn't.
Mr. POOLE. Not by a long shot.
The CHAIRMAN. I didn't, but it seems to me, couldn't you provide
each of them a copy of the points, what was it, about three or four
pages long, of the points, the corrections that they agreed to in the
letter of agreement?
Mr. POOLE. Well, the report has a cover letter and it is addressed
to the board of directors and it is sent to the bank.
The CHAIRMAN. Yes, sir. Shouldn't the members of the board—if
you had asked the members of the board to sign the letter of agreement, that letter of agreement—what was it, five or six pages long?
Mr. POOLE. Yes,

sir.

The CHAIRMAN. Shouldn't they all have copies of that letter they
signed?
Mr. POOLE. Of the agreement?
The CHAIRMAN. The letter of agreement.



416
Mr. POOLE. NO, sir. I don't think we need to have any more
copies of that document circulated around than we have to.
The CHAIRMAN. HOW in God's name do you expect them to remember 3 days later what they signed?
Mr. POOLE. Well, the agreement appointed members of the board
to establish compliance committees to see that the articles were
complied with, and they were to therefore have constant contact in
the bank on a regular basis to oversee the compliance with those
articles.
The CHAIRMAN. I apologize to Mr. Weber for taking his time. It is
just absolutely incredible. You know, it is as though everybody in
the Comptroller's Office took the vow of silence. You know, you can
be oh-so-oversecretive here. This whole secrecy bit is absolutely
banal, idiotic and ridiculous.
Mr. POOLE. I would like to point out that the procedures where
we send only one report to the bank with a letter to the board and
also one copy or whatever of the administrative agreements has in
the vast majority of cases worked well for the Office and has not
led to a breakdown in the quality of communication between the
Office and the banks. It has worked well and we have not deemed
it necessary to change it. But this is a Washington policy matter. It
is not my policy.
The CHAIRMAN. I agree with you you are not the one. You don't
set the policy. But I still say to you and to everybody here assembled that I think it is absolutely ridiculous and preposterous the
way we dealt with these people today. These are nice people, these
people on that board of directors, high class individuals, and, by
cracky, I think that they could have been trusted with the copies of
those letters of agreement, very definitely. I am going to tell you
there are going to be some changes made here. Hopefully we are
going to make some changes in things like that.
Mr. WEBER. I only have one more question. Let me just follow
through with what the chairman said. My evaluation of the people
that we saw on that board of directors, a lot of good, solid citizens
of this and other communities trying to do the best they could but
way in over their heads in dealing with a management that was in
many ways headstrong and recalcitrant and possibly devious, and
there perhaps are some other criticisms that I could make; but my
question really is to what extent did you gentlemen share that observation and proceed and give this board of directors the kind of
help that they needed?
Did you specifically tell them how to implement policy and how
to monitor and how to enforce? Or did you just tell them, this is
your job, you go to it? Because it sounds as though you told them
these are the policies the bank has to have and it is your job to
enforce them, but you didn't tell them how to do it. And maybe I
stand corrected, but did you tell them specifically this is what you
need in the way of a compliance committee or whatever it is that
will have the power and the ability and the capacity to oversee
what this management is doing and to be able to override their
judgments since you were not willing to go so far as to recommend
their removal?



417
Did you go so far as to recommend a committee that would
review every loan and report to the directors, not report to Mr.
Jennings and not report to Mr. Patterson?
Mr. POOLE. The administrative agreement was fairly detailed in
addressing how the compliance committee would be set up and how
it would report to the Office and how it would function.
Mr. WEBER. Excuse me. Who was on that compliance committee?
Mr. POOLE. I do not recall.
Mr. WEBER. DO you know if a compliance committee actually was
set up?
Mr. PLUNK. Yes.
Mr. POOLE. I believe it
Mr. WEBER. Did you

was.
review whether or not the compliance
committee had regular meetings and kept minutes of those meetings?
Mr. POOLE. I believe the compliance committee was established
after our meeting in July, and we found that it was established at
our September meeting. I do not recall the extent to which they
were sending information to us. It would have been requested. But
my point was, as far as your question related to the detailed banking policies, that as you pointed out, it would be very difficult for
the lay members of the board to conjure up, to deploy, let's say,
those policies that were in effect. Our more direct direction to them
was to strengthen the management team of the bank, which as I
pointed out before, we thought they had done with Mr. Beller and
his staff, and that these individuals, being experts in the field of
banking, would aid the board in living up to its responsibilities to
oversee the development of policies and the carrying out of those
policies. And it was our impression based upon our examination in
September that in fact this was the process that had begun, the development of these policies.
Mr. WEBER. Thank you, Mr. Chairman.
The CHAIRMAN. YOU say that they should have known all of this.
The Comptroller's Office was not aware of the fact that this poor
Mr. Beller, who was supposed to be the savior here—God bless him,
I sympathize with him—that there were instructions or memorandums of agreements to the effect that he could do nothing about
loans in the energy area by Mr. Jennings and Mr. Patterson? The
Comptroller's Office was not aware of that?
Mr. POOLE. NO, sir.

The CHAIRMAN. Yet to blame these poor members of the board of
directors, they should know about everything, and you are the professionals. They are just ordinary citizens.
Mr. POOLE. Well, the board, you know—and I say this because I
say it in some board meetings, and it is part of, I guess, my spiel, if
you want to call it that—the boards have to realize that we have
no money in the bank, we have no deposits, we have no stock in
the bank; it is their bank, they are the ones who organized it, and
they are the ones who are charged with the responsibility and they
are the ones who meet on a monthly basis to oversee the activities
of the bank. We are not in the bank 365 days a year. We can't
manage the bank.



418
The CHAIRMAN. Wait a minute. Let me interrupt you. But don't
forget your responsibility to the taxpayers of the United States of
America.
Mr. POOLE. I think my responsibility
The CHAIRMAN. And you have got to remember and I have got to
remember that those responsibilities are that $100,000 deposit
guarantee to all depositors, and that is why you exist, because of
the insuring fund, not just to have meetings of the boards of directors.
Let me ask you this. Is this an accurate report from the minutes
of the meeting held on July 29, 1981 with the board in Dallas?
Mr. Smelser asked Mr. Poole what steps the director should take if he disagrees
with the management actions. Mr. Poole answered by first noting that a director's
job is to make certain the association has a good management team and to be properly informed on that. Thereafter, the director can make his disagreement known
and attempt to have management change its position and ultimately to resign.

In other words, if management won't change its position, resign,
because you see, in this instance
Mr. POOLE. Would you give me a chance to explain what I said?
The CHAIRMAN. YOU will in half a second. In this case you have
got a strong chap, Mr. Jennings. He actually appointed all of these
board members, not originally but he kept them on. Like I said
before, he is the big man in this operation. They couldn't remove
him, could they, Mr. Poole?
Mr. POOLE. Sir?
The CHAIRMAN. They couldn't remove Mr. Jennings, the board of
directors?
Mr. POOLE. I believe they could.
The CHAIRMAN. A S a practical matter? Who appointed most of
them? Who owns the stock in this institution?
Mr. POOLE. Why could they not?
The CHAIRMAN. Who controls the stock in the institution? Was it
Mr. Jennings and his close friends and relatives?
Mr. POOLE. I believe he was a large stockholder, yes.
The CHAIRMAN. The controlling stockholder.
Mr. POOLE. Right.

The CHAIRMAN. Who calls the shots as to who remains on the
board of Directors.
Mr. POOLE. In other words, you are saying you could strip him of
his title, you could take him out of the bank and he would still
have that power. Is that what you are saying?
The CHAIRMAN. What I am saying is when a particular gentleman appoints all the members to the board, he is the powerhouse.
As a practical matter, how many times have you seen that board
rebel against the powerhouse in the institution?
Mr. POOLE. I have seen it happen in certain instances.
The CHAIRMAN. Well, if you would, send me a little note to my
Washington office, and I would like to review this. I don't want to
waste your time here or tax your memory or the time of your
people here, but I would be interested in seeing this.
Mr. POOLE. There was one case where I believe the owner owned
practically all the stock of the bank and we succeeded in getting
him to sell the bank. That is the only way in that case. You can
strip his title. You can even have the board vote him off as a direc


419
tor if that were possible, if someone were a majority owner. But if
he still owns all the stock, there arises the question of will that individual still be able to exercise his authority over the bank.
The CHAIRMAN. YOU said you wanted to explain your statement
to Mr. Smelser?
Mr. POOLE. Yes, sir.
The CHAIRMAN. About resigning.
Mr. POOLE. I don't remember exactly

how the question went, but
I can assure you that my answer was probably in response to a
series of questions such as what does a board member do if he disagrees with the management. Well, to make sure that you have a
good management team is the director's first responsibility, and to
be properly informed on matters. Thereafter the director can make
his disagreements known. My comment, I'm sure, was, when I was
pressed, that what if you try to do this as a board member conscientiously and you failed and you have no other course of action
except to sit there and compromise your principles and your integrity, I guess I said then your alternative would be to resign. I was
not trying to be facetious or suggest that any board member would
resign.
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Mr. Poole, can you say that the Penn Square Bank
was typical of the average national bank that you and your staff
examined?
Mr. POOLE. NO, sir.
Mr. BARNARD. Why
Mr. POOLE. It was

was it not typical?
not typical for two reasons. First, it is a 3rated bank, a problem bank; and second, the level of growth and
the concentration in energy credits made it unique.
Mr. BARNARD. The charges that are before you were taken from
the records of the Comptroller of the Currency, and I think you
have pretty well identified that this was an untypical bank. The
problem had many, many aspects of it: rapid growth, as you just
said, and concentration of loans, as you just said. Do you approve of
a bank like the Penn Square Bank being a loan production office
for a national banking system?
Mr. POOLE. By a national banking system
Mr. BARNARD. I mean for Chase, Continental, Seattle First?
Mr. POOLE. It is unusual. Normally I guess the flow of correspondent relationships is in the opposite direction.
Mr. BARNARD. It is certainly not typical for a bank to hold no
more than 20 percent of its total loan production, is it?
Mr. POOLE. I would say that is unusual.
Mr. BARNARD. Especially for a bank in the situation that Penn
Square would be.
Mr. POOLE. I'm not sure about what you mean.
Mr. BARNARD. Well, here you are talking about a smaller bank
in a big city, not by any measure the largest bank in the community.
Mr. POOLE. Correct.
Mr. BARNARD. Yet probably producing more loans than three or
four other banks put together.
Mr. POOLE. It is unusual, yes, sir.



420
Mr. BARNARD. The whole point is that I think it was untypical to
the degree that it required more attention than the Comptroller's
Office gave it. Now, you said you couldn't be there all the time.
Mr. POOLE. Right.
Mr. BARNARD. But what do you do when you get a call report?
Aren't call reports analyzed and aren't they compared with bank
examination reports to determine what progress a bank has made
in its operations?
Mr. POOLE. Well, in the case of Penn Square we had monthly reports after a period of time.
Mr. BARNARD. YOU had monthly reports?
Mr. POOLE. Yes, sir.
Mr. BARNARD. And yet

you did not find such severe deterioration
until Mr. Plunk came in in April of 1982?
Mr. POOLE. Yes, sir. The reports would only indicate the degree
to which the bank was, as you pointed out, in an unusual situation.
Mr. BARNARD. It would show overdrafts, wouldn't it?
Mr. BARTON. NO, the reports did not show overdrafts.
Mr. BARNARD. DO you mean to tell me a call report does not
show the volume of overdrafts?
Mr. BARTON. The monthly reports we received from the bank did
not.
Mr. BARNARD. Well, why didn't they? That is a typical measure
of qualifications. And also I am surprised you didn't ask for a
schedule of overdrafts because we found in several instances that
you had—Mr. Plunk, didn't you find some overdrafts which were
beyond the legal lending limit?
Mr. PLUNK. Yes, sir, we

did.

Mr. BARNARD. Was that before 1982 or in 1982.
Mr. PLUNK. Most were during 1982.
Mr. POOLE. I don't believe overdrafts were a severe problem in
the bank, to my memory, prior to the examination this year.
Mr. BARNARD. Some of the directors who read your examination
report thought it was a severe problem. That was brought out this
morning. They were concerned about overdrafts. I know you are
sensitive about this and I think you have got a right to be sensitive
about it, but I hope the other 215 class 3 banks that you have in
the country are getting more attention than Penn Square Bank
got. I don't feel that the Board of Directors were aware that the
situation was as severe, even though they have had two meetings
with officials of the Comptroller's Office
Mr. POOLE. If they didn't hear it, then they didn't use their ears.
It was given very clearly, as I testified. I gave it just as clearly, if
not more clearly, than I have in the dozens and maybe even hundreds of board meetings that we have held in regional offices that I
have been in charge of.
Mr. BARNARD. But you didn't sense the seriousness of the situation and do anything about it.
Mr. POOLE. The seriousness of the situation as it developed this
year was not in existence in earlier years.
Mr. BARNARD. But it jumped from a class 3 bank to a class 5
bank.
Mr. POOLE. Yes, it did, and I think that is an accurate assessment of the degree to which the problem developed in the bank.



^421
Mr. BARNARD. In the meeting t h a t was held in Dallas on July 29,
1981, Mr. Clifton was reviewing the report and he was talking
about the growth of continued liability. That is on page 3 of t h a t
report. It is interesting to note t h a t he was advising the bank how
they could possibly secure sources of funds to satisfy these contingent liabilities, and Mr. Clifton advised the bank t h a t they could
either go to Fed funds, to large CD's and to participations. Don't
you think t h a t they had pretty well saturated the participations
area?
Mr. POOLE. At t h a t time I think they had something like $380
million or $390 million of participations.
Mr. BARNARD. Out of a total loan portfolio of what?
Mr. POOLE. I don't recall what it was at t h a t particular time.
Mr. BARNARD. SO from 1981 on, it grew $2.2 billion in loan participations?
Mr. BARTON. It grew $1 billion after September 1981, so the
market was not saturated with participations.
Mr. BARNARD. HOW did you know that, Mr. Barton?
Mr. BARTON. HOW did I know t h a t then?
Mr. BARNARD. HOW did you know it was growing at this rate?
Mr. BARTON. We did not know it was growing at t h a t speed until
we began the examination in April 1982.
Mr. BARNARD. N O further questions, Mr. Chairman.
The CHAIRMAN. Mr. Wortley.
Mr. WORTLEY. Thank you, Mr. Chairman.
I would like to go back to a statement made earlier today by
Ronald Burks, who testified that Mr. Jennings spoke with the
Comptrollers personnel July 2, indicating t h a t the bank in his
opinion was insolvent. Jennings indicated, however, t h a t the Comptroller's personnel disagreed with his assessment at that time and
that the Federal Reserve stood ready to support the bank through
its discount window.
What is your understanding of this particular occurrence?
Mr. POOLE. I have no knowledge of it, sir.
Mr. WORTLEY. Somebody on your staff has to have some knowledge of it.
Mr. PLUNK. I was at a meeting, I was at several meetings on July
2, and the question of solvency or insolvency was discussed theoretically on several occasions, but there was no formal presentation
or no formal statement made about insolvency.
Mr. WORTLEY. Neither you, Mr. Plunk nor anybody else told Mr.
Jennings t h a t the bank was not insolvent.
Mr. PLUNK. I don't recall the exact words used, but at that time
losses identified did not exceed the bank's capital structure. Therefore, we could not say t h a t it had been declared insolvent.
Mr. WORTLEY. Let's look at some of the other chronology of this
period. Your agency commenced general examination of the bank
on April 19, but you didn't notify the FDIC until J u n e 23.
Mr. POOLE. No, sir, May 21.
Mr. WORTLEY. May 21?
Mr. POOLE. Yes, sir.
Mr. WORTLEY. DO you have documentation
Mr. POOLE. Yes, sir. There is a copy in my



on that?
testimony.

422
Mr. WORTLEY. Why did it take about a month until you got
around to notifying the FDIC of the problems?
Mr. POOLE. Well, even at that time when I talked to Mr. Jackson
I was not sufficiently aware of the extent of the bank's problems to
give him any real feel for the problems that existed, and it was
truly not until June 23 that my knowledge of the depth of the
problem was sufficient to provide any detailed information. The
call on May 21 it was just a preliminary indication that I could tell
him what I had heard from the examiner on May 13.
Mr. WORTLEY. Did your people notify either the depositors of
Penn Square or the correspondents of Penn Square during the final
days of the bank's operation as to the status of the situation? In
other words, did you folks tell Continental and then tell Chase that
a problem existed?
Mr. POOLE. I think I was asked that question earlier with regard
to the upstream banks, and to my knowledge, and my knowledge is
only second hand, I think if any contacts were made, they were
made in Washington. We did subsequently, as the chairman pointed out, have one of our examiners in Continental, but that was
after, I think, any contact was made by the Washington office to
Continental. But those contacts would not have been made by the
regional people. That would have been a decision on the part of the
Washington office to make those contacts.
Mr. WORTLEY. Well, what determines whether you notified?
Mr. POOLE. Normally there would not be any notification.
Mr. WORTLEY. Was anybody looking out for the small depositor?
Mr. POOLE. I don't know of any way that the small depositors
could have been notified without running the risk of causing a run
on the bank. If you were to call someone and tell them the bank
was in crummy shape, first of all I think I would be violating the
law by putting the bank in jeopardy by disclosing to someone information based upon a confidential examination report.
Mr. WORTLEY. IS there a level of interest that determines whether you are going to be notified or not?
Mr. POOLE. NO, sir, I did not notify anyone. I think the notification, and I will bear being corrected on this because I was not involved, I think the decision to notify was based on the concern for
the Penn Square Bank and the hope that maybe a recuperative
effort as sponsored by a combination of four or five largest upstream participants might be arranged; and also, as I said before,
over our office's concern with the quality of the assets in those
banks too as reflected by our examination of Penn Square. But that
is not necessarily accurate. It is only what I have heard was the
motivation regarding action that I am guessing was taken by the
Washington office.
Mr. WORTLEY. Was there any time in these final days when you
became concerned about the volume of CD's that were owned by
credit unions out there?
Mr. POOLE. We were concerned about the volume of uninsured
deposits, yes, sir, period.
Mr. WORTLEY. Mr. Beller claims that he prepared and presented
a list of CD's to Mr. Robinson in the Office of the Comptroller. Are
you aware of that?



423
Mr. POOLE. Yes, sir, I did hear that that was done. Mr. Robertson
is an official, a deputy controller in the Washington Office.
Mr. WORTLEY. Was anything done about that, to notify the credit
unions?
Mr. POOLE. I don't know that that would have been proper, to
notify any depositor. What would we have told them?
Mr. WORTLEY. YOU were notifying Continental and you were notifying Chase.
Mr. POOLE. Well, as I have indicated, I am not sure when who
was notified.
The CHAIRMAN. Six to seven days before.
Mr. POOLE. Sir?
The CHAIRMAN. Six to seven days before. These were the pearls
of wisdom from the mouths of Mr. Homan and Mr. Conover.
Mr. POOLE. Well, I guess in my opinion their decisions were
based on their motivation for recuperative efforts, and these were
upstream participants and not upstream depositors, if I am not
mistaken. These were people who shared in credit, not people, institutions that had deposits in the bank.
Mr. WORTLEY. In 1978 and 1980, and again in 1982, your examination cited insider activity on loans. In the other intervening periods there is no mention of any insider activity on loans. Am I correct in that?
Mr. POOLE. Yes, sir.
Mr. WORTLEY. Well,

do you think you were doing your job effectively if you were not looking into that during those interim periods?
Mr. POOLE. Yes, sir. In the information I reviewed, even the
volume of insider credit was very minimal. And when there were
any loans to insiders classified, it was only a very small percentage
even of that small percentage.
Mr. WORTLEY. In 1978, 1980 and 1982, there was only very light
activity; is that what you are saying?
Mr. POOLE. Yes, sir, I believe that is correct.
Mr. LEACH. Would the gentleman yield?
Mr. WORTLEY. Yes.
Mr. LEACH. I believe

your 1978 examination indicated that 41
percent of the bank's capital was loaned to one officer of the bank.
I believe it also pointed out that 142 percent of the bank's capital
was lent in one industry. If I am mistaken, please correct me.
Mr. WORTLEY. YOU are right.
Mr. POOLE. But if that were neither illegal nor imprudent, it
wouldn't be a subject of criticism, necessarily.
Mr. LEACH. Forty-two percent to one officer is normal operating
procedure and is acceptable under your auditing guidelines?
Mr. POOLE. I am not familiar with that situation but I would
have to believe that it was not an executive officer of the bank, and
that it was not a type of lending situation that was combinable
under the provisions of 12 U.S.C. 84, or that it fell under one of the
13 exceptions to 84.
Mr. LEACH. Let me read this and maybe you can explain it.
Other concentrations included related lines of credit of 41 percent of the capital;
directors' and other related loans that have been sold to other banks and related
lines sold to another bank were up 23 percent.



424
Mr. POOLE. It is our practice to list what we consider to be concentrations of credit, and these are not listed for purposes of criticism but for purposes of information to the board so that they
might be aware of those concentrations, if they are not.
Mr. WORTLEY. Are you finished, Mr. Leach?
Mr. LEACH. Yes.

Mr. WORTLEY. Thank you. I would say 41-percent concentration
in loans to insiders is pretty high. How can you say, as you did a
moment ago, that it wasn't a critical issue?
Mr. POOLE. It would not be a critical issue unless the loans to the
insider or to the insiders were of poor quality. There is nothing intrinsically wrong with lending—with loans to insiders, as long as
those loans are not at preferential rates and as long as they are not
at preferential terms, and as long as they are properly structured
and are not of poor quality.
Mr. WORTLEY. And the loans that you determined should have
been written off when you closed Penn Square, were any of those
made to insiders?
Mr. BARTON. Yes.
Mr. WORTLEY. They were?
Mr. BARTON. Yes.
Mr. WORTLEY. DO you have the names of those insiders?
Mr. SERINO. We would prefer at this time, Mr. Congressman,

not
to disclose the names of the borrowers in the financial institution.
Mr. WORTLEY. I will accept that.
The CHAIRMAN. Excuse me, would the gentleman yield?
Mr. WORTLEY. I would yield.
The CHAIRMAN. Are you talking about loans to insiders that were
in excess of the statutory amounts?
Mr. SERINO. Yes.
Mr. POOLE. That was not the question, was it?
The CHAIRMAN. Well, let's ask the question that way.
Mr. PLUNK. Yes, there were.
The CHAIRMAN. Were there loans to insiders beyond

the—that

exceeded the statutory amounts?
Mr. PLUNK.

Yes.

Mr. POOLE. There were both loans to insiders that were criticized
and there were loans to insiders that were in violation of the law.
The CHAIRMAN. And under FIRA, aren't you required to make
those public so that they are available to the public, at the regional
office of the Federal Reserve Board? Loans to officers and insiders?
Mr. SERINO. Mr. Chairman, there are some requirements in
FIRA for reports to be submitted to our office. One deals with borrowings from officers of correspondent banks, and this was a loan
made by this bank to certain of its directors.
The CHAIRMAN. DO you have the aggregates among the insiders
at the end of the year?
Mr. SERINO. Yes. I believe that is in the summary that was submitted today.
The CHAIRMAN. I thank the gentleman for yielding.
Mr. WORTLEY. YOU concerned yourself with insider loans that
had been originated by the bank that then were taken over or participated in by Continental Illinois or Chase or someone else?



425
Mr. POOLE. Loans t h a t were sold by one bank—insider loans—to
another.
Mr. WORTLEY. Insider loans made by Penn Square and then sold
to another bank.
Mr. POOLE. We would be concerned from the standpoint of FIRA,
the extent to which we would make sure t h a t the directors of one
financial institution were not using their influence as insiders of
that institution to gain preferential loans at another institution.
Yes.
Mr. WORTLEY. Thank you. I yield back the balance of my time,
Mr. Chairman.
The CHAIRMAN. Mr. Plunk, you stated that there were what,
3,000 loans? What was t h a t 3,000 number you gave us a little while
ago?
Mr. PLUNK. That was an internally prepared list of collateral
and credit-filed exceptions.
The CHAIRMAN. That is an internally prepared list prepared by
the bank?
Mr. PLUNK. By the bank's internal review.
The CHAIRMAN. And when did you first come across that list?
Mr. PLUNK. I think t h a t would have been early May.
The CHAIRMAN. And when was the previous list prepared? Was
that the first time they prepared one?
Mr. PLUNK. I think so. That was the first list, and it was prepared as of March 31 and was manually prepared, so it took that
long to get it together.
The CHAIRMAN. Manually prepared? There are quite a number,
aren't there? How long do you think it took to accumulate 3,000
loans that were improperly collateralized, et cetera, or documented?
Mr. PLUNK. Given their loan volume, which was a billion dollars
in loans were put on the books in the last 7 to 8 months.
The CHAIRMAN. Well, you are giving us a number, but a lot of
those loans were of pretty high numbers, weren't they?
Mr. PLUNK. Yes, sir.
CHAIRMAN. HOW many loans would t h a t $1 billion
PLUNK. I have no way of knowing.
CHAIRMAN. Would you supply that for the record?

The
Mr.
The

represent?

Mr. PLUNK. Pardon?

The

CHAIRMAN.
Mr. POOLE. Yes,

Would you supply t h a t for the record?
sir.

[As a result of the above colloquy, the following letter, dated September 28, 1982, was received from Comptroller of the Currency
C. T. Conover:]




426

O
Comptroller of the Currency
Administrator of National Banks

Washington, D.C. 20219
September 28, 1982

Re:

Penn Square Bank, N.A., Oklahoma City, Oklahoma
Loans sold after 9/81

Dear Mr. Chairman:
During testimony in Oklahoma City, you asked for information
regarding the volume of loans sold by Penn Square Bank, N.A.,
after the September 1981 OCC presence in the bank. While our
records do not reflect the actual number of transactions, the
figures listed below, and displayed graphically in the
attachment, demonstrate the massive change in the bank's loan
volume in late 1981 and early 1982.
Date

Balance of Total
Participations Sold

9-30-81
12-31-81
3-31-82
6-30-82

$1,135,000,000
1,573,000,000
1,873,000,000
2,116,000,000

Total change - $981,000,000 or 86%
You also asked for some additional information regarding loan
documentation exceptions. The credit and collateral exceptions,
as developed during the April 1982 examination, reflected 709
loans, totalling $1.1 billion, with 3,101 exceptions. Of these
loans, $798,000,000, or 73% of the total, were made after
September 30, 1981.




427
Also, the losses on assets originating after September 1981 break
down as follows:
Accrual interest on loans
Miscellaneous, other assets
and overdrafts
Overdrafts related to
borrowers' lines
Actual loan balances
TOTAL
Sincerely,

C.T. Conover
Comptroller of the Currency
The Honorable
Fernand J. St Germain
Chairman, Committee on Banking,
Finance and Urban Affairs
2129 Rayburn House Office Building
Washington, D.C.
20515
Attachment




$(2,801,000)
(733,000)
(6,548,000)
(18,424,000)
($28,506,000)

428
PENN SQUARE BANK, N.A.
LOAN GROWTH HISTORY
($ MILLIONS)

^GROSS
/LOANS

TOTAL
LOANS
SOLD

12/79

3/80




6/80

9/80

12/80

3/81

6/81

CALL REPORT DATES

9/81

12/81

3/82

429
Mr. POOLE. There could be a number of documentation exceptions.
The CHAIRMAN. We would like to know how many loans this involved. That would be most helpful.
Mr. BARTON. With the billion-dollar increase in the participation
sold?
The CHAIRMAN. Correct.
Mr. BARTON.

OK.

The CHAIRMAN. DO any other members have anything else?
Mr. LEACH. Just one conclusion. Financial institutions have
modes of operation t h a t perhaps change faster t h a n we in Congress
or the regulatory bodies realize. But it strikes me t h a t this bank
has been examined as kind of a community bank when in reality it
was on the cutting edge of a new kind of go-go banking. Penn
Square was the queen of spades in the house of cards t h a t stretches
the length and breadth of American banking, and based upon
changes in banking, I think bank regulators are going to have to be
a little quicker in looking at problems as they arise over time.
I would say finally, though, on the positive side, t h a t you people
understood and followed the problem and, in the final measure,
closed the bank in decisive fashion. Some of us, in retrospect, might
have wished it were closed a little bit earlier or t h a t corrective
action had been taken that would have preserved the bank and,
more importantly, the relationships with other banks. But I think
that you did act very promptly before the American banking
system was stretched too far.
It is my hope this is going to be a lesson for the entire banking
industry and I am sure you are going to have to look at your
agency, just as we in Congress are going to have to look at our legislation, in a little different way given the new type of banking
that is developing. I don't think you get an A, but I also don't
think you get an F. The fact of the matter is t h a t all of us have a
lot to learn from this.
Mr. POOLE. I can assure you t h a t the Comptroller's Office, and I
personally as a regional administrator, and all of our examiners, it
is not a pleasant experience, and our people have had to work hard
and we are deeply troubled by the closing. And while we believe we
acted properly, we are continuing to evaluate our procedures, as we
always are, and we will make changes in our procedures and, hopefully, we will learn from this situation, too. But it is an expensive
lesson.
Mr. LEACH. Mr. Poole, I appreciate t h a t statement more than
anything t h a t has been said here today. Thank you.
The CHAIRMAN. The Chair would like to thank the witnesses.
There may well be some additional questions t h a t we would like
answered in writing. Some of those I have myself, but I am sure
you do not have the answers at your fingertips.
Mr. Evans also has some questions he would like to submit, and
we will submit them to you and we would appreciate your answering them for the record. Thank you, gentlemen.
We will call Mr. Roy Jackson, regional director, FDIC, and
James Hudson, FDIC liquidator in charge of liquidation at Penn
Square.
[Witnesses sworn.]



430
TESTIMONY OF ROY E. JACKSON, REGIONAL DIRECTOR, FDIC;
AND JAMES HUDSON, LIQUIDATOR IN CHARGE OF PENN
SQUARE, FDIC

The CHAIRMAN. Mr. Hudson, we have read some complaints on
the FDIC's handling of the liquidation of Penn Square. They have
ranged from accusations that you allowed large banks to take files
out of the bank; that you have frozen set-aside accounts; that you
have not been cooperative with borrowers in seeking to find other
financing sources.
We would like to have your version of these stories, specifically,
did upstream banks have access to the bank records, and have accounts been frozen, and under what circumstances. What is the
process used in allowing loans to be refinanced with other banks?
Just start with those three, just so we can clear them up. First, did
upstream banks have access to bank records over and beyond what
others have had?
Mr. HUDSON. We arranged for them to receive copies, yes, sir.
The CHAIRMAN. Have accounts been frozen, and under what circumstances?
Mr. HUDSON. Yes, accounts have been frozen. We freeze the accounts of directors and we freeze accounts where we have offset capabilities. When a loan is past due, we have the right of offset.
The CHAIRMAN. In other words, the same individual has a deposit
Mr. HUDSON. It was mutual, yes, sir.
The CHAIRMAN. Has a loan as well.
Mr. HUDSON. Yes,

sir.

The CHAIRMAN. That is what you mean by offset?
Mr. HUDSON. Yes, sir.
The CHAIRMAN. What

is the process used in allowing loans to be
refinanced with other banks?
Mr. HUDSON. We encourage customers to go out to—they need an
ongoing banking affiliation, and we encourage them to go out and
refinance if at all possible. If not, we collect the loans in accordance with their terms.
The CHAIRMAN. Mr. Hudson, have you completed your inventory
of the assets of the bank?
Mr. HUDSON. Almost; not quite, sir.
The CHAIRMAN. Can you at this point tell us as to those assets
that you have inventoried what is the percentage of and/or the
dollar volume of energy loans? What does it look like to you at this
point?
Mr. HUDSON. Approximately $321 million.
The CHAIRMAN. In energy loans?
Mr. HUDSON. Yes, sir.
The CHAIRMAN. That are assets?
Mr. HUDSON. Yes, sir.
The CHAIRMAN. That includes the

participations that were sold

off? Is that correct?
Mr. HUDSON. NO, sir.

The CHAIRMAN. Mr. Hudson, has everyone received receivorship
certificates of their accounts in amounts receivable from the bank?



431
Mr. HUDSON. NO, sir. The ones that have claimed, most of them
have received a receipt, but it is not a receivership certificate. They
will be processed and it will take some period of time to access all
of those.
The CHAIRMAN. Can you tell us approximately how long that
might take?
Mr. HUDSON. Thirty to 90 days; I understand some of the financial institutions have received certificates so they could discount it
to the Fed.
The CHAIRMAN. Mr. Jackson, when were you first contacted by
the regional administrator in Dallas of the Comptroller's Office regarding the problems at Penn Square?
Mr. JACKSON. Mr. Chairman, the first reference I had to Penn
Square was the May 21 conversation with Mr. Poole in which he
concluded by indicating that he would soon be providing my office
with a copy of 4-rated banks, and included on that list would be
Penn Square after the conclusion of the examination.
The CHAIRMAN. And the next contact?
Mr. JACKSON. The next contact was on a Wednesday, late in the
afternoon, June 23, at which time he advised me that the loans
classification at that time approximated $22 million against a capital account of about $37 million. And I believe I have those figures
about right.
He also apprised me of the fact that there were a great deal of
upstream participations and downstream participations.
The CHAIRMAN. AS the regional director of the FDIC, what were
you doing during that period June 28 through the liquidation
period itself?
Mr. JACKSON. Beginning on June 30, my first act was to move
two people into Oklahoma City for the purpose of going into Penn
Square on Thursday morning. It was sort of a dual thrust. One, we
needed to get as much information as we could to determine
whether or not a purchase and assumption transaction would be
feasible.
Second, they wanted to be developing financial data and other information so that in case we could do a purchase and assumption
transaction, an assisted transaction, that we would be in a position
to do so. That was Wednesday.
Thursday, we determined to move six more people into Oklahoma City as backup for the purpose of going into the bank to help
with this package. And we placed, I suppose, an additional 17 or 18
field examiners on notice, preparing them to go to Oklahoma City
on short notice.
On Friday morning, we determined to move the balance of our
examiners that were on alert to Oklahoma City to be on standby
for whatever occurred. On Friday afternoon I moved to Oklahoma
City myself to be there for whatever might transpire.
I worked at the Oklahoma City field office throughout the weekend coordinating matters with our examiners in the bank, and continued to develop financial data for the purpose of an assisted
transaction, if such were possible.
One other action that I was taking—and this began about
Wednesday—we started developing a list of what we refer to as potential bidders; those groups and individuals who we think might



432
have the financial capability and the expertise to enter into some
sort of an assisted transaction, if we do such.
The CHAIRMAN. What happened to t h a t list? It was not a very
long list that you came up with, was it?
Mr. JACKSON. It is very difficult in Oklahoma. Yes, sir. I think
we ended up with a basic list of about 12 groups and individuals
t h a t we thought might have some interest. With the State law
being like it is, it is very difficult in Oklahoma.
The CHAIRMAN. But obviously, as a result of what happened, t h a t
list of 12 just withered away.
Mr. JACKSON. That is correct, sir.
The CHAIRMAN. It became nonexistent, is that correct?
Mr. JACKSON. It resides somewhere in the files, yes, sir.
The CHAIRMAN. The Comptroller of the Currency's witness a
little earlier—I think he was sitting right back there—stated—Mr.
Plunk said t h a t the loans, many of these loans, might bring about
25 cents on the dollar. How does this compare with the 80 percent
numbers t h a t the FDIC has been floating to date?
Mr. JACKSON. That estimate would not compare very favorably,
sir.
The CHAIRMAN. Well, whose estimate do you think might be
closer to accuracy?
Mr. JACKSON. I am not sure I would be in a position to respond. I
have never looked at the loans. I only have the figures t h a t were
given to me, sir.
The CHAIRMAN. But we are getting those numbers from—did we
get t h a t from the FDIC? Who gave us those? The Federal Reserve
gave us that?
Mr. JACKSON. The 80 percent you referred to?
The CHAIRMAN. Yes.
Mr. JACKSON. I am

not sure where it was originated. It was
passed down to me from our Washington office immediately after
the closing of the bank, but I am not too sure who came up with
the figure.
Mr. LEACH. If you would yield, Mr. Chairman.
The CHAIRMAN. Let me just ask Mr. Hudson if he has a feel for
what this will be worth.
Mr. HUDSON. N O , sir.

The CHAIRMAN. Is 25 cents on the dollar more accurate t h a n 80
cents, or is 80 cents more accurate t h a n 25 cents?
Mr. HUDSON. It is difficult to tell at this time, with the amount of
loans t h a t have been upstream and downstream, estimating where
the losses are going to go. It would be impossible, in this short
period of time, to have any degree of accuracy in the forecast of
that.
Mr. BARNARD. Mr. Chairman, would you yield? Isn't this estimate included in the receivership certificate?
Mr. HUDSON. N O , sir.

Mr. BARNARD. I was under the impression that it was.
The CHAIRMAN. YOU are not the only one.
Mr. JACKSON. I believe the estimate represents the allowable
value against each certificate. The certificate would represent 100
percent of the claim, if I am not incorrect, and the banks or financial institutions were allowed to book 80 percent of t h a t figure.



433
The CHAIRMAN. Mr. Leach?
Mr. LEACH. Mr. Chairman, we are here not just to criticize; we
want to learn from this experience. From the FDIC's perspective,
what weaknesses exist in the regulatory process that should be corrected, and what changes should be considered by Congress so that
we don't have another Penn Square? Specifically, do you think that
there is a need for five banking regulatory agencies? Is there a
need for three separate deposit insurance funds? Do you think deposit insurance premiums should reflect the risk posed by the insured entity rather than continue the present flat rate system?
Mr. JACKSON. If you will keep in mind that I am speaking as a
lowly regional director and not a policymaking body from Washington, I will certainly try to respond.
Mr. LEACH. Please.
Mr. JACKSON. I have opinions on most of those subjects. The first
one I believe dealt with which one, Mr. Leach?
Mr. LEACH. The five regulatory
Mr. JACKSON. Despite my allegiance to the FDIC and my conviction that deposit insurance has, indeed, served its purpose and
served it well, I have reluctantly come to the conclusion sometime
back and shared it with whoever would take time to listen to me,
that that is not really realistic. That this many regulatory bodies
simply does not make a great deal of sense, and it is with a great
deal of reluctance that I say that.
The CHAIRMAN. Don't feel bad.
Mr. LEACH. HOW about the three deposit insurance funds?
Mr. JACKSON. Well, you know, once again I have a personal problem here. We have a very stable fund and one that has a 50-year
buildup behind it. The $12, $13 billion did not happen by accident;
it happened because a lot of responsible people dealt very carefully
with the assessment funds that we received. And I think a great
deal of study would have to go into the various funds to see if, in
fact, overall, we would be improving or not improving. I am not
sure I could express an opinion on that.
Mr. LEACH. Should deposit premiums be based upon risk?
Mr. JACKSON. I think it would be a wonderful concept. I am very
much in favor of it. The only thing is I have never been able to
figure out how we could come up with that factor. It would be the
ideal solution, if we could simply come up with the answer.
Mr. LEACH. Mr. Hudson, would you concur in these observations?
Mr. HUDSON. My observation would be no, yes and no. [Laughter.]
Mr. LEACH. Fair enough. Let me conclude with two brief comments. Whenever we look at a bank failure, it is tempting to see
only the bad. Because of the FDIC, because of the Comptroller's
office, and because of the State regulatory agencies, however, bank
failures are unusual occurrences rather than the norm.
If I were a college professor giving grades, the Comptroller's
office would get a C or a C— in this case. The FDIC, however,
would get a very high mark, indeed. When it was brought into the
Penn Square case, the FDIC made decisions with a resoluteness
that is admirable. In the final measure, the Federal Government
exercised good judgment, which reflects very well on the FDIC and



434
less well, but certainly not negatively, on the Comptroller of the
Currency.
The CHAIRMAN. Mr. Barnard?
Mr. BARNARD. I have no questions, Mr. Chairman.
The CHAIRMAN. Mr. Weber?
Mr. WEBER. I just wish you a lot of luck in collecting those
assets.
Mr. JACKSON. Thank you.
Mr. HUDSON. Thank you.
Mr. Chairman, may we have permission to put our statements in
the record?
The CHAIRMAN. Yes, at the conclusion, we will place your entire
statements in the record.
[The statements of Mr. Jackson and Mr. Hudson follow:]




435
STATEMENT OF

ROY E. JACKSON
REGIONAL DIRECTOR
FEDERAL DEPOSIT INSURANCE CORPORATION

BEFORE THE

COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS

August 16, 1982
OKLAHOMA CITY, OKLAHOMA




436
The letter inviting me to appear before this Committee suggested that
my testimony would be valuable to the Committee's understanding of the
relationship between the FDIC and the OCC and of the events leading to the
closing of the Penn Square Bank, N.A.

I f m happy to be of as much assistance

as 1 can.
The FDIC's Dallas Office works at maintaining cooperative relations
with the Office of the Regional Administrator of National Banks, as well as
with the other bank supervisory agencies.
reciprocated.

Our efforts are, I believe,

As example of efforts by the various agencies to improve

interagency coordination and cooperation is the quarterly meetings of members
of executive staffs of the agencies.

The last such meeting, held on July 22,

included senior representatives from the Federal Reserve Bank, Dallas;
Federal Reserve Bank, Kansas City; Office of the Comptroller of the Currency,
Dallas; FDIC, Dallas; State Banking Department, Austin; and State Banking
Department, Oklahoma City.
Regional Administrator of National Banks Poole and I have frequent
telephone conversations on banking matters of mutual interest and our staff
members do not hesitate to call their counterparts as the need arises.

My

office routinely receives and reviews copies of all reports of examination
of National banks, developing and maintaining basic statistical and narrative
data from all examination reports and providing our Washington Office with
comprehensive memorandums on 4 and 5 rated banks in which we focus on the
identification and nature of the problem and the corrective action being
taken.
In developing an outline of the chronology of events leading up to the
Penn Square Bank closing, I have reviewed my telphone notes and submit the
following:




437
On May 21, 1982, a telephone conversation with Regional Administrator
of National Banks Clifton Poole, on supervisory matters in general, concluded
with an indication that he would soon- send me a list of any " 4 " rated
National banks in Oklahoma, and that the list would include Penn Square
after the examination in process was concluded.
On June 23, 1982, Mr. Poole informed me by phone that the incomplete
examination of Penn Square had disclosed loan losses of $22 million, sizable
overall adverse classifications, and a heavy volume of loan participations
sold.

Total capital was indicated to be some $37 million with owners pro-

fessing to have $22 million available for injection if necessary.

The

information was relayed by telephone to our Washington Office with a File
Memorandum prepared for the record.
On June 28, 1982, Mr. Poole called to inform me that he and other
representatives of OCC were to meet with the Penn Square directorate either
Wednesday, June 30, or Thursday, July 1, to inform them of findings to date.
Mr. Poole indicated he would place a Cease-and-Desist Order on the bank
which would require additional capital and correction of defects in loan
documentation.

This conversation was reduced to File Memorandum and also

relayed to our Washington Office.
On Wednesday, June 30, I arranged for FDIC examiners to go to Oklahoma
City to develop data needed by the FDIC.

Also, the FDIC Dallas Regional

Office staff spent Thursday, July 1 and the morning of Friday, July 2, primarily in continuing to prepare for a possible purchase and assumption
transaction and in arranging for additional examiners to move in the direction
of Oklahoma City from various parts of our four-State region.

On Friday after-

noon, July 2, I moved my base of operations to Oklahoma City, where I worked
out of our Oklahoma City Field Office preparing for a purchase and assumption
transaction or payoff, depending upon the determination of the Board of
Directors of the FDIC.

I returned to my Dallas office July 7, 1982.

I hope the Committee will find the foregoing comments to be helpful.




438

August 5, 1982

MEMORANDUM TO:

Committee on Banking, Finance and
Urban Affairs
House of Representatives

FROM:

James P. Hudson

MR. CHAIRMAN:
I AM PLEASED TO HAVE THE OPPORTUNITY TO TESTIFY BEFORE THIS COMMITTEE
REGARDING FEDERAL DEPOSIT INSURANCE CORPORATION'S LIQUIDATION PROCESS IN
THE FIELD REGARDING PENN SQUARE BANK, N.A. OF OKLAHOMA CITY.

ON THURSDAY NIGHT, JULY 1, 1982, I RECEIVED NOTICE THAT PENN SQUARE BANK
OF OKLAHOMA CITY WAS IN IMMINENT DANGER OF FAILING AND THAT I WOULD BE
NAMED LIQUIDATOR-IN-CHARGE.

I WAS AT THAT TIME ATTENDING A TRAINING

SESSION IN WASHINGirN, D.C. AND ARRANGEMENTS WERE MADE FOR ME TO TRAVEL
TO OKLAHOMA CITY FRIDAY MORNING.

UPON ARRIVAL IN OKLAHOMA CITY THAT AFTERNOON, URGENT NOTICE WAS RECEIVED
FROM THE OFFICE OF THE COMPTROLLER OF THE CURRENCY'S EXAMINERS IN THE
BANK THAT THEY REQUESTED SENIOR FDIC EMPLOYEES ON HAND TO COME TO THE




439
BANK AS IT APPEARED THAT THE BANK MIGHT CLOSE THAT AFTERNOON.

MICHAEL

NEWTON, WAYNE NESS AND I RESPONDED TO THE REQUEST AND MET MR. WILLIAM L.
ROBERTSON OF THE COMPTROLLER'S OFFICE AT THE BANK.

ALL FDIC EMPLOYEES IN OKLAHOMA CITY WERE PLACED ON READY ALERT FOR A
POSSIBLE CLOSING AT 12:00 NOON SATURDAY.

THIS WAS CONSIDERED A CRITICAL

TIME IF WE WERE TO PREPARE FOR ANY EVENTUALITY ON TUESDAY MORNING,
MONDAY BEING THE FOURTH OF JULY HOLIDAY.

ACCESS TO THE BANK'S RECORDS

AND EMPLOYEES ARE CRITICAL TO OUR OPERATIONS.

SATURDAY AFTERNOON WE RECEIVED.A CALL FROM WASHINGTON THAT NEWTON, NESS
AND I WERE TO PROCEED TO THE BANK TO MEET WITH MR. BILL JENNINGS. WHEN
WE ARRIVED AT THE BANK WE MET IN MR. JENNINGS' OFFICE WITH HIS ATTORNEY
MARION BAUMAN.

WE HAD A GENERAL DISCUSSION OF FDIC PROCEDURES AND MR.

JENNINGS OFFERED TO BRING IN SOME OF THE BANK'S SENIOR OFFICERS TO MEET
WITH US TO PLAN FOR ANY EVENTUALITY ON TUESDAY^ AFTER LEAVING THE BANK,
WE WERE INFORMED TO KEEP OUR STAFF ON READY ALERT.




440
ON SUNDAY AFTERNOON WE WERE AGAIN ORDERED TO THE BANK TO MEET WITH MR.
JENNINGS AND REQUEST SPECIAL SERVICES OF THE DATA PROCESSOR AND OTHER
INFORMATION FROM THE BANK PERSONNEL TO PREPARE FOR A POSSIBLE CLOSING ON
TUESDAY.

WE WERE INSTRUCTED NOT TO TAKE ANY ACTION, HOWEVER, THAT WOULD

CAUSE THE BANK NOT TO REOPEN AS USUAL ON TUESDAY MORNING.

WE EXPLAINED

FDIC'S PROCEDURES ON A STRAIGHT PAYOFF AND A DEPOSIT INSURANCE NATIONAL
BANK (HEREAFTER REFERRED TO AS "DINB") OPTION TO MR. JENNINGS.

WE

ADVISED THAT THE OPERATIONS OF A DINB WOULD BE IN THE BEST INTERESTS OF
THE DEPOSITORS SINCE THE INSURED DEPOSITORS WOULD HAVE IMMEDIATE ACCESS
TO THEIR FUNDS.

WE ADVISED THAT WITHOUT ACCESS TO EMPLOYEES, RECORDS

AND DATA PROCESSING FACILITIES, WF WOULD BE UNABLE TO OPEN A DEPOSIT
1
r

_

*
-

i

INSURANCE NATIONAL BANK ON TUESDAY MORNING.N MR. JENNINGS ADVISED THAT
HE WOULD CALL IN THE SENIOR OPERATIONS OFFICERS TO ASSIST US IN
PLANNING.

;&S^iET THAT NIGHT WITH SOME OF THE SENIOR OFFICERS AND WE BEGAN
PREPARING A WORK PLAN FOR TUESDAY.
BY SUNDAY MIDNIGHT.




SPECIAL RUNS WERE MADE AND DELIVERED

FDIC EMPLOYEES WORKED ALL NIGHT SUNDAY IDENTIFYING,

441
WITH THE HELP OF BANK PERSONNEL, THE EXCESS DEPOSITS AND POSSIBLE
OFFSETS AGAINST DELINQUENT LOANS. WE WERE SOMEWHAT HANDICAPPED BECAUSE
SOME OF SATURDAYf S\ WORK WAS LOCKED IN VAULTS AND WE COULD NOT HAVE
ACCESS UNTIL TUESDAY MORNING.

WE AGREED TO MEET WITH THE OFFICERS THE

NEXT MORNING (THE MONDAY HOLIDAY) TO CONTINUE OUR WORK.

THROUGHOUT

MONDAY OUR WORK CONTINUED ON FREEZING EXCESS AND OFFSET ACCOUNTS.
BANK EMPLOYEES WERE BROUGHT IN TO HELP.

SOME

OUR STAFF WAS STILL UNDER

ORDERS NOT TO DO ANYTHING THAT WOULD KEEP THE BANK FROM NOT OPENING
TUESDAY.

THAT AFTERNOON WE MET WITH SENIOR AND EXECUTIVE OFFICERS OF

THE BANK AT WHICH TIME THE PLAN WAS DISCUSSED.

AT 7:05 P.M. WE RECEIVED WORD THAT THE BANK WAS DECLARED INSOLVENT BY
THE COMPTROLLER OF THE CURRENCY, FDIC WAS APPOINTED RECEIVER AND A
DEPOSIT INSURANCE NATIONAL BANK WOULD BE OPENED AT 9:00 A.M. TUESDAY
MORNING.

THE DINB OPENED AT 9:00 A.M. TUESDAY MORNING AND LINES FORMED

THROUGHOUT THE DAY.

HOWEVER, AT 7:00 P.M. THE LINES HAD DISAPPEARED AND

THE BANK CLOSED FOR THE EVENING.

AFTER MAKING TRAFFICING CHANGES ON

WEDNESDAY, THE LINES FOR SMALL DEPOSITORS DISAPPEARED, HOWEVER, BECAUSE




442

OF ADMINISTRATIVE PROCEDURES IN PROCESSING TIME AND EXCESS DEPOSITS, A

LINE

OF

APPROXIMATELY

30 PEOPLE

REMAINED

THROUGH

THE WEEK.

BY

TEMPORARILY PAYING INTEREST ON TIME DEPOSITS, WE WERE ABLE TO AVOID VERY

EXTENSIVE LINES.

DEPOSITORS COULD CONTINUE WRITING CHECKS TO THE EXTENT

OF THE INSURED DEPOSIT TRANSFERRED

EXCEPT THOSE CUSTOMERS WHO

ACCOUNTS FROZEN FOR EXCESS AND POSSIBLE OFFSET PURPOSES.

WE ATTEMPTED

TO ACCOMMODATE THE EXCESS DEPOSITORS WITH TRANSACTION ACCOUNTS

QUICKLY AS POSSIBLE.

HAD

AS

CUSTOMERS WERE ENCOURAGED TO OPEN ACCOUNTS AT

OTHER BANKS IN THE AREA TO AVOID COMING TO THE BANK AND THE AUTOMATIC

TELLER MACHINE WAS TEMPORARILY UTILIZED TO PROVIDE FURTHER ACCESS TO THE

DEPOSITORS FUNDS.

THE DINB IS STILL IN OPERATION AND AS OF 8-12-62 THERE REMAINED ON

DEPOSIT $30,500,000.00.

CERTIFICATES

TOTAI ING

IN ADDITION WE HAVE ISSUED 558 RECEIVERSHIP

APPROXIMATELY

3153,000,000.00

ACCOUNTS TOTALING APPROXIMATELY $31,500,000.00.

AND

OFFSET

250

A TREMENDOUS VOLUME OF

WORK HAS BEEN PROCESSED BY THE DINB AND IT PROVED TO EE A QUICK METHOD

OF MEETING FDIC'S OBLIGATION TO THE INSURED DEPOSITORS.




LONGER LINES

443

AND PANIC WERE AVOIDED BY THE SMALL DEPOSITORS WHO WOULD HAVE BEEN
REQUIRED UNDER A STRAIGHT PAY OFF TO WAIT IN LONGER LINES IN THE 100°
JULY HEAT.

MICHAEL NEWTON IS RESPONSIBLE FOR THE OPERATIONS OF THE TEMPORARY
DEPOSIT INSURANCE NATIONAL BANK AND AL PORTERFTELD IS RESPONSIBLE FOR
THE ADMINISTRATION OF CLAIMS.

I AM RESPONSIBLE FOR RECEIVERSHIP

ACTIVITIES AND THE COLLECTION OF ASSETS.

WHILE TAKING CONTROL OF THE BANK AND PROVIDING FOR THE INSURED
DEPOSITORS, OUR PRIMARY OBLIGATION, WE SIMULTANEOUSLY
ATTENTION TO THE COLLECTION OF ASSETS.

FOCUS OUR

AS OF 8-12-82, THE LIQUIDATION

$TAFF TOTALS 50 LIQUIDATORS, 72 LOCAL PROFESSIONAL EMPLOYEES AND 178
CLERICAL SUPPORT EMPLOYEES.

WE ARE UTILIZING THE BANK'S COMPUTER SYSTEM

FOR THE ASSETS.

THE TASK AHEAD OF US IS GREAT AND TO THIS END WE ARE PREPARED TO USE OUR

YEARS OF EXPERIENCE IN LIQUIDATING BANKS TO MAXIMIZE THE RETURN TO THE

CREDITORS.

97-830 0 - 8 2 - 2 9




444
The CHAIRMAN. We will have some additional written questions
for you. I am still holding my ratings in abeyance, unlike Mr.
Leach. Don't be concerned about your opinion as to the consolidation of the regulatory agencies. If you think back a while, I think
you will remember that I recommended this quite a few years ago
and still feel that way. And it seems as though more and more
people are beginning to feel that way.
Mr. LEACH. Mr. Chairman, we will give you an A. [Laughter.]
The CHAIRMAN. Thank you, gentlemen. As I say, we may have
some written questions for you.
At this point, we would ask Mr. Guffey, the president of the
Kansas City Federal Reserve Bank, to approach the witness table.
[Witness sworn.]
TESTIMONY OF ROGER GUFFEY, PRESIDENT, KANSAS CITY
FEDERAL RESERVE BANK
The CHAIRMAN. Mr. Guffey, Penn Square, as you know, is owned
by a holding company.
Mr. GUFFEY. Yes, sir.
The CHAIRMAN. And

holding companies naturally are under the
direct supervision of the Federal Reserve Board. Could you tell us
what oversight was performed by the Kansas City Federal Reserve
Bank relative to the holding company that had control of Penn
Square Bank?
Mr. GUFFEY. Yes, Mr. Chairman. The Federal Reserve Bank of
Kansas City conducted an inspection of First Penn Corp. in February of 1981, and again in January of 1982.
The CHAIRMAN. And what were the results of the inspections, as
it were?
Mr. GUFFEY. We are referring now to the February 1981 inspection. We had some question with respect to the condition of the corporation, particularly with regard to the procedures that were in
place for management of the corporation.
Second, there was some indication at that time that the commercial paper was being sold through the holding company, and it was
being sold at the bank and without the proper notification on the
face of the commercial paper certificate. And we asked that they
correct those procedures.
And an additional concern was the capitalization of the holding
company, and at the time the holding company was approved in
early 1976, there was a commitment by the directors of the holding
company that they would maintain the capital at an 8 percent of
ratio of capital to assets, and it had fallen below that level. And we
required them to come forth with a plan to provide capital to the
holding company.
The CHAIRMAN. That was 1981?
Mr. GUFFEY. That was in February 1981, yes, sir.
The CHAIRMAN. When did you next revisit them?
Mr. GUFFEY. The next inspection was in January 1982, and that
inspection revealed some improvement in the holding company's
written procedures that had been put in place. Further, there had
been considerable capital injected into the holding company during
1981.



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Part of our review, of course, is based upon the supervisor's
report of the bank itself which was the principal asset of the holding company, and we noted at that time that there was some improvement in the bank itself.
I guess I should also add that the criticism that we had of the
commercial paper issuance within the bank lobby, and particularly
with respect to the notation on the face of those certificates that
they were not obligations of the bank had been corrected.
The CHAIRMAN. Were you aware of the fact that indeed, what
was happening with that commercial paper was that during 1980,
the holding company entered the commercial paper market; by
yearend 1981, it had over $30 million outstanding in commercial
paper. Information indicates that portions of the proceeds from
such sales were invested in Penn Square CD's. The rate paid on the
commercial paper was higher than that paid by the bank on the
CD's. Thus, the holding company had a negative spread at one
point, leading to a negative cash flow of $1.5 million. Was that
brought to your attention?
Mr. GUFFEY. Yes, that was brought to our attention. As a matter
of fact, I believe it is correct to say that there were some of those
funds that were raised through the commercial paper market that
were invested in bank CD's that bore no interest payment at all.
The CHAIRMAN. And so, what did the Kansas City Federal Reserve Bank do about this?
Mr. GUFFEY. Well, our concern, of course, was that the paper was
being used or utilized for the principal purpose of, or the principal
asset of the corporation, and our concern was that they were funding the bank with very short-term paper. And it was our urging
that they bring forth a further injection of capital and lengthen
their liabilities of the holding company for the purpose of pouring
funds into the bank.
The CHAIRMAN. Were you aware that the real estate subsidiary
formed by the holding company in 1981 was originally owned by
Mr. Jennings, and that the company injected capital into the realty
company, and in turn, used the proceeds to repay loans made to it
by Mr. Jennings? So assets of Penn Realty on an apartment project
that was funded by Penn Square Bank?
Mr. GUFFEY. I am aware that a realty subsidiary was formed and
with our permission for the purpose of taking over from the bank
the Quail Run apartment project. And I believe that came into the
holding company—at one point, $2 million, if I recall—and came
from the bank into the holding company.
The CHAIRMAN. $1,250, right. And then Penn Realty in turn used
that money to repay loans made to it by Mr. Jennings and four
other directors of the company. Were you aware of what the use of
the proceeds was?
Mr. GUFFEY. After the property came in as an asset of the holding company. What the holding company then paid the bank for
the use of those funds may have been, I am not aware of.
The CHAIRMAN. When the $20 million was provided by the
Federal Reserve Board on June 30 through the discount window of
the Kansas City Bank, were you aware of this, and were you consulted about this?
Mr. GUFFEY. Yes, I was.



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The CHAIRMAN. And did you contact Washington on this, as
well?
Mr. GUFFEY. No, I did

not.

The CHAIRMAN. What collateral was behind that $20 million
loan, and how did you determine that the funds you had were sufficient collateral? This was done in a very speedy fashion.
Mr. GUFFEY. First of all, maybe
The CHAIRMAN. This is the $20 million, June 30. That was repaid
very rapidly. But nonetheless, you had to have collateral, right?
Mr. GUFFEY. That is right.
The CHAIRMAN. Who looked at that collateral for you?
Mr. GUFFEY. Let me, if I may, in response to your question about
speedily—the request came to the bank on Monday, June 28, for a
line of credit of $15 million for 30 days, and in preparation for
those discussions, the bank had delivered to our branch located
here in Oklahoma City customer notes totaling something in the
area of $21 million for the purpose of collateralizing any borrowing
from the Federal Reserve.
The CHAIRMAN. Customer notes in the amount of $20 million?
Mr. GUFFEY. That is correct.
The CHAIRMAN. But you had no way of knowing what the value
of those customer notes was?
Mr. GUFFEY. It was our understanding that the notes that would
be delivered, customer notes that would be delivered and used as
collateral for any loan that might transpire in that period ahead
would be those notes properly collateralized that had been inspected or looked at by the Comptroller during the course of his examination. When those notes were delivered and our staff took a look
at them, they returned some $3.5 million of the notes because—and
I don't know that these numbers are precise, but—one $300,000
note, for example, had not been signed. Another $2V2 million or so
was a nonperforming loan.
So at the time that—after those loans had been returned to the
bank, there remained then approximately $17 million of customer
notes held in the possession of our branch here in Oklahoma City.
Before the loan was made on I believe it was Tuesday, an additional $7.9 million of customer notes were delivered to the branch
and inspected or reviewed by our staff.
The CHAIRMAN. HOW did that inspection go?
Mr. GUFFEY. Pardon me?
The CHAIRMAN. HOW did that inspection go?
Mr. GUFFEY. It went
The CHAIRMAN. On that $7.9 million additional.
Mr. GUFFEY. We took those and looked at them. We had our
credit people here from Kansas City that took a look at those $7.9
million, which was added then to the $17 million roughly, which
gave a total of $26 million in collateral, which was available at the
time the $20 million in loans was made.
The CHAIRMAN. On June 30?
Mr. GUFFEY.

Yes.

The CHAIRMAN. That is a very interesting story.
Now, I would like to ask would it be possible for you to provide
to the committee the customer notes that you accepted?
Mr. GUFFEY. I do not have those available.



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The CHAIRMAN. I realize you don't have them now.
Mr. GUFFEY. I would also hesitate to make a commitment to provide them because it does involve some confidential information
with regard to individuals.
The CHAIRMAN. Well, your staff knows about it, right?
Mr. GUFFEY. Our staff, of course, knows about it.
The CHAIRMAN. Yet—you know I am pretty proud of our staff,
our bipartisan staff, and of the Members of Congress, and of the
fact that we can honor confidential information as well. So I hope
that you will consult with the Chairman of the Federal Reserve
Board, and I hope that you will find that we are as responsible as
any employee of the Federal Reserve Bank of Kansas City is
Mr. GUFFEY. I trust that is true, Mr. Chairman.
The CHAIRMAN [continuning]. To honor confidentiality. Now, let
us get back. You tell us that the Comptroller's Office OK'd the $24
million; said they were wonderful, but then your staff went over
them and you found $2Vfe million was what, undercollateralized?
Or—no, was on which they weren't making payments, right?
Mr. GUFFEY. Mr. Chairman, I believe I testified that our agreement with Penn Square officials was that they would deliver to the
branch here in Oklahoma City customer notes, only customer notes
that had been reviewed and passed by the Comptroller. And obviously, that did not take place.
The CHAIRMAN. Oh, you mean those $24 million had not been reviewed and OK'd by or approved by the Comptroller?
Mr. GUFFEY. Well, I would assume that one of the notes for
$300,000 that wasn't even signed certainly would not have been
passed in a review by the Comptroller's examination staff.
I am suggesting to you, sir, that the notes that were delivered to
us, the customer notes that were delivered to us, may not have
complied with the agreement we had with the officials of Penn
Square Bank.
The CHAIRMAN. HOW can we find out? Is there anyone left here
from the Comptroller's Office?
VOICE. I think they are in the hall, Mr. Chairman.
The CHAIRMAN. Mr. Serino, could you find out if, indeed, the
Comptroller's Office OK'd that $24 million in customer notes?
Mr. SERINO. We will find out and provide the committee.
The CHAIRMAN. We will wait around. I would like to know about
it now. This is very exciting. I am holding my breath.
So you returned that, and now you have $17 million. You have
another $7.9 million, right?
Mr. GUFFEY. Yes, I believe those figures are correct, Mr. Chairman.
The CHAIRMAN. NOW, that $7.9 on the second sweep, your people
looked at those. Were they more customer notes?
Mr. GUFFEY. Yes, they were.
The CHAIRMAN. And had they been reviewed or examined or approved by the Comptroller's Office?
Mr. GUFFEY. I cannot tell you that. I cannot tell you whether
those specific notes had been reviewed or not.
The CHAIRMAN. NOW, you are getting collateral so that you can
lend money at the discount window to Penn Square Bank.



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Mr. GUFFEY. That is correct. But let me point out, Mr. Chairman,
that we did not rely upon the Comptroller's evaluation of those
notes, nor did we ask the Comptroller specifically to look at those
notes. Either the $17 million or the $7.9 million. We relied upon
our own analysis of our own people as to the creditworthiness of
the notes that we took as collateral for the $20 million loan.
The CHAIRMAN. Were some of the notes energy loans?
Mr. GUFFEY. Yes, I am sure some of them were.
The CHAIRMAN. And some of them were backed up by reserves?
In other words, oil or gas in the ground?
Mr. GUFFEY. I am sure that they were.
The CHAIRMAN. And in that period of time, did the Fed have
some energy experts, engineers, et cetera, et cetera, who could determine whether or not these loans were worth their salt?
Mr. GUFFEY. The answer is "no." We have what we believe to
be—and the people who reviewed these loans in a very short timeframe, very short, that looked at these loans and determined the
creditworthiness. And as a matter of fact, it was our agreement
with the bank that we would take those loans that they allegedly—
that had been delivered to us and allegedly looked at by the Comptroller's Office, that we were prepared to take
The CHAIRMAN. Excuse me, but you don't know that the Comptroller's Office—we are confused about that now. We do not really
know whether the Comptroller saw those.
Mr. GUFFEY. Our agreement with the bank was that they would
give us only customer notes that had been reviewed and approved
or passed, if you will, by the Comptroller's Office.
The CHAIRMAN. But you now are not sure whether or not that
happened. You told me that a few minutes ago before I asked Mr.
Serino to check with Mr. Poole.
Mr. GUFFEY. Yes. If I said that the Comptroller specifically
looked at the $21 million of notes, then I misspoke.
The CHAIRMAN. I have been informed that we may be fortunate.
Mr. Poole? Has he returned?
Mr. J. COYNE. I have the answer, Mr. Chairman.
The CHAIRMAN. Were those customer notes, $24 million worth,
sent over to the Fed from Penn Square, were they approved by the
Comptroller before they were sent over?
Mr. J. COYNE. NO, sir. We were not asked to certify nor did we
certify.
The CHAIRMAN. Ah-ha. Therefore, Penn Square Bank did not
comply with that which they told you they would do; to wit: To
have it certified or examined by the Comptroller. In view of what
we have just heard
Mr. GUFFEY. I think there is a misunderstanding, and I would
like to clarify that misunderstanding, if I might, with this statement.
Our understanding with the Penn Square officials on Monday
was that they would provide to us customer notes in some amount,
and that we asked them to send to us only those notes that had
already been reviewed by the Comptroller. Whether or not they
complied with that I can only surmise they did not.
The CHAIRMAN. Let me understand you. What you are saying is
not that the Comptroller on that day looked at the customer notes



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that you were getting, but that the bank told you that maybe a
week ago, 2 weeks ago, a month ago, 6 months ago, the Comptroller
looked at those customer notes and certified that they were in good
condition?
Mr. GUFFEY. I do not think the Comptroller certified, nor did we
ask him to certify.
The CHAIRMAN. OK, approved them.
Mr. GUFFEY. We were concerned about the creditworthiness of
the collateral that would be submitted to us.
The CHAIRMAN. I imagine that you should be.
Mr. GUFFEY. One, because of the shortness of time. One of the
conditions that we asked them to meet—and I am talking about
the bank—was to send loans that had already been looked at by
the Comptroller's Office.
The CHAIRMAN. What exactly does that mean, that were looked
at?
Mr. GUFFEY. That they had been reviewed and, I assume, not
classified.
The CHAIRMAN. YOU assume not classified, but you are not certain of that?
Mr. GUFFEY. Of course not.
The CHAIRMAN. Because you, indeed, got some that were
classified, right?
Mr. GUFFEY. I do not know that they were classified.
The CHAIRMAN. Well, if they weren't classified, they were not
performing. $7% million was not performing.
Mr. GUFFEY. NO. $300,000—a note for $300,000, the note was not
signed.
The CHAIRMAN. HOW about the other portion?
Mr. GUFFEY. The remainder, of about $3 million roughly, were
either nonperforming or our people, when they took a look at
them, felt that they were not creditworthy for the purpose of securing a loan from the Federal Reserve.
The CHAIRMAN. SO then, subsequently, you got another—to replace that you got another how much?
Mr. GUFFEY. $7.9 million.
The CHAIRMAN. $7.9 million, and your people looked at that $7.9
million.
Mr. GUFFEY. That is right, but we relied upon
The CHAIRMAN. Your own individuals. And you made a decision
that they were, indeed, good collateral.
Mr. GUFFEY. Yes.
The CHAIRMAN. SO you had the collateral of $24.9 million?
Mr. GUFFEY. NO, approximately $26 million.
The CHAIRMAN. Of $26 million at that point.
Mr. GUFFEY. Of which, because of some uncertainty, I should

say,
Mr. Chairman, we valued for collateral purposes those loans that
had been provided and looked at, supposedly looked at, by the
Comptroller's Office of 75 percent—for collateral purposes, 75 percent of face. And of the $7.9 million that our people had reviewed
in some detail, we were prepared to take those at 90 percent of face
value.
The CHAIRMAN. SO what was your total? Did you have $26 million?



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Mr. GUFFEY. We had $26 million.
The CHAIRMAN. Of which 75 percent of $17 million, right, you
felt was good?
Mr. GUFFEY. That is correct.
The CHAIRMAN. And what was the percentage of that?
Mr. GUFFEY. Not that we thought was good, Mr. Chairman.
The CHAIRMAN. I mean, that is what you were—the tag you were
putting on it, right? The value you were
Mr. GUFFEY. For collateral purposes, yes, sir.
The CHAIRMAN. And what percentage of the balance?
Mr. GUFFEY. Ninety percent of the $7.9 million.
The CHAIRMAN. Ninety percent of the $7.9 million.
Mr. GUFFEY. I believe I saw the figure someplace, that came out
to have a collateral value, for our valuation purposes, of
$21,834,000.
The CHAIRMAN. $21,834,000. You know, I would like to tell you a
little story. We were asking about this in Washington a little while
ago, and initially, we were told that the advances at the discount
window at the Penn Square Bank were preferential, and therefore,
would take precedence. That was later corrected. We said oh, that
was erroneous; they were not preferential? They were supercollateralized with three to four times—remember that, Jim, you were
there—three to four times the amount of collateral as against the
loan.
[See excerpts from conduct of monetary policy hearing of the
Banking, Finance and Urban Affairs Committee held on July 21,
1982, appearing in the appendix section as appendix G.J
Now we find out it is $21 million some-odd as against $20 million. I will tell you what, sir. I am a little disappointed. The story
changes every time we listen or hear it told. It is the first time you
tell it. Yours has not changed.
Mr. GUFFEY. Fortunately, that is correct.
The CHAIRMAN. But this is the third version. Really and truly,
this version No. 3. You talk about the perils of Pauline!
The other thing that interests me is when did it come to your
attention that Penn Square Bank was in difficulty, to you at the
Kansas City Bank. Now, Paul Volcker told us they found out about
it maybe a week before the Fourth of July weekend, because some
ingenious individual at the Federal Reserve Bank in Washington
decided to make a phone call to the comptroller's office.
Now, when did it come to your attention?
Mr. GUFFEY. I believe that a call came to one of our staff members on June 18, which was on a Friday, and he was unable to
return a call to the Dallas comptroller's office. He returned that
call on Monday, June 21, at which time he was told that they were
in the process of the examination course; that they had identified
what they believed to be about $22 million of loss, and that there
had been some passing of criticized loans from the bank up to the
holding company, and suggested that we might want to take a look
at the holding company.
The CHAIRMAN.